By Megan Bowman, UNSW

SYDNEY: 14 June 2013 - On 29 May 2013 Smithfield Foods, Inc. (Smithfield) and Shuanghui International Holdings Limited (Shuanghui) announced a merger agreement, unanimously approved by both boards. US-based Smithfield is the world’s largest pork processor and hog producer, and one of the biggest and oldest pork producers in the US. Hong Kong-based Shuanghui is the majority shareholder of China’s largest meat processor, Henan Shuanghui Investment & Development, which is publicly listed on the Shenzhen Stock Exchange. The total proposed deal is valued at US$7.1 billion, pursuant to which Shuanghui will pay $34 per share and assume Smithfield’s debt. In short, it represents the largest potential Chinese takeover of an American company.

Not surprisingly, the proposed deal has received significant media attention in recent weeks and will undergo review by the US Committee on Foreign Investment (CFIUS). The CFIUS regime is contained in s721 of the US Defense Production Act 1950 and the decision process (including Presidential intervention) arises from the 1988 Exon-Florio Amendment to the Omnibus Trade and Competitiveness Act 1988 and its subsequent amendments. Shuanghui voluntarily filed for CFIUS review, which has the advantage of creating an expectation that the deal will be exempt from further review once approved (ss 721(b)(1)(D). It also indicates a healthy degree of caution and genuflexion by Shuanghui in a politically-charged China-US investment environment at present.

CFIUS has mandate to review the effects of proposed foreign investment on national security (s721(b)(1)), which extends to critical infrastructure and technologies (s721(a)). Acquisitions that trigger CFIUS review are ones that ‘could result in a foreign person controlling a person engaged in interstate commerce in the United States’ (s721(a)) and CFIUS reviews tend to focus on four categories, being transportation, manufacturing, mining and construction, and finance and information services. Deals relating to agri-business, food supply, or the humble porkchop are not specifically mentioned in the mandate of CFIUS. Nonetheless, its jurisdiction is necessarily broad to satisfy the non-specific nature of ‘national security’.

A number of recent reports on the CLMR Portal have documented political antipathy by US politicians toward Chinese corporate investors on the basis of supposed threats to national security (see for example, CLMR Director Justin O’Brien’s articles on Huawei, and Greg Golding’s pieces on Sany Corporation and the proposed SoftBank/Sprint merger). Yet the Smithfield proposal bears little resemblance to these previous proposals for three key reasons: first, the subject matter lacks the sensitivity of its predecessors; secondly, the purpose of the deal is to open Chinese import markets to benefit US business, not the reverse; and thirdly, Shuanghui is not a state-owned enterprise (SOE). Indeed, it was originally created as an SOE 20 years ago; however Goldman Sachs and CDH Investments (a leading private equity firm in China) bought out the government’s interest several years ago for over US$100 million.

However, Smithfield (not Shuanghui) has enjoyed a direct vendor relationship with the US Department of Defense and may also have subcontracted to food service companies that supply that Department and other government agencies. Given the breadth of Smithfield’s product reach across the US, this situation is arguably unsurprising. Nonetheless, the deal raises potential national security concerns regarding: locations/staffing of US government facilities; and whether the takeover places Shuanghui in a position to disrupt food supply in the US.

Undoubtedly for these reasons, the Smithfield/Shuanghui merger media release employs language and concepts designed to assuage public and political concerns. For example, it makes explicit the commercial ‘supply-demand’ purpose of the deal, stating that “together we will be able to meet the growing demand in China for pork by importing high-quality meat products from the United States”. Importantly, the media release makes clear that Shuanghui’s intentions are not only benign but also beneficial for US business: “Shuanghui is committed to…continuing to work with American farmers, producers and suppliers who have been critical to Smithfield’s success” and it will be “business as usual – only better – at Smithfield. We do not anticipate any changes in how we do business operationally in the United States and throughout the world”.

Indeed, Smithfield’s CEO, Larry Pope, is clear about the non-threatening nature of the deal: “We’re not exporting tanks and guns and cyber security. These are pork chops,” he said in a recent media interview. Nonetheless, given that (a) this is one of the first agriculture deals to be reviewed by CFIUS and (b) it represents the largest Chinese takeover in America thus far, CFIUS will undoubtedly be highly considered in reaching a decision. Importantly, its decision will likely set policy for Chinese deals generally in the US, and may also influence policy decisions in other Western jurisdictions such as Australia.

The significance of this case and its implications for global markets and state capital cannot be overstated, particularly in light of recent OECD/FAO predictions.

The international Agricultural Outlook 2013-2022 report is set to be released on 26 June 2013, and China is its special focus. The report is a collaborative effort of the OECD and the United Nations Food and Agriculture Organization (FAO) with assistance from the Chinese Ministry of Agriculture and the Chinese Academy of Agricultural Sciences and contains projections of production, consumption, stocks, trade and prices for agricultural products for the period 2013 to 2022.

Although the full report is not available until the end of the month, the OECD/FAO pre-released a ‘Highlights’ teaser (the Report) last week, which sets out key data and analysis in Chapter 2 titled ‘Feeding China: Prospects and challenges in the next decade’. A clear message is the increasing symbiosis between global markets and China’s appetite and output: “With one-fifth of the world’s population, high income growth and a rapidly expanding agri-food sector… [d]evelopments in Chinese agriculture may have a major influence on world markets.” (p.9)

The Report predicts that although China should remain self-sufficient in the main food crops (such as rice and sugar), overall agricultural output growth from China will slow in the next decade even as Chinese demand rises due to a rapidly growing and urbanizing population. Specifically, the report asserts that while “the success of China’s agricultural sector has been remarkable” to date (p61), output will likely slow in the next decade due to increasing resource constraints on production, land degradation and water depletion, and greater production variability due to climate change.

Part of the issue is that China now lacks the rural workforce needed for more complex large- scale farming operations; its rural sectors have been drained of modern, skilled agricultural workers due to land tenure policies and higher urban wages. Moreover, there are serious constraints to any further expansion of agricultural production. Increased urbanisation will likely limit the usage of arable land and the quality of extant cultivated land is deteriorating. The Report makes the situation clear: “Affected by global warming, reduced rainfall, depletion of surface runoff and groundwater levels, the northern region, especially the northern farming and animal husbandry areas, faces very serious soil wind erosion and desertification problems.” (p65) Specifically, cereals productivity will likely decline, such as maize and coarse grains for livestock feed (p70). The Report concludes that the net result will be limited productivity within the decade, which will necessarily curb supply from China (p63).

Concomitantly, however, the rapid increase in China’s urban population will continue to impact on global food demand patterns. The Report projects a total population explosion to 1.392 billion by 2022, comprising a potential significant urban population increase (p63). And urbanisation has significant ramifications for food demand and global markets. Urban zones are associated with higher incomes and larger food consumption rates, including meat, dairy and fish. Indeed, while China is expected to remain the largest fish exporter and maintain its aquaculture leadership at 63% of global production, it is also predicted to become the world’s leading consumer of pig meat per capita, surpassing the European Union by 2022.

The result of reduced domestic supply and increased domestic demand is just simple economics: China’s policy choices will need to address domestic resource constraints, which necessarily entails higher foreign imports. The Report explicitly notes this choice set: “(a) import more meat, for example to contain environmental problems associated with livestock production and limit the growth in feed  requirements, and/or (b) lower competition for land and land stress associated with high intensity crop production by importing more coarse grain, to meet rising demand” (p84).

Such policy choices give strong impetus to China’s transition from export-driven economy to a consumer-based one in the next 10-30 years, an aspiration confirmed by China’s Prime Minister Li Keqiang last week during the Fortune Global Forum.  The opening of ‘soft resources’ commodities markets in China represents timely new opportunities for Western meat, dairy and grain producers. As I have documented previously on the CLMR Portal, along with CLMR colleague George Gilligan, recent reports have heralded the end of the mineral resources boom in Australia. Yet, due to increasing Chinese agricultural demand, ANZ Bank's CEO Mike Smith has predicted that “China is about to do for Australian farmers what it did for the country’s miners a decade ago” given Australia’s comparative advantage in the region and minimal logistics costs.

The question remains, however, whether these changes will be welcomed by foreign investment policymakers. Certainly, the outcome of the test case of Smithfield/Shuanghui may influence foreign policy in other jurisdictions that have demonstrated reticence toward Chinese inward investment. Yet, the OECD/FAO Report is optimistic; predicting that markets will become increasingly open and integrated within the decade. To this end, it contends that information sharing and policy cohesion “will be critical in best utilizing global resources to feed the world’s population sustainably in the longer term” (p87). While some market actors seem ready and willing to embrace this call to action, it remains to be seen whether policymakers will respond in kind. What is clear, however, is that the intertwining of food supply and Chinese investment issues will only gather momentum as the decade proceeds.