Marfrig (OTCPK:MRRTY) recently purchased, through an open auction, shares of BRF SA (BRFS). Before this operation, Marfrig only owned 4.9% of BRF SA, and now it owns 24.23%. Followers of BRF SA and/or Marfrig saw headlines of a merger between the two a couple of years ago, but it didn't pan out. This time I believe that there is a high probability that this will occur for the reasons that I will outline in this article.

O site Brazil Journal publicou mais cedo que a Marfrig já havia comprado 4,9% do capital da BRF e estava comprando ações adicionais do fundo de pensão Previ, mirando fatia de cerca de 20% na empresa.

The above sentence in Portuguese explains that there were rumors that Marfrig was attempting to buy shares of BRFS from the Brazilian Pension Fund "Previ" before purchasing shares on the exchange. "Previ" is a pension fund for Banco do Brasil employees and owned a little over 9% of BRF SA. Maybe you just noticed that I said owned; well turns out that the journalists were initially wrong. The truth is that "Previ" sold nearly 1/3 of its position to Marfrig, going from owning 9% to 6.04% of BRFS.

Not Their First Rodeo

As I said earlier, this is not the first time investors of Marfrig and BRF SA have heard the word merger. On May 30th of 2019, both companies signed a Memorandum of Understanding stating that both parties would explore the possibility of a merger over the next 90 days. A few months later, both parties terminated the negotiation. According to both companies, they could not reach an agreement on who would govern the new organization.

At the time of this proposed merger, a Seeking Alpha contributor Stephen Simpson wrote an article on this proposed merger. In his article, he stated something that I feel was one reason the merger didn't occur. "I don’t exactly hate the idea of BRF+Marfrig on a long-term basis, but it seems like a big swing for BRF management to take when there are still a lot of things within BRF that need fixing."

In 2019, BRF SA was still recovering from years of poor results, its involvement in the scandal "weak meat" ("Carne Fraca"), and very public management disagreements between Abilio Diniz and other shareholders. Diniz's fund Península and a Private Equity fund called Tarpon, which backed Diniz's Board position in BRF SA, liquidated their positions in the company. This left the pension funds "Previ" and "Petros" as the largest shareholders still in the company.

Around the same time, BNDES (Brazil's National Development Bank) liquidated its position in Marfrig due to new political policies. Also, Marfrig's results were not good in 2018, and the company was highly leveraged.

What Makes This Time Different

1. Marfrig's current ownership of BRF SA.
   1. In 2019, the only thing connecting the two companies was a memorandum of understanding that said the companies would study the possibility of a merger.
   2. Marfrig is now the largest shareholder of BRF SA.
2. Pension Funds' strategy at the time.
   1. "Petros" sold a small percentage of its shares of BRF SA last year, and now it owns a little less than ten percent when it did own a little more than eleven percent.
   2. "Previ" sold a part of its shares to Marfrig last Friday, somewhat of a signal of accepting the merger idea.
   3. Both funds have been invested in BRF SA for some time now, and they may want to realize some of their profit.
3. Marfrig's operation in 2018 vs. 2021
   1. In 2018, Marfrig owned brands that competed with Sadia and Perdigao (brands owned by BRFS).
   2. Now Marfrig is exclusively a producer of beef-based products.
   3. BRF SA purchases already processed beef from other companies as their beef operations are almost nil.
   4. The probability that the Brazilian government will approve the merger is greater now than it was.

Conclusion

From a balance sheet perspective, a merger of the two will benefit more Marfrig than BRF SA. Currently, Marfrig's debt to equity is 7.4x, and BRFS's is 2.9x with combined leverage of around 4.4x. The new company would be better positioned to compete with global players like JBS SA (OTCQX:JBSAY) and Tyson (TSN) if the merger does occur. There is a long list of possible synergies such as shared logistics, lower COGS on beef-based products, and shared administrative resources, to name just a few.

In my opinion, Marfrig has the most to gain from this merger. Historically I have been very bearish on Marfrig due to its dependence on beef products which is very cyclical. As for BRF SA, I have mostly been bullish as I am bullish on the process food industry here in Brazil.

Before I recommend buying, selling, or holding, I want to see what the new company will look like and who will be operating that new company. I do believe you should follow BRFS and Marfrig because if the two are correctly managed, there should be no reason why they couldn't dominate the Brazilian processed food industry.