IPO Watch: East 33 to handle a quarter of world's Sydney rock oysters

For this week’s IPO Watch we’re chatting to James Garton, who is the Executive Chairman of East 33 which is a producer and supplier of Sydney rock oysters.

East 33 is undertaking its IPO as part of a second round of acquisitions, having completed its first round in 2019 where it acquired four oyster farming operations. This second round involves acquiring another six operations in a bid to grow its oyster production from 4 million in financial year 2020 to 15 million in the 2022 financial year. The plan for East 33 is to become vertically integrated by controlling everything from the nursery and grow-out leases to processing, distribution, retail and export of these oysters. As James explains to me, around 85 per cent of Sydney rock oysters are consumed in NSW but they’re also looking to international markets, mainly in south-east Asia.

They’re hoping to raise $32 million at an offer price of 20 cents per share, indicating a market cap of $82 million upon listing and the offer closes on November 16.

Here’s James Garton, Executive Chairman of East 33.

Table of contents:
Appeal of Sydney rock oysters
First stage of acquisitions  
Second stage of acquisitions
Vertical integration plan
Company history
Cash position
Oyster pricing and margins
Addressable market
South-east Asia market
COVID impact on business
Short/medium-term outlook

Thanks for joining us, James, the prospectus for East 33 says its mission is to create Australia's largest vertically integrated Sydney rock oyster producer and supplier. I thought a good place to start would be an explanation of the market for Sydney rock oysters and what's the appeal of this type of oyster specifically?

Well, absolutely, so the key bit here to understand is just, it comes back to the rarity, provenance and heritage. Every oyster on the planet is a Pacific Oyster, but there's just 41 locations in the world, up and down the east coast in Australia that are capable of producing Sydney rock oysters, and there's only 75 million Sydney rock oysters produced and their desire in the marketplace is so significant that 85 per cent of all of them get consumed in New South Wales before they even get out of the state, let alone out of the country. And so the key thing from our perspective in terms of creating the largest vertically integrated business is to enable that to have consistent growth by virtue of investing in the productivity to increase that 75 million total production to much higher, to enable us to service consumer appetite, both domestically and internationally. And so without being vertically integrated, that becomes challenging and without having access to capital, hence the IPO, that also has historically been very challenging.

You've built your portfolio in two phases it seems, in terms of acquisitions. Could you give us a bit of a rundown of that first stage of acquisitions that was completed in December last year?

Absolutely. All of the businesses, both the first stage and the second stage have actually been operating together as an ecosystem albeit individually owned, not singularly owned for the last 20 years. What we sought to do in the first phase of our acquisitions is enable us to invest prior to the IPO and IPO investors’ participation, in infrastructure in the water so that the next three years’ worth of growth, 300 per cent growth I might add, is already covered in terms of volume. Stage one and the purpose of stage one was to enable us to invest in infrastructure, which we did to catch more wild oysters, which we did. So that coming into the prospectus, we've got 45 million saleable oysters, which covers the 300 per cent of growth over the next three years and that's the reason we've done this in two phases.

Then you've got obviously a second stage of acquisitions, which is come in as a condition of your listing. Could you explain what assets you're adding to your portfolio as part of this second stage?

Absolutely. The first phase of the business had a small scale fully vertically integrated business. The second stage, which sees us acquire $27 million worth of assets includes bulking out our nursery, which provides us the baby oysters, drastically bulking out our productive hectarage, and most importantly, acquiring Australia's largest processor, wholesale and distributor. And so that stage two and underneath this IPO sees us acquire really significant businesses, but again, those businesses had already been operating as a fully integrated component. They just hadn't been paid for yet.

An interesting point is that these oyster farms that you'll be acquiring are actually run by, or have involvement with families that have been in the oyster industry for several generations. Is this a deliberate start strategy to enhance East 33’s knowledge and expertise in the oyster industry?

I think the key point is made here and that is that these artisans, these farmers, it is their strategy. The partnership acquisition approach really saw the founders of East 33 partner with key farmers, key distributors to execute their business plan. It's not our business plan. It's their business plan that East 33 executes in terms of management, corporate business branding and access to capital which is executing on the farmers and the distributors’ business plan. That's why, from our perspective, when you look at the composition of our management team, you see it deeply steeped in both in the industry at all levels and out of the industry. That's what's really powerful and unique and that's what no one's ever done before in the Rock Oyster business is bring in external resources to bear, to elevate what is an amazing product.

Could you delve a bit further into this vertical integration? Is the plan to have control over the whole supply chain from processing to distribution and retail of these oysters?

It absolutely is. Everything comes back to quality and given the supply constraint of this industry personified by the lack of locations where you can grow it and the cottage nature of the industry, the first port of call is to unlock that supply, so you have to have your own productive farm so that you can produce and scale up volume. Now, once you've got the volume, you need to have direct access to the market, so that that storytelling and that quality can be pulled all the way through. And then off the back of that, once you've built out that volume and that awareness, then taking that into the international markets and the online markets with the direct to consumer offering, is the full vertical integration we're talking about. East 33 will own 9 per cent of all of the waterways that are possible to produce Sydney rock oysters, and we'll handle 25 per cent of the entire volume, distributing it down through all of the three key channels, the restaurants, the online, and indeed the export.

How has East 33 gotten to the stage? Could you provide us a bit of history about the business? Because it seems like in the last two years, in particular, there's been a pretty strong acceleration in terms of expansion. What was happening prior to that? Was this always the plan to acquire and publicly list?

Really it was, and again, it comes back to one of the co-founders being a long-term resident of the Wallis Lake Forster/Tuncurry area and was listening to the plight of farmers all too often heard that the farm gate price didn't make any money and all the money was made in the capital cities with the distributors. East 33 was formed based on that fundamental farming idea and that was about four years ago. Over that four year journey we'd been working with that ecosystem of farmers that already operated together, but not under a single banner, listening carefully to what it is that they're trying to do while building out both the export market and the downstream consumer-facing branding offering with a mindset of bringing all of these businesses together under one banner underneath a listed business. The key component to it being listed business is to (a) ensure forever Australian ownership; and (b) to enable us to have access to capital and access to listed scrip, to further consolidate the industry.

As you would have undoubtedly heard in many cottage farming and agricultural businesses, there's a lot of the next generation that hasn't wanted to stay on the farm and so succession planning is a real issue, which we see as a real opportunity for us to further consolidate through acquisition and the listed vehicle enables that.

The stage two acquisitions are going to cost around, I think it's $39 million. Could you give us a breakdown of how that is being paid? I presume a large portion of that's coming from the IPO money?

Yes, of the full acquisition value, the vendors are leaving $12 million in the business and so that's the first port of call, is that the value of those businesses and the value of East 33 moving forward is recognised by the vendors, the farmers and the distribution businesses and so they're leaving that with us. The balance of the capital to acquire it is coming directly from IPO proceeds. Of the $32 million that we are raising and underneath the IPO, $27 million is going to acquisitions, $4.5 million is going to growth capital to continue to scale up that volume. And the balance is going to the marketing and working capital of the business to enhance that growth profile moving forward in the, in the eyes of the marketplace.

And what sort of cash position does that leave you in upon completing these stage two acquisitions?

We're in a strong cash position at $14 million, which will enable us to take advantage of any and all of the opportunities that we expect to see both domestically and internationally.

How many oysters are you producing at the moment per annum and what do you think that number will get to upon completing these acquisitions?

Annually as an acquisition group we're producing last year 8 million oysters. Next year, we'll do 12 million, then 15 million and our FY 23 forecast is for 18 million. That's when, at that level that we project, we see a $50 million revenue and a $20 million EBITDA line. And in fact, that is the basis of the performance hurdles and the performance shares that is shared between not just the founders, but also the incoming vendors of the business and so that level of growth from 8 to 18 million sees us sell all 45 million oysters that we currently have in the water over the next three years.

Could you explain the pricing behind it, the price you sell the oysters at, and then the margins you're able to get as well?

Yeah, absolutely. The Sydney rock oyster is a premium product even in the domestic market and so my guess is a lot of your followers that much like me, have paid $5-6 per oyster in the restaurants. But basically, when you look at it, the vast majority of the margin stack stays with the downstream participants, the restaurants, or the online or the exporters. And so when you break down the margin stack throughout the industry, what you see is that from the historic 48 cents production cost, that the farmer makes roughly 22 cents an oyster, the distributor makes 10 cents an oyster, but the restauranteur makes nearly $3 an oyster. What we'd sought to do with our direct to consumer offering is provide consumers with instead of a $5 oyster, a restaurant-grade, $2.80 an oyster, but that sees us make nearly three times the profitability as otherwise if we sold it in the distribution side. The key rationale to the vertical integration is to consolidate and capture all of that margin stack.

The financial forecast in your prospectus indicates revenue will increase from $26.8 million to $40.2 million over the next two years. Where does that leave you in terms of forecast profit, given the costs from the acquisitions and costs associated with expansion?

Well, unlike a lot of businesses that experience extremely high growth like this, we have a very low working capital requirement and we had an extremely low ongoing capex requirement, which means that all of the $8 million of EBITDA in that FY22 period, the vast majority is distributed directly back to free cash flow. And so what we will be doing is determining how successful we are in the export market over the next two years as to determine how much of that $8 million of free cash that we pay as a dividend or alternatively continue to invest in growing the productivity of the farms or promoting the brand awareness in various jurisdictions.

Can you provide us some detail on the Sydney rock oyster market in terms of the addressable market you're looking at, you mentioned most of the customers, I think 85 per cent, you said we're based in New South Wales, but there is, I guess, the opportunity to expand into international markets is there?

There absolutely is. We see the domestic market as it's a $241 million market at a retail value and is growing 12 per cent annually. It’s a really, really healthy and strong market, regardless. However, the average price of an oyster in the jurisdictions that we're targeting for export mostly Southeast Asia and Asian communities, see the average retail price of an oyster at $10.30. Just contrast that against Sydney cafe at $5, there's a tremendous opportunity to capture incremental profit in the international markets and as a result of that opportunity, we built a business plan and attracted commercial partnerships, in particular, with Moet Hennessy to enable us to go into those jurisdictions with a Dom Perignon plus East 33 Sydney rock oysters to land our product at the right price point.

Now, I should note Alex, that this is not about bulk commodities, it's not about selling fish or salmon or, or any of the bulk commodities. This is about an extremely rare product where just 7 million oysters into the international community sees us generate $20 million of EBITDA and that's what this is about. It's about landing it at the correct position, and it's about utilising and celebrating the provenance, that rarity and the heritage.

What's the plan for that then in terms of tackling that south-east Asia market, do you have distribution channels set up there already, or is that something that's going to be coming over the next few years?

We're extremely well advanced in jurisdictions and still nascent in other jurisdictions, so across the stack, we're spread all the way from having completely tested distribution partners with forward order book to identifying the correct distribution partners in those, in those jurisdictions. We were tremendously aided again by the collaboration with Moet Hennessy. And that came only in the middle of this year, which has changed our strategy to enable us to offer a direct to high-end restaurant in those jurisdictions, piggy-backing those sales channels. And so naturally in a COVID year we've been far more focused domestically than internationally, but we're very well advanced on how we're going to do it, and where and when.

I did want to also ask you about what you just mentioned this year and how COVID has impacted the business, did you say demand full at all as restaurants and shops closed in lockdown, or has it held up?

We've been very fortunate because of the massive scale of our distribution. We service such a wide array of distribution points from five star, fine dining, all the way down to Coles and the like, and so the breadth of our market has meant that whilst one market was down some of the other retail markets, 300-400 per cent. What we found is the resiliency of people wanting to enjoy a little bit of luxury in the gloomy environment, but still a really healthy choice meant that yes, in the very heights of COVID, we were down some 40 and 50 per cent, but we're delighted to be back. In fact, we're slightly up year on year coming into October and November.

In terms of the near future, obviously your focus at the moment, it's the second stage of acquisitions and the IPO, but do you think there's room for further acquisitions in the short to medium term or once you've made these current acquisitions, are you happy with where you're at?

We see that there's a tremendous degree of opportunity. In fact, it's the primary reason for listing on the stock exchange is to enable that further consolidation and acquisition opportunities. We believe that not only is there a great outlook for people that are acquired by East 33 to have stock and build into that component, but also for us to shine a real spotlight on the industry at large. The opportunities for us in terms of both improving and increasing our supply lines through acquisition, and also improving and increasing our online presence through additional jurisdictions and opening new market opportunities in the international community means that the listing is the very, very beginning. It's the base, the growth all comes moving forward, and we hope that not only will the performance shares for the existing vendors and founders, but the uplift in value created from the achievement of those milestones is then shared by the incoming IPO investor.

Over the next 12 to 18 months, what could shareholders or potential shareholders look out for in terms of what's in the pipeline?

Well the thing is again, it’s increased breadth of market, it's increased product lines, it's further guidance as it relates to growth in productivity, it's incremental acquisition, it's opening up new markets. And we think that if you fundamentally keep it simple for a second and look at well, why would an IPO investor come in here? You just need to look at the performance targets of which we will be measured and meaningfully compensated or not and those are 30, 50, and $1 stock price over a three-year period. We believe that we've got more than enough market opportunity in all of the areas I just mentioned to ensure that on a rational basis, the market at large can see that we've imputed that much value. And as a result of that, we’ve put our money where our mouth is, and the vast majority of our compensation comes from achieving those 30, 50, and $1 stock price over the next three years.

Thanks very much for your time, James.

Alex, thank you.

That was James Garton, the Executive Chairman of East 33.