May 29, 2013 7:17 pm

Smithfield: Chinese pork

Investors have been offered a meaty premium. They should grab it

It is argued that wireless networks and oil wells are strategic assets, and should be domestically owned. What about bacon? Breakfast is, after all, the most strategic meal of the day. This is a live question in the wake of Shuanghui International Holdings’ agreed offer to buy Smithfield Foods, the largest US producer of hogs and pork products, for $34 per share in cash, or $7.1bn including debt.

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Breakfast is no less safe, however, if the owners of Smithfield’s farms and plants happen to be in China – and given that Chinese ownership will open doors for greater exports to China, the US agricultural industry should be pleased. The trickier question is whether Smithfield’s shareholders are receiving a fair price.

The offer is a meaty 31 per cent premium to the share price on the day before the announcement, and amounts to 17 times Smithfield’s forward earnings (against a three-year average under 10). Things are not so simple, however. Smithfield’s largest shareholder, Continental Grain, argued in March that the company could release value by breaking up, separating the cyclical, low-margin hog production business to focus on stable, high-margin pork and packaged foods.

Given that Shuanghui has said emphatically that Smithfield’s management is going nowhere, it is natural to worry that Smithfield’s bosses have accepted the deal in order to protect themselves. In this case, however, the company’s arguments for vertical integration make a lot of sense. Crucially, owning the whole supply chain lets Smithfield control and take full responsibility for the quality of the product, which is increasingly important (horse meat, anyone?). And as BB&T research points out, it is not clear who the buyer for a separated hog production unit would be. Investors have been offered a good premium. They should grab it. That’s how the sausage gets made.

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