on bugs and seeds (SANW)

We inhabit a world of bugs that has existed / will exist far longer than us and will feast on us when we are long gone. As a homeowner, I have my regular battles with the insect world. The termites get professional treatment; Chlorfenapyr indelicately pumped into the ground beneath my foundation every few years. But they always come back, b/c they smell wood and can't help it. 

On the ants, I use the NY State legal version of Fipronil, a nasty neurotoxin that workers bring back to their colony, feed to the larvae, and then the entire colony dies. It's brutal but they will have the last laugh. 

I bought the Fipronil direct from DIYpestcontrol, one of those sites that of course exists and of course has horrifying comments like "It's great!! I sprayed it all over my yard and now nothing moves!!" when the instructions call for sparing use in a few specific locations.  I think insects live a more deterministic life than we do but those comments beg the question: "Who in fact is the insect here, mindlessly consuming and destroying b/c they don't know any other way?" 

Both ants and termites trace back to the Crestaceous period, more than 100M years ago. They are born in dirt, feast on wood and other decaying cellulose (in the case of termites) or pretty much anything (in the case of ants), live as part of a colony and then they die. My house was built in their environment and I will fend them off, at least as long as I'm a homeowner. Thereafter, it'll be someone else's responsibility. 

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I didn't set out here to write about insects so much as technical bugs, specifically one related to this blog. Feedburner is turning off email subscriptions, so if you subscribe, thank you, first and foremost, but be prepared that at some coming date, I think in July, new posts will no longer generate emails. 

I'm sure there is a workaround but I haven't bothered to figure it out yet. I'm now five years into running an investment management firm and my clients get most of my attention. If you're an accredited investor, I'd love to connect since I'm at a point in my business where I feel comfortable expanding my customer base, but anyone can sign up for quarterly letters through my website: www.longcastadvisers.com. 

In my last letter, I wrote about two companies and in this here penultimate blog post before the subscriptions get turned off, is what I wrote about S & W Seed. 

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You likely notice we’ve been purchasing S & W Seed (SANW), a producer and manufacturer of agricultural seeds. At current price of $3.90 and with 34M diluted shares and $50M in debt, SANW has an enterprise value of ~$180M. Against trailing 12-month sales, this infers a 2x EV / sales multiple which is in the mid point of the 1x-3x range typically seen in the industry space. 

My interest in the company was piqued b/c I was looking for something that would work as a potential commodity hedge against inflation, and agriculture tends to do that. Digging in, I saw two broad attributes that make this company compelling. 

First, agriculture unfolds over a time frame that is utterly foreign to Wall Street – 6 to 8 year development cycles, limited by growing seasons – and that makes the company largely uninvestable to anybody but the most patient investor. It’s perfect for us! Second, the company is coming towards the end of a product development cycle with three new products to be released in the next 24 months. These will be the first new product launches since the company altered its strategy about six years ago. 

By way of backstory, back in 2015, SANW was pretty close to a pure play on alfalfa seeds and Saudi Arabia was its second largest market. Then, in the midst of a drought, the Saudi monarchy decided to no longer grow domestic alfalfa. 

The company had a large shareholder, noted small cap value investor Michael Price, who owned a ~10% stake in the company and he brought on the Board Mark Wong, an agriculture industry veteran who had previously built, grown and sold companies in the industry and in his retirement, ran his own ag business “for fun”. The company was already in the process of a slow pivot to diversifying its products and end markets when Price asked Wong to take over, which he did, in June 2017, with the understanding that the pivot would take several years and require a significant capital commitment from Price. 

We are now four years in. Price, through various stock offerings and capital raises, now owns ~50% of the company. The share count has nearly doubled to 34M diluted shares but revenues are roughly where they were in FY2017 and to the outside observer of financial statements it would seem like nothing has changed but the destruction of capital. 

What has in fact changed is a significant investment to diversify to “secondary crops” such as grain and forage sorghum, sunflower, pasture seed, stevia and alfalfa with key markets in the US and Australia. The diversification was enabled through various acquisitions including of two distressed businesses, Chromatin out of US bankruptcy, which delivered a sorghum portfolio, and Pasture Genetics, Australia’s third largest pasture seed company, while Australia was in the midst of a drought. Both were acquired at roughly 1x trailing sales. 

One further consequential change to the company was that it previously operated under a distribution agreement to sell its alfalfa seeds through the Pioneer brand, which is owned by Corteva. In 2019, Corteva wanted to bring this brand back in house and agreed to pay SANW $70M to exit the distribution agreement, essentially pulling forward the remaining term to one year. The implied valuation on the sale of this product was 3x revenues. Buying at 1x and selling at 3x might be a theme of the way CEO Wong runs his business. 

To date, there is little on the income statement to show for all this diversification. However, backing out Pioneer, the remaining “core” business grew revs 54% in FY20 (year end June 2020) and 27% YTD this year without even hitting the peak season (winter and spring in the northern hemisphere). The key is that most of the major investment is done. If the products find a market, there is significant room for rewards. 

The three products expected to commercialize in the next two years are all non-GMO by US standards (which to be fair has pretty weak GMO standards) and include a low lignin alfalfa that is easily digestible to dairy cows (and therefore potentially able to lower methane waste), an herbicide resistant sorghum and most compelling a dhurrin free sorghum using technology licensed from Purdue University. When one considers land use, water use and potential carbon offsets related specifically to forage crops, there is a lot of potential for this company to be where the puck is going, realizing that in this industry, the puck and the company move very slow. 

If any of these product launches work, this business becomes something completely different than what it appears to be today and what it has been in the past. Ultimately, the goal is to create a company that can dominate secondary crops the way the big four (BASF, Corteva, Monsanto and Syngenta) dominate the primary crops (corn, soy and cotton). Since it takes so long to develop a product, any success would be protected by a wide moat and would appeal to these larger companies for an acquisition. I’ll add below a comment made by the company in its most recent shareholder letter: 

Stocks in this space tend to trade at 1x-3x sales and we’re currently buying it at the midpoint of this range on a trailing basis and without the benefit of new product launches. If they’re successful – and this management team has a history of success – I think this easily fits into our threshold of three to five year doubles. In short, I see this as a small cheap bet on the potential for something becoming much bigger that would unfold over time. 

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ALL RIGHTS RESERVED. PAST HISTORY IS NO GUARANTEE OF PRIOR RETURNS. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS IN THE COMPANIES MENTIONED HERE, WHICH I MAY OWN.