Image Source: Aqua Mechanical
After Monsanto (MON) COO Brett Begemann called any takeover talks “wild speculation” just a week ago, German health care and agricultural product firm Bayer (BAYRY) on May 23 officially confirmed that it has offered to acquire US seeds company Monsanto for $62 billion in cash, or $122 per share. Monsanto’s shares continue to trade at a discount to the disclosed price in light of the uncertain path to deal completion.
The proposed offer represents a substantial premium to Monsanto’s May 9 closing price of ~$89 and our standalone fair value estimate in the low $90s. At a deal multiple of nearly 16 times Monsanto’s trailing EBITDA and one far above our fair value estimate, Monsanto shareholders are getting a great price. Bayer expects the deal to have total (annual) synergies of $1.5 billion after the third year after closing, making the deal worthwhile to pursue for the German giant, in our view. We will update our valuation of Monsanto accordingly to account for the incremental information and expect a probability-weighted fair value outcome.
The economics of the transaction make a lot of sense. Bayer anticipates core EPS accretion in a mid-single digit rate in the first full year after closing and double-digit accretion after the first year. The German giant also expects a significantly improved agriculture R&D pipeline as a result of the deal, which has been a main driver behind consolidation across the agricultural chemicals industry as of late, “Corporate Shopping This Holiday Season (December 2015).” Monsanto, itself, recently rescinded a bid for Syngenta (SYT), initially offering to buy the firm in August 2015, Dow Chemical (DOW) and DuPont (DD) have agreed to merge before splitting into three separate firms, and Syngenta has now agreed to be acquired by ChemChina. The wheeling and dealing has come as no surprise, as we outlined in our work late last year:
According to Monsanto CEO Hugh Grant, “everybody has been talking to everybody.” We think this speaks to the threat of ongoing weakness in demand for crop protection products as a result of falling grain prices and farm income. According to the Food and Agriculture Organization of the United Nations, the rate of growth in world demand for agricultural products has slowed, and the pace of expansion is expected to continue to weaken. By extension, demand for crop protection products may remain suppressed, to a degree, stimulating deal-making across the space in search of driving bottom-line growth through cost cutting endeavors.
Whether or not these deals will make it over the necessary regulatory hurdles is something we’ll be watching closely, and regulators in the US especially have been cracking down on major mergers as of late, not only related to tax inversions (PFE-AGN), but also of the anti-trust variety (ODP-SPLS, BHI-HAL). Bayer’s expectations for strong free cash flow generation following the deal lead it to believe the combined company will still garner an investment grade credit rating immediately after closing, and we wouldn’t expect the company won’t be able to meet that internal goal in light of the financial flexibility it retains. Rapid debt deleveraging after the transaction will be in line with the firm’s commitment to achieving a single ‘A’ category credit rating over the long haul.
All things considered, we aren’t expecting consolidation talks to slow anytime soon as agricultural chemicals firms continue to search for growth in a maturing industry. We believe that BHP (BHP) may be increasingly more active in the space, and we wouldn’t expect to see its interest in Potash (POT) reignited in light of continued malaise in the iron ore markets. Air Liquide’s recent acquisition of Airgas (ARG) may mean that other industrial gas plays Air Products (APD) and Praxair (PX) are being looked at by foreign suitors as we speak, and we can’t ignore that Intrepid Potash (IPI), now teetering on bankruptcy, may be attractive to a buyer that wants to use the Chapter 11 courts to rightsize costs and production. Even if one or more of the many deals proposed in the agricultural chemicals space falls through, it is likely that another proposition may take its place, as we saw recently with the Syngenta situation.
We’re keeping a close eye on further developments in the space.