Shuanghui International Holdings Ltd.’s $4.7 billion bid for Smithfield Foods Inc. (SFD), the world’s biggest hog producer, faces hurdles from regulators and rivals to what would be the largest Chinese acquisition of a U.S. company.
Under the terms of its deal, Smithfield has 30 days to continue talks with possible bidders Bangkok-based Charoen Pokphand Foods Pcl (CPF) and Sao Paulo-based JBS SA (JBSS3), according to a person familiar with the matter who asked not to be named because the deliberations are private. The U.S. may also rule that Chinese ownership could be a security risk, Ken Goldman, a New York-based analyst for JPMorgan Chase & Co., said in a report yesterday.
Buying Smithfield would give China’s biggest pork producer control of 460 farms that raise about 15.8 million hogs a year, according to Smithfield, Virginia-based Smithfield’s website. While China’s consumption of pork is rising with the expansion of its middle class, the nation’s food industry has been wracked by scandals ranging from tainted milk to the illegal dumping of hogs in rivers.
Smithfield accepted Shuanghui’s offer of $34 a share yesterday, priced at 31 percent premium to the close the day before, the companies said yesterday in a statement. Its shares ended the day at $33.35.
Valued at $7.1 billion including debt, the deal would be the largest for a meat producer and the biggest Chinese takeover of a U.S. company, according to data compiled by Bloomberg. It’s subject to approval from Smithfield shareholders and regulators, and is expected to close in the second half.
“The deal, valued at 19 times Smithfield’s 2012 earnings, isn’t a bargain,” said Liu Hui, a Shanghai-based analyst with Capital Securities Corp. “We don’t see clear signs how the deal will enhance coordination between the two markets and how Shuanghui will benefit from the deal.”
The deal is unlikely to boost China’s imports of American pork products because China already has overcapacity, Liu said. It also won’t boost Shuanghui’s exports amid global concern about China’s food safety issues, she said.
Shuanghui apologized in March 2011 over illegal additives found in its meat and halted output after China Central Television reported that farmers in central Henan province fed an additive to their pigs and then sold them to a slaughterhouse owned by the group. The company subsequently pledged to step up quality control.
Henan Shuanghui Investment & Development Co. (000895), the listed unit of Shuanghui Group, jumped 8.7 percent to close at 42.86 yuan in Shenzhen, the highest level since March 14, 2011. The stock had earlier climbed by the daily limit of 10 percent. The local benchmark index dropped 0.3 percent.
While Smithfield can’t actively seek better offers, it can respond to unsolicited bids that are superior to Shuanghui’s, the person said. If Smithfield were to try to reach a deal with CP and JBS after the 30 days, said another person familiar with the matter, it would have to pay a higher fee to break off the Shuanghui deal.
Smithfield Chief Executive Officer C. Larry Pope confirmed in an interview yesterday that he agreed to a limited “go-shop” period as part of its deal with Shuanghui. He declined to elaborate or comment on other bidders.
“I can’t comment on that -- I can only direct you to our merger agreement,” said Pope, who will continue as CEO and president of Smithfield under Shuanghui’s ownership.
Smithfield can provide detailed financial data and negotiate deal terms with CP and JBS for the next 30 days, said one of the people familiar with the matter, and would pay Shuanghui a breakup fee of $75 million, smaller than a typical charge for a deal this size. That fee would jump to $175 million if a deal is reached with CP, JBS or any other bidder after 30 days, this person said.
Shuanghui has also agreed to a breakup fee if it can’t complete the deal due to financing or regulatory issues, said this person. It wouldn’t have to pay that fee if the deal was derailed by the Committee on Foreign Investment in the U.S., or CFIUS, the person added.
CP had hired advisers and was lining up financing for an offer as of late last week, said one of the people. CP said today in an e-mailed statement that Smithfield was one of the opportunities available to the company, though this came with a “very limited timeframe”. It declined to provide any more information citing a non-disclosure agreement.
JBS, the world’s largest beef producer, declined to comment in an e-mailed response to questions yesterday. An official at Shuanghui declined to comment on the interest from the other companies.
Shuanghui and CP are vying for access to Smithfield’s pork supply as rising incomes in Asia mean more shoppers can afford meat. Buying Smithfield may also help the winning bidder ease Asian consumers’ concerns about food quality following a safety scare this year in China, the world’s largest consumer of meat. Shanghai cracked down on distributors after the discovery of thousands of dead pigs in the city’s main waterway in March.
U.S. pork exports to China last year were up more than sevenfold since 2003, according to data from the U.S. Meat Export Federation. Shipments of the meat to China accounted for almost one-fifth of total U.S. pork exports last year.
The transaction is subject to approval from Smithfield shareholders and regulators including CFIUS, and is expected to close in the second half.
“On the one hand, pork is not directly an issue of national security, as defense or telecom might be,” JPMorgan’s Goldman, who has a hold rating on the shares, said in the report. “On the other hand, if CFIUS comes to believe that Chinese ownership of the U.S.’s largest hog farmer and pork supplier presents a food supply risk, then it may have a heightened concern.”
While the Shuanghui deal doesn’t pose a national security risk, the CFIUS will give it a “good study,” Pope said. The takeover will open up new Asian markets for Smithfield’s pork products and help the company’s new owners learn about safe ways to raise livestock and produce meat, Pope said.
The inter-agency committee will scrutinize Smithfield facilities near U.S. military bases and other sensitive locations, said Stephen Mahinka, an attorney with Morgan Lewis & Bockius LLP, who according to his firm profile has won clearance from CFIUS for almost 40 deals.
“The integrity of the food-supply chain gives rise to national security considerations,” said Farhad Jalinous, a lawyer at Kaye Scholer LLP in Washington who represents companies in CFIUS cases. “Is this likely to be blocked? Not likely, but based on the conclusions the government makes about the risk profile, CFIUS could require a mitigation agreement to resolve perceived risks.”
Smithfield has about 46,000 workers and has contracts with 2,100 others across 12 U.S. states. As well as its namesake label, the company owns packaged-meat brands including Farmland and Eckrich sausages.
Shuanghui will honor labor agreements already in place with union employees, plus the existing wage and benefit accords for non-union workers, according to the statement. No plant will be closed under the merger agreement, both companies said.
Smithfield has underperformed some of its biggest U.S. rivals because its farms have seen rising costs for feed ingredients such as corn and soybeans. Last year, the U.S. experienced its worst drought since the 1930s, which pushed crop prices to a record.
The shares have declined about 18 percent in the past five years before yesterday, while competing U.S. meat producers Hormel Food Corp. and Tyson Foods Inc. climbed 118 percent and 37 percent respectively in the same period.
Smithfield’s hog farms have held back the company’s performance, shareholder Continental Grain Co. said in March. The meat company should consider splitting up its packaged meats, international operations and livestock businesses, Continental said in a March 7 letter. It also called for the company to start paying a dividend and to add several new directors to the board.
Smithfield has been talking to Shuanghui about a deal since late last year and Continental’s letter “probably accelerated” the discussions, Pope said yesterday in the interview.
Despite the call to split up Smithfield, the company had already successfully accessed the Chinese market, Tim Ramey, a Lake Oswego, Oregon-based analyst for D.A. Davidson & Co. who has a buy rating on the shares, said in a report yesterday. That’s because of the structure of its business, which spans raising pigs to packaging bacon, he said.
“This deal is a clear vindication of the Smithfield strategy of vertically integrated pork operations,” Ramey said.
The takeover will be financed through a combination of cash, the rollover of existing Smithfield debt, and additional debt that has been committed by Morgan Stanley and a group of banks, according to the statement.
Smithfield’s $1 billion of 6.625 percent notes due 2022 traded to 112.625 cents on the dollar to yield 4.9 percent at 3:04 p.m. yesterday in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Barclays Plc is Smithfield’s financial adviser and Simpson Thacher & Bartlett LLP and McGuireWoods LLP are its legal counsel on the deal. Morgan Stanley is the financial adviser for Shuanghui and Paul Hastings LLP and Troutman Sanders LLP are serving the company’s legal counsel.
The Shuanghui offer values Smithfield at about 7.4 times annual earnings before interest, taxes, depreciation and amortization, according to data compiled by Bloomberg. That compares with a median Ebitda multiple of 7 for 20 similar deals valued at $100 million or more that were announced in the past five years, the data show.
“Any number of companies could buy Smithfield at a premium to the $34 bid and have an accretive transaction,” Ramey said. “We would not be surprised to see a higher offer.”