The unbundling of agricultural conglomerate Aico Africa Limited saw former parastatal Cottco emerge as a standalone business for the first time since 2008.
When Cottco acquired Seed Co to form Aico, many stock market participants celebrated the move saying the new look company's synergies would create value and benefit shareholders.
For a while that seemed to work. Aico became one of the market darlings and the choice pick for stock market investors looking for exposure to the agriculture sector.
But the fairy-tale did not last long as the group ran into problems ranging from non-paying debtors, high levels of borrowings and viability challenges in some of the operating units. Aico's problems finally culminated in an unbundling in December 2013.
Cottco recently held its first analysts' briefing following the unbundling and reported on the performance of its cotton operations excluding the Seed Co and Olivine, the unbundled units.
The results were shockingly dismal and left many questioning not just the viability of the company but the cotton industry as a whole. Cottco was born out of the Cotton Marketing Board (CMB), a parastatal that operated as a monopoly, buying cotton from farmers and processing it for export.
Even after the privatisation of CMB and liberisation of the cotton industry, Cottco maintained market leadership. Many cotton buyers emerged but Cottco was always able to buy more than half the national crop.
A key advantage Cottco had over the competition was that it ran what was termed an Input Credit Scheme. Under this arrangement, Cottco would commit its own funds on an annual basis to provide seasonal finance to smallholder farmers, none of whom could access funding through normal commercial channels. Additionally, the company provided technical assistance to farmers at every stage of production.
At some point Cottco's, model was threatened by the emergence of "side marketing", a practice under which farmers who had accessed working capital from Cottco would then sell their produce to other buyers in violation of their contract. Most of the time these buyers were able to offer the farmer a better price, and Cottco argued that they only did so because they did not have to factor in the cost of financing the crop. Although efforts were made to regulate the industry and root out side marketing, they have been largely unsuccessful.
In the latest results, Cottco only took in 35 000 tonnes of cotton or just 24% of the national production volume of 145 000 tonnes. Not only is Cottco's market share down, national production itself is 59% below the 353 000 tonne peak achieved in 2000.
With waning fortunes for both the industry and the company it is highly likely that Cottco will find the going even tougher going forward. Cotton farming has mostly remained subsistence in nature with most farmers operating on a small scale and relying on family labour and out-dated methods that achieve low yields.
Some farmers have opted out of the industry, preferring instead to do tobacco which although requiring higher initial investment has better prospects for returns. Falling total output and declining production can only result in shrinking sales for Cottco.
Yet shrinking sales are not the only worry for Cottco. The drop in volumes has also led to more far reaching consequences. Scale of operations has had to be rationalised.
A retrenchment exercise saw 56% of the permanent staff complement being laid off at a cost of US$2,1 million. Some ginneries were sold off and Cottco remained with just 5 out of the 9 ginneries. As a result ginning capacity fell to 150 000 tonnes from 265 000 tonnes.
The disposal of SeedCo and Olivine raised US$45 million, easing the debt burden for Cottco to US$41,5 million. Despite this gearing levels still remain precariously high as shown by the debt-to-equity ratio of 131%! Management's efforts are highly laudable but in the end Cottco remains a victim of its industry and its history.
Notwithstanding all efforts the new-look Cottco is a fast falling market leader which is losing its share of a troubled and dwindling industry. The company also has to contend with high levels of borrowing. In fact, the nature of their business model is such that they will always need to borrow to on-lend to farmers through their Input Credit Scheme.
Due to less than optimal methods and antiquated technology the farmers they lend to can only achieve low yields and incur high production costs of up to US 56 cents per pound.
To make a profit they have to get good prices and are often tempted to sell to other buyers despite being contracted to Cottco.
With no fundamental change in the structure of the industry or Cottco itself it is hard to envision how the fortunes of the company will turn. Being a commodity cotton's prices are determined by international market forces. Developed world farmers which use GMO seeds and advanced farming methods achieve higher yields and therefore drive down these prices. Unless the industry changes, Cottco seems doomed to fail.