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Guest Post: Kaveri Seeds Update Part 3, The Royalty Mess Continues

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In two posts earlier, our guest Ravi Duggirala has mentioned about the issues at Kaveri Seeds. This one is a follow up. Please read:

Ravi Duggirala is a budding value investor and an ardent admirer of Warren Buffet, Charlie Munger and Prof Sanjay Bakshi. (Full Bio Below)

Ministry of Agriculture has issued a notification last month fixing the maximum selling price of BT cotton seeds at ₹800 for FY17 throughout the country.The G.O. also stated that the trait value or royalty fees that technology providers can charge, should not exceed ₹49 per packet. Mahyco Monsanto Biotech Limited (MMBL) has been charging a royalty of ₹160-₹180 per packet from the past few years. Earlier BT cotton seeds were sold between ₹830-1050 across various states in India. With this notification, the govt has brought in uniform pricing all over India.Govt Uniform Pricing Seeds

This is inline with the recommendations of the nine member committee set up by the government, and is supposed to benefit nearly 80 lakh cotton farmers across the country. An interesting point to note is that, the economic survey report released in February expressed contrasting views on this matter.  Cotton Price Control Policy

The National Seeds Association of India (NSAI) welcomed the decision and industry bodies such as ‘Association of Biotechnology Led Enterprises Agriculture Group’ (ABLE) slammed the govt’s move.

  • MMBL approached the Delhi HC in January to get a stay on the Cotton Seeds Price Control Order, but the court has rejected MMBL’s plea.
  • In March, ABLE filed a petition in the Karnataka HC and the court said that “the centre cannot fix royalties as they are based on mutual agreements between different companies.” It, however, allowed the government to fix the maximum sale price (MSP) of BT cotton seeds for the benefits of farmers.

Some key developments in the whole episode are as follows

  • Last year MMBL had filed a case against 8 domestic seed companies at the Bombay High court for non-payment of royalty dues worth ₹ 450 Cr.  
  • In January 2016, MMBL has cancelled the license of Nuziveedu seeds and its subsidiaries, for non-payment of royalties worth ₹160 Cr. It has accused that in spite of collecting full price of seeds from farmers (prices inclusive of trait value), the domestic seed firms haven’t paid them the royalty fee.
  • In February 2016, the Andhra Pradesh government has asked the union commerce minister to make licensing of BT cotton seeds compulsory  or revocation of the patent for the BT cotton technology. “Monsanto is having a monopoly and through one-sided sub-licence agreements is completely controlling all the cotton seed firms and, thereby, collecting excessive royalties”
  • Following complaints from NSAI and other farmer associations, the  ministry of agriculture had earlier asked the Competition Commission of India (CCI) to probe MMBL on the charges of abusing its dominant position in the industry.

In this backdrop of these events, lets have a quick re-look at our earlier analysis of the possible outcomes

Outcome#1: Govt. controls neither the MSP nor trait value

This is out of question as government has already started regulating the maximum selling price through the Cotton Seeds Price (Control) Order, 2015.

Outcome#2: Govt controls the MSP but does not interfere in fixing the ‘trait value’.

This if it happens would be a big blow to the Indian seed companies like Kaveri,Ajeet etc. On one end, their selling price would be capped and on the other hand, they would have to shell out royalty as stipulated by MMBL. The royalty charged by MMBL for FY15 stands at Rs 160-180 per packet. If the MSP is set at Rs. 635-800 per packet, they stand to see substantially reduced margins.

Outcome#3: Govt regulates both MSP and Trait Value

This is exactly what the government is doing currently. It has fixed the maximum selling price and trait value to be charged for FY17 throughout India.

Analysing KSCL Using Porter’s Framework

Porter’s five forces analysis is a framework that attempts to analyze the level of competition within an industry and business strategy development.

Porters Framework

 

  • Bargaining Power of Suppliers: KSCL and other domestic seed companies never had any bargaining power with its key supplier, Monsanto (technology provider). Over the last decade, the royalty/trait fee was always stipulated by MMBL. In 2007, the AP govt had issued a directive, mandating seed companies not to sell BT cotton seeds above ₹750 per packet. MMBL had to reduce it trait value to current levels  of  ₹160-180 from the highs of ₹900-1200.
  • Bargaining Power of Buyers: Cotton seeds are procured by the dealers from seed companies and sold to farmers. With seasonal and uncertain incomes, farmers are given credit by most of the seed players including KSCL. Seed companies also offer discounts to dealers and KSCL claims to have brand value and thereby offers lesser discounts. KSCL sells seeds at ₹930 per packet, but after discounts has a net realization of ₹750-780.
  • Rivalry among existing competitors: There is intense competition among the existing competitors. There are 400 seed companies in India out of which 49 of them have the license to sell BT II cotton seeds. In the current year KSCL has lost market share in its key markets of Andhra and Telangana to players like Nuziveedu, Raasi due to sharp price cuts.
  • Threat of substitute products or services : There is a need for new and improved variety of seeds from time to time.There is widespread discussion on the effectiveness of BT II cotton seeds as whitefly and pink bollworm have damaged the cotton cro
    p to a considerable extent in few states this year. If MMBL introduces BT III technology in India and
    doesn’t licence its technology to KSCL due to the non payment of royalty dues for the current year, it’ll be a big blow for KSCL. Though such a possibility is remote, it cannot completely be ruled out looking at the existing relationship between MMBL and the domestic seed companies.
  • Threat of new entrants:  There is no regulation which stops new firms entering into the cottonseed industry, but developing an extensive network of dealers through goodwill and strengthening the relationship takes time.                              

                                               Its’ pretty evident from the above analysis that KSCL isn’t any superior business and is subject to many controllable and uncontrollable risks. Though the management has been trying to reduce its dependence on cotton seeds, by developing alternate revenue streams, no significant progress has been made in maize, paddy, wheat etc.

Forensic Audit

                            In December 2015, M/ s. Sarath & Associates, Chartered Accountants, Hyderabad, were appointed by the SEBI for conducting forensic audit of the company’s books. The management had then issued a note specifying the company’s investments across various AMCs. The audit is currently in progress and the result/findings aren’t out yet.

KSCL Investments

In the Q3 concall, the CFO had stated that this kind of an audit is a normal thing and nothing to worry about but an RTI, filed by a member of the valuepickr forum, revealed a different side. As per the response received from SEBI, this kind of a forensic audit was ordered on only two companies in the past 3 years, of which KSCL is one. Here is a snapshot of the reply given by SEBI to the RTI applicant. (RTI by Amit Mantri, thanks for that, Amit!)

SEBI Letter

 

Bottomline : Visibility of growth seems to be missing. Multiple risks in the form of Government price regulation and relationship with MMBL, make it too complicated.

Disclosure: No position in the stock.

Author: Ravi Duggirala is a budding value investor and an ardent admirer of Warren Buffet, Charlie Munger and Prof Sanjay Bakshi.

Photo

 

 He loves reading annual reports and attending AGMs whenever possible.