Via Jay Gold, CFA of JPMorgan… After the close yesterday, Smithfield Foods, Inc. (NYSE:SFD) a proxy statement (link) related to its proposed acquisition by China-based Shuanghui. We find three particular areas of interest: 1) The narrative recounting events leading up to the deal, which we summarize herein; 2) The revelation that during the courtship with Shuanghui, Smithfield bid on (and was rebuffed by the owner of) a large packaged meats business; and 3) Smithfield’s belief – at least in the documents it used during merger discussions – that it would earn ~$3 in EPS this year, versus the consensus $2.59. We normally would not place much value in an EPS estimate issued during a merger negotiation; however, in Smithfield Foods’s 10-K, which also came out yesterday, Smithfield Foods seemed to suggest even ~$3 might be conservative.
The proxy’s narrative of the bidding process provides a crisp read, in our view. We summarize it in the body of this note. The most important takeaway, in our opinion, is that before agreeing to be bought by Shuanghui, Smithfield Foods, Inc. (NYSE:SFD) was actively pursued by two other potential suitors who made competitive bids. Based on media reports, i.e., Bloomberg, we think these suitors are Thai-based CP Foods (covered by J.P. Morgan analyst Kae Pornpunnarath) and Brazilian-based JBS (covered by J.P. Morgan LatAm Staples Analyst Alan Alanis). Though it was not necessarily news that these companies were in the mix, the high quality of their offers – both close to $34 – was noteworthy, in our opinion.
Mystery object of Smithfield’s affection. At the same time that Smithfield Foods, Inc. (NYSE:SFD) was taking offers, it also was bidding on (and rebuffed by the owner of) a “large business in the packaged meats sector” that goes unnamed in the proxy. We do not know which company is being referred to; however, there are few packaged meat companies of size in the United States. Possibilities, in our view, may include Hillshire Brands (HSH – Overweight), Bar-S Foods (owned by Mexican Grupo Alfa, covered by J.P. Morgan LatAm Capital Goods and Agribusiness analyst Cassio Lucin), privately held Land O’Frost, and privately held Johnsonville Sausage, among others. Note, too, that Smithfield Foods, Inc. (NYSE:SFD) said it pursued a “business,” not a “company,” which may indicate it was only looking at the packaged meats portion of a larger firm. Sizable US packaged meats businesses that are part of larger companies include Oscar Mayer of Kraft and some of Hormel’s brands.
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Very constructive outlook for FY14E in both proxy and 10-K. In the proxy, Smithfield Foods, Inc. (NYSE:SFD) said it expected $3.39 in EPS this year, or $2.77 assuming 100 basis points below the initial target (a level SFD recommended once it saw its disappointing 4Q13 numbers). These figures compare favorably to the $2.59 Bloomberg consensus estimate. But these estimates perhaps were created to appeal to a suitor during a potential takeout and therefore we place little weight on them. Perhaps of greater consequence is that in its 10-K, also published yesterday, Smithfield guided to some lofty margins for the year. Management now expects Hog Production margins in the mid-single digit range (vs. -3.8% in FY13 and prior guidance of “below normalized but improved”), Fresh Pork margins also in the mid-single digit range (vs. 3.3% in FY13 and prior guidance of roughly 3-4%), and Packaged Meats $/lb in the low to middle part of the $0.15-$0.20 range (vs. $0.14 in FY13, with guidance more or less unchanged). By our math, these ranges suggest EPS between $3.46 and $4.79 this year, far above consensus. We have low confidence in these figures, too, since managers of protein companies do not possess much more visibility into commodity prices than outsiders do. We merely wanted to highlight that the company is publicly calling for a very impressive year.
Investment read-throughs for SFD and HSH. We view the proxy and 10- K as positive for Smithfield Foods for two reasons. First, though we take it with a grain of salt, guidance in the 10-K for FY14E EPS is quite strong. Second, the bids from the alternative suitors – likely JBS and CP Foods – were close to Shuanghui’s winning offer. Though both JBS and CP have said or implied they will not raise their bids, they could change their minds. We also view the proxy as positive for Hillshire: Though we do not know which large packaged meats business was targeted by Smithfield Foods, it is not impossible to imagine HSH in the part. No matter which company it was, however, the fact that any large packaged meats business was being pursued should be read as a positive for a pure play such as Hillshire, as it suggests an attractive M&A environment.
Investment thesis. We are Neutral the Smithfield Foods stock. We believe the company will be purchased by Shuanghui for the proposed $34/share. As we previously wrote (link), we do not think either JBS or CP Foods will make a sufficiently attractive counter-offer.
Valuation. We believe the company will be purchased for $34/share and thus this figure remains our Dec-13 price target.
Risks to our rating and price target. Upside: A superior offer for the stock may come in. Downside: 1) US government regulators may reject the acquisition, 2) Shuanghui may opt out of the deal (and pay a termination fee).
Highlights of the Smithfield Foods Proxy’s “Background of the Merger” Section
January, 2013 (no exact date specified): Smithfield begins considering a “potentially significant acquisition” of a large business in the packaged meats sector.
March 21: A representative of Shuanghui calls Smithfield CEO Larry Pope to say the company is prepared to send a written, non-binding proposal to acquire all of the outstanding shares of Smithfield common stock for $30/share in cash. Smithfield’s
board agrees that $30 is too low but wants to see if Shuanghui will make a better offer.
March 22-23: Mr. Pope tells Shuanghui’s representatives that Smithfield Foods is not for sale, and if it were, $30 is too low.
March 24: Shuanghui sends a written, non-binding proposal to buy Smithfield for $33/share. On approximately this date, representatives of Shuanghui request that Mr. Pope and Smithfield Foods Chairman Joe Luter III travel to Hong Kong to meet with Shuanghui’s chairman. Smithfield declines, saying it is premature to schedule a trip at that time.
March 25: Smithfield formally submits an offer to buy the aforementioned large packaged meats business.
March 29: (Per the proxy, Company A and Smithfield in 2010 engaged in discussions regarding a combination of