A quiet small town in Virginia with a history that dates back to pre-Revolutionary colonial times is the setting for what will be a “leading global pork enterprise,” quite possibly the largest this side of the U.S. Congress.
Smithfield, Virginia is home to Smithfield Foods, whose management recently announced the firm’s merger with China’s Shuanghui International Holdings Limited. Calling it a merger is technically accurate, but it is equally accurate to describe it as the sale of Smithfield to Shuanghui, since the Chinese firm “will acquire all of the outstanding shares of Smithfield at $34 per share in cash.”
Smithfield is a large, successful company, and the purchase price, which works out to $7.1 billion — $4.7 billion in cash plus the assumption of $2.4 billion in debt — is approximately two times the U.S. firm’s equity and just under twenty times its 2012 net earnings.
The sale of Smithfield has several interesting economic dimensions, the first stemming from the company’s organizational structure. It is what economists call “vertically integrated,” to a degree not often seen in today’s corporations.
Smithfield insures its product quality by controlling every stage of production, processing, marketing and distribution. It is a textbook example of how this quest for control can be combined with success and undoubtedly one of the most remarkable instances of vertical integration since Ford Motor Co.’s Rouge River Plant in Dearborn, Mich.
Ford’s manufacturing plant took eleven years to build and when completed in 1928 was a technological and organizational marvel, a factory that generated its own electric power, whose raw materials arrived at its own docks, were transported on its own railroad and were refined and fabricated into finished automobiles.
The Rouge River Plant eventually aged beyond economical repair, and its foundation of vertical integration no longer fit into today’s ideas of manufacturing, outsourcing, branding and corporate structure. It especially did not fit into the world of modern corporate finance with its “make money without actually doing things” philosophy. The last automobile production line in 2004 at “The Rouge” turned out Ford Mustangs, a fitting last act for an iconic American manufacturing plant.
There is little doubt that Smithfield’s experience and success in creating and managing a vertically integrated food products organization was a significant part of what Shuanghui wanted to buy. Its chairman, Wan Long, said that his company “will gain access to Smithfield’s best practices and operational expertise.”
Shuanghui has experienced some large food safety problems that have sullied its domestic and global reputation. Smithfield’s management can obviously be of help in restructuring its quality assurance and product flows. Additionally, though, teaming up with a U.S. firm which enjoys an earned and enviable reputation here and abroad would add credibility to Shuanghui’s effort to straighten itself out.
Smithfield’s experience isn’t the only factor in the purchase. Wan Long acknowledged that “importing high-quality meat products from the United States” was also a goal.
The benefits of this sale would go to Shuanghui, who is paying for them, and to the Smithfield shareholders who get the cash. There are other economic consequences, though, which are worth considering.
First among these consequences are the costs to American consumers. Increasing exports of pork to China will very likely raise prices in the United States. Normally increased exports of food would be an unalloyed good thing, because the increased output needed would be met by increased production — more jobs, more profits, but not necessarily any price increase.
In the case of U.S. pork, though, despite the decline in domestic consumption over the past few years, production remains at the point where environmental mitigation costs are a significant factor and increased production will in all likelihood mean increasing marginal costs. In the end, American consumers will end up paying more and, in a present value sense, underwriting a portion of Smithfield’s sale price.
The value of a brand is also playing a part in this proposed U.S.-China deal and it certainly is at risk. On paper, the Smithfield name will boost Shuanghui’s reputation while it improves its quality assurance. In demonstrably inept hands, though, the value of this boost would be short-lived.
The record of mergers and acquisitions is not at all encouraging in this regard; most of them fail. How this one will play out, taking with it the ultimate fate of the Smithfield name, though, is still a matter for speculation.
Sales of American icons to overseas investors aren’t surprising, for they are the by-product of a monetary policy based on maintaining artificially low interest rates. These magic rates lower the market value of the U.S. dollar, encouraging exports, but also undervalue U.S. assets such as real estate and business enterprises. This should bother us. Maybe someday it will.
James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Herald Business Journal.
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