Description

Bayer AG is a pharma, crop science, and consumer/OTC medicine company headquartered in Germany. The Crop Science segment is a dominant supplier of seeds, traits, and crop chemicals. One of these crop chemicals, an herbicide called Roundup (which is Bayer’s formulation of glyphosate) has made headlines for years because it allegedly causes non-Hodgkin lymphoma (NHL). 

I believe Bayer is cheap due to years of litigation overhang, a German domicile, a disliked CEO, and a conglomerate discount. All of these headwinds are subsiding. We have litigation settlements and tighter bounds on remaining costs; activist pressures; a new American CEO; and an announcement today that Bayer is considering a spin off of the Crop Science segment. 

I’m guessing that most of you are at least vaguely familiar with the history of Bayer and Monsanto, as their problems have made headlines for the past seven years. The short of it is that Bayer pushed to acquire Monsanto despite red flags - including IARC (a division of the WHO) stating that glyphosate is “probably carcinogenic” and also >100 lawsuits blaming Monsanto for non-Hodgkin lymphoma - and closed the deal in June 2018. 

A WSJ article summarizes the terrible fact pattern nicely: “Ten days after Werner Baumann became chief executive of Bayer in May 2016, he made a bid for Monsanto that was designed to turn the inventor of aspirin into the world’s biggest crop-science business. Within weeks of the acquisition closing in June 2018, Bayer lost a lawsuit alleging Monsanto’s Roundup herbicide causes cancer. Another two defeats followed, landing Bayer with damage payments of more than $190 million. More cases are coming: A total of 18,400 plaintiffs have filed suits.” (Bender, Ruth. "How Bayer-Monsanto Became One of the Worst Corporate Deals—in 12 Charts." The Wall Street Journal, 28 Aug. 2019, https://www.wsj.com/articles/how-bayer-monsanto-became-one-of-the-worst-corporate-dealsin-12-charts-11567001577)

I personally think that the evidence against Roundup isn’t great, and I put it in the same category as the evidence that aspartame is carcinogenic (another zinger from IARC) but that is less relevant today. Totally sane California juries helped plaintiffs win key cases against Bayer, and thus Bayer has been forced to settle at relatively high amounts. In 2020 Bayer reached an agreement in principle with plaintiffs, and currently of the ~150,000 claims, about 100,000 have been settled (for over US$10b) or are ineligible for some reason. As of 12/31/22, Bayer had US$6.4b provisioned to settle future claims. Recent wins in court and favorable studies on glyphosate both lead me to believe that their provision is adequate. Soon Bayer will also stop selling Roundup to consumers, which will limit future lawsuits and have almost no impact on profitability. 

I’ll lay out the sum of the parts valuation now, and for those of you who aren’t familiar with the segments you can first read the segment descriptions further below. As an aside, I know that people haven’t cared about SOTP valuations, or really anything but US growth, for a long time, but this is not a theoretical exercise given the activist pressure, new CEO, and news that they are considering a spin-off of the Crop Science division. 

SOTP

I value the Crop Science division based on comps Corteva and FMC:

Bayer’s Crop Science division is superior to Corteva, and, litigation aside, the seeds and traits business is quite good and would be almost impossible to replicate. 

Syngenta, another large competitor, is looking to raise $9.5b in an IPO at a $60b valuation (vs. USD$75b for Crop Science). Crop science stacks up quite well against Corteva and Syngenta:

The Pharmaceuticals segment is tougher to value because some of the larger drugs face patent cliffs. I try to triangulate NPVs from third parties but I also compare the EV/EBITDA of a large set of peers to their sales CAGRs from 2023 through 2030 to account for the patent lives of comp portfolios. I’ll post that chart in the comments if anyone cares. 

The consumer business is compared to Reckitt, Beiersdorf, and Perrigo:

After deducting EUR7.7b for corporate overhead, I get the following SOTP:

Note that I use after tax numbers for provisions and that “Other provisions” is intended to capture all other non-Roundup future litigation. 

In summary, we have plenty of upside to a conservatively estimated SOTP, where the value of those parts is quickly becoming more obvious from both litigation and segment value standpoints. 

Segment Descriptions

Crop Science

The Crop Science division sells seeds, traits, and crop chemicals. These all typically work together, i.e. a corn seed is sold with traits that make it Roundup resistant and also resistant to things like drought and pests. Crop chemicals and traits eventually lose their patents, but there are no shortcuts to duplicating the seed germplasms that Crop Science possesses. These are the results of decades of selective breeding and are an insurmountable moat for someone looking to enter the business. 

Pricing in the Crop Science division happens in waves coincident with farmer incomes. Bayer delivers yield improvements with each generation of seeds and traits, and when farmers make money you get periods of catch up pricing where Bayer captures some of the additional value (in yield) that has been delivered to farmers. 

The data on seed costs and farm incomes is readily available in the US, and you can see the relationship:

We’ve had a period of low net farm incomes, and thus seed prices didn’t do much: 

But recently we’ve had high crop prices, high farm incomes, and thus pricing power in Crop Science. Recent history reflects a period of catch up pricing from the dynamic I outlined above. 

What muddies the picture in Crop Science a bit is that, due to covid restrictions in China, we had a huge spike in glyphosate prices and thus profitability for Bayer, and recent declines in those prices have masked the pricing power in the rest of the division. Bayer is one of the largest producers of glyphosate globally, and the swing in pricing had a large impact on Crop Science profitability. In the addendum I get into the weeds on glyphosate profitability. 

I’ll summarize the Crop Science discussion by saying that 2023 is close to mid-cycle for the business as it reflects a normalization of glyphosate earnings but a continued upswing in the rest of the business. 

Pharmaceuticals

I’ll spend less time on this division and keep it at a cut and paste job for now. It’s either that or some drug by drug NPV where I really don’t have an edge anyways. 

I try to make up for a lack of edge here by triangulating the NPVs of others and sanity checking against a regression of peers’ long term projected growth rates. 

Consumer

The consumer business is a small part of the SOTP and is a well diversified business across products and geographies:

This business was built off acquiring (and overpaying for) the consumer health division of Merck. It’s a fragmented industry that is a constant battle between the pipeline from rx to OTC versus private label erosion. Bayer is one of the larger players in the industry and has a decent portfolio of brands. 

Addendum on glyphosate profitability:

Bayer is 40% of the global glyphosate production, so they understandably have provided little historical detail about that businesses cost structure, pricing vs. the generic, etc. We can take their call comments and combine those with what we know about historical Monsanto and triangulate.

First, we know that profits in glyphosate have been volatile. Monsanto’s Agricultural Production segment housed the glyphosate business, and there were several large cycles:

In recent years glyphosate prices spiked due to China’s covid restrictions and higher production costs:

And Bayer has provided some additional disclosures in this quarter on the impact to the top line:

We still have no idea how much glyphosate moved segment profitability (and I’m looking at FY23E to assess the reasonableness of consensus and treating 23E as near normal), but I think it’s safe to say that the upper bound is the difference between the FY23E topline and the topline in CY20. I estimate that to be EUR770mm.

We do know that 2/3rds of sales in this business is COGS, and that most of COGS is raw materials. They are backward integrated into phosphate (a key ingredient) but not into other chemicals that form glyphosate. If you look at some of those, like EO, Acetic Acid, or even the coal they use in the US production facility, prices moved by >50%. Thus I assume that 1/4th of COGS went up by 33% from ’21 to ’22, and that in ’23 we get back 1/3rd of that cost increase. I also assume that 2/3rds of the price increase from ’20 to ’21 flowed through to EBITDA. Doing this, I get:

This is probably too low on ’20 and too high on ’22 but I’m giving high contributions from price to be conservative.

I think it's fair to treat 2020 as close to “normal,” because at those prices the glyphosate margins for producers without any cost advantages were negative:

Most likely the glyphosate profitability underpinning ’23 is close to mid-cycle (perhaps + a couple hundred million on EBITDA of 6.5b).  We could overshoot on the downside but I’d note that even in past downcycles the profitability stayed positive.

Catalyst

Litigation settlements and tighter bounds on remaining costs; activist pressures; a new American CEO; and an announcement today that Bayer is considering a spin off of the Crop Science segment.