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China’s Pork Deal May Hinge on the Risk for an Uproar

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Who knew that pork could be a national security problem?

That may be the case with the $4.7 billion offer from Shuanghui International of China for Smithfield Foods. The deal will be subject to a national security review by the Committee on Foreign Investment in the United States, or Cfius. There are important implications not just for pork but for how Washington looks at Chinese investment.

Shuanghui's proposed purchase would be the largest Chinese acquisition of an American company, so it is bound to receive intense scrutiny. Shuanghui was not required to submit to a review, but that would have been foolhardy given the size of the deal and the money at stake. The decision also means that the United States government cannot come back later and undo the transaction once the committee approves it.

To understand what will happen next, it is important to understand the sometimes dry history of the national security review.

The Committee on Foreign Investment has its origins in the 1980s when the United States feared not investment from China but Japan. In 1987, Fujitsu, a Japanese company, tried to acquire the 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." The law is administered by the committee.

In 2011, according to the most recent data available, 111 review notices were filed with the panel, 40 were investigated and 6 deals were withdrawn.

The law came under a spotlight in 2007 during Dubai Ports World's proposed acquisition of Peninsular and Oriental. Dubai Ports is in the United Arab Emirates, one of the United States' strongest allies in the Middle East.

The supposed threat of a Persian Gulf country's operating ports in the United States pushed Congress to pass the National Security Foreign Investment Reform and Strengthened Transparency Act. The bill strengthened and broadened the review process, adding critical infrastructure and foreign-government-controlled transactions as factors for consideration.

Reviews have centered on four categories of companies: manufacturing, finance and information services, mining and construction, and transportation.

(Read More: Chinese Purchase of Smithfield Unlikely to Sway Bacon Buyers)

In the case of the deal for Smithfield, the product is pork, and it is unclear whether the panel has ever examined such a transaction.

The review is likely to cover three categories. First, it is likely to look at any contracts Smithfield has to supply pork to the military or other security agencies. Second, it is likely to examine any special technology like farm-rearing techniques that might be transferred to China. Finally and perhaps most relevant, there is the food supply chain itself and whether Shuanghui will be in a position to disrupt the United States' food supply — or at least the supply of pork.

It is the issue of food supply protection that most experts believe will probably get the bulk of the attention of the committee.

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Shuanghui bolstered its case by announcing plans to keep Smithfield's operations in the United States under current management. It is hard to see the risk to the supply chain in such a circumstance.

Indeed, beyond giving the deal a good hard look, it is difficult to see the committee blocking the sale of Smithfield. At first blush, it seems likely that the panel will order Shuanghui to adopt protections to prevent the transfer of technology or of control over certain parts of the business dealing with the government, but that is probably all.

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 fee of $275 million if its financing falls through.

And while the acquisition agreement requires Shuanghui to take steps to resolve the government's national security concerns, Shuanghui does not have to take any steps, like selling parts of Smithfield, that would have a material impact on Smithfield.

The language in the agreement suggests that Smithfield didn't think that the review would raise significant problems. Alas, Smithfield may have been too optimistic.

The Chinese have not done a bang-up job managing their food supply, and the recent, vivid images of 16,000 dead pigs in the Huangpu river is not great public relations for this acquisition. And let's face it, these days, the perceived foreign threat is often China.

There is the possibility that the same kind of hysteria that drove Congress to act after the Dubai Ports deal may arise here. Adding to this mix is the fact that the committee has been focused on deals involving Chinese companies, even recently forcing the divestment of a Chinese deal for four United States windmill farms because they were too close to a military base.

Given that this is one of the first agriculture deals under review, the committee is also likely to be careful. It may take its time in setting a broad policy. And any decision will most likely apply to Chinese deals generally.

It's a volatile mix that has the potential to place this deal in the regulatory spotlight. The risks are mitigated by the fact that the process is supposed to be free from politics.

Yet while politics can't overtly enter the process, it is possible that an outcry could spur the committee to take a harder line with Shuanghui. There is also the possibility of Congressional action.

In the end, the biggest danger boils down to this "uproar risk." In other words, will there be a public outcry about China and food that leads the committee or Congress to act as something other than a neutral regulator?

For Smithfield, the hope is that clear thinking prevails.