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.
See page 7 for analyst certification and important disclosures.
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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 assets. In this potential transaction, Smithfield Foods would acquire the US assets of Company A in exchange for issuing stock to Company A, and Smithfield Foods would be rendered a public company controlled by Company A. These discussions were subsequently discontinued.) A representative of “Company A,” a non-US public company, contacts Mr. Pope and asks if he would be interested in reviving the conversation. Mr. Pope says no, but indicates if Company A were looking to buy the entire company, the board might be interested.
Note: We believe, based on media reports, that Company A is either Thai-based CP Foods (covered by J.P. Morgan analyst Kae Pornpunnarath) or Brazilian-based JBS (covered by J.P. Morgan LatAm Staples Analyst Alan Alanis). Further, based on
other comments in the proxy – see the May 22 item below for details – we think Company A is more likely to be JBS than CP.
April 4: Representatives from Smithfield Foods communicate to representatives from Shuanghui that $33 is insufficient.
April 11: “Company B,” also a non-US public company, terminates a prior confidentiality agreement with Smithfield Foods regarding a possible joint venture, but indicates it is interested in acquiring a significant minority stake in Smithfield Foods. We believe Company B is probably CP Foods, for reasons highlighted below.
April 16: A representative of Company B meets with a representative of Smithfield Foods to discuss the April 11 letter. Company B indicates that while its current intention is not to buy more than 9.9% of the company, if Smithfield Foods were to be involved in a transformative acquisition or management-led buyout, Company B would be interested in participating.
April 17: Mr. Pope indicates to representatives of Shuanghui that he would be supportive of and recommend a proposal from Shuanghui to acquire Smithfield Foods between $35-$36/share.
April 19: Shuanghui sends a revised proposal increasing its offer to $33.50/share. At the same time, representatives of Shuanghui indicate to Smithfield that despite the increased offer of $0.50/share, the impact of the expected disappointing 4Q13 results (Shuanghui had access to Smithfield Foods’s books) had “significantly limited” the company’s willingness to increase its proposed price and, in fact, Shuanghui had considered lowering the offer from $33.
April 21: Smithfield’s board meets to discuss strategic alternatives, including a) a spin-off of the hog farming business along with part of fresh pork, b) a variation of the first option that involved an IPO of the remaining businesses (part of fresh pork, all of packaged meats and international), c) the acquisition of the aforementioned large business in the packaged meats sector, and d) the sale of Smithfield Foods to a private equity firm. After discussing these options, the board reaffirmed its view that the spin-off and carve-out alternatives raised “substantial management and operational issues” and did not appear to be “currently feasible” due to the underperformance of the hog production business and the uncertainty as to market receptivity of the IPO of the rest of the business. The sale to a private equity firm was deemed difficult for a number of reasons. Smithfield management informed the board at the meeting that in light of the disappointing 4Q13 earnings to come, it would be appropriate to discount Smithfield Foods’s banker’s margin assumptions by at least 100 basis points.
April 26: Company A offers $30/share for Smithfield Foods.
April 28: Mr. Pope tells Company A its proposal was too low for Smithfield Foods to meaningfully engage in discussions.
May 3: Company A raises its offer to $33.50/share.
May 8: Mr. Pope and other Smithfield Foods representatives meet with Shuanghui representatives, including the chairman of the board, in Hong Kong.
May 8: Company B proposes a purchase price between $31 and $35 per share. Smithfield’s advisors respond by telling Company B the breadth of the value range made the proposal “difficult to evaluate.”
May 21: Company B offers $34/share. Also on this day, Smithfield’s representatives inform Shuanghui that other bidders had emerged. Smithfield says it would like all three interested parties to submit their best price (along with a proposed contract and financing commitments) no later than May 31.
May 22: Smithfield’s board of directors conducts a conference call. Either on this call or in a communication from Company A (we are not certain which), the topic came up of Company A’s presence as a competitor in the US that could pose “potential antitrust issues.” (This is the reason we believe Company A is likely JBS; JBS has a meaningful presence in US pork while CP Foods does not.) Also on this date, Company B told representatives of Smithfield Foods that for internal reasons, it would not be able to execute or announce a transaction prior to June 13.
May 24: Smithfield receives notice from Shuanghui’s attorneys that if the parties did not sign the merger agreement by May 28 at 6pm ET, its offer would be withdrawn. Shuanghui agrees, however, that after May 28 Smithfield Foods will be permitted to continue to negotiate and solicit further proposals from existing bidders – that is, Company A and Company B – with termination fees to be paid if one of the other company’s offers is accepted.
May 25: Smithfield asks Company B if it would be able to significantly accelerate the process and was informed this was not possible. Smithfield is also of the view, it states, that because Company A still had not entered into a confidentiality agreement or performed due diligence, et al, it would not be able to reach an agreement with Smithfield Foods by the May 28 deadline. Smithfield Foods makes a counterproposal to Shuanghui requesting an increase in the offer to $34.50 and changes to the termination fees. Shuanghui responds with an offer of $34 and smaller changes to the fees than requested by Smithfield Foods.
May 26: The Smithfield Foods board agrees that the Shuanghui proposal is sound and directs management and advisors to work toward the merger.
May 28: Smithfield’s board unanimously adopts and approves the merger agreement and recommends that shareholders vote in favor.
May 29: The deal is announced.