I've had a love/hate relationship with China's Zhongpin (HOGS) for some time now. I love emerging market food stories, and I believe ongoing consolidation in meat processing in China plays into this company's hands. What I don't love, though, is the company's ongoing capacity additions in an arguably already over-built market, to say nothing of the company's emphasis on selling through company-owned stores.
With Tuesday's developments, though, this story may be close to its final squeal.
An Appealing Bid …Maybe
Shortly after the open on Tuesday, Zhongpin announced that it had received a letter from the company chairman Xianfu Zhu offering to take the company private for $13.50 per share in cash. At the time of the letter, Mr. Zhu already owned more than 17% of the company's shares.
At this point, it's not clear if this bid is a viable offer. As Mr. Zhu's own letter acknowledges, he does not currently have the capital to execute the proposed transaction. While Mr. Zhu intends to to raise the funds, this seems like more of an idea than a firm offer at this point. What's more, he will need over $400 million to complete this deal and that could be challenging in an environment where Chinese banks have reportedly been cutting back on lending for "speculative" purposes. As Zhongpin stock is currently trading below $12, it's clear that the market has its doubts as to whether this deal will actually happen.
A Largely Fair Price
Should the deal go through as contemplated, Zhongpin shareholders are getting what looks like a fair price to me. Zhongpin recently seriously disappointed the Street with significant downward revisions to sales and margin expectations (relative to prior sell-side expectations), but the long-term prospects for this business still look attractive.
Were Zhongpin able to log multiple years of double-digit revenue growth and achieve a free cash flow margin of 4% around 2022, the shares should trade for around $13 per share today. Granted, a 4% free cash flow margin is a little robust compared with American protein producers like Tyson (TSN), Smithfield (SFD), and Hormel (HRL), but it's not so out of line when including other emerging market names like China Yurun and Marfrig.
Should Investors Hold Out For More?
Investors in Zhongpin have a difficult decision. As the fourth-largest pork producer in China (about one-quarter the size of Shanghui and one-third the size of China Yurun), there is definitely some growth potential here as incomes and meat consumption rise in China. What's more, companies like McDonald's (MCD), Wal-Mart (WMT), and Carrefour are listed as clients of Zhongpin and it's not hard to see how the company could grow with the support of big-name buyers.
Still, there is a lot of risk in these shares - not the least of which comes from its peers that seem willing to continue adding capacity irrespective of the economics. With China's government actively looking to reduce the number of small independents operating processing facilities (with an eye toward improving public health/food quality standards), there's incentive to get as big as possible as quickly as possible…and that's not good for anybody's margin.
As I see fair value of around $13 here, $13.50 would indeed be a nice takeout. The trouble is whether that deal is real. If I already owned these shares, I might be tempted to hang on - banking on either the deal going through, a competing offer coming in, or the the underlying growth potential of the business eventually leading to that target price. That said, don't listen to rumors about a company like Tyson or Smithfield stepping in - if a rival comes in with a competing bid, it will almost certainly be another Chinese company.
If I didn't already own the shares, I'd sit and wait. Yes, it's tempting to buy $13.50 shares for less than $12, but the risk of the deal falling apart (and the stock falling back into the single digits) should not be ignored. With more downside than upside with a proposal already on the table, I'd sit tight and look for better emerging market food stories today.