BADM 636 UC Challenges in Managing Vertical Integration Discussion I have attached the files in which one there is question and other one is the pdf file of the content. In the question file we have to just answer the question number 2. What are the challenges in managing vertical integration for Agfeed? 400-500 wird For the exclusive use of A. Doss, 2020.
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AGFEED INDUSTRIES INC – FROM REVERSE
MERGER TO REVERSAL OF FORTUNE
HBP No. NTU065
Publication No: ABCC-2012-004
Print Copy Version: 11 Apr 2013
Tan Kok Hui & Yang Lishan
This case discusses the issues faced by AgFeed Industries Inc, a China-based company seeking growth
through the US capital market, both from the perspective of the Chinese company, as well as US
investors. It chronicles the evolution of a small, local animal feed farm into a troubled international pork
producer. While some may posit that AgFeed’s journey is typical of many China-based companies, the
lessons from this case are relevant to fast-growing companies worldwide. The case surfaces discussions
on corporate governance and ethics, issues concerning capital market regulations, business strategies
in fast-growing industries, the challenges of cross-cultural management, and management capability.
Associate Professor Tan Kok Hui and Yang Lishan prepared this case. It is based on public sources. As the case is not
intended to illustrate either effective or ineffective practices or policies, the information presented reflects the authors’
interpretation of events and serves merely to provide opportunities for classroom discussions.
COPYRIGHT © 2013 Nanyang Technological University, Singapore. All rights reserved. No part of this publication may be
copied, stored, transmitted, altered, reproduced or distributed in any form or medium whatsoever without the written consent
of Nanyang Technological University.
For copies, please write to The Asian Business Case Centre, Nanyang Business School, 50 Nanyang Technological University,
Nanyang Avenue, Singapore 639798
Phone: +65-6790-4864/5706, Fax: +65-6791-6207, E-mail: asiacasecentre@ntu.edu.sg
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2020.
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ABCC-2012-004
INTRODUCTION
Dr Li Songyan, one of the founders of AgFeed
Industries Inc (AgFeed), found himself having to
resign from the Executive Committee of the company
in February 2011. Despite his status as founder and
Chairman for over 15 years, building the company from
scratch with his own hard work and expertise, he left
the Board. Subsequently the company delisted from
NASDAQ and moved on under the leadership of an
American CEO.
As at July 2011, more than one-fourth of all federal
securities class-action lawsuits filed in 2011 came
from investors in China-based companies listed on
the US stock exchange through a method known as
reverse merger or backdoor listing.1 A slew of highprofile Chinese reverse merger deals struck in the
early 2000s had caused a sensation2, resulting in
other companies following suit. Consultancies were
soon set up that specialised in helping China-based
firms with the process.
China-based companies would purchase a dormant
American shell company that was already listed and
adopt its ticker symbol. This method circumvented
the scrutiny typically imposed by an initial public
offering (IPO), offering easy access to the US capital
market. Following a string of lawsuits, scandals and
probes by the authorities, share prices of such firms
fell more than 50 percent by mid-2011, and continued
to do so throughout the latter part of the year.3,4 Some
of these Chinese companies had been embroiled in
financial scandals that resulted in the firing of auditors,
restatement of earnings, and in some cases, even the
admission of falsified assets, resulting in billions lost
in market value, thereby affecting the reputation and
stock prices of other China-based reverse merger
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companies. In late September 2011, share prices of
Chinese companies listed on US exchanges were
particularly hard hit after a top American regulator
announced that the Justice Department was reviewing
accounting irregularities at various companies based
in China.5 In the ensuing fall-out, AgFeed was to come
under scrutiny as well.
AGFEED
AgFeed produced animal feed and also raised hogs
in China, where pork accounted for 65% of meat
consumption. The business started in 1995 when Li
along with three others setup of Nanchang Tiandi Feeds
Technology Co Ltd (later renamed Nanchang Best
Animal Husbandry) in Nanchang, Jiangxi Province,
China.6 The company steadily gained inroads in this
booming industry right from its inception up to the
point of listing. From 1990 to 1998, the feed industry
in China had an average growth rate of 15 percent
per annum7, and the four men running Nanchang
Best were well-placed to exploit this growth potential.
(See Exhibit 1 – China’s Feed Industry: Overview.) By
2004, they were running three companies involved in
the feed industry.
Li also served as the Chairman of AgFeed between
2006 and 2010. In 2006, the company undertook a
reverse merger with a shell company that was listed on
the NASDAQ-managed OTCBB. AgFeed then started
to expand aggressively – in a bid to vertically integrate
up the supply chain, between September 2007 and
June 2008, it acquired 25 hog production farms spread
across seven provinces in China. By 2008, it had more
than 500,000 hogs in production annually. Despite the
increasing demand for pork in the domestic market
and the initial boom of the reverse merger companies
Ahmed, A. (2011, July 26). Chinese reverse-merger companies draw lawsuits. The New York Times.
China’s shortcut to Wall Street. (2011, August 1). Reuters.
According to the US-based Public Company Accounting Oversight Board (PCAOB), out of the more than 600 companies that were
given access to US exchanges through reverse mergers between January 2007 and March 2010, 159 were from China. The US had
sent a joint delegation from the Security and Exchange Commission and the PCAOB to Beijing to discuss the inspection process and
cross-border auditing oversight system for US-listed Chinese companies. Shalal-Esa, A. and Lynch, S. (2011, September 30). Justice
Department probing Chinese accounting. Reuters.
China, US to close stock regulation loopholes. (2011, June 28). China Daily.
Ahmed, A. (2011, September 29). Chinese stocks plummet on news of Justice Department inquiry. The New York Times.
Even though Nanchang is considered one of the largest Chinese metropolises, Jiangxi is a poor province when compared with its
neighbours, having the lowest wages in all of China. Retrieved November 30, 2012, from http://www.thechinaperspective.com/topics/
province/jiangxi-province/
The long-term Boom in China’s feed manufacturing industry. (1999, December). Agricultural Outlook. USDA Economic Research
Service.
This document is authorized for use only by Amber Doss in BUOL 537 Legal, Ethical, & Social Environment-1-1 taught by Daniel Kanyam, University of the Cumberlands from Dec 2019 to Jun
2020.
For the exclusive use of A. Doss, 2020.
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Page 3
ABCC-2012-004
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that flourished on US exchanges, the company found
itself in trouble as several competitors were plagued
by health scandals.8 (See Exhibit 2 – China’s Hog
Industry: Overview.) Against a backdrop of lawsuits,
financial scandals and bad publicity, AgFeed, itself the
target of class action lawsuits, had its trading halted by
NASDAQ in October 2011. In February 2012, AgFeed
voluntarily delisted from the exchange.
The founders had focused on sound business
fundamentals and their decision to list on the NASDAQ
had borne the good intention of furthering the
company’s growth, yet the company ran into trouble.
What were the circumstances that led to investors’ loss
of confidence in AgFeed and its resultant precarious
position? How were the investors on the one hand,
and the company on the other, impacted?
China Firms on US Bourses: Feeding the NASDAQ
Frenzy
Despite the higher cost for disclosure requirements
and the complications of being a public-listed company
in the US, some Chinese firms were still eager to list
their shares in the US. One main reason was that
China’s IPO market was not market-driven. Instead,
it was regulated and companies wishing to list were
subject to a stringent approval criteria, as well as a
quota levied on the number of IPOs allowed each
year, which resulted in a wait time of one to three
years.9 Chinese firms also sought US listing as a
means of putting them within the reach of sophisticated
investors, providing access to international funds
and international recognition for future expansion
in global markets. As foreign investors had limited
access to China’s stock market, US investors were
eager to participate in China’s growth story by buying
US-listed Chinese company stocks in the mid-2000s
to mid-2011.
However, by end-2011, a few high profile fraud cases
and accounting scandals, many involving small-cap
Chinese companies that had entered the US bourses
through reverse mergers, caused US market sentiment
to see stocks such as AgFeed in a negative light.10 As a
consequence, the initial attraction among US investors
towards the entire cluster of small-cap China stocks,
turned into aversion.
AgFeed’s Inception
Agfeed Industries Inc began as Nanchang Tiandi
Feeds Technology Co Ltd (Nanchang Tiandi) on 15
May 1995. The management team was headed by
Xiong Junhong (Chief Executive Officer), Zhou Feng
(Finance Officer), Li (Chairman and Head of Technical
Research and Development) and Xiong Zhengru
(Head of Operations).
All four men had vast experience in the agricultural
sector and had come together with less than
RMB10,000 in personal savings each, to form
Nanchang Tiandi. (See Exhibit 3 – Organisational
Charts and Exhibit 4 – AgFeed Personalities.) Sharing
the common belief that focusing on quality and safety
would lead to success in the hog business, they set
about creating a company that would be known for
producing good quality and safe pork. However, as
quality hog production required quality animal nutrition,
the management team decided to first develop the
pre-mix business. At this time, most of the feed mills
were owned by Chinese government agencies.
Privately owned mills accounted for only 8.33% of
total feed mills in 1992. Nanchang Tiandi was set up
to exploit a market with huge growth potential but a
low penetration rate.
Spurred by the feed industry’s annual growth rate
of 15% (1990-1998), a second company, Shanghai
Best Animal Husbandry, was set up in July 1999 to
focus on blended feed for the domestic market and
the manufacturing and sale of fodder. This second
company also served the purpose of expanding
Nanchang Tiandi’s market share in China, as well
as generating more capital for their research and
development (R&D) investment. Large feed mills were
constructed, along with hostels for employees and
their families to live on site. A third company, Guangxi
Huijie Science & Technology Feed Co Ltd (Guangxi
Huijie) in Guangxi province was set up on August 2,
8
Leading hog industry players, Shuanghui Investment and Development Co Ltd and Yurun Food Group Ltd were scrutinized by the
media for the use of illegal additives and having their products contain lymphoma-causing agents, respectively.
9 China Securities Regulatory Commission. Retrieved November 30, 2012, http://www.csrc.gov.cn/pub/csrc_en/laws/rfdm/
statelaws/200904/t20090429_102757.htm
10 NASDAQ. Ryniec, T. (2012, July 16). Why I broke up with Chinese stocks – Investment Ideas [News and Commentary].
This document is authorized for use only by Amber Doss in BUOL 537 Legal, Ethical, & Social Environment-1-1 taught by Daniel Kanyam, University of the Cumberlands from Dec 2019 to Jun
2020.
For the exclusive use of A. Doss, 2020.
Page 4
ABCC-2012-004
2004. AgFeed was not the largest company in China in
the animal feed or the hog industry, but it had created
a nutrient additive for feed that set it apart from its
competitors.
Reverse Merger and Listing: Going to the Market
In 2006, Li and his team planned to list their main
company, Nanchang Best, as a means to gather
funds from investors to expand the value chain. They
decided to enter the US to become an international
player in the industry. Since listing through an IPO
would be intensive in terms of time and manpower,
the company decided on the reverse merger process
instead. New York Global Group (NYGG), a company
that claimed to specialise in helping private firms
list on various boards through the reverse merger
process, was hired as its consultant to this end.
NYGG’s founder and president, Benjamin Wey, had
assisted many China-based companies to list on the
US stock market since 1998 and positioned himself
as an expert on China-US business issues.11 (See
Exhibit 5 – AgFeed’s Consultants.) However, Wey had
been in the news for questionable business practices
prior to his engagement by Nanchang Best. This was
seemingly not picked up on by the company, which
was swept up in its eagerness to carry out its listing
and expansion plans.
On 31 October 2006, Wallace Mountain Resources
Corp (Wallace), listed on Over-the-Counter (OTC) on
NASDAQ with the ticker symbol of WMTN, closed a
share purchase agreement with Nanchang Best, which
became a public-listed company.12
At the end of 2006, reappointments were made to
the management team. Li was appointed as the
Executive Chairman and Chairman of the Board
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of Wallace, J. Xiong continued as CEO, Yan (who
had joined Nanchang Best in 2003 as a financial
consultant) as CFO and Zhou as Director. (See Exhibit
3 – Organisational Charts.) The company changed
its name to AgFeed Industries Inc on November 17,
2006. The new management team immediately went
on to acquire the other companies related to Nanchang
Best.13 AgFeed embarked on its acquisition plans in
2007 to expand within the hog industry.
Acquisitions: Going Whole Hog
On 2 February 2007, AgFeed was named as one
of China’s top suppliers of Animal Food in the ‘safe
agricultural products’ category by the China National
Agricultural Wholesale Market Association. AgFeed
announced its 2006 financial results with a record
profit from the sale of animal nutrition products. Net
income was US$1.18 million, a double-digit growth of
75% over the previous year and gross profit increased
to US$3.15 million which showed 39% growth from
2005. CEO J. Xiong commented:
Our results for the year reflected continued
growing demand for safe and high quality
animal feed products and the increased
strength of the AgFeed brand. AgFeed
has a simple business model: serving
China’s vast and highly fragmented
animal feed industry, which is ranked
the second-largest in the world, valued
at approximately US$40 billion in 2006.
With annual growth of approximately
15%, China’s animal feed industry enjoys
the world’s fastest growth in customer
demand as China’s population gets
wealthier and demand for meat products
increases substantially. In 2007, with
11 Benjamin Wey and the power of PR Felix Salmon (Nov 23, 2010) Columbia Journalism Review; How NYGG and Mr. Benjamin Wey Can
Help Understand Discrepancies Found Between Chinese SAIC and U.S. SEC Filings (Jan 22, 2011) 1888 Press Release; Benjamin
Wey – A China Expert’s Views on Understanding SAIC and SEC Filing Discrepancies for U.S. Listed China Based Companies (Sep
27, 2010) PR Newswire
12 Wallace acquired all the issued and outstanding capital stock of Nanchang Best in exchange for 5,376,000 shares of common stock.
Wallace also closed an agreement with Shanghai best, acquiring all the issued and outstanding capital stock from its shareholders in
exchange for 1,024,000 shares of common stock. Together with the two purchase agreements, Robert Gelfand, the former president and
CFO of Wallace, returned 2,600,000 shares of the company’s common stock to the treasury for cancellation without any compensation.
Shortly after the acquisition of Nanchang Best and Shanghai Best, the sole officer of Wallace, Gelfand, resigned from the company.
On November 12, 2006, Wallace announced a stock dividend of two additional shares of common stock for each outstanding share
of its common stock.
13 AgFeed struck a purchase agreement with Guangxi Huijie in December 2006. Under this agreement, AgFeed acquired all the outstanding
shares of Guangxi Huijie for a total purchase price of RMB 8.6 million.
This document is authorized for use only by Amber Doss in BUOL 537 Legal, Ethical, & Social Environment-1-1 taught by Daniel Kanyam, University of the Cumberlands from Dec 2019 to Jun
2020.
For the exclusive use of A. Doss, 2020.
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our strategic financing already in place,
Agfeed will continue to execute our growth
strategies through organic growth and
select strategic acquisitions.14
In April 2007, AgFeed invested US$2 million in R&D,
collaborating with a reputable animal nutrition expert
from Purdue University, US. By mid-2007, AgFeed
had opened its 120th franchise chain store in China
exclusively for its animal feed products. Li enthused:
Since we pioneered the model of
independently-owned franchise chain
store sales in January 2007, we have
experienced significant success both in
product sales and new sales channel
development. Our current dual channel
product distribution system is unique
and highly effective in our industry. We
have developed over 600 nationwide
wholesalers targeting commercial hog
farms and over 120 franchise chain
stores targeting individual farmers. We will
continue to deepen market penetration by
adding new distribution outlets throughout
the year. As pork prices are at the highest
level in the last eight years in China and
as wealthier Chinese consumers demand
more and quality meat products, we are
experiencing strong sales for our products
across all product lines.15
Given the high price of pork (See Exhibit 6 – Pork
Price Chart), in August 2007, AgFeed announced its
second-quarter financial results – 510% rise in net
income, 229% increase in revenue and net income
margin exceeded 21%. Li emphasised that AgFeed
would continue to have strong corporate governance
aligned with its business development.
Two weeks after the announcement of these financial
results, AgFeed received approval to list its common
stock on the main NASDAQ Stock Market. Trading
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of AgFeed stock started on August 29, 2007 with the
stock symbol, FEED. AgFeed proceeded to carry out
its acquisition plans – between September 2007 and
June 2008, twenty-five hog production farms spread
across seven provinces in China were acquired, a
rapid expansion that proved attractive to investors.
(See Exhibit 7 – Hog Farms Acquired by AgFeed.)
Analyst Giamichael observed, “The investor interest
came on the heels of rapidly rising pork prices and
the evolving story in which the company intended to
acquire a network of farms that would position it as the
largest hog producer in China.”16
The acquisitions occurred despite the fact that none of
the founding members had any previous experience in
running hog farms; their experience had been limited to
animal feed and nutrition. The hog farming business,
dealing with live animals, was by nature far more
complex than the feed and nutrition business. In its
Form 10-K filed with the US Securities and Exchange
Commission in 2010, the company acknowledged, “We
have a limited operating history in the hog production
business. While we are a leader in the feed product
industry, the current management team does not
have the same depth of experience in the hog farming
business.”17 The same report also stated, “We have
made 30 acquisitions since entering the hog farm
business in November 2007. Prior to that time, we
had limited experience in growth through acquisition.
Our future financial results depend upon our …
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