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Coffee and controversy: Torrance-based Farmer Bros. weighs options By Muhammed El-Hasan
For the price of one share of Farmer Bros. Co. stock, you could order about 100 Venti-sized caffe lattes at a typical South Bay Starbucks. Farmer Bros., the Torrance-based coffee roaster and distributor with a $300-plus stock price and no debt, is being bombarded with criticism over that very stock price, its financial holdings and its public disclosures. Dissident investors say the thinly traded stock is undervalued, the company too secretive and its management out of touch. The criticism has forced Farmer Bros. to defend long-standing practices. The conflict forces pivotal questions about the future of one of the South Bay’s oldest publicly traded companies: Should Farmer Bros. go private, register as an investment company or continue on the path it’s followed for decades? Does the company need to broaden its investor appeal or is its low-key approach better? Has the Farmer family — which owns or controls a 52-percent stake — put all investors’ interests first or has it run the company for narrow personal gain? Adding to the mix, one shareholder has filed a court petition to have Farmer Bros. chairman Roy F. Farmer — who happens to be the petitioner’s uncle — removed as trustee of four family trusts. The nephew cites a “long sordid tale of treachery.” Leading the dissidents Franklin Mutual Advisers, a unit of Franklin Resources Inc., is leading the dissident investors’ charge. Owning 9.6 percent of Farmer Bros. stock, Franklin Mutual financed an investor forum run by investment banker Gary Lutin in April 2002. Lutin insists the forum is for all Farmer Bros. shareholders and not controlled by Franklin Mutual. But Lutin has taken Farmer Bros. to task, creating a Web site and sending regular e-mails to anyone who might care detailing the criticisms against the company. “Franklin . . . had the resources to hire advisers to put pressure on the company. Otherwise, the minority stockholders, no one would be giving a crap about them,” said Jack Norberg, chairman of Standard Investment Chartered Inc., a Costa Mesa investment company that holds less than 1 percent of Farmer Bros. stock. One of the main criticisms lodged against Farmer Bros. is that the company has stockpiled about $300 million in cash. During a Dec. 26 speech at the company’s annual meeting, Farmer Bros. Chief Financial Officer John E. Simmons said that money represents “working capital, our business interruption insurance.” The cash could help the company weather a downturn caused by a drought, price war or other unforeseen event, Simmons said. He added that the cash also could be used to buy other companies. Dissident investors say Farmer Bros. shouldn’t be hoarding so much cash, which amounts to about 70 percent of the company’s assets and eclipses its annual sales of $200 million and annual profit of $30 million. They argue the cash holdings don’t provide an adequate return. One demand from these investors is for Farmer Bros. to register as an investment company either by breaking off part of the firm as an autonomous entity to administer the cash, or through an alternative corporate structure. Franklin Mutual had submitted a shareholder proposal to force Farmer Bros. to become an investment company by complying with the Investment Company Act of 1940. The proposal, which would have increased disclosures regarding the cash holdings, was voted down at the December shareholder meeting. “All that would be required for compliance of the Investment Company Act would be the company reporting information that’s relevant to investors and the establishment of independent board control of the funds,” Lutin said. Simmons, during an interview in the company board room, insisted the shareholder proposal, which Farmer Bros. fought unsuccessfully to keep off the ballot, was ill conceived because “we’re not an investment company.” Farmer Bros. also provided the Daily Breeze with a list of more than 50 California firms that hold a higher percentage of cash or cash equivalents than Farmer Bros. “If you’re an investor who owns shares in General Motors, is it really appropriate to call General Motors and say you want it to go into the boat business?” Simmons asked. The dissident investors have a strong case, said Darin Clay, assistant professor of finance and business economics at USC’s Marshall School of Business. “It seems that they’re just as much an investment firm as anything else,” Clay said. “I just don’t see any reason to have so much cash.” Holding too much cash can hurt investors, Clay said. The company may collect interest or an equivalent return on the funds. But it’s a relatively low return, which is then taxed, Clay said. Investors make stock sales or receive dividend payments, which also are taxed. “There’s the corporate tax and then the investors pay tax, too. So the money is being double taxed,” Clay said. “Ultimately, the cash belongs to the investor. Either return it to the investor or use it to improve the company.” Some technology firms have been known to amass large cash holdings to deal with a volatile market. But the coffee business is different, Clay said. “(Technology firms) are in a business where one bad product can kill their valuation. But people always drink coffee. You have to ask yourself if this business is as risky as creating microchips,” said Clay, who reviewed Farmer Bros.’s financial disclosures and the investor complaints against it for the Daily Breeze. Liquidity questions The other main complaint is that Farmer Bros. stock is undervalued mostly because of low liquidity and limited demand. One thousand of about two million Farmer Bros. shares change hands daily on average. The Farmer family and more than 50 institutional investors own nearly all shares. No analyst covers the stock. The dissident investors say the low liquidity hurts them by possibly lowering the share price if they sell a large chunk of stock. So, if an investor puts 10,000 shares on the market and there’s demand for only 1,000 shares, the stock price will drop until all the shares are sold. Aside from making large stock sales riskier, a lack of shareholder interest has hurt the stock’s performance by limiting demand, the dissident investors say. They want Farmer Bros. to attract a broader range of shareholders including small-time investors. They say this requires splitting the stock to lower the price, securing analyst coverage, and being more responsive to current and potential investors. “Whether it’s intentional or not, management’s policies have discouraged investment in the stock. . . . In the past, management has been overtly discouraging of public investors, refusing to communicate with them and even being discourteous,” Lutin said. Among other things, the company hasn’t adequately answered investor questions on how it manages its cash holdings or how much its real estate is worth, Lutin said. Simmons noted that since 2000, Farmer Bros. has created additional demand by purchasing $30 million in company shares through its employee stock ownership plan, or ESOP. The company has said it likely will invest an additional $50 million or more over time in the ESOP. “We’ve provided liquidity to anyone who wants to sell shares. . . . We’re in the market every day,” Simmons said. Farmer Bros. repeatedly has said it meets or exceeds disclosure requirements. It also questioned the pertinence of some queries including the value of its real estate. Some public companies including Microsoft Corp. readily provide the value of their real estate holdings. Others such as Hughes Electronics Corp. of El Segundo don’t break out that figure. It’s rarely an issue. But the dissident investors argue such information is crucial to determine the company’s true value. Clay, the USC assistant professor, noted that many public companies don’t have analyst coverage, adding that it’s hard to attract analysts’ attention unless there’s enough demand for market studies on a specific firm. He added that splitting the shares to lower share price “might (have) a marginal effect, but not much.” A high share price could mean the company wants mostly institutional investors, said Sandy Green, assistant professor of management and organization at the Marshall School of Business. “Institutional investors usually are bringing significant amounts of money to the table,” said Green, noting that he’s unfamiliar with the Farmer Bros. situation. “They are usually more stable over time than individual investors because their positions are so much larger. So they are not going to sell as quickly.” Simmons said that until recently, the company didn’t put its financial statements on the news wires because that information is available for free through the Securities and Exchange Commission. He also acknowledged that if a prospective shareholder calls the company asking for an annual report, none will be sent because a copy is available with the SEC. Even the annual report is thin and visually low-key compared to glossier publications produced by many other companies. Simmons says Farmer Bros. is proud of its low-key approach because the company wants investors interested in substance over flair, those who will pursue a long-term relationship with the stock. The firm has little interest in Wall Street players ready to dump the shares after scoring on a price spike. “On the other hand, a low profile means investors don’t know much about you,” Clay said. “More information is better for broadening your investor base, which can positively impact stock price.” Clay added that the criticism of a low stock price “looks like . . . that of a short-term investor. . . . If they were long-term, they wouldn’t care.” Farmer Bros. easily could quiet much of the criticism, Clay said. “Investors have lost trust in the market, and the only way to regain trust is through open dialogue,” Clay said. “They think they can continue doing things as before. What was good yesterday isn’t going to be good enough for today.” Ironically, the investor complaints imply the company’s management has run the coffee business well, Clay added. “The argument from the other side isn’t bad management or underperformance. They’re saying you did a better job than what your stock price represents,” Clay said. “They’re saying if you’d only report more, your stock price would be higher and your performance would look better. It’s sort of an odd argument for fighting management.” More openness forced Norberg, of Standard Investment, praised the company’s coffee operations while echoing dissident investor criticisms. Norberg also said Franklin Mutual helped boost the Farmer Bros. stock price by forcing more openness, including the recent election of two new independent board members. (Lutin has questioned the independence of the new directors.) The investor complaints against Farmer Bros. date back “many, many years,” Norberg said. Norberg recently wrote an 11-page report on Farmer Bros., concluding that the company should repurchase outstanding shares and go private. He suggested a buyback price range of $430 to $470 per share.FranklinMutual also has suggested the company go private. “Companies just have to understand that there’s a higher reporting standard, a higher governance standard,” Norberg said. “You do one of two things. You make changes in your board and management to meet the standards, or you get rid of everyone and buy everyone out.” Norberg mentioned another concern, also discussed by Lutin, that the Farmer family may be trying to keep the share price low to limit estate taxes in the event that chairman Roy F. Farmer dies. At 86, Farmer has reduced his involvement in the company because of health problems. In March, he handed his chief executive position to his son, Roy E. Farmer. The company won’t disclose Farmer’s ailment. Norberg and Lutin’s concern hinges on the assumption that if the share price is artificially low and the elder Farmer dies, the Farmer family could save millions on estate taxes and, therefore, would have to sell less stock to pay it. Selling too much stock would ultimately weaken the family’s control over the company, they say. “They’re focused on shareholder control and they’re focused on passing the assets from one generation to another,” Norberg said. “It certainly benefits the family to keep the share price low.” Roy E. Farmer, the chairman’s son, said in a letter to the Daily Breeze that “any statement that we favor some shareholders over others is false and defamatory.” The junior Farmer noted that the company’s stock has risen from $17 in 1980 to more than $330 today. Short Hills, N.J.-based Franklin Mutual, which bought its Farmer Bros. stock more than a decade ago, always looks for undervalued companies whose stock would make a good buy, said Bradley Takahashi, Franklin Mutual vice president. “One of the biggest ways to gauge an undervalued stock is public dissatisfaction with the stock,” Takahashi said. “And one way to improve the value is to make suggestions. You hate to sell something that’s worth a dollar for 50 cents.” Simmons said the dissident investors’ criticisms confound him. “They knew what they were buying when they bought it,” Simmons said. “People vote with their stock. If they like one type of company, they buy. If they don’t like the company, they sell their shares.” Simmons wouldn’t speculate on the dissident investors’ motives. “There’s something afoot. But I don’t know what it is,” Simmons said. Publish Date:June 29, 2003 © Copyright 2003 Copley Press, Inc.
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