July 12, 2013 8:43 pm

Shuanghui / Smithfield: dark meat?

Why a Chinese group paid so much for a lacklustre US pork producer

Protectionist squeals were expected at the US Senate hearings on Shuanghui International’s $7.1bn acquisition of Smithfield Foods. An unexpected treat was listening to politicians weigh in on merger and acquisition pricing. Michigan Senator Debbie Stabenow wondered what dark (meat?) motives were behind the one-third premium the Chinese group paid for an underperforming US pork producer. Setting aside Congress’s own issues with paying too much for things, Ms Stabenow’s question – how a lacklustre pork business can attract a top-shelf price – is worth taking seriously.

Is 30 per cent a hefty premium, as Ms Stabenow thinks? Among transactions of a similar size, according to the fairness opinion of Smithfield’s banker, the top quartile of premiums in recent years has been above 42 per cent. So 30 per cent looks middling by that standard. But the difference between the trading price and the offer price is not the main issue. The crucial test of a deal’s value to the buyer is one of control and of the cost savings from the combination.

Critics wondering whether Shuanghui is paying an irrational or politically motivated price are better served focusing on valuation. The results here are mixed. Using multiples based on Smithfield’s recent weak financial results makes the $34-a-share price look fat, but when the improved forecast is incorporated in a discounted cash flow model, $34 looks trim – at least according to the fairness opinion. These standard profit and cash metrics ignore asset valuation – in this case, the hogs themselves. One activist investor, incorporating all those piggies, asserts that Smithfield should change hands for at least $44.

Ms Stabenow may have answered her own question when she argued that perhaps the Chinese just want Smithfield’s advanced pork technologies, which had been developed with taxpayer assistance. That the Chinese want better meat and are willing to pay American shareholders cold hard cash for it is unsurprising, and positive. If Shuanghui is indeed paying a fair price, American taxpayers should be pleased that their investment paid off and enjoy the capital gains taxes.

Email the Lex team in confidence at lex@ft.com

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