Guy Norton in Zagreb -

One of Croatia's flagship companies Podravka has become mired in a corporate governance scandal that threatens to totally undermine its financial credibility. As a result, the food-to-pharmaceuticals conglomerate's former chief executive has been forced to resign and pressure is now building on the country's deputy PM to explain his possible role in the affair, which has sparked a criminal investigation into Podravka's actions and threatened a shareholder revolt.

The scandal revolves around HRK65m (€9m) worth of loans granted to rival food company SMS in 2007 by Podravka's then-CEO Darko Marinac without any consultation with his supervisory board. The purpose of the loan was supposedly to help SMS boost its production and marketing activities. But in March, SMS admitted it was unable to repay the loans due to the global economic slowdown, leaving Podravka to salvage what it can from the wreckage of the SMS business, which has now been placed in administration.

In the year in which SMS received the loan, it had annual sales of just HRK43.6m and made a net profit of less than HRK0.5m, which has not surprisingly raised questions about why Podravka would grant such a substantial amount of money to a corporate minnow. Initial investigations by the financial police and the Croatian media at the end of September, though, have uncovered a more complex picture, with reports emerging variously of a defence against a hostile takeover or a secret management buyout (MBO) plan. Both versions were reportedly hatched by Podravka in conjunction with Fima, a Croatian financial group.

Food fight

In the first version of the story, Milan Horvat, chief executive of Fima, says Podravka was keen to ward off the unwelcome attentions of Norwegian food company Rieber & Son, which had expressed an interest back in 2006 in buying up a total of 37% of Podravka's shares. To stymie Rieber's ambitions, Fima bought a 10.6% stake in Podravka with the management's agreement. The purchase was apparently financed by a loan from US investment bank Merrill Lynch, with the funds the channelled through SMS to an offshore subsidiary of Fima, Fima Ami Ltd. The loan was said to be secured against the value of Podravka shares and when the value of the equity slumped, an additional HRK110m or HRK136m - the exact figure has yet to be established - had to be channelled through SMS to avoid Merrill Lynch exercising a margin call and seizing the shares. Hovat claims that all the transactions were cleared by the Croatian National Bank (HNB), the Croatian Financial Services Supervisory Agency and the Croatian tax authorities. Horvat also claims that Podravka's management board told him that the project had political support and the consent of the company's supervisory board.

The alternative version of the saga is that Prodravka's senior management was looking to execute a secret MBO plan. This operation was apparently codenamed Spice - a somewhat oblique reference to food flavouring Vegata, Podravka's most famous product.

Whichever version turns out to be true, the continued police investigation and media probing has destroyed Podravka's image for being a leader in corporate communications and financial transparency. The corporate governance scandal is the last thing that Podravka needs right now, given mounting criticism of its business strategy in recent years.

Local analysts say the company has lost its way and that the scandal threatens to stymie efforts to restructure it. Nada Harambasic, consumer research analyst at Raiffeisen Centrobank in Zagreb, recommends that investors reduce their positions in Podravka, saying the scandal and management changes will stop the cost-cutting process and slow down the development of the company. "We expect further dubious transactions to be discovered in the wake of the police investigation and media hype," she says.

Meanwhile, a number of pension and investment funds, which together hold around 22% of Podravka shares, have threatened to unload their holdings if the company fails to improve its management team and its communications with investors. Despite the heady whiff of scandal surrounding Podravka, Norwegian investment fund Skagen Kon-Tiki has stepped in and taken its holding in the company to 8.23%, making it Podravka's fourth biggest stakeholder. It is believed to be acting on behalf of Rieber.

As well as tarnishing Podravka's corporate image, the scandal also has a political dimension, with Deputy PM and Economy Minister Damir Polancec, once a long-time Podravka employee, being called on to explain if he was aware of the underhand goings on at the company, where the Croatian government owns around a 27% stake. Croatia's opposition, led by the Social Democrats, have demanded a vote of confidence in parliament for Polancec. And on October 26, Milorad Pupovac, the leader of the Independent Democratic Serb Party, which is a partner of the ruling coalition, told PM Jadranka Kosor that his party would not support Polancec in the event of a no-confidence motion against him in parliament.

The affair also has an important social dimension, as Podravka is the main employer in the Croatian city of Koprovnica where it is headquartered, as well as the principal financial sponsor of the local basketball and football teams.

A final irony is that in the past, Podravka has won plaudits for its innovative annual reports. In 2007, it produced one printed with thermo-reactive ink that had to wrapped in foil and baked in the oven for 25 minutes at 25°C to reveal the text for a series of recipes featuring its products. Cooking the books is, it seems, something of a speciality for Podravka.

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