BRFS: Merger approved - Full steam ahead

The BRFS merger was approved with concessions.

Overall, only 13% of the merged company will be impacted by the concessions.

Full steam ahead.

"BRASILIA, July 13 (Reuters) - Brazilian antitrust regulators gave their support on Wednesday to a deal that saves the merger that created processed foods company Brasil Foods.

Antitrust watchdog Cade endorsed a plan by which Brasil Foods SA (BRFS3.SA)(BRFS.N) will sell 80 percent of flagship brand Perdigao's production capacity and halts the sale of some of its products for between three and five years.

The agreement averts a forced breakup of Brasil Foods, the Sao Paulo-based processed foods giant spawned from the 2009 takeover of debt-ridden Sadia by smaller rival Perdigao. Cade had threatened to derail the merger, citing Brasil Foods' dominance in several markets."

Brasil Foods : Suffering from turbulence

Brasil Foods is currently facing two major issues. The first is a rejection of the merger creating the company. The second is the ban of importing of Brazilian chicken into Russia. BRFS currently provids 40% of the chicken imported into Russia, and has a large presence in 40 other markets across the world.

Brasil Foods is currently facing regulator objection to the merger to create the larger company from the combination of Perdigao SA and Sadia SA. Apparently the Brazilian anti-trust regulator has rejected the merger for fear of price fixing in the domestic market do the potential dominance of the new firm on the basis of market share.

But the merger, arranged when Sadia had huge currency derivative contracts blow up on them for a $1B loss, was financed by the Brazilian government. So the same government that put up the money for the merger is now rejecting the combination. There are lots of variables on the motivation of the government, but what is obvious is that this merger is in line with the directive of the Brazilian government to create "national champions".

The regulatory finding is ... a rebuke to Brazil's strategy of using tax-payer money to form "national champion companies" that it hopes will project the country's rising economic power around the globe. Under an explicit strategy to bulk up Brazilian companies for global competition, Brazil's state development bank, BNDES, provided major financing to back the merger.

In fact, JBS, BRFS' main competitor, completed a similar deal last year between JBS SA and Bertin SA to create the world's biggest exporter of beef. The horse has left the barn, why try to close the gate now?

The author believes some compromise will be reached and the merger will go through with various concessions. It would be too painful to keep these companies after so much has been invested.

Regarding the Russian ban, a temporary affair. Russia has, without warning, banned Brazilian meat exports for periods of time on four different occasions in the last ten years. Each time, it has been proven that the "justification" for the ban was without merit. The author feels this will also be the case on this occasion.

The author still long BRFS.

Brasil Foods long

Brasil Foods S A is new company formed by Sadia and Perdigão. Peridigao is the second largest protein producer in Brazil and the tenth largest company in the country. Before running into trouble with currency derivative trades, Sadia was a very profitable protein exporter to 110 countries. The combination of the two companies joins to high growth entities in the Brazil domestic market and abroad.

The author sees tremendous upside in BRFS as Brazil expands and the global economy recovers. BRFS is the second largest exporter of meats in the world, and thus will benefit from even a muddling world economy.

The company sells at a 14B USD market cap, in line with 2009 sales. Yet the company reported in 3Q 2010 it is growing at an 8% rate and guided to grow at 10-12% in 2011 due to continuation of the global economic rebound.

Risks to this investment include a rise of the Brazilian Real or fall in the USD. Brazil is also tremendous exporter of commodities so economic deceleration in China or around the world could cause significant problems for BRFS.

But while the world is living on stimulus and papering over economic problems, I am long BRFS.

The author recommends buying BRFS at $15.8.