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Bayer: Baby Possibly Thrown Out With The Bath Water

Some are calling for heads to roll. With the acquisition of Monsanto, thus far perceived as disastrous because of the avalanche of legal claims alleging that Roundup causes cancer, Bayer has come to epitomize foolish dealmaking and large-scale shareholder value destruction.

But fears look overblown. In pharmaceuticals, the German group owns a peerless collection of assets in oncology, cardiology, women’s health and ophthalmology. Best-sellers include Xarelto, Eylea and Xofigo. Sales have been steadily growing and cash earnings — a.k.a free cash-flow — reach €3bn per year on a normalized basis.

Patent expirations entail a legitimate concern, so valuing the marketed portfolio at ten times earnings — a conservative assessment in every respect — should prove reasonable. On the research side, management expects the six most promising compounds — out of fifty under development, among which nine in late-stage — to deliver up to €6bn in revenues.

A multiple of four times these anticipated revenues — at the low range of comparable transactions in the private market, and counting all the other programs for zero — would value the pipeline at €24bn, or just twice the cumulated R&D spending over the last five years. Taken together, the portfolio and the pipeline would amount to €54bn in value for the pharmaceuticals segment.

Not unlike its peers, the animal health segment has shown modest growth over the long cycle. The markets it addresses remain stubbornly cyclical, while pricing power is scarce. Bayer ranks fifth in scale behind Zoetis, Merck, Boehringer Ingelheim and Elanco.

The industry is undergoing consolidation and Bayer’s business looks rife for a sale or a partial IPO, à la Covestro — see Covestro: Lies, Damned Lies & Valuation Ratios. In line with its historical performance, it delivered €360mil in earnings before tax, interest and amortization last year. A multiple of fifteen times EBITDA — again in the low range of comparable transactions — would amount to €5bn in value.

The consumer health segment draws on a portfolio filled with over-the-counter blockbusters such as Claritin, Aspirin, Aka-Seltzer, Dr. School’s, etc. Following a bountiful era, sales reached a plateau and pricing wars eroded returns. There may be no easy way out.

Here, too, the industry is undergoing consolidation at forced march. Healthcare groups divest their troubled OTC businesses to the profit of Unilever, Reckitt Benckiser or P&G, among others. A multiple of fifteen times EBITDA — still way below private market’s averages — would amount to €15bn in value, akin to more or less thirty times the segment’s free cash-flow.

Finally, despite hefty restructuring costs, the crop sciences segment delivered €2.7bn in free cash-flow last year. A multiple of ten times earnings — which seems excessively cautious for this growing, high-return and oligopolistic business — would amount to €27bn in value, less than half what Bayer agreed to paid to acquire it from Monsanto.

Although the latter’s sulfurous reputation needs no introduction, farmers around the world keep using its seeds with unabated enthusiasm. Casual observers may be missing the big picture, or at least some parts of it.

Adding up the four segments gives a total asset value of about €101bn, from which we’ll subtract €17bn in net debt and provisions, as well as a 20% holding discount to account for potential litigations. Adjusted net asset value comes at €67bn or, split between the 980 million shares outstanding, €68 per share — versus a current price of €53.

This sum-of-the-parts assessment makes sense because Bayer will likely sell off assets in order to raise cash and deleverage its pressured balance sheet. Of course, the hypotheses laid out above are adjustable at will.

(No position.)

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