No Ratings Agency Endorsement on Smithfield China Buyout

Smithfield Foods, Inc. (NYSE: SFD) should be enjoying a nice day-after in the sun now that it has answered activist investors with a new buyout offer for the company. The problem is that China-based Shuanghui International, one of the top meat processors in China, is the acquirer and it is very hard to know how this company would be governed and how it would address persistent Chinese quality control issues. Then there is that pesky national security issue as well. Moody’s Investors Service has now even said that Smithfield is being moved into a category called “under review direction uncertain.”

Moody’s placed the long-term Smithfield debt ratings under this uncertain review status after the announcement of the $7.1 billion buyout. We now at least have the criteria for which direction this could go, or at least the suppositions for an upgrade or a downgrade. Smithfield’s ratings could be upgraded if the resulting capital structure and credit profile be stronger than Smithfield’s is currently. The flip side is that the rating could be downgraded if the transaction is financed largely with debt and at a burden on Smithfield creditors.

Its commentary from Brian Weddington, a Moody’s Senior Credit Officer, said, “We currently do not have sufficient details on the proposed transaction to understand the overall effect on the company’s credit profile, but it is likely to be significant.”

Moody’s went on to say that this review will focus on details of the merger agreement, the post-closing capital structure proposed for Smithfield, and the terms of related financing arrangements (as they become available). Moody’s will also assess the credit profile of Shuanghui and its likely influence on Smithfield’s future business profile.   What we find interesting is that the rating was already under investment-grade as the corporate family grading was Ba3 and the senior unsecured debt was B1 rated. On this, Moody’s said,

“Smithfield’s current Ba3 Corporate Family Rating reflects its global leadership in hog production and pork processing balanced against its single-protein focus that results in high exposure to commodity price volatility. The company’s key growth opportunities include expansion into global export markets, particularly in emerging markets, and further development of its processed and branded meats portfolio, which have greater profit margin potential.”

Smithfield shares are down 1.1% at $32.96, which leaves a 3.15% merger-arbitrage for investors. With no competing bidder exactly jumping up in the air and with a CFIUS review that has historically been critical of Chinese ownership of sensitive American assets, our only point we would make is that a 3% arbitrage spread might not be enough to reflect the inherent risks associated with a deal of this nature.

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