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BASF Being Left Out In The Cold?

|Includes: BASF SE (BASFY)

The DOW-DuPont, Syngenta-ChemChina, and now Bayer-Monsanto merger proposals have gotten plenty of press, but one other agricultural giant has been conspicuously absent from the deal-making trend. Germany's BASF may be the world's largest chemicals company for the time being, but the consolidation of its chief rivals in the pesticides industry may leave the company unable to keep up in the sector over the long term. Even looking at total revenue (including BASF's agricultural business and its wider chemical portfolio), for example, a combined Dow and DuPont (prior to that company's planned split into three) will be enough to overtake BASF by a small margin. Narrowing down the focus to pesticides and herbicides, however, BASF risks being crowded out of the market and essentially being relegated to the position of a second-tier competitor.

At present, BASF's agricultural division occupies third place in the insecticides and herbicides markets (behind Syngenta and Bayer respectively) and has no seeds portfolio. In the event the other six agricultural players successfully merge into three companies, BASF will occupy a distant fourth. According to Morgan Stanley's May 2016 numbers, the German company will control only 8% of the global insecticides market (compared to 19-23% for the three main industry leaders). In herbicides, BASF will control just 10% of market share while all of its main competitors control at least 20% and Monsanto-Bayer would control over a third of the entire market.

Even in the current climate, the company has struggled to match its not-yet-combined competitors in growing sales as the drop in oil prices and demand cut into its Q3 earnings and hurt its 2015 outlook. Sales last year dropped 5.2% from 2014, from €74.33 million to €70.45 million. Between April and October of last year, BASF's shares dropped by over 20%, and the company's stock hit bottom in February (dipping to $63.75) before rebounding. At around the same time, the company revealed that it expected little better for its 2016 earnings, anticipating up to a 10% drop in profits (assuming oil prices of $40 a barrel).

BASF's board is sounding a positive tone over being left out of the scramble to merge, with executive board member Sanjeev Gandhi insisting BASF was not feeling pressure and was perfectly comfortable seeing how the industry would shake out. Just this past March, however, BASF was considering a long-shot counterbid for DuPont that ultimately wasn't in a position to crack the union with Dow. The synergies from a potential BASF-DuPont merger came up noticeably short compared to the benefits Dow-DuPont will offer in terms of costs eliminated and tax savings potentially earned.

One of BASF's primary areas for concern in a consolidated agricultural market will be its ability to keep up with its competitors in research & development. At the same time BASF voiced its expectations of reduced 2016 profits, CEO Kurt Bock announced the company would be halving its plant biotechnology research workforce as a cost-cutting measure. BASF's competitors will enjoy a considerable leg up, especially if they are able to join forces in terms of research. One of the main advantages Bayer sees in acquiring Monsanto, for one, is the acquisition of its industry leading "smart farming" activities and its expertise in genetically modified crops. Dow and DuPont, for their part, are looking at their merger as a way of saving in the R&D department on the road to $3 billion in total annual savings across their operations.

Even before the consolidation phase really got going (with the announcement of the Dow-DuPont deal last December), Bock was beginning to feel the heat over his company's poor performance last year. While much of the blame for its recent struggles has been attributed to the energy markets, the conglomerate model and Bock's conservative "pruning" of BASF have gone from earning plaudits to criticism over lower overall revenues (dropping from €73.5 billion in 2011 to a projected €63.6 this year). The BASF CEO has also invested heavily in new production capacity (primarily in Asia, a major focus for the company), but did so at an inopportune time, considering the struggles of China and other emerging markets.

One road forward for BASF might be found in the same Dow-DuPont merger it was considering running interference on a few months ago. Once those two companies merge, the plan is for them to rapidly break up the resulting conglomerate into three specialized companies: one will focus on agricultural products while the two others will dedicate themselves to industrial materials and specialty products. BASF has long been committed to its "Verbund" conglomerate model, where its different divisions are able to draw off each other's research and conserve resources by recycling byproducts. With sales struggling and its lack of resilience in the face of the oil price crash, however, BASR might need to look for a more flexible model.

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