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China Makes its Largest Monetary Play in a U.S. Based Supply Chain

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Prediction Seven in our annual Supply Chain Matters 2013 Predictions for Global Supply Chains (available for no-cost download in our Research Center) noted that Chinese based manufacturing and service firms will markedly increase their presence in global supply chains. We based that prediction on reports that China’s leaders were encouraging industry to buy assets overseas and build more internationally focused businesses. A further strategic goal in this strategy was industry supply chin penetration, particularly at the lower but critically important tiers of industry supply chains. Up to this point, these deals have included energy production, mining and automotive components sectors.

Today, business and other media are buzzing with the headline that China’s largest meat processor, Shuanghui Group intends to acquire U.S. pork products provider Smithfield Foods, a global leader in hog farming and pork production for approximately $4.7 billion. Smithfield’s brands include Armour, Farmland and Health Ones. This deal is headlined as the biggest Chinese takeover of a U.S. based company to-date and is subject to all-important approval by the U.S. Committee on Foreign Investment. Shuanghui’s offer was a healthy 31 percent premium to Smithfield’s closing stock price yesterday and represents a premium of 17 times earnings. Smithfield however, has been experiencing some financial challenges of late with profitability declining by over 30 percent since 2011, with an activist investor, Continental Grain Company actively lobbying for a break-up. Smithfield must also convince its key customers on the strategic benefits of this deal and that important domestic supply will not be re-routed to China’s massive market. Smithfield’s eroding margins have been caused by a squeeze in rising feed and commodity costs vs. an economically stressed U.S. consumer unwilling to pay higher prices for pork products.

According to statements from the parties involved, the primary purpose of the deal is to foster more export of Smithfield products towards China’s booming market.  China’s pork consumption is estimated to be over 52 million metric tons and some analysts point to facts that the country does not have enough current arable land to sustain further growth of that market. The parties have been openly declaring that this deal does not involve the import of Shuanghui products into the U.S. market. In its reporting, the Wall Street Journal and other outlets have cited 2011 incidents in which Chinese health inspectors discovered the food additive substance clenbuterol which speeds muscle growth in hogs but is harmful to humans among pork products produced by a subsidiary of Shaunghui. That substance is banned in both China and the U.S. Further, many in social and other media have probably witnessed the recent graphic photos of thousands of dead pigs dumped by Chinese farmers in rivers surrounding Shanghai.

Chinese consumers remain highly distrustful of Chinese food producers, thus a deal such as this which can increase availability of U.S. bred and produced pork products across China at a potentially premium price has strong benefit for Shaunghui. Other food producers in China have come to the discovery that to insure consistency in product quality and overcome corrupt practices, they need to control the entire food supply chain from seed to consumption.  In a Supply Chain Matters commentary penned in March, we observed how New Zealand based Fonterra was turning supply chain risk into opportunity by re-entering China’s infant formula market via a strategy of controlling the entire milk and formula supply chain.

The WSJ reported that the idea of a deal was first broached over four years ago but that price and value was a continual issue in these discussions. In separate reporting, the WSJ notes that the U.S. political approval process may get rather interesting since agribusiness interests have been lobbying for food companies to scale and pay more attention to growing global markets. Thus these business interests may lobby for regulatory approval. U.S. politicians however, hearing the voice of farmers and consumers, may balk at the deal.  One editorial penned by John Bussey in the WSJ calls for legislators to seek quid pro quo from Chinese leaders in lifting current restrictions for imports of U.S. food products and on opening-up further markets to U.S. companies.  Thus, the political approval process can get dicey regarding this deal. Smithfield’s CEO has indicated to business media that are at least two other suitors waiting if the Chinese deal does not come to pass.

If consummated, the implication is that a major Chinese food producer will have a presence and voice in the U.S. pork products supply chain.  The Chinese will have a major U.S. presence and their bacon, if you pardon the analogy. Management philosophies and policies could follow unless Smithfield management is provided an independent voice in running its operations.

Chinese companies are indeed shopping for international deals and they are exercising savvy in global supply chain influence.  We may well observe other deals in the months to come.

Bob Ferrari

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  1. Bob Ferrari says:

    Hello Everyone,

    This is an added update to our commentary related to the acquisition of U.S. pork products producer Smithfield Farms.

    According to filings with the U.S. Securities and Exchange Commission (SEC), executives and senior employees of Smithfield are eligible to receive as much as $48 million in retention bonuses upon completion of the acquisition. Six senior executives will receive upwards of $24 million while an unspecified number of other employees would share an additional $24 million. Smithfield’s existing CEO is eligible for an $8.3 million bonus to be paid in four installments if he stays with the combined entity for three years. Similarly, all other executives are eligible for phased payments over a three year period.

    In other related news, Continental Grain Company, Smithfield’s largest non-institutional shareholder and major supplier now indicates that it will sell its entire 6 percent stake in Smithfield, thus eliminating another potential objection.

    It seems as though a lot of planning and thought went into this acquisition.

    Bob Ferrari