The real reason behind Shuanghui's purchase of Smithfield

June 4, 2013: 10:42 AM ET

It's not just a combination of property rights and market demand -- environmental factors are the impetus behind the deal.

By Minxin Pei

130529083451-smithfield-foods-620xaFORTUNE -- A week after the announcement that Shuanghui International, China's largest pork producer, has struck a deal to purchase Smithfield, the largest U.S. pork producer, for $7.1 billion (including debt), the development is still being digested. Many theories have been advanced to explain the deal -- which is so far the largest acquisition of an American firm by a Chinese company. Some people see this move by Shuanghui, a private firm based in Henan, as a masterstroke to expand its ability to supply a fast-growing market with premium-brand pork at higher prices. Some view the purchase as a means to acquire valuable hog-farming and processing technology. Others worry that Shuanghui might use Smithfield as a channel to sell its products in the U.S.

As with other Chinese purchases of American assets, this particular deal can be seen from several perspectives. Except for the understandable, but unfounded, fear that this transaction could open the door for unsafe Chinese food to find its way into American supermarkets, most interpretations manage to tell part of the real story. Yes, Shuanghui's acquisition will help increase its ability to supply China's market. But here we need to have some perspective. Per capita consumption of pork in China last year was 85.3 pounds, compared with 59.3 pounds in the U.S. When you factor in the difference in the size of each country's population -- 1.344 billion vs. 314 million -- the Chinese demand for pork is still about six times larger than in the United States.

In 2012, the number of hogs slaughtered by Smithfield, which has about a quarter of the U.S. slaughter capacity, would account for only 3% of China's slaughtered hogs. In other words, Shuanghui may be able to source more of its pork from Smithfield's modern, efficient, and safe pig farms and processing facilities, but the quantity that can be exported to China in the foreseeable future will be miniscule relative to the size of the Chinese market.

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What about taking advantage of Smithfield's technology and management? On paper, this is an attractive proposition. American pork farming is a consolidated modern industry with economies of scale. Eighty-seven percent of the pork sold in the U.S. is produced on big pig farms with more than 2,000 hogs. Such farms are climate-controlled and self-contained to minimize the spread of disease. By contrast, the Chinese pork industry is fragmented, small-scale, and low-tech. Seventy percent of the pork in China is produced by pig farms with 500 hogs or less. Hygienic conditions are often primitive.

However, transforming a Chinese pork producer like Shuanghui into a Smithfield faces two difficult hurdles. The first one is property rights. Land is owned by the state, and private property rights are insecure in China. Consolidating the hog industry in China, while technologically feasible, can be a legal and bureaucratic nightmare, even for an entrepreneurial company such as Shuanghui.

The second hurdle is practically insurmountable. Whatever technology one might want to use to make the Chinese pork industry more efficient, ensuring the safety of the feed will be almost impossible because of widespread pollution in China.

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This touches upon perhaps the real driver behind Shuanghui's acquisition of an iconic American food producer. It may be about all of the things mentioned in the intensive media coverage of the deal. But there is more.

When we exhaust our analysis, we should find that the most strategic explanation for this acquisition is China's environmental degradation. For years, observers have been trying to figure out the real-world consequences of the extensive pollution of air, water, and farmland in China as a result of its rapid economic growth. Various estimates have been used to calculate the economic costs and human toll of pollution (estimates of the costs of pollution range from 5 to 8% of GDP, depending on the value of a statistical life used for the exercise). Such numbers are shocking but abstract.

With Shuanghui's purchase of Smithfield, these numbers are less abstract. The real story behind this transaction is that far-sighted Chinese entrepreneurs fully understand that, because pollution has contaminated major parts of China's food chain, their future profit opportunities lie in buying the entire food-production process abroad. Bagging Smithfield, in this sense, is not about getting its hogs, pork-processing technology, or even premium brand. It is really about owning access to America's safe farmland and clean water supplies.

This strategic calculation is truly brilliant. Based on official Chinese data, more than two-thirds of its waterways are polluted. A sample study of farmland conducted in the late 1990s showed 10% contaminated with heavy metal. A three-year national survey of soil conditions completed in 2010 must have yielded such alarming data that the Ministry of Environmental Protection declared the data a "state secret."

Given the fact that cleaning up land and waterways despoiled by heavy metal and other carcinogens requires huge amounts of money and takes a long time, buying food producers that own their land and have access to safe water supplies is a far more attractive proposition.

If this analysis is correct, the Shuanghui purchase of Smithfield is a harbinger of things to come. Pressured by the catastrophic consequences of environmental degradation, Chinese food producers will have no choice but set their sights abroad. No doubt, this will present great business opportunities for many, but a rapid increase in Chinese acquisitions of food companies overseas will almost certainly create tensions between China and the rest of the world. Sadly, there are no good policies in place to address this challenge.

Minxin Pei is the Tom and Margot Pritzker '72 Professor of Government at Claremont McKenna College and a non-resident senior fellow of the German Marshall Fund of the United States

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