Monsanto Multiple Choice – Going it Alone, Merging, Selling, Spoiling?

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Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

gcopley@/nlipinski@ssrllc.com

May 16th, 2016

Monsanto Multiple Choice – Going it Alone, Merging, Selling, Spoiling?

  • We see a range of possible outcomes for Monsanto in the wake of a renewed push for consolidation in the agricultural chemicals space – on balance we would own MON
  1. Go it alone – Price fair with some growth upside -5-10% this year
      • In this scenario, the stock is likely fairly valued at current levels around $100 per share today, but has upside if the suggested growth can come through from 2017
      • Improvements in crop fundamentals would be a boon but shakeups in the industry pose threats – DOW and DD potentially taking share, Syngenta competing on price
  2. Merge/JV – Upside uncertain – 15-20% this year likely lower if MON in charge
      • MON would likely prefer to retain control (as would Bayer and BASF!) in a potential JV. To give up control MON shareholders would need some cash (more from BASF) but would also benefit from a share of the possible synergies
      • We do not believe that either BASF or Bayer would be as focused on synergies as MON, suggesting more synergy driven upside in a JV with MON in charge
      • No premium in a MON controlled entity so holders might be better off taking some cash and share of lower synergies
  3. Get acquired (by Bayer or BASF?) – Best current case for shareholders – 35%+
      • Structural impediments preclude the robust synergy opportunities outlined by DOW and DD – synergy target higher for Bayer than BASF because business is bigger
        • Nature of headcount reduction in Europe more problematic than in North America due to rigidity of labor system
        • Specific opportunities for DOW/DD (IT platforms, sales force) and pre-merger business improvements by the companies themselves
      • Recent Bayer management presentations/discussions suggest focus on an integrated life sciences platform (rather than shrink to Pharma) and expanded US exposure
  4. Act as spoiler – Worst case some initial downside – Best case mildly positive
      • MON has guided away from major acquisitions and towards smaller M&A but, with its back to the wall (if it has no interest in these deals), this could change
      • FMC’s CPC businesses would complement MON’s largely seed based offering
      • FMC could also make sense in BASF’s portfolio, and given a MON-Bayer deal, might be a logical next step for the industry
  • If we assume that the driving forces behind consolidation in the ag industry have been not only the recent weak macro environment but also the trend towards a more holistic, “solutions” based business model, then from a strategic perspective, MON likely needs to take one of steps 2-4 to position its portfolio for the new order
    • There is clearly a chance that MON gets a large cash bid, and possibly learning from the Syngenta saga, chooses to take it – we would own MON, recognizing that the cash bid is the best of four options
    • FMC may be the more interesting investment – we also remain positive on DOW/DD
    • Remain cautious on BASF – no opinion on Bayer, but hard to see a cash bid as popular with holders

Exhibit 1

Source: SSR Analysis

Overview

Bayer is apparently still intrigued by the idea of a combined life science platform, embracing pharma, agriculture and animal health. This may be a genuine preferred strategy or may have evolved as the company has examined the possibility of focusing on only pharma and has discovered that deals are expensive (more so than Ag), hard to do, and don’t drive more synergy than Ag. A big Ag based deal would certainly offer a great deal of synergies and even with a premium Monsanto may be more accretive/less dilutive than a good pharma deal. Monsanto is “best in class” and it would be almost impossible for Bayer to acquire a “best in class” pharma company. Some might argue that MON itself is a product of a failed “life science” strategy – unravelling through the Pharmacia/Pfizer deal, but this was a long time ago and the landscape today is very different. Then Monsanto was more about promise than results and today the results are very evident – MON’s revenues today are more than 2x what they were 10 years ago and net income is almost 10x what it was in 2005.

We already have plenty of rumors about BASF and MON, but Bayer should be able to pay more as its Ag business is much bigger than BASF’s and consequently the synergies should be higher. In a cash competition for an outright purchase Bayer should win. Oddly, in a scenario where some sort of joint venture was considered with the German company taking control, BASF would likely be a more attractive option for MON holders as it would need to pay more cash to get 51% of the venture than Bayer.

Any of the options discussed so far offer upside to MON shareholders versus the “go it alone” strategy – 15-20% would be our guess in the case of a JV and as much as 35-40% in an outright acquisition, especially if Bayer has to outbid BASF.

Aside from these options, things become a lot less clear. If MON is not willing to be sold or give up control in a JV then MON becomes the buyer, whether it is to get the BASF or Bayer business outright or in some sort of JV and there is no premium bid for MON – there is however the share of what could be significant synergies. In a well-structured deal the synergies could be additive to the current share price – in a less well constructed deal the synergy benefit would come after some initial discount.

The real spoiler would be MON buying FMC in a move to “go it alone” and make itself less interesting to others. We think that FMC is probably as valuable to Bayer and more valuable to BASF, and assuming something happens with MON we struggle to see a scenario in which FMC does not get picked up by someone – as such it would be our preferred way to play this whole game today.

The risk/reward on MON looks good as long as we do not get an (original) Syngenta or DuPont like “reluctance to listen/deal” reaction from MON management – in which case you probably still win in the end but the path may be volatile and frustrating.

As we have written many times, we like the DOW/DD opportunity, partly because of the Ag deal but also because there are plenty of additional levers and we still see value in both stocks. The one we would avoid here is BASF – see recent work – unlikely to be a seller into Ag consolidation, more likely to pay up.

We are thinking about the possibilities as detailed below.

  1. Go It Alone Strategy – Possibly OK Longer Term, Not so Good Short Term

Monsanto has done a pretty good job of painting a picture of what a standalone strategy looks like – one without large scale M&A. We don’t particularly like that picture near term, as it focuses on what we see as one of the problems in the Ag market today – seed/farm productivity. It is our opinion, supported by data for the last couple of years, that the productivity gains on the seed side are outstripping demand growth for corn and soy, keeping prices low and farm economies weak. While we recognize the weakness in Brazil as a driver of disappointment also over the last two years, we think that the yield gains are a bigger issue. Farmers need pricing power to give seed producers pricing power – in the US we do not have the ethanol growth kicker for corn anymore and we are producing more on fewer acres. While corn acres look like they will rise this year, these projections are against a backdrop of very high inventories and (according to an article on the CHS website) farmers jumping at an opportunity to sell inventories at only incrementally higher corn prices in recent months (suggesting that they are not filled with confidence of a recovery). Monsanto’s stated path forward focuses on more advances in productivity and we believe that this will keep production high and pricing low, absent a US growing season which has a significant negative surprise on the weather front.

As shown in Exhibit 2, the company has seen significant negative revisions over the last two years and the stock has reacted to those revisions. Prior to the recent rumors the stock was 25% off its highs. That said, if the negative revisions continue through 2016 it is hard to see how the stock works.

Exhibit 2

Source: Capital IQ, SSR Analysis

Competitive dynamics driven by consolidation elsewhere in the industry also pose problems for a standalone MON.

While possible, we think it is highly unlikely that DOW/DD mess up the Ag JV. This deal has been in DOW’s crosshairs for years and new leadership at DD is focused on driving value at a level of intensity the company has not seen in decades, if ever. While we have some concerns about the efficiency of other DOW businesses, the DOW Ag business has been a stand-out for several years and has been very well managed. The efficient combination of Pioneer, the legacy DuPont CPC business and DOW’s Ag business creates a very competitive platform across both seeds and chemicals that will likely be significantly lower cost than everyone else. The companies have already discussed revenue synergy opportunities of $500 million and we suspect that this target is very conservative. These revenue gains come at someone else’ expense – MON, BASF or Bayer, most likely.

Syngenta will be under new management, and while the company has hired an experienced CEO in Erik Fyrwald, there remains the risk that the ChemChina acquisition is unsettling, causes others to try and take both people and share from Syngenta, and results in Syngenta responding with the only tool available – pricing. Again, in such a situation, MON, BASF and Bayer, as standalone businesses with no deal related offsets are the most vulnerable.

But both of these events should at the same time drive a very cautious approach to M&A for all three companies because paying a large M&A premium is challenging at the best of times and even more so when the market structure of focus is undergoing so much change.

Some sort of merger makes much more sense – but very hard to get done.

2/3. Merge/JV (Ag Only Combinations) or Full Acquisition

Below we frame the relative sizes of the major Ag players on revenues and EBITDA – Exhibit 3. Despite a larger base, Bayer has outperformed BASF in recent years, growing sales and EBITDA at a faster pace – Exhibit 4. Bayer Ag’s larger absolute size compared to BASF Ag would likely yield greater synergy opportunities – Exhibit 5. We look to the announced synergy estimates from DOW/DD as a proxy. In our view any deal involving the Europeans deserves a haircut to the DOW/DD proxy given opportunities specific to DOW/DD and the greater rigidity of the labor system in Europe (lower reduction in headcount). For what it is worth, we believe that the DOW/DD synergy number is understated today and that more cost opportunities will emerge as the businesses combine – this is one of the reasons why we like the DOW/DD deal. It is unclear whether we can extrapolate that opportunity to others as DOW’s lower margin (relative to the pack) may provide much of the opportunity to cut costs further.

Exhibit 3

Source: Capital IQ, SSR Analysis

Exhibit 4

Source: Capital IQ, SSR Analysis

Exhibit 5

Source: Capital IQ, Company Presentations, SSR Analysis

Exhibit 6 looks at some pro-forma portfolio and geographic exposures. Combining either Bayer or BASF with MON would result in a largely balanced seed/chemicals portfolio. The “Other” in the Bayer-MON combination is Bayer’s Environmental Science business. Bayer, unlike BASF, currently has seed/traits exposure – Exhibits 7 and 8 – which could be a plus for potential synergies.

Exhibit 6

Source: Capital IQ, Company Presentations, SSR Analysis

Exhibit 7

Source: Company Presentations, SSR Analysis

Exhibit 8

Source: Company Presentations, SSR Analysis

Exhibit 9

Source: Capital IQ, Company Presentations, SSR Analysis

Exhibit 10

Source: Capital IQ, Company Presentations, SSR Analysis

The merger related premiums we suggest in the bullet points and in Exhibit 1 are arrived at by equalizing the EBITDA and assuming that BASF or Bayer need to pay 10x that difference to MON in cash to get 51% of the venture – hence the bigger number for BASF. We are assuming that synergies would then be shared equally and are not reflected in a premium. We are only using 10x because this is what Dow/DD are suggesting as a value for synergies – which are assumed to be directly additive to EBITDA. This is probably a best case.

  1. MON as Spoiler – FMC a Complementary Option

FMC is a plausible option for MON if it is serious about its projected role as an Ag consolidator rather than a target. The Ag portfolio at FMC (exclusively crop protection) complements MON’s predominantly seed based offerings. Selling off the Lithium business would not likely pose any problems (ALB a potential acquirer if it can persuade competition authorities that Lithium is a global business – we should also not dismiss Tesla – or one of Musk’s other companies as a buyer). Health & Nutrition might make sense for DuPont’s similar business, or could find a home at Bayer of BASF.

FMC’s business does not look that great given revenue growth through CPC acquisitions which have not really driven commensurate earnings growth over the last few years – this may be less than perfect execution on the part of FMC but may be much more about timing given that the acquisitions have taken place in the face of a weakening Ag market and a weakening Brazil and Brazilian currency climate.

FMC would likely attract as much as a 25-30% premium in a sale – given Ag synergies and the possible values of the two businesses that would then be for sale – if BASF was the buyer it would have synergies in each business.

Exhibit 11


Source: Capital IQ, Company Presentations, SSR Analysis

©2016, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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