Low Paine tolerance: ‘Best and Final’ offer for largest Aussie fruit ‘n veg stock won’t Costa much

On Monday the nation’s largest fresh produce grower Costa Group Holdings (ASX:CGC) revealed that the agri-aligned US private equity firm Paine Schwartz Partners had come back with a low-balling second bid which slashed the original offer price by over $135 million.

Costa shares took it on the chin, stepping back -4%.

Which suggests – among other things –  that a lot less than 4% of CGH stockholders were surprised, dismayed or outraged into selling by the revised offer, wherein Costa shareholders would receive $3.20 apiece for the remaining 85.16% stake that the US firm does not already own, lower than the $3.50 apiece offer received in July.

This values Costa Group – literally the country’s biggest fruit and veg company – at $1.49 billion.

Paine snared a 13.78% stake in Costa on October 25 last year at $2.60 a share, but PSP began to take a more formal interest in Costa Group six months later in May 2023 with a non-binding indicative proposal to acquire all the rest of CGC shares it didn’t already own.

Under that proposal, Costa shareholders were to receive $3.50 cash per share, while also being entitled to any interim dividend for the June half-year of up to 4c per share.

On July 4, after circa four weeks of due diligence, PSP reconfirmed the original indicative proposal of $3.50 a pop, the cash offer representing a handsome 34.6% premium to the $2.60 share price at which PSP acquired its initial stake in Costa last October.

This is what the Costa share price has done since the initial bid in July:

 

 

‘Best and final’

On Monday, Costa Group told the ASX the latest offer “is the best and final price at which the PSP-led consortium can deliver the proposed transaction”.

“The Costa board, together with its financial and legal advisers, is considering the revised non-binding offer and is continuing to engage with PSP regarding the terms and conditions of the offer to enable the Costa board to comprehensively assess whether the revised non-binding offer is in the best interest of shareholders.”

CGH added there is no “certainty that a binding offer will be received”.

Costa, which in August reported a fall in its half-year earnings and forecast a grim outlook for its key citrus products, also told shareholders PSP called the offer the “best and final” it could make… but could go lower if the Costa board thought a goodbye-to-an-era-dividend might be appropriate.

Perhaps more surprising is the already official go-ahead of the FIRB (Australia’s Foreign Investment Review Board), which has been a determined OS investment gatekeeper in days gone by, perhaps when the foreign influence of countries like China were easier to spot.

For Costa, Australia’s biggest farmer etc, the deal has already been approved, although the exact source of PSP’s money and the influence behind it is less transparent.

 

Paine and Costa

The California-based private equity firm is all about investing and building a portfolio in global agribusiness and sustainable food chain investing.

“With a differentiated focus on the global food and agribusiness sector, we leverage a thesis-driven approach and operational expertise to enhance value in each of our investments,” goes the PSP raison d’etre and Costa is the ideal addition, considering the strong position in Costa they already boast.

PSP know the business well.

Starting as another local fruit shop in Geelong (in 1938), the company listed on the ASX in 2015. Costa is Australia’s largest grower, packer and marketer of fresh fruit and vegetables, supplying produce to supermarket chains as well as independent grocers and a range of food industry stakeholders.

• Estimated market share of over +15%
• Principally supplying fresh fruit and vegetables to the major Australian supermarkets
• Growing produce like berries, mushrooms, tomatoes, citrus, table grapes, bananas and avocados
• Supplemented by third-party growers, CGH products are largely sourced from around 7,200 planted hectares of farmland, incl;
• 40ha of tomato glasshouse facilities, and mushroom-growing facilities across Australia
• Costa also operates berry farms in Morocco and China as part of its international business.
• Exports to Asia, North America and Europe

 

Feel the Schwartz

But back to business, materially lightening its indicative offer to acquire the agribusiness by 9% (to $3.20 per share), Morningstar’s analyst Angus Hewitt says the payout cut probably won’t sabotage the deal.

Angus Hewitt’s playbook on the second PSP bid for Costa Group Holdings (ASX:CGH)

Despite Paine Schwartz Partners lowering its indicative offer to acquire no-moat Costa by 9% to AUD 3.20 per share, we continue to think the deal is more likely than not to proceed.

While now at a much-reduced premium, the offer is still relatively attractive on valuation grounds, representing a 22% premium to the closing price prior to the proposal and a 3% premium to our stand-alone valuation.

Paine Schwartz indicated that this is its final offer.

We lower our probability-weighted fair value estimate to AUD 3.18 per share on the lower offer.

All else equal, we would revert to our stand-alone valuation of AUD 3.10 per share if a binding offer fails to materialise.

So regardless of the optics of the reduced offer, Hewitt reckons the trim to the CGH premium isn’t as premium for this deal as is the stock’s currently unloved valuation.

Hewitt’s Morningstar crew were also among the more braced for the second offer, following a drawn-out due diligence which began to allow for PSP to take stock of a growing fiscal uncertainty and then come back with an account of the shifting economic sands.

Hewitt says his team were not surprised by the lower bid.

We had previously flagged that the risk that Paine Schwartz returns with a lower offer (or walks away completely) has risen in light of the more challenging near-term outlook.

The overhang from wet weather conditions is set to weigh on citrus volumes and size in the second half of 2023, and softer tomato demand combined with high industrywide supply is set to weigh on pricing in the near term.

Morningstar analysts had already done the math on the likely chance of a chastened PSP taking its sweet time to get back with a less flavourful, more appropriately grim offer.

Hewitt says the uncertainty in the near-economic outlook as well as Costa’s own short-term headwinds left PSP bidders with the ideal angle, to let Costa stew on unseasonally wetter conditions and wait until they play out across any of many segments – lower citrus quality, doubts around the strength of crop yields and late-easing inflationary pressures.

The havoc on supply and demand demand, PSP suggests, is the main reason for the new low-ball numbers, that, and not simply walking away altogether.

Costa themselves reckon the factors weighing on citrus quality are considered non-structural, and the ongoing health and productive capacity of their orchards remain unaffected.
 

BOM lobs a bomb: El Nino

However, one can now add to this drama – the declaration late on Tuesday by the Aussie Bureau of Meteorology which has officially decided we’re all in an El Nino weather event, heralding a hot, dry summer for most of the country.

The BOM expects the weather event to last on through ’till at least the close of summer, bringing with it heat and enhanced fire risk and the associated drought-like conditions which make such challenging times for growers.

The announcement on Tuesday afternoon that El Nino was in effect came after months of speculation and earlier declarations by overseas meteorological organisations.

Morningstar is however weather agnostic when it comes to the CGH share price outlook, which still makes the new offer a strong one.

“Nevertheless,” Angus adds, “we think shares screen cheap on even a stand-alone basis.”

We think headwinds are likely to prove short-term and continue to expect citrus quality to improve as the weather normalizes.

Indeed, Costa noted the factors weighing on citrus quality, namely wet weather, are considered nonstructural, and the ongoing health and productive capacity of the trees remain unaffected.

The Australian Bureau of Meteorology indicated drier conditions are probably around the corner, leading to better crop yields and quality in Costa’s main farming areas.

We also expect elevated input costs, notably in fertilizers and labor, to continue easing. In the longer term, we expect low- to mid-single-digit domestic fruit and vegetable growth to be supported by population growth, inflationary price increases, and a continued increase in per capita fruit and vegetable consumption.

 

Costa Effective: CGC share price, (12 months)

“Nevertheless,” Angus adds, “we think shares screen cheap on even a stand-alone basis.”

Likewise, in a note on Tuesday, Brokers at Ord Minnett agreed that despite Paine Schwartz Partners lowering its indicative offer they continue to believe the deal will likely proceed.

“The premium is reduced but the offer is still relatively attractive on valuation grounds and a 22% premium to the closing price prior to the proposal.”

And Ord Minnett were also unsurprised by the lowered bid, given the more challenging outlook,  the wet weather overhang…  likely to weigh on citrus volumes in the 2H and amid softer tomato demand.

Ord Minnett Maintain a Hold rating. The Price Target (PT) is $3.18.

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