Bayer may need to top up offer for Monsanto – analysts

LONDON (ICIS)–The agrochemicals mergers and acquisitions (M&A) frenzy reached new heights on Monday when German Bayer offered to pay $62bn for US agrochemicals major Monsanto, but analysts warned the offer might not be enough to convince management and shareholders.

If that is the case, some analysts have pointed to German chemical major BASF still as a candidate to enter the race although others point to the unlikelihood of that given the company’s current stretched finances.

Earlier on Monday, Bayer made public the terms of its offer to acquire Monsanto, as well as the friendly letter the German firm’s CEO sent to his peer at Monsanto on 10 May.

“Dear Hugh [Grant, Monsanto’s CEO]… Given the significant time and resources we have already devoted to analysing this potential combination [of both companies], we can complete this process quickly, with minimal disruption to Monsanto’s business or its employees,” said the letter.

Advised by major banks BofA Merrill Lynch and Credit Suisse and global legal firms Sullivan & Cromwell and Allen & Overy, Bayer has already done all the maths and thinks with an offer of $122 per Monsanto share – a 37% premium over the 9 May closing price of $89.03 – management could give its green light to the transaction.

But other options could also be on the table. According to Ulrich Huwald, analyst covering Bayer at Germany-based Warburg Research, management could reject the current $122/share offer and Bayer might choose to go hostile, addressing Monsanto’s shareholders directly and trying to lure them with more money.

“I think if management was to reject the current offer, they [Bayer] would pursue it further and increase the offer slightly, although there is not much more room for improvement, even if they were able to finance it. All in all, the current offer is a good offer,” said Huwald.

The financials of what would be the largest German acquisition yet are being scrutinised by Monsanto management since the letter sent on 10 May and, since Monday, by analysts and investors and among the former there are voices who think the transaction would still represent a “financial stretch” which could put Bayer’s balance sheet under large pressure.

“We think the current offer price ($122, 35% premium) is not high enough, and at least $135 (50% premium) is needed to get the deal done. The additional $6bn (€5.5bn) cash offer will have to be raised through equity raise,” said chemical analysts at global consultancy Bernstein Research.  

The additional $6bn to be raised for a $135/share offer would be added to the already $15bn raised for the initial offer, said Bernstein, with the $38bn remaining coming from debt – loans and bonds.

Bernstein’s analysts went on to say such a financing would push Bayer’s net debt ratio to earnings before interest, taxes, depreciation and amortisation (EBITDA) to 4.9 times including pension liabilities. Normally, a healthy net debt to earnings ratio is considered to be 3 times or less.

“Yet the company has been very clear that they expect to maintain their investment grade rating with this structure (A to BBB). To us this seems a stretch even with a good plan to de-lever,” said the analysts at Bernstein.

If Monsanto was to be integrated under Bayer’s umbrella, Bayer CropScience would account for 50% of the German major’s business, a move which some analysts – echoed by investors, who have punished Bayer’s shares since 20 May when its intentions were announced – see as a problem: those investors who thought Bayer Life Sciences – the pharmaceutical division – was the main growth driver might be scratching their heads now.

Buy pharma, get a major seeds and crops supplier.

The analysts at Bernstein said the company might be lagging behind in the pharma race for future drugs in key areas like cancer, arguing they are “less sure the company have enough in the pipeline” while Warburg’s Huwald agreed investors who bought Bayer thinking about pharma might be quite disappointed now.

Bayer’s shares were trading at €86.62 on Monday midday in London, down 3.26% compared to their close on 20 May. On that day, the stock had already fallen 7% following the company’s disclosure it had had conversations with Monsanto for a potential acquisition.

While genetically modified crops is a key product among Monsanto’s offering, most of the EU forbids their use and Bayer’s reputation to the wider public might take a hit if it was to acquire a company which has come to represent, in the eyes of environmentalists and consumer groups, an enfant terrible of agrochemicals.

Some European analysts have pointed to Monsanto’s “behaviour” regarding those practises potentially improving in the future following a Bayer acquisition.

“Long-term consumer resistance to genetic modification could hamper growth potential as well as any changes in regulation. Delay of product launches could have a similar effect,” said Bernstein, citing potential hurdles ahead for the combined business.

Finally, if Monsanto’s management was to reject the current offer, would German chemical major BASF – also with agrochemicals operations – try to enter the race, so it can keep up a leading position in the field?

Most analysts agree if Bayer/Monsanto become one company, BASF would stand in a distant fourth place among the agrochemicals players globally, far from a “leading position”.

However, BASF fortunes have turned quite negative in the last 12 months, and currently would not be the time to acquire big as earning have been taking a hit due to lower crude oil prices.

“We are talking about a BASF which currently faces a massive shortfall in earnings and income due to very crude low oil prices, and the company is highly dependent on the earnings stream from oil and gas to come up with a decent EBITDA every year,” said Oliver Schwarz, analyst covering BASF at Warburg Research.

“BASF is able to generate EBITDA close to €10bn annually, but we are talking here about an acquisition which would be close to $70bn – that’s a huge difference,” he added.

Focus article by Jonathan Lopez