Why Chinese Purchase Of Smithfield Could Be Game Changer For Pork Trade

American pork exporters have spent years trying to ramp up sales to China, the world's most ravenous pork market. Their sales pitch has been stymied by onerous quarantine rules, protectionist impulses, and chaotic distribution channels. After a jump in 2011, shipments to greater China dipped 3% by value last year to $886 million. Given China's growing protein diet and widespread worries over food safety, there's plenty of upside for quality pork imports. That's why the deal announced Wednesday by Smithfield Food Inc, the largest U.S. hog processor, to sell itself to China's top producer, Shuanghui International could be a game changer. If the takeover goes ahead, Smithfield would get a crack at the most lucrative slice of China's market: chilled, processed pork for supermarkets and convenience stores.

Shuanghui isn't home dry as Smithfield still has the option to court other bidders. Thailand's CP Group, the largest agribusiness operator in Southeast Asia that runs poultry farms in China, and Brazil's JBS are reportedly in the mix. Neither has the muscle of Shuanghui in navigating the Chinese market for pork products, though CP has a foot in the door. Smithfield's board may be swayed by other opportunities outside its mature North American markets. But Shanghui has a head start, including financing from Morgan Stanley , its lead advisor, and other foreign banks. Should there be a gap it can count on credit from Chinese policy banks that have supported previous overseas acquisitions. The Smithfield deal - $7.1 billion, including debt - would be the largest yet consummated by a Chinese buyer in the U.S. Investors seemed happy about the bid: Henan Shuanghui Investments shares were up 9.3% mid-afternoon Thursday (the bidder is the unlisted parent company in Hong Kong, which is controlled by chairman Wan Long).

U.S. regulators must approve any takeover and already there are cries of alarm over food security and tales of dodgy Chinese meat. Indeed, many Chinese consumers are suspicious of Shuanghui and other meat companies, with good reason. Floating pig carcasses and rat meat disguised as beef are only the latest food scares to hit the headlines. But a Chinese acquisition of a U.S. processor doesn't mean that Americans will be eating crock Chinese cuts. The trade in pork is all the other way, and so is the technology transfer that Chinese firms crave as they seek to consolidate a fragmented, poorly run industry. Shuanghui isn't looking to offload Chinese pork in Los Angeles. What it wants is to become the leading player in China. "Nobody has got a dominant share. It's wide open," says Joel Haggard, senior vice-president for Asia at the U.S. Meat Export Federation (USMEF).

Based in Hong Kong, Haggard keeps a close eye on market access in Asia. While China is a growing market [pdf] for pork, it lags behind Japan, which last year imported 455,000 tons worth $1.9 billion. China and Hong Kong took nearly as much in volume - 431,000 tons - but paid out less than half in value. Sure, Japan is richer. But the real story is what goes into U.S. containers bound for China: frozen pork that ends up in wholesale markets and food service channels. You may be eating American pork, but you wouldn't know it. By contrast, Japan imports chilled U.S. pork products that are sold by retailers, a much higher margin business. Haggard says that roughly 15% of China's hog production is turned into sausages, hams and bacon. But, as in developed markets, retail sales of processed meat should rise as harried Chinese urbanites work more, cook less and live alone. That creates an opening for U.S. exporters, provided their meats can clear customs and get onto supermarket shelves on time. "What we hope to see in long term is higher value shipments of fresh product as table meats. That hasn't happened yet," says Haggard.

Which brings us back to Smithfield and Shuanghui (Haggard declined to comment on specific companies). U.S. pork producers have repeatedly run into trouble in China over their use of ractopamine, a drug that is also banned in Russia and the European Union. In March, China adopted stricter standards that require U.S. suppliers to certify their pork as ractopamine-free. Guess which U.S. pork producer has taken the lead on eliminating the muscle-promoting drug from its feedstock? Yes, Smithfield. Last month CEO Larry Pope said that half of its hog plants would be ractopamine-free by June. Pope said Wednesday that he'd been talking to Shuanghui since late last year about a deal. No prizes for guessing why Smithfield is ahead of the curve on verification of plants. As a side note, it's ironic to see China setting U.S./global standards on additives in meat, given the rampant abuses in its own industry (as Yum Brands discovered recently to its cost).

So we have a vertically integrated U.S. processor that's ensured that half of its plants can ship pork to China. Its would-be acquirer is the largest player in a messy market that is slowly becoming more receptive to processed meats. Smithfield's pork will still need to clear quarantine inspection, whoever owns its stock, but Shuanghui can be counted on to smooth its path and, crucially, to access retail channels where chilled meats are sold. Getting product on the shelves is half of the battle. Other U.S. pork exporters must be watching closely. So, too, will Shuanghui's rivals.