Reports emerged earlier this month that US agribusiness giant Cargill is exploring the possibility of buying Archer Daniels Midland’s (ADM) cocoa business. While not confirmed, such a purchase would create a global giant in the sector. Michelle Russell takes a closer look.

ADM last month confirmed it was in talks over a potential sale of its cocoa business. A spokesperson for the group said the company was evaluating “strategic options” for the unit as part of its long-term commitment to “create shareholder value”.

Weeks later and reports surfaced that Cargill had performed due diligence on the ADM business. However, it is as yet unclear whether the company had actually placed, or intends to place, a bid for the unit, which is estimated to be worth around US$2bn.

Cargill and ADM are two of the world’s biggest cocoa merchants and bean grinders. Should Cargill purchase ADM’s cocoa division, combining the two would create a company that could compete effectively with Zurich’s Barry Callebaut, the world’s leading industrial chocolate product manufacturer.

Cargill is already a major name in the cocoa space, so such a deal with ADM would certainly make it something of a bellwether in the commodity.

The company has shown more interest in the chocolate business lately so a deal like this could certainly make sense. It recently announced plans to start building a $100m cocoa processing plant in Indonesia to meet regional demand for cocoa products and in 2011 bought German cocoa grinder Kakao Verarbeitung.

The company currently operates cocoa plants in the major growing regions of West Africa, Brazil, Indonesia and in major consuming countries in Europe, so acquiring ADM’s business could be a good bet on the growing demand for chocolate and cocoa from the emerging markets.

For ADM, a sale of its cocoa unit would mark a shift closer to the grains sector. After months of wrangling, ADM bought Australia’s GraIncorp., the largest bulk grain handler on Australia’s east coast, in a $3bn takeover deal in May. It comes at a time when demand for grain from emerging markets, including China, is growing. And any proceeds from a sale could be used towards the acquisition of GrainCorp.

Francisco Redruello, senior food analyst at Euromonitor International suggests ADM’s decision to move away from cocoa could be a sensible one given that international cocoa prices are looking “quite bearish for some time to come”.

In addition, he says there is “concern” on growth across emerging economies, particularly given that “much of the liquidity is flowing back to developed markets”.

He adds: “There is probably more long-term potential for grains, because stocks in the long term are less secure and there is plenty of economic growth coming from Asia – that is not going to change. We should not forget that grains have long-term growth potential because demand for fresh meat, which uses grains as an input, is continue to grow strongly. In Asia Pacific, we predict sales of fresh meat to rise by 12m tonnes over the 2012-2017 period.”

While a deal with Cargill appears to be the most plausible option, some analysts have suggested that competition concerns could arise, particularly in Ivory Coast and Ghana, the world’s top two growers. Both companies own processing facilities in these countries, which could potentially prevent Cargill from being successful with a bid.

“Cargill could be a potential buyer but then I think there are probably going to be monopoly concerns,” says Kepler Capital Markets analyst Jon Cox.

He dismisses Barry Callebaut as a potential candidate due to its recent acquisition of Petra. The Swiss group moved for the Petra ingredients business in December, paying $950m for operations in some of the world’s fastest-growing cocoa and chocolate markets.

However, Cox suggests there are other, less sizeable companies, that could purchase the unit without incurring antitrust issues.

“Other than Cargill there are probably some smaller players like Blommer Chocolate Co. in the US that could be in the mix.”

The move by ADM – the ‘A’ of the so-called ‘ABCD’ group of firms that dominate agricultural trading, along with Bunge, Cargill and Louis Dreyfus – comes as the company looks to improve its return on capital.

Cocoa and chocolate operations are capital intensive and bad weather and political instability in key growing regions have resulted in volatile margins.

In May, the company booked a drop in first-quarter profits as higher costs hit the bottom line. ADM said its performance was “as expected” as operations felt the impact of last year’s poor grain harvest, due to the drought in the US. Its Cocoa and Other Operations unit posted operating losses of $22m, compared to an operating profit of $159m in the prior year period.

Nonetheless, ADM remains the number three in cocoa bean processing, handling almost a fifth of global supplies. Together with Cargill and Barry Callebaut they jointly account for around 40% of the world’s cocoa bean grinding capacity.

Any deal would need to be made by a company that has the balance sheet, knowledge and experience to take on such a large and well-established business. This, therefore, seems to place a limit the number of potential suitors.