1

Thisisastoryaboutanewlyengagedcouple.
Aswithalllovestories,thereisconflict,andanuncertainending.
Willsomethinggetinthewayoftruelove?Orwilltheyconsummatethemarriageandlive
happilyeverafter?

OurcoupleisBayerandMonsanto,andasIwalkyouthroughtheirjourney,thereisone
thingyouneedtokeepinmind:
Whethertheymakeittothealtar,orgetthwartedalongtheway,theresgoingtobea
celebrationforBayershareholderseitherway.
Withcake.Andwelikecake.

Afewyearsago,IwasabearonBear;todayIamabuyerofBayer.
Bayerisworthabout73billionEuroswithanEnterprisevalueof104billionEuros.
Historicallyachemicalsandpharmaceuticalcompany,Bayeristransformingintoalife
sciencescompany.
ItspunoffLanxess in2005,andisnowsheddingCovestro,itsremainingchemicals
business.

ThinkofCovestro astheexboyfriendinneedofanewmate onemorecompatiblewith

itscyclicalnature.
LastyearBayersold31%ofCovestro inanIPO,withplanstodivesttherest.

Whatremainsisapremiumlifesciencesbusinesswithhighbarrierstoentryandan
excellentcompetitiveposition.
Itismadeupoffourprimarydivisions:
Pharma,cropscience,consumerhealth,andanimalhealth.
In2015,ithadtotalrevenueof34.3billionEuros.

Withtheexgone,themarketexpectedBayertofurthersolidifyitspharmabusinessby
courtingacleanshaven,welltodopharmapartner.
Instead,itdecidedtogowitharoughcut,cropsciencesdudenamedMonsanto,andthe
marketdidnotrespondwell.

Thestockhadalreadybeenfallingfromthemid130slastJulytoabout100.
Acouplelatestagepipelineproductsdisappointed.
Thecontinuedagcycleweaknesscausedearningsexpectationsfor2016tocomedown
fromahighofabout8Eurospersharetoalowof7.25.
WhenBayerannouncedthiscornyacquisition,thestockcollapsedto85Eurospershare, or
only11.3xearnings.

Themarketisdividedonhowitviewsthedeal.
TherearethosewholookatMonsantoasaterriblepartnerandwantnothingtodowithit.
Someofthoseinvestorssoldtheirstockontheannouncement,andwouldbehappytobuy
backinifthecouplebreaksup.
Andthentherearetheinvestorswholikethepairing,butseeobstaclesonthewaytothe
altar.
Theywontjointhepartyuntilthemarriageisconsummatedandtheweddingispaidfor.

10

Andthatswherethingsstandnow.
Someinvestorsonlywantweddingcake,othersonlywantbreakupcake, andneithergroup
seemstowanttoownthestockuntilitknowswhichcakewillbeserved.
Wethinkthatstheopportunity.Wecanbuythestockknowingthattherewillbeaparty
eitherway.
Andthoughwethinkweddingcakeisalittlebetterthanbreakupcake,bothoutcomes
comewithcake.
Andagain,welikecake.
Letsstartbylookingatbreakupcake,orhowBayerlookslikeonitsown.

11

Bayerspharmaceuticaldivisionhasbeenaroundforever.
Someofits100yearoldproductslookfamiliar(thoughthey nolongersellheroin)but
yourelikelytorecognizeitscurrentdrugsonlyifyouoralovedonesuffersfrom

12

Hearttrouble,braintrouble,skintrouble,diabetes,cancer,hemophilia,certaineye
diseases, someinfectiousdiseases,variousgynecologicalconditions,erectiledysfunction,
oralloftheabove.

13

BayerstwobiggestsellingdrugsareXarelto andEylea.
XareltoisabloodthinnerwhichisreplacingWarfarin,a veryolddrugwithnastyside
effects. ItreducesstrokesandBayerisconductingstudiesforadditionalindications.
Inthethirdquarterof2016,Xareltorevenuesgrew35%.
InSeptember,managementincreaseditsestimatesofannual peaksalesfrom3.5billion
Euros toover 5billion.
Inresponse,themarket yawned.

14

EyleatreatsmaculardegenerationandallIcansaywithoutcringingisthatinvolveseyes
andneedles.
Inthemostrecentquarter,Eyleagrew28%.
InSeptember,managementincreaseditsestimatesforannual peaksalesfrom1.5billion
Euros toover 2.5billion andthemarketyawnedaboutthis,too.
ItmakesuswonderifBayerhasanydrugsinthepipelinetotreatinappropriateyawning.

15

Notonlyareitskeyproductsingrowth mode,butBayeralsohasa favorablepatentcliff,

withnothingsignificantexpiringformanyyearsincludingEylea andXarelto.

16

Andnotallpatentcliffsarecliffy.
Eylea andthehemophiliadrugKogenate arebiologics.Biologicsaredifficulttoreproduce,
socompetitionwillbeslowtomarket,andsaleswillfalloffgently.
AndthemanufacturingforitscancerdrugXofigo requiresaccesstoanuclearfacility,sonot
justanyonewillbeabletoproduceageneric.
TheMirenaIUDandKogenate shouldhavelonger exclusivityasaresultofsomethingcalled
LifecycleManagement.

17

Lifecyclemanagementinvolvestweakingadrugjustenoughtomakeiteligibleforanew
patentoranextension.
Itsabitlikewhenmypetgoldfishdied.MymomkeptsecretlyreplacingLambeau witha
newgoldfishuntilshefinallyagreedtogetmeabrother.

18

TheMirena IUDlostitsfirstpatentin2015,butBayerhasbeenabletoextendprotection
through2029bydevelopinganewinserter.Salesgrew18%lastyear.
InthecaseofKogenate,thepatentisntforthecompounditself,butratherforitshardto
replicate manufacturingprocess.Thatpatentexpiresin2017.
Thatswhy,startinginthefirstquarterof2016,Bayerisgradually replacingKogenate with
Kovaltry,asimilarbutlongeractinghemophiliadrugthatmagicallyusesthesame
manufacturingfacilities.
In2018,BayerwilladdDamoctocog alfatothehemophiliafranchise,puttingitselfone
morestepaheadofgenericcompetition.

19

Losingapatent doesntnecessarilyleadtolosingsales.
BayersnonpatentprotecteddiabetesdrugGlucobay andprescription aspirin,which
hasntbeenunderpatentforaboutahundredyears,each grewover 2%tooverhalf a
billionEuros in2015.
Thisperformance wastypicalofBayers8billionEurooffpatentportfolio.

20

ThisisBayersnewdrugpipeline.Bayerisdevelopingnewdrugsforcancer,lymphoma,
chronicheartfailure,diabetickidneydisease,anduterinefibroids.
These areallsmallopportunities,whichmeansthattheearningstrajectoryforthenextfew
yearsisntverydependentonclinicaltrialoutcomes.

21

Bayerestimatesthatthepotentialrevenuevalueofthesepipelinedrugsis5 billionEuros.
Andmostofthenew pipelineisexpectedtocomeonlinepriortotheexpirationofexisting
patents.

22

Some U.S. competitors havetakenmassivepriceincreasesondrugsovertime,andthe

publicityhassparkeddiscussionaboutregulatorybacklash.
Bayermostlyhasntengagedinthis,anditssalesinEuropeandJapanarealreadysubject
topricecontrols.
Comparedtoitspeers,Bayerislessexposedtofuturepricingpressure.

23

Thepharmabusinessisgrowingwellandisunderappreciated.
Pharmapeerswithpipelineworriestrade inthelowteens.Peerswithgoodprofiles,like
Roche,SanofiandGSKtradearound14xearnings.
Bayerhasaportfolioofestablisheddrugsinthemiddleoftheirgrowthcurve,apipelineof
newdrugscomingoutinthenext34years,noimminentpatentexpirations,andstrategies
toextendthoseatrisk.
Alltold,wethinkBayerdeservesapremiummultipletothegroup.

24

Inadditiontopharma,Bayeralsohasasolidconsumerhealthbusiness.
At 6billionEurosofrevenue,its18%oftotalsales.

25

Oddsareseveraloftheseareinyourmedicinecabinet,likeClaritinandAleve.
OrinyourbeachbaglikeCoppertone.
Orunderyourfeetlike Dr.Scholls.
OrnexttoyourBloombergterminal,likeAlkaSeltzer.
Thesearefamiliarbrandswhicharegrowingmoderatelyandhavegoodmargins.
Othercompanieswithbrandslikethese,suchasProcter&GambleandColgatePalmolive,
tradeatlow20sP/E multiples.

26

Bayer alsohasasmallanimalhealthbusinessthatconsistsofvaccinesandantibioticsfor
householdpetsandlivestock.
Animalhealthisan attractivesectorwithlowtomidsingledigittoplinegrowthandstrong
EBITDAmargins ofaround23%.
WithinBayer,itsoverlookedandunderappreciated.Withtime,Bayerislikelytobeefitup
ormonetizeit.
Zoetisisthebestcompandtradesaround21x earnings.

27

Andnowwegettocropscience, theotherfarmabusiness.

28

Bayeris theworldleaderincropprotection, whichinvolvesalotofcide action asin

insecticides,herbicides,andfungicides.
From2011 through2016,salesinBayerscropbusinesshavegrown40%.
Becausethebusinessisfocusedoncropprotectioninsteadofseeds,Bayerhasbeen
relativelyimmunetothecurrentdowncycle inagriculture.

29

TheBayercropsciencebusinesshassomeofthebestelementsofthepharmabusiness.
Manyofitsproductshaveintellectualpropertyonmorethanoneingredientand
formulationsthatprovidebarrierstoentrybeyondtheirpatentlife.
PeerslikeSyngenta andDuPonttradeclosertoa20x P/Emultiple.

30

Bayerstandalonetradesat11x2017earnings,whichisasizablediscounttothevalueof
itslowestmultipleongoingbusiness.
Wethinkitscheap,butyoudonthavetotakeourwordforit.

31

Rememberthatbeforethedealwasannounced,Bayerwastradingata14xmultiple.
SinceMay,expectationsinpharmahaveimprovedandmosteverythingelseisunchanged,
butthestocktradeswithabigpenaltyforthepossibleMonsantodeal.
Itseemstousthatifthedealbreaks,thestockshouldrecover.
TherewouldbeagoodpartyforBayershareholders.
Withcake.Andwelikecake.

32

Whywouldanyoneliketoseethemnotmakeittothealtar?
Letsmeetthefianc.

33

Monsantoistheworldslargestdeveloperofgeneticallymodifiedseeds.Itisalsothe
inventorandlargestproducerofRoundup,themostwidelysoldweedkillerin theworld.
Itdoes76%ofitsbusinessintheUnitedStates,BrazilandArgentina,incontrasttoBayer,
whichis muchmorefocusedinEuropeandAsia.

34

Thevalueofagricultureisshiftingfromlandandlabortotechnology.Thisiswhere
Monsantoanditsintellectualpropertydominates.
Monsantodevelopsmosttraitsthatgointoseeds.Monsantosellstheseedstofarmersand
alsolicensesthetraitstoothercompanies.
FarmershavetochoosebetweenaninferiorharvestorpayingMonsanto,directlyor
indirectly,aroyaltyforitstechnology.
Monsantograbsanincreasinglylargesliceoftheagriculturalpie,withgreatmargins
worthyofafancymultiple.
Monsantoisinacommoditybusiness,butitisnotacommodity.

35

Thisisappealingtoanyonewhorecognizesthatfoodproductionisincreasinglyrelianton
GMOs.
Butnoteveryoneisonboard.EuropeansinparticularhaveobjectionstoGMOs,andare
especiallyputoffbyMonsantosreputationasthecompanythatbroughtusAgentOrange.
Andsomeinvestorssimplyarentinterestedinexpandingthecropsciencebusinessatall.

36

Butwhataboutthepeoplewhowantweddingcake?
Forthem,thedealhastogetpasttheregulators,andthereareconcernsthatitwont
close.
Certainly,themarketthinksitprobablywont,asMonsantostockat$102tradesatahuge
discounttothe$128dealprice.

37

Thefirsthurdleisproductoverlap,andalthoughthereisntalotbetweenthetwo
businesses,thereissome.
Specifically,Bayermayhavetodivestsomeofitscottonseedandherbicideproducts.
Thestreetestimatesthedirectoverlaptobe$1.2billionofsales,whichleavesacushionto
the$1.6billionthatBayerhasagreedtodivestifnecessarytosatisfyregulators.
WethinkthereisalsoconcernthatregulatorsmaymistakenlyconfuseBayersacquisition
ofMonsantosexistingmonopolywithananticompetitivemerger,eventhoughthemerger
itselfwouldnotincreasemarketconcentration.

38

Anotherantitrustconcernisthattherearealotofagriculturaldealsrightnow:
SyngentaandChemChina
PotashandAgrium
DowandDuPont
TheSenateJudiciaryCommitteehasheldhearingstoaddressconcernsovertheagindustry
consolidationandmayraiseobjectionstothecombinedimpactofallthemergers.

39

Thisdealisthelargestallcashtakeoveronrecord,andwithaheadlinepriceof28times
earnings,thepurchasedoesntseemcheap.
Andworse,Bayerplanstofundaportionofthepurchasewithanequityrightsoffering,
whichcreatesaperceivedoverhangonthestock.

40

Buttheheadlinepricedoesnttellthewholestory.
Monsanto isagreatbusinesswithapipelineofitsown.
Itearned$4.48thisfiscalyear.Theproxyprojectsacoupleofscenarioswithaverage
earningsof$7.22in2019.
Webelievethatifcornreturnstoanormalpriceof$4.50abushel,itwilladdmorethana
dollartothoseprojectedearnings.

41

Together,BayerandMonsantohopetocutcostsandraiserevenues.
Thedealissupposedtocloseattheendof2017.
By theendofthethirdyearfollowingtheclose,Bayerthinksitcansave$1.2billionby
cuttingduplicatesalesandmarketingorganizationsacrosstheglobe, andincreaseearnings
byanadditional$300millionbysellingitscurrentproductsintoadditionalmarkets.

42

BayerandMonsantoexpecttoachievegainsinR&Daswell.
Thefutureoftheagriculturalproductsbusinessisinselectivity;cropprotectionneedsto
killpestsandweeds,butnotcrops.
Today,Monsantohasindependentlydevelopedseeds,andBayerhasindependently
developedcropprotection.
Togetherthecombined companyhopestodevelopinsecticidesthatworkwiththespecific
seedstomakebetter complimentaryproducts.

43

Addingthe$1.5billioninsynergiesaddsanother$2.60toMonsantosearnings,which
bringsthemultipledownfrom28toabout12.

44

Hereisamultiyear proformaBayercombinedforecast,theyearafterthedealcloses,
assuming$4.50cornandBayerdivestingCovestro.
In thefirstyear,BayerwillgenerateproformaEBITDAof16.1billionEuros.
Workingdowntheincomestatement,therewillbe1.6 billionEuros ofDepreciation,2
billion ofintereston58 billionEurosofproformadebt,and25%taxestogetnetincomeof
9.4billionEuros,orabout 10xtheproforma earnings,whichtakesintoaccountthecoming
equitydilution.
Fromthere,midsingledigitrevenuegrowthwithsynergiesrampingshoulddrivehigh
singledigitEBITDAgrowthanddoubledigitearningsgrowthforthenextseveralyears.

45

While somenowformerBayershareholderswereupsetwithpaying28xforMonsantoand
itsmonopolisticseedbusiness,if youbuyBayersstocktoday,youarentpaying28x.
Onacombinedbasisthebusinesswillbe48%agriculture,36%pharma,13%consumer
brands,and3%animalhealth.Weactuallyboughtabunchofcakestomakethisslide.The
Greenlightkitchenwasverycrowdedthatday.
Allofthesebusinessesdeservemultiplesof1422times,andpeoplebuyingBayertoday
getthepackageforabout10x,ifthemergercloses.

46

SoBayerisstuckbetweentwogoodoptions:
Get fatonweddingcake,orgetfatonbreakupcake.
Wepreferadealtonodeal,butatthisprice,eitherway,wegetcake.

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48