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Why Einhorn is Long Bayer With or Without Monsanto

Have Your Cake and Eat It Too – David Einhorn, Robin Hood Conference (11/28/16)

Background

  • Few years ago, I was bear on Bayer but today, I am a buyer of Bayer
  • Historically chemicals and pharma company, transforming into life sciences company
    • Spun off Lanxess in 2005 and is now shedding Covestro (remaining chemicals business)
    • In 2015, sold 31% of Covestro through IPO with plans to divest the rest
  • What remains is life sciences business with high barriers to entry and excellent competitive position; four divisions including pharma, crop science, consumer health, and animal health
  • 2015 total revenues of €3 billion; market cap of €73 billion and EV of €104 billion

Monsanto Acquisition

  • Market expected Bayer to further solidify pharma business but instead announced acquisition of Monsanto and market did not respond well
  • Bayer stock had been falling from mid 130s in July 2015 to about 100; couple late stage pipeline products disappointed and ag cycle weakness
  • When Bayer announced acquisition, stock collapsed to 85 or 11.3x earnings
  • Market is divided on the deal: some don’t like Monsanto and sold the stock and would be willing to buy back if deal breaks up; others like the pairing but see obstacles for deal to close and would like to buy when deal is consummated
  • Einhorn thinks latter scenario is a better outcome but he likes Bayer with or without Monsanto deal

Bayer

  • Key products from its pharmaceutical division are in growth mode and also has favorable patent cliff with nothing significant expiring for many years
  • Patent cliffs are not the same as key products are biologics which are difficult to reproduce and manufacturing of its cancer drug, Xofigo, requires access to nuclear facility (not just anyone can produce a generic)
  • Healthy pipeline with small opportunities which means earnings trajectory for the next few years is not dependent on clinical trial outcomes
  • Solid consumer business with brands like Claritin and Aleve; growing moderately and good margins
  • Small animal health business consisting of vaccines and antibiotics with low-to-mid single-digit top line growth and EBITDA margins of 23%
  • Crop business has grown at 40% from 2011 through 2016; focused on crop protection instead of seeds so relatively immune to current down cycle in agriculture
  • Bayer stand-alone trades at 11x 2017 earnings, which is a sizable discount to value of its lowest multiple ongoing business based on comps (consumer peers: 22x; crop peers: 20x; pharma peers: 14x; animal health peers: 21x); we think it’s cheap
  • Before the deal was announced, Bayer was trading at 14x; since May 2016, pharma expectations have improved and everything else is mostly unchanged but stock trades with a big penalty for the possible Monsanto deal

Monsanto

  • World’s largest developer of genetically modified seeds; inventor of Roundup
  • 76% in US, Brazil, Argentina in contrast to Bayer which is focused in Europe and Asia
  • Value of agriculture is shifting from land and labor to technology – this is where Monsanto and its intellectual property dominates
  • Monsanto grabs an increasingly large slice of the agricultural pie with great margins worthy of fancy multiple
  • This is appealing to anyone who recognizes that food production is increasingly reliant on GMOs but not everyone is on board; put off by Monsanto’s reputation and some investors are simply not interested in expanding crop science business at all

Deal Close

  • Deal has to get past the regulators and there are concerns that it won’t close
  • Monsanto trading at $102 which is a huge discount to $128 deal price
  • First hurdle is product overlap: street estimates direct overlap to be $1.2 billion of sales which leaves cushion to the $1.6 billion that Bayer has agreed to divest if necessary to satisfy regulators
  • Another anti-trust concern is that there are a lot of agricultural deals right now: Syngenta-Chemchina; Potash-Agrium; Dow-DuPont

Deal Value Proposition

  • Deal is the largest all-cash takeover on record and with a headline price of 28x earnings, the purchase doesn’t seem cheap
  • Monsanto earned $4.48; proxy projects a couple of scenarios with average earnings of $7.22 in 2019; Einhorn believes that if corn returns to normal price of $4.50 a bushel, it will add more than a dollar to these projected earnings
  • Deal is “supposed” to close at the end of 2017
  • By the end of third year, Bayer thinks it can save $1.2 billion by cutting duplicate sales and marketing organizations, and increase earnings by additional $300 million by selling products into additional markets; expect to achieve R&D gains as well
  • Adding $1.5 billion in synergies adds another $2.60 to Monsanto’s earnings which brings multiple down from 28 to about 12x
  • On a combined basis, business will be 48% agriculture, 36% pharma, 13% consumer brands, and 3% animal health
  • Pro forma businesses deserve multiples of 14 – 22x and people buying Bayer today get the package for about 10x (if the merger closes)
pro-forma-forecast
Source: Greenlight Capital Presentation at Robin Hood Investor Conference
  • Prefer a deal to no deal but at this price, like Bayer either way

David Einhorn is the founder of Greenlight Capital, a long/short hedge fund with an estimated AUM of over $10 billion as of 2015.

Image Source: Thomson Reuters

 

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