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Bayer-Monsanto: The Logic Behind The Offer

|Includes: BAYZF, Monsanto Company (MON)

With the seeds and pesticides industries rapidly converging over the past several months, Bayer has taken a bold step to keep up with ChemChina's $43 billion offer for Syngenta and the $130 billion Dow-DuPont merger. The German pharmaceuticals and chemicals giant is taking a confident line in discussions of its $62 billion bid to acquire Monsanto, with the new Bayer CEO Werner Baumann - at the helm since May 1 - taking the lead in highlighting the synergies between the two companies and answering concerns over potential regulatory hurdles.

The $62 billion offer being put forward by Bayer is equivalent to $122 a share for Monsanto, which closed at $109.90 on Tuesday. Many investment analysts see the offer as somewhat low even though it represents a 37% premium on Monsanto's closing price from earlier this month. They point out that it is not as high as the bid ChemChina put in for Syngenta in February. ChemChina's $43 billion offer represented about 16 times Syngenta's EBITDA, while the amount being proposed by Bayer comes in at 15.8 times Monsanto's EBITDA by Bayer's own measure. Matching the ChemChina-Syngenta offer would mean Bayer putting up $145 a share, according to Bloomberg.

Keeping in mind that the agricultural industry is currently in a downturn, expectations are for Monsanto's earnings to rise significantly as the sector's fundamentals improve. Not surprisingly, Monsanto rejected the offer on Tuesday, but indicated that it remained open to discussions given the strategic merits of the combination. Meanwhile, Bayer responded to Monsanto's rejection by expressing its commitment to working together to complete the transaction. This most likely means that the companies will negotiate a price within the range of $135-$140 per share, which sell-side analysts such as Bernstein's Jeremy Redenius and Deutsche Bank's Tim Race see as more probable.

Bayer's offer to Monsanto would help strengthen their competitive positions as others are combining resources with cost savings to be estimated at $1.5 billion over three years. The Dow-DuPont merger, when and if it is approved by regulators, will create the world's largest agrochemicals company with 17% of the global pesticides market. That company would also control 41% of corn seed and 38% of soybean seed sales in the US (according to 2014 figures).

By comparison, combining Bayer and Monsanto's US sales for both crops would amount to 36% of the corn seed and 28% of the soybean seed markets, respectively. The planned ChemChina acquisition of Syngenta, meanwhile, would give the Chinese company Syngenta's market-leading 21% of the crop protection market on its own (Bayer and Monsanto together make up 29% of crop protection sales). Even though Bayer's CropScience division is very much present in the US market, the only major overlap between the two is in certain pesticide-resistant seed variants, which Bayer has been marketing as an alternative to Monsanto's offerings (glufosinate-resistant soybeans in Brazil, for example).

From a competition perspective, Bayer and Monsanto would be able to compete at scale with other companies that are merging, particularly Chinese government-owned companies that are building up their agricultural assets. This transaction would allow the two companies to pool their research and development efforts, leveraging Monsanto's already leading pipeline to create an even stronger R&D platform. This would come as a boon to Bayer since Monsanto tends to spend more on research in relation to sales than any of its peers (11.1% of its 2011-2014 sales). What's more, the two companies have previously worked together on combining crop protection projects, including Monsanto's Acceleron and Bayer's Poncho/Votivo seed treatments in 2011, further illustrating the power of this combination beyond the strategic rationale.

Monsanto's research strategy is presently geared toward building a comprehensive package including seed, pesticide/herbicide, and "precision agriculture" (perhaps better known as smart farming). This not only offers farmers crop protection tools, but also tailor-made crops for their use as well as big data analytics services to increase yields and manage weather patterns and pests. The company has made its investments in smart farming tools a priority, especially after its $930 million purchase of the Climate Corporation in 2013. At least as far as Monsanto CEO Hugh Grant is concerned, the race to develop new, data-driven agricultural products helps explain the impetus for offers like Bayer's.

Because the companies have little overlap in their portfolios, few see anti-trust issues arising from the deal, which is unusual for a transaction of this size given that the Syngenta-ChemChina and Dow-DuPont transactions continue to face significant regulatory hurdles. The Syngenta and ChemChina deal has been delayed because of significant CFIUS concerns around Syngenta selling to a Chinese state-owned enterprise, which was a major impetus for the USDA to join CFIUS review in the U.S. The Dow-DuPont merger would escalate market share of the combined company to about 40% of U.S. Corn Seeds and Traits as well as US Soybeans Seeds & Traits. In regard to the Bayer-Monsanto combination, Bayer's diverse portfolio (more weighed toward healthcare than agriculture at present) means any necessary divestments should be feasible. Bayer is not a major player in either corn or soybeans (the two biggest crops in the US, measuring by acres planted), but the German company may need to find a workaround for its assets in vegetables and cotton seeds.

The bottom line is clear. With the agricultural industry going through an intense consolidation phase, Bayer's proposal to buy Monsanto might be its best remaining chance to keep pace with the industry. Interestingly, it also seems to leave BASF as a sub-scale competitor without many options at this point. However, that's another discussion entirely.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.