Poor safety standards at China’s mega-farms are threatening investors with a crisis. But the potential returns earned by improving meat production processes provide an opportunity of the same scale.
In 2002, eager to combat the systematic use of antibiotics amid a rise in bacterial resistance, France launched a media campaign with a catchy motto: “Les antibiotiques, c’est pas automatique” (“antibiotics are not automatic”). National consumption dropped by nearly 30 percent, and anyone who was more than four years old at the time still remembers it today.
This week the Farm Animal Investment Risk and Return initiative sought to convey a similar message. In a report underlining the risks posed by antibiotics overuse at Chinese factory farms, it said the global agriculture supply chain – and the investors standing behind it – could face “financial food poisoning” if they didn’t face up to the hygiene challenges caused by the explosive growth of Asia’s meat industry.
Food safety issues are not unique to Asia (Brazil recently went through a meat crisis of its own) or indeed emerging markets (witness Europe’s recent egg scare). But they are especially prevalent there, because rising demand for meat means a wave of small, undercapitalized producers is growing very fast. That leaves their immature logistics processes unable to catch up. The consequences are regularly exposed in graphic terms: in 2013, 16,000 dead pigs were found floating in the Huangpu River, which supplies Shanghai with drinking water.
Left unchecked, fast-paced industrialization carries major risks for investors exposed to Asia’s agribusiness. Most obvious is the immediate impact on portfolio companies’ balance sheets, resulting from lost sales and spoiled merchandise. Equally ominous is the reputational risk associated with major food scares: customers continue to avoid a tainted brand long after its products have become safe again.
But a third risk, less often discussed, can also inflict serious damage to investors – the threat of regulatory backlash. The Chinese government is especially sensitive to food safety, because a string of scandals since the late 2000s, from adulterated baby milk to expired beef and chicken, has made such issues deeply political. “There is tremendous suspicion and concern around food among China’s rising middle class,” says Melissa Brown, a partner at Hong Kong-based advisory Daobridge Capital.
“China is particularly active in regulatory measures that will be focused on foreign, truly big companies. It’s a strategy that many people are familiar with: you go after the big kids that you can make an example of,” she adds. Understandable from a political point of view, the move also makes sense from a policy perspective: Beijing generally hits hard at the companies that have more capacity to invest around a solution.
Luckily, this is precisely where Asia’s biggest agri opportunity lies. Weaning the industry off antibiotics is a very big deal, and “there’s not enough capital looking at it,” a US investor told us this week. “Using data to make crops more efficient is going to change things but on a marginal basis. It’s when the industry moves away from antibiotics that we’ll see a gigantic transformation.” A broader move towards quality, Brown adds, is a big part of Asia’s “value proposition.”
For investors, the dividends of improving standards go beyond fostering customer loyalty. Nudging portfolio companies toward better practices can allow them to unlock lucrative new markets: KKR-backed COFCO Meat was chosen as the official meat supplier of the country’s Olympics delegation in recognition of the “safety and quality” of its products, according to its 2016 IPO prospectus. Crucially, better standards also open up the ability to export – a chief motive behind Navis Capital Partners’ 2013 acquisition of Go Dang, a Vietnamese seafood processing business, for example.
A number of buyout giants understood this opportunity early on. KKR earned a 2.9x return when it exited China Modern Dairy in 2013, having bought it as the adulterated milk scandal was at its peak. Carlyle and Zhang International Investment pocketed $1.6 billion soon after when they sold baby-formula producer Yashili International to China Mengniu – the same group that had bought KKR’s Modern Dairy. Private equity firms capable of derisking food businesses will often find themselves catering for a hungry market.
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