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Hi Shay,

I think the analyst you talked to is generally right about farms and agriculture. It is capital intensive, though most of that capital intensity comes in the form of upfront costs for land and equipment. In this case we’re getting these costs after the fact at below book value. The maintenance capital required to keep the business going isn’t as onerous, and it helps that the equipment is shared across farms. Farming is also cyclical and unpredictable. It has in many cases been a tough way to make money in certain periods and very rewarding in others – though having scale helps. There's a long history of that and I won't argue with that history, but I think the future looks a bit different. Not different in that cycles and unpredictable weather go away, because they won’t, but different in that changes in demand and environmental instability will create more periods or extended periods when pricing is strong.

Historically, China has been self sufficient in wheat production, but because of water issues, chemical fertilizers that deplete the soil, and increasing build out of industrial, commercial, and residential construction it is losing arable land. This year the winter droughts have put its wheat crop in danger and it's in a tough position to keep its production in balance going forward. Similarly arable land in other parts of the world is dealing with competition for crops as fuel versus food along with increasing demand from developing economies as they grow. In the past everything was held in check with acres of arable land per person and crop yield improvements keeping pace with population and economic growth, but the recent developments mentioned previously have caused demand growth to outstrip the growth of improvements.

Cotton prices are at an all time high and I'll be surprised if they stay there, but there is a similar story here. Growing economies create growing demand for clothing. Here there are substitutes in synthetic fibers, but that gets us into oil (another price sensitive commodity), so overall I do think cotton prices stay stronger than they have been in the recent past. Again, like wheat in China there are competing factors going on for the land and longer term tightness in the cotton market that have developed. Cotton’s high price will cause that demand to tilt back towards additional acres planted, but there is still a balance there versus other high price crops.

As for the questions on the insiders selling farms into PrimeAg, that initially concerned me, too. The background is that the Corish family had partial ownership stakes in two of the initial three farms that PrimeAg was seeded with (25% ownership in one, and 50% ownership in the other). A board member runs the fund that had an interest in the third seed property. That fund also gave PrimeAg options on some of the other properties it purchased shortly after its IPO. The combined purchase price of the three properties and the properties it had options on was AUD 83.2MM.

Since then PrimeAg has added approximately AUD 146.5MM (purchase price) in farms and water entitlements to its operations. From my research these properties did not come from insiders and the prices paid per cropable hectare are similar to those paid in the seeding transactions. So I don't like the initial seeding transaction, but after reviewing the entire balance sheet and subsequent actions of insiders I don't think the intent here was to craft an exit at an excessive price. The main reason I don’t think that was the intent is because Corish and the other insiders haven’t sold additional properties into PrimeAg, don’t appear to have done so at onerous prices (some of them are the cheapest per cropable hectare that they have purchased) and they have been buyers of the stock when it was down -- in small quantities -- since the IPO, but haven’t sold, even though their shares are outside of the lockup period and they could sell. The last point that matters to me on this topic is that the shares now trade at a discount to the IPO price and book value. The farms added in 2008 and 2009 (during the fallout from the GFC) now make up most of the balance sheet. If we see them selling shares or selling additional properties to PrimeAg that would change my opinion.

Finally, on the real estate valuation front, residential real estate and agricultural real estate are different markets, have different financing requirements, and different demand drivers.

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