Doing the splits

This week, in an interview with Bloomberg, Sunny Verghese, the CEO and co-founder of Olam International, announced that his company would be splitting into two parts. The first, Olam Food Ingredients, will be made up of cocoa, coffee, edible nuts, spices and dairy. The second, Olam Global Agri, will contain the traditional commodity businesses of grains, animal feeds, protein, edible oils, rice, cotton, and commodity financial services.

Each new entity will seek to take advantage of two distinct trends. The first is the growing desire among wealthy consumers for healthy, sustainable and traceable products. (Milk farmers will be pleased to read that dairy products are included in this category.) The second trend is the dietary shift in developing countries, particularly in Asia and Africa, away from carbohydrates towards meat and fats.

In other words, the company is to be split between bulk food, feed and fibre for developing countries, and traceable, sustainable food ingredients for developed countries.

As I wrote in my recent book, traditional commodity trading companies have been struggling in recent years to reconcile these two trends: the need for traceability versus the desire for tradability.

With the exception of Glencore, the ABCD+ group of trading companies has chosen to build an active presence all along the supply chain. This has a number of advantages. It means that the companies trade more with themselves, increasing traceability while lowering counterparty risk. Moving downstream can increase profitability with less emphasis on low-value commodity businesses and more on higher value consumer businesses. Being present in the whole supply chain can also help to even out earnings. Steady profits from downstream businesses can dampen the earnings volatility of traditional commodity businesses.

A presence along the entire supply chain can also provide trading opportunities. As Brian Zachman told me, Bunge has an ‘end-to-end presence in the supply chain; that’s an inherently strong position, which is not easy to replicate. From the standpoint of risk management, our network also provides us with a lot of proprietary information that helps us optimize our value chains. In a way, our asset base is a call option on volatility in the supply chain.

Finally, maintaining a strong commodity-trading base does not stop you growing your higher value ingredient businesses. ADM has invested massively in food ingredients, particularly flavours, over the past few years. As Greg Morris told me in his interview for the book, ADM views these investments ‘as expanding the value chain of our processing streams to create additional value for our customers. It allows us to create a stronger connection with our customer base, participate in faster growing markets and create a more stable business.

In other words, being closer to the customer, and listening to what the customer wants, helps ADM in all their businesses.

However, Olam is not drawing a dividing line in the supply chain between upstream and downstream businesses. They are separating off the unglamorous, low-growth and cyclical commodity trading businesses from the sexy high growth food ingredients businesses. To achieve that, they are splitting the company between different commodities, not splitting it between two different parts of the supply chain.

Unfortunately, the distinction is not always a clear one. People in rich countries also need food, feed and fibre. People in developing countries also care (enormously) about food safety, and hence traceability. Coffee and cocoa can be just as cyclical as soybeans or wheat.

In addition, there is something to be said for being in a range of different commodities. Corn, say, can have a bad year while cocoa has a good one. This, in theory at least, helps even out earnings.

Olam is splitting with the aim of increasing their market capitalisation. The company argues that it will ‘unlock(s) significant long-term value’. Some investors, they believe, like the growth potential of the foodstuffs business but don’t like the cyclicality of the bulk commodity business. Other investors like the (sometimes outsized) profits that commodity trading can bring during the up cycles, and they are long-term enough to sit out the down cycles.

Even so, investors in public companies usually look for steady growth. Because of the cyclical and low growth nature of our business (Wilmar excepted), commodity-trading companies tend to have lower PE ratios than, say, food ingredient or food processing companies. In addition, investors tend to view commodity trading as not only cyclical, but also high risk.

Being in traditional commodity trading tends to act as a weight, a drag, on a company’s share price. That’s why some argue that traditional commodity-trading companies are better off as privately held, rather than publicly held, companies. But as Glencore Agriculture shows, being private doesn’t mean not having outside investors.

Both Olam and Noble went public during the commodity super-cycle. As the market cooled Noble got into financial trouble and Olam effectively took the company private, finding a white knight in Tamesek (the Singapore Sovereign, Wealth Fund) and later Mitsubishi. Splitting Olam into two may provide both an opportunity to exit.

Of the two new entities, Olam Global Agri may be the harder sell. Rather than being IPO’d, one source suggested that it could end up privately held with a couple of strategic investors; Tamesek and Mitsubishi may remain on board.

Having said that, it will take a couple of years before the reorganisation is completed. It is not impossible that by then commodities will once again be booming (sugar appears to have already turned). Perhaps Olam will once again get their timing right.

© Commodity Conversations ® 2020

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