Who knew that pork could be a national security problem?
That may be the case with $4.7 billion offer by Shuanghui International of China to acquire Smithfield Foods. The deal will now be subject to a national security review by the Committee on Foreign Investment in the United States, or Cfius. It’s a review with important implications not just for pork, but how Washington looks at Chinese investment more broadly.
Cfius had its origins back in the 1980s, when the United States feared not China but Japan. This was the time when Japan was going to take over the world and Hollywood made some forgettable movies about it, including my favorite of the genre, “Gung Ho,†starring Michael Keaton about a Japanese takeover of a U.S. automaker.
In 1987, Fujitsu, a Japanese company, tried to acquire Fairchild Semiconductor Corporation. Congress responded by passing the 1988 Exon-Florio Amendment, which grants the president the ability to block or unwind a foreign acquisition if there is “credible evidence†that a “foreign interest exercising control might take action that threatens to impair the national security.†Cfius is the panel that administers this law.
The panel got off to a bang in 1990, when President George H.W. Bush ordered China National Aero-Technology Import and Export Corporation to divest Mamco Manufacturing, an American aerospace company. But after that action, Cfius became something of a sleepy backwater.
It reemerged into the spotlight in 2007, when Congress threw a temper tantrum over Dubai Ports’ proposed acquisition of Peninsular and Oriental. Dubai Ports is based in the United Arab Emirates, one of our strongest allies in the Middle East. But the supposed threat of a Persian Gulf country operating U.S. ports pushed Congress to pass the National Security Foreign Investment Reform and Strengthened Transparency Act. The bill strengthened and broadened the Cfius review process, adding critical infrastructure and foreign government-controlled transactions as factors for review.
Before this amendment, the Cfius review had also been voluntary. A foreign entity did not have to receive national security clearance, but if it did file for a review and was cleared, the president could not subsequently unwind the transaction. The 2007 amendments changed this voluntary mechanism, making a review mandatory when there is foreign government control or an acquisition of critical infrastructure.
The panel had already flexed its muscles, blocking a takeover of Unocal Corporation by Chinese oil producer CNOOC in 2005. But since 2007, Cfius has become even more important and has been largely focusing on China.
In 2011, 111 Cfius review notices were filed, 40 were further investigated and 6 deals were withdrawn during the process, according to the most recent figures available.
And the review process has had consequences in surprising ways. This year, for example, President Obama unwound the acquisition of four Oregon wind farms by a Chinese acquirer because they were too close to a naval base. The huge Chinese telecommunications company Huawei was also forced in 2011 to divest the assets of 3Leaf, a $2 million deal .
Huawei, by the way, has been a repeat target, having been previously being blocked from acquiring 3Com in 2008 and making investments in 2Wire and Motorola. And in 2009, a Chinese company was even prevented from acquiring a gold mine held by the Firstgold Corporation because it was too close to U.S. military bases.
These actions have deterred many a Chinese company looking to buy in the United States.
This brings us to Smithfield.
Shuanghui’s purchase is the largest Chinese acquisitions of an American company, so it is bound to receive a lot of scrutiny. In this case, the Cfius review process is voluntary - Shuanghui does not need to make a filing. But that would be foolhardy, given that such enforcement would come only after Shuanghui spent more than $4 billion to acquire Smithfield. Given the size of the transaction and the money at stake, Shuanghui really had no choice but to seek a voluntary pre-acquisition review.
Historically, Cfius review has centered around four categories of companies: manufacturing, finance and information services, mining and construction and transportation. In this case, the product is pork, and it is unclear whether the panel has ever examined a food manufacturer acquisition.
So this may be a first for Cfius, and any review is likely to cover three categories. First, it is likely to look at any contacts Smithfield has to supply pork to the military or other U.S. security agencies. Second, it is likely to focus on whether there is any special “pork†technology such as farm-rearing techniques that might be transferred to China. Finally and perhaps most relevant, there is the issue of the food supply chain itself and whether Shuanghui will now be in a position to disrupt the U.S. food supply (at least the food supply for pork and those who eat it).
It’s the issue of food supply protection that most experts believe will likely garner the bulk of the attention of Cfius.
Still, beyond giving the deal a good hard look, it is difficult to see Cfius blocking the sale of Smithfield. The panel may order that Shuanghui adopt some protections to prevent technology transfers or control over certain parts of the business dealing with the government, but that is likely all.
Examining the acquisition agreement for the deal, it appears that Smithfield agrees. Shuanghui does not have to pay a reverse termination fee if the transaction is blocked for national security reasons, even though it does have to pay a reverse termination fee of $275 million if Shuanghui’s financing falls through and the deal collapses. (The agreement is favorable to Smithfield in other ways, like including a “go-shop†provision that allows Smithfield to continue discussions with two other bidders. If a deal is reached with either of these bidders, then Smithfield has to pay a termination fee of only $75 million.)
And while the acquisition agreement requires Shuanghui to take steps to satisfy Cfius of any national security concerns, Shuanghui does not have to take any steps, such as a divestment of parts of Smithfield, that would have a material adverse effect on Smithfield. It also means that Smithfield likely didn’t think that this review would raise significant problems.
Smithfield may be too safe in its assumption.
The Chinese have not done a bang-up job managing their food supply and the recent, vivid images of 16,000 dead pigs floating in the Huangpu river is not great public relations for this acquisition. Still, Shuanghui has announced plans to keep Smithfield’s operations here under current management. It is hard to see the risk to the supply chain in such a circumstance. Nonetheless, there is the real potential that the same hysteria that drove Congress to act over Dubai Ports may arise here.
In addition, given that this is one of the first agriculture deals Cfius will be reviewing, it is going to be careful in setting an initial policy. It may decide to err on the side of caution or least to take its time in setting broad policy of how to deal with these types of acquisitions. And any policy choice will likely apply to Chinese deals generally.
These risks are mitigated by the fact that the process is very much a regulatory one that by law is supposed to be free from politics. This means that those hoping that Washington might trade approval for this deal for more access to China are going to be disappointed.
Still while politics can’t overtly enter the process, it is possible that an outcry could spur Cfius to approach this deal in a different way and take a harder line with Shuanghui. It’s a real risk, though maybe not a huge one.
In the end, the biggest danger boils down to “uproar risk.†In other words, will there be a public outcry about China and food that leads to Cfius or Congress acting? These days it is not hard to see the public getting worked up over a controversial issue, but this is a risk that Smithfield likely took, because after all this is an American not Chinese problem.
For Smithfield, the hope is that clear thinking prevails.
