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Another U.S. activist investor takes on Bay Street Add to ...

Ceres Global Ag Corp. is named after the Roman goddess of agriculture, but, these days, it might be more appropriate for the company to be in the purview of Mars, the war god.

At first glance, Ceres would hardly be expected to be the scene of the only major corporate governance battle under way in Canada. A new entrant on Report on Business magazine’s Top 1000 list and little known to most investors, Ceres owns a string of grain elevators, along with a quarter interest in a short-haul, 132-kilometre Saskatchewan rail line.

But Ceres is in the middle of a nasty brawl between Front Street Investment Management, a prominent Bay Street money manager, and an upstart U.S. activist investor, VN Capital Management. VN is convinced that Ceres is a treasure trove of value just waiting to be unlocked, with a share price that could soar, except that it has a flaw preventing investors from harvesting the capital gains. According to VN, the problem lies in the management deal with Front Street to oversee the company, in return for fees worth about $3 million a year.

Ceres went public in 2007, at $12 a share, through an IPO initiated by Front Street. It was set up as an investment vehicle to give exposure to the then-red-hot agricultural sector. If food demand was going to rise for decades, as many people were then predicting, because of improving diets in China and global population growth, the sector would be a great long-term bet. Given its origins as an investment vehicle, Ceres also came with lucrative hedge-fund-style fees for Front Street, pegged at 2% of assets under management and 20% of capital appreciation when the net asset value exceeds the value of the company when it went public. To show that they were on side with other investors, the principals of Front Street also took a position in Ceres, and own 2.9 million shares, or about 20%.

Ceres started out safe and boring, buying stocks like Potash Corp., Agrium and Monsanto. But shortly after its launch, the financial panic hit, and the agricultural sector sank with the rest of the market. Ceres, with easy access to cash because of its IPO and portfolio of liquid, high-quality companies, was able to pounce. In 2010, it bought—at the distressed price of $70 million—a U.S. grain elevator company called Riverland Ag. The firm was being shopped around by a U.S. fund manager, Whitebox Advisors, which needed to quickly raise some cash. It was a presciently timed deal that transformed Ceres, in one stroke, from a mutual-fund-like entity into an operating company, with grain storage facilities spread through Minnesota, North Dakota, Wyoming, New York and Ontario.

Oddly enough, Ceres repeated this lucky stroke of timing when it picked up the rail line, also in 2010. After the crash, Canadian Pacific was looking to dump low-profit short-haul rail lines serving Prairie farmers. Bad move. Some lines, like the one Ceres bought, just happened to roll through Saskatchewan’s part of the Bakken shale oil play, and subsequently became far more valuable as investors cottoned on to the potential of railways to be alternatives to Canada’s strained pipeline capacity.

The problem for investors is that Ceres is trading at only a bit more than half its IPO price, nowhere near reflecting what the elevators and rail line might fetch today on the auction block.

VN claims a prime reason for the disconnect is that Ceres is tainted in the eyes of investors because the hedge-fund fee arrangement is too rich for an operating company. James Vanasek, a principal at VN, has reviewed all of the Canadian companies that are comparable to Ceres in market capitalization, and found that their compensation for senior management averages around $1 million a year, significantly less than Front Street’s $3-million fee.

VN is determined to show Ceres management the door, starting with chairman Gary Selke, who is also Front Street’s president, and bring in a new group of experienced agricultural industry executives, at a lower cost.

The shootout between the two sides is scheduled for July 24, at a special meeting of Ceres shareholders called by VN, where owners will vote on terminating the Front Street agreement.

Ceres’s position is that the shareholder vote won’t be binding on directors, under the principle that the board is entrusted with the fiduciary responsibility to run the company on behalf of shareholders. This isn’t going over too well at New York-based VN. “It’s safe to say that if the board chooses to ignore the results of the ballot and if they would claim or try to claim a technical legal argument that the vote isn’t valid, or only directors can start an action to terminate the contract,” then the next stage will be a proxy fight, promises Vanasek.

Selke, for his part, is irked by the additional $500,000 in expenses that Ceres has had to spend dealing with VN. He views VN as a two-bit gadfly because of its small size—about $85 million in assets under management. “This is not equivalent to [Bill] Ackman, who runs, you know, $15 to $20 billion,” he says, referring to the lionized hedge fund manager who took on Canadian Pacific. Selke dismisses as “a complete canard” the view that axing the management agreement would save much money, because Ceres would still have to replace Front Street.

VN is a deep-value investor, and has done some back-of-the-envelope calculations on Ceres. The railway cost the company around $1.7 million and will probably make nearly that much in profit this year alone. Ceres also bought grain elevators at about $1.20 per bushel of capacity. Recently, it sold one for about $5 per bushel of capacity. The figures suggest that Ceres, at its recent price of around $6.50 a share, is trading way too cheaply.

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