After months of speculation and a previous failed attempt to combine their operations, the announcement of the merger between Perdigao and Sadia came as little surprise to the market. While the rationale behind the merger is compelling, Katy Humphries contends that, in many respects, it is a deal born out of necessity.

Perdigao and Sadia, two of Brazil’s top packaged food makers, officially announced to the market that a merger deal had been struck yesterday (19 May).

Under the agreement, Perdigao will change its name to Brasil Foods (BRF).

Meanwhile, Sadia’s majority shareholders – 92% of shareholders who vote as a block – will create a new holding company, HFF. Shares in HFF will then be converted into BRF shares at a “control premium” ratio of 1 to 0.166247.

The remaining 8% of Sadia’s preferred free-float shareholders would be offered BRF shares at 80% of the control premium value.

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Current Perdiago shareholders will control 68% of the new entity and Sadia will operate as a 100% owned subsidiary of BRF.

With annual revenues of around BRL22bn (US$10.7bn), BRF would join the ranks of the world’s largest food manufacturers, leapfrogging Tyson Foods to become the world’s largest poultry producer by market value.

BRF would operate 42 plants in five countries and the group would have sales offices in 17 countries across Europe, South America, the Middle East and Asia.

Alongside its strong presence in the poultry sector, BRF would be active in the pork and beef markets and the firm would hold a dominant position in Brazil’s domestic frozen and prepared meal market.

It seems likely that the group would be able to leverage this increased scale to drive efficiency gains across its operations and improve its bargaining position with suppliers.

“We do believe that there are a number of areas where cost savings can be achieved,” a spokesperson for Perdigao confirms to just-food.

However, despite media reports that synergies could total BRL2-4bn, management has resisted providing guidance on the total savings that have been identified and is also playing-down the prospect of large-scale job cuts.

Further detail on the expected savings will be provided at an “appropriate time”, Perdigao CEO Nildemar Secches insisted during a conference call with analysts.

Meanwhile, given the highly price-sensitive nature of domestic and international markets, Sadia chairman Luiz Fernando Furlan suggests that a proportion of these savings would be passed along to consumers – a move that the group hopes will further its ambition to expand in international markets by increasing the competitiveness of its exports.

Through the deal, BRF will gain the financial strength “to grow mainly in international markets”, Sacches said.

“We will be a very powerful export house, exporting to more than 110 countries,” he predicted.

When the merger is completed, exports will account for 42% of total sales. However, the company intends to increase its presence overseas.

BRF would be in a position to leverage Sadia’s international presence in key markets such as Russia – where the group currently operates one production facility – through fresh investment.

The new company would also be well positioned to capitalise on the trade agreement signed yesterday between Brazil and China, which will allow Brazilian manufacturers to export poultry products from plants that have passed Chinese health inspections.

Additionally, with its greater emphasis on processed foods, Sadia’s product stable will add higher margin products to the mix.

While the merger agreement would bring logistical benefits, cost savings and a stronger platform for overseas expansion, a major factor driving the deal was financial necessity.

Both firms have posted quarterly losses this year as higher commodity prices and a tougher trading environment took their toll.

Sadia, in particular, has struggled after huge losses on currency derivatives in the previous fiscal saddled the group with high levels of debt.

Sadia lost some BRL2.3bn after bets on the continued appreciation of the Brazilian real were sunk by the onset of the global financial crisis. The company was forced to seek a cash injection, but its attempts were hampered as the global credit markets dried up.

In 2006, Sadia had attempted to acquire Perdigao in a hostile takeover that was rejected by the latter’s shareholders.

Over the past three years, Perdigao has outgrown its formerly larger rival and Sadia returned to the negotiating table in a weakened economic condition, propelled by fears that despite rising revenues the company could falter.

Despite these pressures, according to HSBC analysts Diego Maia and Pedro Herrera, the deal’s valuation of Sadia is “not quite cheap”.

“Our calculations indicate that Perdigao is paying about an 8.9x EV/BITDA multiple, which on the surface we view as not quite cheap, as ultimately Sadia is a distressed company due to its high leverage and historical EV/EBITDA multiples ranging between 7x and 7.5x,” Maia and Herrera wrote in a research note today (20 May).

“However, at this point, our multiple calculations assume no synergies, which we believe could potentially be significant,” they add.

Following the merger, BRF will look to raise capital of BRL4bn through an equity issue.

According to management, there has been “a lot of interest” in the new share issue, with existing shareholders expected to buy about half of the shares on offer.

Meanwhile, Brazil’s national development bank, BNDES, has been “very supportive” of the negotiations.

The state bank has worked with Sadia to ensure the future stability of the group, which is a significant employer in Brazil. While no official guarantees have been given, BNDES will likely take on the remaining 50% of the offering, Secches and Furlan reveal during an analyst presentation.

The funds raised through the new share issue will be used to paydown short-term debt and optimise the new group’s financial structure, Secches and Furlan insist. “There will be a lot of optimisation,” they say.

The merger between Perdigao and Sadia has always made sense from a logistical perspective and will likely create a global food powerhouse. When it was previously considered in 2006 – when the economic situation and commodity prices were at different levels – neither group was willing to cede to the other and the deal failed to go through. Financial difficulties have, in many respects, brokered the agreement announced yesterday.