Caixin
Jun 04, 2013 03:20 PM

Dissecting Shuanghui's Big Deal with Smithfield Foods

(Shanghai) – Chinese meat processing giant Shuanghui International Holdings Ltd.'s US$ 4.72 billion acquisition of Smithfield Foods is set to become the largest Chinese investment in the United States.

The deal, announced on May 29, offered US$ 34 for each Smithfield share, a 31 percent premium of the previous day's trading price. Shuanghui also agreed to take over Smithfield's US$ 2.4 billion in debt.

The transaction is expected to be completed by the end of this year, but it requires the approval of U.S. regulators.

The capital markets welcomed the deal. After the announcement, Shuanghui's saw shares in its domestically listed subsidiary rise 8.7 percent, while Smithfield's New York-listed stock surged 28.42 percent.

Dan Rosen, head of the China practice at the advisory firm Rhodium Group, said the deal would allow Shuanghui to learn about modern food enterprise management, complying with advanced food-safety regulations and optimizing investment in R&D. "The company will also benefit hugely from a global brand to help set it apart from the tarnish on domestic Chinese brands."

A report by China International Capital Corp. said the acquisition will help Shuanghui gain experience in pig breeding, branding and industry chain management. It will also get access to abundant meat resources.

The benefit for Smithfield is a financial payout. The firm will be financially stronger as a result, Rosen said, and more likely to grow and be better positioned to participate in global opportunities.

Quality Contro

Larry Pope, chairman and chief executive of Smithfield, said on May 29 that the two companies started talks in 2009, but price issues stalled talks.

"Smithfield's current business performance is not very good, but in next three to four years, its profitability is likely to improve," said Heather Jones, an analyst at investment bank BB&T Capital Markets. "The price is a good deal for Smithfield's shareholders."

Jones said the most valuable part of Smithfield for Shuanghui is its business scale and its control over pork sources. Smithfield slaughters about 280 million pigs every year, making it the largest pork processor in the United States. By raising more than half of its pigs itself, the company has been able to build a reputation for quality.

The annual Pork Powerhouses report issued by U.S. magazine Successful Farming shows that by the end of 2012, Smithfield has 862,000 sows, about 30 percent of the country's total.

By the end of January, Smithfield had total assets of US$ 7.6 billion, but profitability was unstable. It suffered net losses of US$ 198 million in 2009 and US$ 101 million in 2010, then had profits of US$521 million in 2011 and US$ 361 million in 2012.

Jones blamed the fluctuation on changing feed costs and market demand, but indicated Smithfield addressed the problem. "Smithfield has launched business reshuffles in the past few years, which increased automation and profitability," she said.

No Smithfield Plant

Shuanghui plans to use Smithfield to export pork to China, which will help the company improve its image amid widespread food-safety concerns.

"The deal will offer Smithfield new channels in the China market and a strong distribution network," said Yang Zhijun, executive director of Shuanghui International. "We hope to export high-quality products from the United States to meet the rising demand for pork in China."

China is now the world largest pork consumer with annual consumption exceeding 50 million tons, about half of the global total.

Due to lower feed costs, pig breeding is much cheaper in the United States than in China. The United States exported 640 million pounds of pork to China in 2012, up 77 percent on 2008, data from the U.S. Treasury shows.

Since Chinese regulations prohibit the import of live pigs and cooked meat, Shuanghui said Smithfield would only export processed pork to China, and Shuanghui's domestically produced products will not be sent to the United States.

Smithfield's major competitor, Hormel Foods Corp., which is based in the U.S. state of Minnesota, has set up joint ventures with Beijing Sanyuan Foods Co. and Jinjiang International Holdings Co. to make meat products in Beijing and Shanghai. But Shuanghui said there are no plans to set up a Smithfield plant in China.

But a Chinese livestock industry professional said the deal's impact on the country's pork production industry and food-safety problems would be limited because it will not affect pig breeding in China, where the profit margin is small.

"Only when meat processors have their business cover the entire industry chain can the food-safety problem be solved," the source said. "But the costs are high."

Public Perception

The US$ 4.72 billion acquisition is greater than Shuanghui's assets. Company information shows that by the end of last year, the company had total assets of US$ 3.5 billion. The company had annual sales growth of 31 percent.

Shuanghui said funding for the acquisition will come from its own capital, Morgan Stanley Senior Funding Inc. and syndicated loans.

Industry insiders said that after the acquisition, Smithfield may delist in New York and Shuanghui could launch a Hong Kong listing to raise money.

"After the deal, (Shuanghui) saw its assets expand and brand image improve," a source from a private equity fund said. "It will be easy to raise money from a Hong Kong listing."

However, the deal needs the approval of the U.S. Committee on Foreign Investment in the United States (CFIUS) and anti-monopoly regulators. Many analysts said the deal would get the approval of CFIUS because it has few national security implications.

"I do not anticipate problems," Rosen said. "The Smithfield deal does not appear to present great concerns in terms of proximity to military facilities, technology or critical national infrastructure."

But Jones expressed caution. "The deal will enable a foreign company to control 40 percent of the U.S.' pork production. It is quite concentrated. I don't know whether CFIUS will raise the red flag."

The U.S. government lists food and agriculture industries among the 11 areas related to its people's livelihood, so a review for such an acquisition may take longer than expected, Jones said.

In addition, analysts also warned of challenges to Shuanghui following the acquisition, including costs related to animal welfare requirements and labor.

Qilu Securities said in a report that Smithfield plans to build an independent shelter for each pregnant sow by 2017, amid calls from animal welfare protection organizations, a move that would cost US$ 300 million.

Meanwhile, Smithfield has 46,000 employees, and 20,000 are union members. A source close to the situation said Shuanghui would likely face pressure from labor issues and rising wages.

Shuanghui has committed to retaining Smithfield's management team and employees. It also promised to maintain all its factories and partnerships with farms and suppliers.

Another challenge for Shuanghui could be concerns over China's food-safety problems among the U.S public. After the deal, Shuanghui emphasized it will strictly adhere to the highest quality and safety standards, but public perception could be a problem, the source said.

Smithfield shareholders will be concerned that a bad reputation for quality control in Chinese firms will cause the firm to lose customers, Rosen said. "The new owners will need to make a major public relations effort to retain their brand value."

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