Late in 2016, we discussed our belief that Bayer AG's (OTCPK:BAYRY) announced all-cash acquisition of Monsanto (NYSE:MON) for $66 billion (or $128 a share) would likely fail due to antitrust regulators blocking the acquisition. Our discussion, we should note, took place before the surprising election of Donald Trump as president. Since the election of President Trump, many investors have become more confident with the idea that BAYRY will be able to close its acquisition of MON. Investors' confidence in the closure of such acquisition can be seen in MON's share price, which rose from about $105 when we wrote our first article to about $113. While MON's increasing share price reflects greater investor belief that BAYRY's acquisition of MON will close, we note that MON's share price is still well below the $128 acquisition share price. So, we can conclude that investors are still far from certain that the MON acquisition will ever close. With this in mind, we should point out that much of investors' increased confidence about the MON acquisition results from the election President Trump. The theory of such investors is that since President Trump is a Republican and Republicans favor a less regulatory environment, BAYRY's acquisition of MON is far more likely to close since the November 2016 election. We say that such simple logic is not completely sound and could hurt any investors that follow such logic. In other words, there are more roadblocks to the deal than meet the eye.
Not only has the election of President Trump bolstered investors' confidence about the closure of the MON acquisition, but statements from BAYRY have underscored such confidence as well. Recently, BAYRY indicated that it remained confident about completing its takeover of MON by the end of 2017, even if it faces delays in surmounting concerns of antitrust regulators. BAYRY stated that it would seek approval for the MON transaction in the European Union in second quarter 2017 after regulators requested more information, representing a delay from first quarter 2017. The company is also responding to a second information request from the U.S. Department of Justice. In other words, BAYRY "remains confident" but is already facing delays due to regulatory body concerns in Europe and the U.S. Given such regulatory delays, BAYRY must also refinance most of its $57 billion bridge loan to complete the deal. The company has also filed to seek approval for the MON acquisition from the Committee on Foreign Investment in the U.S. (Note, such "foreign investment" is raising concerns in the U.S. among some that a foreign company is acquiring the technology of the premier U.S. agricultural company.) As BAYRY moves forward in its attempt to close its acquisition, we note that DuPont (NYSE:DD) and Dow Chemical (NYSE:DOW) await regulatory approval for their planned merger along with China National Chemical Corp.'s acquisition of Syngenta (NYSE:SYT). With delays already impeding BAYRY's progress, we can see that MON investors are overconfident that a MON acquisition will close given not only U.S. regulatory concerns but also the more obstinate European antitrust regulatory agency.
BAYRY's announced acquisition of MON is just one transaction in a series transactions comprising industry consolidation to fight off weak fundamentals in the global agricultural economy. The fact that most of the major global agricultural chemical and seed companies seek to merge should send a signal to any thinking investor that any antitrust regulatory agency doing its job should block one or more of the transactions on antitrust concerns. DOW, for example, is facing intense regulatory scrutiny in the U.S. and Europe for the $130 billion merger between itself and DD. As the major companies in the agricultural industry attempt to consolidate, however, consumers and farmers have argued that a consolidation of the major agricultural companies will decrease research and development by the remaining companies and will result in increased prices for consumers. In particular, the European Commission ("EC") will investigate whether the merger may decrease competition in areas such as crop protection, seeds and petrochemicals. If antitrust regulators allowed the announced DOW/DD merger, the ChemChina/SYT merger and the BAYRY acquisition of MON, only one remaining company would be American-owned: the combined DOW/DD. With food/farming technology being critical to the national security of the U.S., investors need to understand that the DOW/DD merger and BAYRY acquisition of MON are likely to face intense opposition given the importance of food/farming technology to American national interests.
While some confident investors will point out that BAYRY's pesticide agricultural business does not significantly overlap MON's globally dominant seed business, farmers remain concerned that seed and chemical costs will continue to increase with such consolidation while grain prices are languishing near lows and farmers' incomes fall. Investors should take note here that while Republicans favor a less regulatory environment, they should remember that many of the voters that put President Trump into office are from "farm country" in the U.S. In other words, would a President Trump allow BAYRY to acquire MON and hurt many of the voters that put him into office? Maybe. The real question is whether a President Trump could stand up to anti regulatory Republicans to protect American farmers. We cannot answer definitively with a yes or no, but can say that the announced BAYRY acquisition of MON is not a certainty by a long shot. American and European antitrust regulators and farmers are correctly concerned that the extreme consolidation of the agricultural chemical and seed businesses will increase the profits of major players in the industry, increase costs for farmers during a time of depressed commodity prices and end up having food consumers paying ever-higher prices for food products.
American and European regulatory concerns arise from a substantial loss of competition given such consolidation and decreased incentives and ability to innovate farming technologies, thereby increasing prices. Reuters reported that if BAYRY completed its acquisition of MON, DOW completed its merger of DD and China's state-owned ChemChina completed its acquisition of SYT, "three companies would control nearly 70 percent of the world's pesticide market and 80 percent of the U.S. corn-seed market." While companies involved in such transactions are willing to divest parts of their businesses in an effort to close their respective transactions, fewer and more powerful providers to the agricultural chemical and seed markets will raise pressure on U.S. and European antitrust regulators to block one or more of the above deals. According to Reuters, "a merged DOW/DD would have about a 41 percent market share, while a merged BAYRY/MON would have about 36 percent. In soybean seeds and traits, the group estimated a merged DOW/DD would have about a 38 percent" market share, while BAYRY/MON would have 28 percent. With each of the announced deals facing increasing regulatory scrutiny, potential investors should not count on BAYRY's acquisition of MON of closing anytime soon, if at all.
MON investors should also not count on BAYRY's acquisition of the company closing if antitrust regulators sufficiently consider farmer/consumer interests. Whether "big money" agricultural interests triumph over farmer and consumer interests, we cannot say. In the current global geopolitical environment, the majority of the transactions may very well close despite the adverse effects such transactions would have. While BAYRY and MON say the combination of the companies would "boost agriculture research and innovation" to feed a global population that will be 10 billion people, farmers are very skeptical. Farmers believe that BAYRY/MON are saying "the exact opposite" of what most people in the industry actually believe. In other words, farmers believe that if the MON acquisition closes, they expect seed and chemical prices to increase. Given that corn and soybean commodity prices are at multi-year lows, increased seed/chemical prices will hurt many family farms. Farmers also believe that consolidating agricultural companies are "locking in their profits" by cornering markets by getting larger and not by creating new and innovative products. BAYRY/MON state they will increase research and development spending, but recent commentary indicates that any increased spending will be minimal (and less than $500 million over six years). One analyst put it more bluntly stating "Let's just cut to the chase: These companies want to make more money, they want to raise prices …. and that [n]o company in this industry needs these deals in order to innovate." (For an in depth analysts of the damage a BAYRY/MON combination along with the other transactions will have on farmers see this excellent article.)
Some analysts and investors have a "take the money and run" attitude with respect to the announced BAYRY acquisition of MON. In other words, if the MON acquisition does not close, its shares will plummet below $90 a share given weak fundamentals in the global agricultural economy. A share price drop may occur initially if the MON acquisition does not close. An informed investor, however, will recognize that such share price drop will likely be temporary given that MON's agriculture business reported positive earnings in January 2017, indicating a possible turnaround in the industry. Readers should remember that all of the transactions mentioned in this article at the likely cyclical bottom of the global agricultural economy and took advantage of such bottom to announce transactions at lower acquisition/merger prices. (Investors confident that the MON acquisition will also point to Warren Buffett's recent purchase of 8 million MON shares.) Investigation into the MON acquisition remains in an early stage as BAYRY hopes to gain all relevant approvals by the end of 2017. Regulatory examinations of the other above-noted transactions are at more advanced stages. The EC may approve the ChemChina-SYT transaction by March 2017. While an approval for ChemChina-SYT would be a positive sign for BAYRY, a decision on the DOW/DD merger would shed more light on whether the MON acquisition would be approved and close given that DOW/DD have the same basic strategy of combining seed and crop protection businesses. (For a more detailed discussion of the likely success of a BAYRY acquisition of MON, see this article.)
We remain skeptical of mega-mergers of any type, including the BAYRY acquisition of MON. Such mergers tend to have short-term rewards from cost reduction synergies. Since the BAYRY acquisition of MON is an all cash deal, we will not have to worry about holding shares of the combined companies. We will "only" be faced with a tax bill for the closed deal. As we have noted in a past article on the MON acquisition, we view such mergers as yielding to short-term investors unwilling to wait out the cyclicality of the markets that companies sell into, such as the agricultural markets that BAYRY and MON sell into. As MON shareholders, we prefer that the company remain independent, as long-term trends favor its businesses even if short-term adversities are significant. Over the long term, MON will likely record above-average earnings growth due to its introduction of next-generation seeds and increased trait penetration, as each contributes to higher average selling prices and generate increased margins. In addition, growth in the world's population and wealth presents challenges and opportunities for the company. For example, several hundred million people suffer from hunger and malnutrition in some of the fastest-growing regions in the world. In addition, as wealth increases for some in the world, more people will add animal protein to their diets, substantially increasing demand for feed crops. MON's technology and products will be able to address such challenges and opportunities.
MON's forward price-to-earnings ratio is 23.90 based on fiscal 2017 earnings estimates of $4.73 and 20.95 based on fiscal year 2018 earnings of $5.39. Earnings estimates have been fallen slightly over the last 3 months for fiscal year 2018. We should note that the median price-to-earnings ratio for MON shares in the past has been about 20. With that said, we believe potential investors should wait for the share price of MON to drop to the $94.30 to 99.70 price range before establishing a full position (a forward price-to-earnings ratio in the range of 17.50 to 18.50, based on 2018 price-to-earnings estimates) to establish a full position. MON shares currently yield about 1.95 percent. As noted above, we believe that if antitrust regulators strongly consider farmer/consumer interests, they would block BAYRY's announced acquisition of MON. We also believe that, despite near-term adversities, MON shareholders will benefit through dividend increases, share buybacks and share price appreciation given the long-term trends that favor the agricultural markets the company sells into. The failure of the announced BAYRY acquisition of MON will benefit MON shareholders over the long term. In addition, BAYRY will end up paying MON a $2 billion break-up fee if the announced acquisition fails.
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Disclosure: I am/we are long MON, DD, DOW.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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