Wednesday, May 29, 2013

Shineway-Smithfield: $7 billion food safety lesson?

Shuanghui Group--known as "Shineway" in English--has announced its plan to acquire Smithfield Foods, a huge link-up between the two leading pork suppliers in the world's two leading pork markets. Shuanghui is paying $4.7 billion for Smithfield's stock and taking on $2.3 billion in Smithfield's debt--a $7 billion deal.

According to company lore, Shuanghui's Chairman, Wan Long, took over a failing state-owned slaughterhouse in Luohe City--a small unremarkable city in Henan  Province--and turned it into the largest meat-processing operation in China. Shuanghui is a private company, not state-owned. Shuanghui reportedly used its own cash and capital raised by Morgan Stanley for the acquisition. Unlike other high-profile deals in Chinese agribusiness industry, this one apparently did not involve the  China Development Bank, the government's giant ATM for favored companies.

According to Mr. Wan Long, "the government encourages and supports big companies to 'go out' [invest overseas]." Wan further explained that food companies especially need to "go out" in order to learn advanced food safety technology and experience. Mr. Wan said Shuanghui's objective in acquiring Smithfield is to pool the two companies' advantages and accelerate the company's global expansion. Wan says the U.S. has resource advantages and Smithfield has valuable technology and brand names.

Smithfield reportedly slaughters 27 million hogs annually and raises 15 million (presumably the rest are procured from farmers who usually raise them under contract for the company). Shuanghui (and other Chinese companies) are trying to figure out how to raise their own hogs or otherwise gain more control over their supply chain--they may think they can learn this from Smithfield. Most Chinese slaughterhouses also operate far below their capacity. Smithfield runs its plants 16 hours a day.

Usually, one would think the acquiring company is the stronger one and will be able to create additional value through the acquisition. However, Shuanghui apparently plans no changes. It says Smithfield's management, brands and facilities will be unchanged and no plants will be closed. Shuanghui's recent history raises doubts about whether the company is capable of effectively operating or adding value to a company like Smithfield. In 2011, Shuanghui was implicated in a major scandal when Chinese Central TV revealed that one of the company's subsidiaries was complicit in the use of illegal feed additives. This was embarrassing since Shuanghui had been a high-profile leader in a "moral food company" campaign designed by the communist party to bolster food safety. The 2011 incident suggested that the company had little control over its subsidiary operations. Its advertising featured "18 tests, 18 assurances" which were criticized by one commentator as "empty words." After the 2011 incident, Shuanghui pledged to open a big company-operated hog farm operation to supply each new slaughter facility it builds.

Smithfield has already been engaged in exporting pork to China, even setting up farms that produce hogs without ractopamine, a feed additive banned by Chinese authorities. The link-up with Shuanghui may firm up the stream of U.S.-to-China pork sales which has been big but highly volatile. Shuanghui's chief business is manufacturing sausages and other processed meat products, so it probably intends to procure pork from Smithfield's operations. With a Chinese company operating at both ends of the supply chain, Shuanghui may have influence to smooth the way for U.S. pork to get past overzealous Chinese border inspectors. Producing pigs in the U.S. for the Chinese market will use grain more efficiently since U.S. hogs have superior feed conversion and more productive sows than their Chinese counterparts.

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