The surprise news that the board of US pork group Smithfield Foods has unanimously backed a takeover bid from Chinese group Shuanghui International highlights the ever-increasing importance of China on the global stage – both as a market for products and as an outward investor actively participating in M&A. However, with regulatory and political hurdles ahead, the transaction is far from a done deal. Katy Askew reports.
Smithfield Foods’ management has been fighting a war of attrition.
On the one hand, the world’s largest pork group has faced investor pressure to bump up returns. Most recently, Continental Grain – Smithfield’s largest stakeholder with 6% of shares – called for the company to embark on a fresh strategic direction, with a break up of the vertically-integrated meat processor aimed at unlocking value. Arguing management should “get serious about creating shareholder value”, the investor suggested as recently as last month that Smithfield could be split into a hog processor, a company supplying fresh pork and packaged meats and a business focused on its overseas business.
On the other hand, Smithfield’s operating margins have been squeezed between rising production costs and weak consumer sentiment in its major markets. Spiking grain prices – the consequence of last year’s weak harvests – have resulted in a jump in production costs. However, Smithfield has struggled to pass these expenses down the chain to consumers, who are already switching to cheaper protein options in their droves as household budgets are hit by the economic downturn. While Smithfield’s growing emphasis on processed products seems to be starting to bear fruit, this road to improved profitability remains a long and hazardous one.
Enter Shuanghui International. China’s largest pork processor yesterday (29 May) tabled a takeover bid for Smithfield that values the company at US$7.1bn, including the assumption of Smithfield’s debt. The group is offering Smithfield shareholders $34 per share, a 31% premium on the share price prior to the proposal’s announcement.
Speaking on a conference call with analysts after the deal was announced, Smithfield CEO Larry Pope was keen to emphasise the agreement ticks all the boxes. He insisted it was a “great deal” for both companies.
Perhaps biting his thumb at activist investors, Pope insisted Shuanghui’s offer validates the Smithfield integrated supply chain model that has come under recent scrutiny. Pope argued Shuanghui recognised the value of the security offered by the integrated model. This, he said, was the primary reason why Shuanghui was willing to pay a “significant” premium in the group’s current share price.
The price, Pope claimed, should satisfy shareholder demands for the group to unlock value. “This is an attractive and compelling transaction for the shareholders of Smithfield,” Pope argued.
The tie-up will also address the second issue besetting Smithfield, Pope continued. By opening up the massive – and rapidly expanding – Chinese market for pork products the group will be able to offset weak demand in developed markets, such as the US.
China is the world’s largest market for pork products. According to figures from Euromonitor International, in 2012 pork volume sales in China totalled 51.8m tonnes – accounting for over half the pork sold worldwide that year (90.29m tonnes) and dwarfing the US market, where pork volumes totalled 6m tonnes.
In a country plagued by food safety scares, the demand for foreign-produced food products with a strong food safety message is growing among China’s rapidly expanding middle classes. And they are prepared to pay a premium for such goods.
The opportunity for pork producers to grow value-added sales in China is clear. And meeting this demand is what attracted Shuanghui to Smithfield, Shuanghui chairman Wan Long added. For him, the equation is a simple one: Chinese consumers want foreign pork, US farmers want overseas markets. It is a “win win” situation.
Even as they highlighted the financial and strategic merits of the proposal, the two companies were quick to address certain concerns.
Firstly, Smithfield will continue to operate on a stand-alone basis. No facilities will be closed, no staff will be laid off, no contracts will be renegotiated. Management will remain in place and Smithfield will continue to be headquartered in Smithfield, Virginia. Smithfield will remain committed to its current animal welfare and food safety standards. The acquisition will not even have an impact on Smithfield’s philanthropic activities and commitments the group makes to local communities in the US, management emphasised. “We want the business to stay the same, but better,” Wan insisted.
Secondly, the move will benefit not just Smithfield but the entire US economy, helping to balance the trade deficit and boost the agricultural sector as a whole, management claimed. “This just paves the way for a much better export for the whole industry – and the whole industry will benefit from this… Hog producers in Iowa ought to be thrilled as a result of this… And it helps the balance of trade deficit – this helps to put more exports out of the Untied States,” Pope insisted.
“People have the belief that everything in America is made in China and I like to tell people open your refrigerators and look inside because American agriculture is the most competitive in the world… This is exporting America to the world.”
Such strong nationalistic rhetoric is not something one would usually associate with an M&A announcement. But this is no ordinary takeover – it is the largest proposed acquisition of an American company by a Chinese firm in the food sector. And, as such, it must be viewed within the political and economic context in which it has been proposed.
Pope played down the likelihood that the transaction will fail to pass regulatory scrutiny, in either China or the US. Afterall, there is very little geographical overlap between the two firms, he claimed. Nevertheless, the agreement will now face a rigorous foreign investment review, with the possibility that US politicians could well throw a spoke in the works.
Regulatory approval will hinge on a key aspect of the agreement: will US politicians find that foreign (and particularly Chinese) ownership of a large US food producer presents a threat to national security?
“In our view, it is unlikely that the Chinese authorities [will] hold up the purchase. However, US authorities may be more of a challenge,” BB&T Capital Markets analyst Heather Jones wrote in a note to investors. “CFIUS [Committee on Foreign Investment in the United States] has not frequently blocked acquisitions of U.S. concerns by foreign concerns, but food/agriculture is one of 11 sectors of ‘critical’ infrastructure.”
And the proposal comes at a time of awkward relations between China and the US. America views the world’s second-largest economy as an important trading partner; but one that is not trusted. Concerns over cyber hacking and trade theft dominate the political discourse in the US. In this context, it is unclear how much weight Smithfield’s “business as usual” message will carry.