Brazil-based meat giants Marfrig and BRF are to hold talks on a merger – a deal that could create one of the largest players in the sector. Market reaction, though, has been mixed.

To some surprise, Brazil-based meat processors Marfrig and BRF have announced they are in talks to merge.

The companies said late last week they were to enter a 90-day negotiation period to see if a deal could be struck.

If agreement is reached, the combined Marfrig and BRF would become one of the world’s largest meat suppliers, competing with Brazilian peer JBS, US behemoth Tyson Foods and China’s WH Group, home to another US meatpacker in the shape of Smithfield Foods.

The new group would have around BRL80bn (US$20.39bn) in sales and some BRL7bn in adjusted EBITDA.

Announcing their plan to hold talks, both Marfrig and BRF touted the geographic diversification the new entity would enjoy. Outside Brazil, BRF, for example, has a notable presence in the Middle East, while Marfrig beefed up in the US last year with its acquisition of local player National Beef.

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By GlobalData

Both companies also mentioned the “complementarity” of their product portfolios – with BRF a major player in poultry (as well as having a product portfolio that branches out into areas like ready meals) and Marfrig in beef.

The combination – if it happens – would come after a taxing period for BRF, which has reported annual losses in each of the last three years. The company spent much of 2018 selling off assets to improve its financial position but, at the same time, had to deal with restrictions on its shipments to Europe.

BRF pointed to “non-recurring events” that “strongly impacted” the company’s results in 2018, including impairment charges on assets sold, restructuring charges and the continued effect of the Carne Fraca food safety affair. However, without those items, BRF’s underlying losses grew on 2017.

Marfrig has also posted a number of annual losses in recent years but did see its profitability – ending up in the black – and debt profile improve in 2018. Nonetheless, a deal would give Marfrig’s investors access to a BRF portfolio that is more diversified and can enjoy higher margins than beef.

According to the statements from the two businesses, based on the current relative values of the companies’ share prices, BRF shareholders would own 84.98% of the enlarged business, with Marfrig investors holding the rest.

Benjamin Theurer and Antonio Hernandez, Mexico-based analysts for Barclays covering Marfrig and BRF, say they “believe a combination would be in the interest of shareholders of both companies” as it would “generate synergies, reduce geopolitical risks, allow for a lower cost of capital and ultimately should drive returns for shareholders of both companies”. 

In a note to clients on Friday, they added: “Combining chicken and beef assets could bring margin stability to the combined business and, considering BRF’s strong position in the Halal markets as well as Marfrig’s strong position in beef in the US, expose the combined company to markets with strong demand and allow it to further leverage its combined Brazilian operation for international exports.”

For all that, the news did raise eyebrows in parts of the investment community, where reaction was mixed.

“One curious aspect of this deal, explaining why it caught us by complete surprise, was that it points towards a very different direction compared to what both companies have been telling the market,” Thiago Duarte and Henrique Brustolin, food-sector analysts at Brazilian investment bank BTG Pactual, argue. 

They point out BRF would be adding beef to its business, which appeared, the analysts said, to be a move away from a previous aim of simplifying its operations (and a move to re-enter a market segment it had left). For Marfrig, the analysts added, the merger would see it re-enter poultry just months after offloading most of US asset Keystone Foods.

The analysts said a more diverse portfolio of products and a wider range of markets in which the combined entity would do business should help to reduce the companies’ debts – but they did raise questions about the synergies that could be derived from the deal.

“While BRF and Marfrig do look stronger together – the reason we believe investors will welcome the transaction – we’d still be conservative on synergies, even more in light of what we see as a rich combined valuation and significant execution and integration risks. We believe though that the operational synergies between beef and pork/poultry are limited.” They again point to the fact BRF and Marfrig have pulled back from each other’s core industry segment in the past due to, the analysts argue the “benefits not being noteworthy”.

Notably, Duarte and Brustolin argue a deal could present “financial synergies [that] are far more tangible than operational ones”. For example, BRF’s debt is 5.6 times its EBITDA; the combined company would see that ratio drop to around 3.1 times. When Marfrig reported its 2018 financial results in February, it pointed to its own “leverage of 2.39 times, one of the lowest levels in the sector” in the wake of the “strategic decisions” to buy National Beef and sell the bulk of the Keystone business.

“We do believe … that the NewCo’s more diverse portfolio of products and geographies should allow for a strong debt cost reduction and liability management,” Duarte and Brustolin added.

Canvassing analyst reaction and three themes do seem to recur when examining market reaction to the news BRF and Marfrig are looking to merge – surprise, scale and synergies.

Victor Saragiotto and Ian Miller, two analysts covering BRF for Credit Suisse, say news of the deal came “much to everyone’s surprise”.

In their note to clients, Saragiotto and Miller underline the size of the new company, describing it as “colossal” and one that would place “the company among the largest protein players in the world”.

However, while the Credit Suisse analysts note the potential positive impact a deal could have on BRF’s leverage, they also share some of their peers’ questions about whether the make-up of the enlarged business could lead to the extraction of cost synergies.

“While it is clear that the greater geographic and protein diversification mitigates the risks embedded in the new company’s operation, it also limits the strong benefits from synergies,” they write. “In order to find attractive upside from the combination to the current joint market cap, we would demand synergies above 1-1.5% of consolidated top line, which we are not comfortable in taking for granted.”

Plenty, then, for the market to chew over over the next three months as Marfrig and BRF get round the table to see if they can come to a deal.