|Shares Out. (in M):||982||P/E||9.55||7.71|
|Market Cap (in $M):||55,821||P/FCF||8.61||6.58|
|Net Debt (in $M):||35,611||EBIT||4,824||8,531|
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The overhang created by the Roundup litigation since August 2018 has had a dual negative impact on Bayer’s share price, firstly, from the uncertainty surrounding the ultimate liability that the Roundup litigation would result in, and secondly, from the overshadowing effect that this litigation has had for the fundamental story underpinning the company’s future – that of the formation of a leading agrochemicals group with the strongest R&D capabilities and a pipeline set to drive strong growth for the decade to come.
The likelihood of an imminent resolution of the Roundup litigation at a reasonable and already largely known price-range, and with finality makes Bayer a very attractive investment, as a settlement would result in the removal of the negative effect from the market’s overpricing of the long-term litigation liability as well as bringing back the possibility of a returned focus on fundamentals which would finally lead to a re-rating of the share price.
With 2 VIC members having already contributed to the long thesis on Bayer informed by the fundamentals of the business, we concentrate on the litigation and our reasons behind being comfortable with Bayer’s ability to achieve finality in its resolution. Note that a lot of our analysis presented below is informed by extensive background research of large multi-district litigations (MDLs) in the US in recent years as well as academic pieces of work such as Elizabeth Cahmblee Burch’s “Mass Tort Deals: Backroom Bargaining in Multidistrict Litigation” (2019), which we won’t detail below but which will form a lot of the background knowledge making us comfortable in making some of the assumptions that we do below.
What has happened to date?
On the 24th of June, Bayer made an announcement about its settlement of 75% of current cases and an agreement on a settlement fund for future plaintiffs. At the moment the outstanding parts of the litigation are the remaining 25% of current plaintiffs which are currently in settlement negotiations with Bayer, and the court approval procedure for the class action settlement that was set up for future plaintiffs. In the case of the latter, an indication by the Judge overseeing the multi-district litigation (MDL) on Roundup that he wouldn’t approve the class action settlement for future plaintiffs in its current form, prompted Bayer and the plaintiff lawyers, that together came to the agreement, to withdraw the class action settlement with the aim of resubmitting it after addressing the Judge’s concerns.
We expect the unresolved parts of the litigation including the 25% of current plaintiffs who haven’t yet settled as well as the class action settlement with future plaintiffs to both be settled/solved at some point in the autumn. In the case of the 25% of the 125,000 current plaintiffs who haven’t yet settled, we expect the majority to settle in the next couple of months and when it comes to the class action settlement for future plaintiffs we expect Bayer and the future plaintiffs’ lawyers to come up with a structure/terms that would be acceptable to the Judge and resubmit the agreement for court approval, also in the next couple of months. In fact, Bayer’s Chairman noted that he expects a revised class action agreement to be ready in 4-6 weeks. Both of these outcomes should allay investor concerns about the finality of the settlement and allow investors to move on to focusing on the fundamentals of the business.
What the June 24th announcement was crucially missing from the market’s perspective was finality, or in other words, a guarantee that this announced $10.1-10.9bn was the full and final payment for all Roundup-related cases. This is because the $8.8-9.6bn that is allocated to all currently filed and unfiled cases (i.e. the full ~125,000) covers the total amount that will be paid both to those ~90-100,000 cases that have already been settled and the remaining ~25-35,000 yet to be settled. Thus, while the company is sure that it will cover the value of both the settled and unsettled cases with the $8.8-9.6bn put aside for current cases, from the market’s point of view the valuation of the unsettled cases remains a large unknown and a key source of skepticism about the finality of the liability announced by the company. These cases aren’t simply unsettled but they are widely known (due to the vocal nature of the lawyers at their helm) to be hold-outs – unhappy with the settlement sum that Bayer is currently offering them. Thus, from the market’s point of view the remaining 25% of cases can not only prove to be a continuing nuisance but also a reason for the total litigation liability to end up above the announced $10.1-10.9bn.
In this case we know that the 75% of current cases that have achieved settlements (though these are yet to be finalized) include inventories of plaintiffs from the following law firms:
with the first three having been involved with the three Roundup trial court cases that have taken place so far.
To understand the importance of the involvement of these leading law firms in the achieved settlement agreements, one first has to look at the workings of the settlement process in general. There are two broad types of settlement structure in mass tort litigations – global settlement and inventory settlement. What we’re seeing in the case of the Roundup litigation is an inventory settlement approach being taken by Bayer, which is where the defendant settles individually with each law firm for its particular inventory of cases. In any mass tort litigation the general pattern is that the leading law firmsin the space, which are also usually carrying the majority of the weight in driving the litigation process in question, tend to get their pick of the best cases which combined with their widely recognized legal expertise in mass tort/product liability cases and in trial court gives them the greatest negotiating power in terms of case valuation in a settlement. This means that settling with the plaintiffs of the leading law firms usually presents the most meaningful obstacle to the defendants, as these law firms’/plaintiffs’ greater negotiating position inevitably means they end up getting significant premiums to the average case valuation in the settlement due to the superior merits of their cases as well as the law firms’ prowess in this area of law. This also means that the remaining law firms involved in the settlement process tend to take what they are given and follow in the footsteps of the leading firms given their lack of negotiating power and clout in the process.
Given this general pattern in mass tort litigations it may be counterintuitive that another general pattern is that the cases to usually hold-out in the settlement process are the weakest ones which garner the lowest valuations. Their decision to hold out initially, is led by an attempt to increase the settlement offered for their cases - which are at the very bottom of the valuation ladder - through mere nuisance value.
Out of the remaining 25% of cases which are unsettled, ~24,000 plaintiffs are represented by the Onder Law firm which is refusing to accept Bayer’s settlement offer. Bayer’s previously rumoured offer of $5,000 per plaintiff for this inventory of cases is already a reflection of their lack of merit and mere nuisance value. Equally telling of the quality of this group of cases is the law firm which represents them – Onder Law. Onder Law was late to this whole process, appearing to opportunistically enter following a number of large damages awards in trial court and with rumours of the emerging settlement. It’s lateness to the process and its advertisement to anyone with cancer and prior exposure to Roundup speaks volumes as to the likely merits of its inventory of cases. Firstly, the strongest cases and those with the greatest supporting evidence (though the conclusiveness of this evidence is still very much undetermined) are those where the plaintiff has developed Non-Hodgkins Lymphoma (NHL), so the firm’s advertisement to all types of cancers means that a significant portion of its cases are likely to not stand up in court given the lack of evidence of a link between Roundup and other types of cancer. In addition, the fact that the firm doesn’t specify the length or intensity of exposure to Roundup needed for it to take on a case also means that with the best law firms having already aggregated and settled the strongest and most meritorious cases, the Onder Law firm has most likely been left with a large number of non-industrial use cases where exposure has been very limited. Such cases are also very low on the valuation scale given that the length and intensity of exposure to Roundup needed to prove causation is very high, as for example in the Johnson case where the plaintiff found himself drenched in the substance on a number of occasions when using it to spray schoolyards. This sort of exposure is very different from exposure in the context of consumer-use for gardening purposes, with the latter not meeting the high threshold of exposure required to prove causation.
The weak legal footing of these hold-outs means that they won’t stand up in trial court and the Onder firm is holding-out (note that in this case the hold-out strategy is driven by the lawyer rather than the plaintiffs) in the mere hope of a slight hike to its settlement sum through its nuisance value to Bayer. With the average 30% pay-out to the lawyer representing plaintiffs in contingent fee cases, the Onder firm stands to gain an estimated 30% of the current $120M in total value attributed to its inventory of cases, i.e. as much as ~$36M. Therefore, we note that given the very low likelihood that any of these cases will go very far in trial court let alone win, means that the firm is very much incentivized to take the settlement especially that the firm has spent very little on the process so far. We therefore expect this inventory of plaintiffs to also settle fairly soon within the $8.8-9.6bn announced for current cases. The above analysis also fully applies to all other unsettled current cases, most of which have been generated by TV advertising and are highly likely to demonstrate all the aforementioned characteristics which mean that they are low-value cases unlikely to go very far in trial court.
We therefore don’t expect these hold-outs to end up being a meaningful obstacle to the finalization of the settlement and overall valuation of the 125,000 current cases.
On the 6th of July, Judge Vince Chhabria – the District Judge who oversaw the multi-district litigation (MDL) over Monsanto’s Roundup – voiced his concerns about the part of Bayer’s announced settlement dealing with future plaintiffs/claims which was allocated $1.25bn out of the total $10.1bn - $10.9bn settlement. To put Judge Chhabria’s concerns into context, we first set out the terms of the class action settlement that applies to citizens or residents of the US who have been exposed to Roundup and have not commenced a lawsuit or otherwise retained counsel in connection with such exposure as of June 24th 2020, i.e. potential future claimants.
The class settlement as it currently stands looks as follows:
Gives those eligible to be class members 150 days from the date of the fee motion to opt out from membership of the class
Those not opting out automatically become class members and are bound by the terms of the class settlement:
An independent Science Panel is to take sole responsibility for providing a definitive and binding answer on the relationship between Roundup and Non-Hodgkins Lymphoma (NHL) – whether Roundup can or cannot cause NHL, and if it can at what exposure levels
A litigation standstill for 4 years, allowing the Science Panel to complete its work, during which time class members aren’t allowed to file new litigation related to Roundup
If the Science Panel finds that Roundup doesn’t cause NHL, no class member will be able to proceed with their claims, whereas in the event that a relationship is found class members that had the level of exposure that the panel decides is capable of causing NHL will be able to proceed with their claims
However, in the latter case only compensatory claims can be made as all rights to claim punitive and medical monitoring damages are waived as part of the settlement
As compensation for the litigation standstill and the waiving of rights to claim punitive and medical monitoring damages, Bayer has set up a $1.1bn fund – non-reversionary cash paid for the benefit of the Class comprised of
A Diagnostic Accessibility Grant Program (DAGP) offering testing for NHL, with a focus on early diagnosis for the most at-risk and medically-underserved populations
Interim Assistance Grants to compensate for the delay in litigation
A Research Funding Program to fund medical and scientific research into the diagnosis and treatment of NHL
Bayer also agreed to pay up to $150m in attorney’s fees and costs
This means that the maximum payout from Bayer to class members over the next 4 years (the time it takes for the Science Panel to make a decision on general causation) irrespective of the number of class members successful in their claims for interim assistance is $1.25bn. In case of a negative decision on general causation (i.e. Roundup doesn’t cause NHL) Bayer won’t be liable for any more payments, capping the total liability for future claimants at $1.25bn. If there is a positive decision on causation, on the other hand, class members will be able to proceed with their claims for compensatory damages - having to prove specific causation (that Roundup isn’t merely capable of causing NHL but that it caused their particular instance of NHL). Given that any potential positive ruling by the Science Panel on the link between Roundup and NHL is only likely to apply to very high levels of exposure (e.g. industrial use with instances of repeated and prolonged exposure), even in this case the number of class members that are likely to be able to proceed with their claims is few. In addition, a study about “Occupation/Industry and Risk of Non-Hodgkin Lymphoma in the United States” (Occup Environ Med, 2009 Jan) showed that there was little difference in the incidence of NHL among the general population and populations who have high glyphosate/Roundup exposure due to their occupation such as groundskeepers or agricultural workers. This means that out of the 125,000 identified as potential class members the same percentage should be expected to develop NHL as would be in the general US population. Applying the 2.1% NHL incidence rate which applies to the general US population to the identified group of class members of 125,000, we get potential current or future NHL patients who haven’t retained a lawyer regarding the Roundup litigation of 2,625. This means that even in the event of a positive decision on general causation by the Science Panel, any future liabilities faced by Bayer are likely to be quite limited.
The structuring of this settlement through a class action means that eligibility criteria and valuation are going to be enforced and carried out in a much more scientific and precise way, unlike in the case of the settlement of current cases where the inventory settlements with law firms meant that payments were made for large inventories of cases reflecting the general merits of the collection of cases but rarely giving a very accurate picture of the sum of the fair valuations of the underlying cases, with many unmeritorious cases most certainly having gotten payouts (even though these would have gotten low payouts) when they didn’t deserve them. This also sets a clear limit on Bayer’s expenditure in the worst-case scenario under the class settlement as it currently stands.
The very same structuring of the settlement with future claimants as a class action, however, means that it is much more regulated and therefore subject to court oversight. Class actions are governed by a procedural rule – Rule 23 – which includes checks and balances and safeguards to ensure fairness and ethicality of treatment of plaintiffs. As the class settlement’s own motion for preliminary approval of the class settlement says, “Fed. R. Civ. P. 23(e) governs a district court’s analysis of the fairness of a proposed class action settlement and creates a multistep process for approval”. This inevitably creates significantly greater scrutiny of settlements which are arranged through class actions, in stark contrast to global or inventory settlements which aren’t regulated and have no court oversight. It is this very need for scrutiny of the fairness accorded to class members that prompted the judge overseeing the Roundup MDL as well as the class settlement for future plaintiffs to issue a list of concerns and a preliminary inclination not to approve the class settlement as it currently stands: “even before receiving opposition briefs, the Court is skeptical of the propriety and fairness of the proposed settlement, and is tentatively inclined to deny the motion”.
Judge Chhabria’s list of concerns includes the following:
Constitutionality of delegating the function of deciding on general causation from juries and judges to a panel of scientists
Closely related to the point above, even if we assume that such a delegation of function is lawful it is unclear how future plaintiffs would benefit from giving up their right to a jury trial and having the issue of general causation being decided by a scientific panel, especially given that juries to date have been very supportive of plaintiffs – granting large compensatory and punitive damages
The appropriateness of locking future plaintiffs into a decision on science rendered by a panel in an area where the scientific consensus is still emerging: “imagine the panel decides in 2023 that Roundup is not capable of causing cancer. Then imagine that a new, reliable study is published in 2028 which strongly undermines the panel’s conclusion. If a Roundup user is diagnosed with NHL in 2030, is it appropriate to tell them that they’re bound by the 2023 decision of the panel because they did not opt out of a settlement in 2020?”
The difficulty of ensuring that all class members have had the opportunity to consider their membership of the class in advance of the deadline for opting out, with an emphasis on the “diffuse, contingent, and indeterminate nature of the proposed class” and the issues that this may cause for ensuring that all those eligible have been notified of their class membership
The Judge’s inclination to oppose the class action agreement as it stands was surprising because the negotiation of this agreement was overseen by the mediator of the Roundup settlement – Ken Feinberg – who is a widely known and respected figure in the mass tort space having previously led mediation talks over the September 11th Victim Compensation Fund, the BP Deepwater Horizon oil spill and the Volkswagen diesel emissions scandal. In addition, Judge Chhabria’s approach of bifurcating the bellwether trials in the Roundup MDL into a section on general causation to begin with to then be followed by a decision on specific causation assuming an affirmative verdict was rendered on the general causation question, seemed to indicate that he would support any efforts to put science at the forefront of any settlement agreement. However, the Judge’s voicing of his concerns becomes more understandable in the context of the highly regulated nature of this area of law, in contrast to settlements that come out of MDLs.
We interpret the share price reaction as a reflection of shareholders’ belief that this development is the equivalent of there being no settlement agreement and it being uncertain whether one can be reached at all and if so what level of finality it can achieve. Our counterarguments to such worries and the share price impact that they’ve had are the following:
Bayer’s management has been very vocal about the crucial nature of the finality of any outcome to its acceptance of a settlement. We believe this is a minimal condition for management which it will be very reluctant to compromise on. While theoretically the settlement of current and future claims are independent, practically Bayer’s management was only ever willing to settle current claims if it was given an attractive deal ensuring finality on future cases. Thus, unless it is able to achieve an agreement on future cases which ensures sufficient finality and an attractive valuation, Bayer could decide to pull its offer to current plaintiffs. This means that both sides are incentivized to reach an agreement that is both acceptable to the judge and Bayer
Note that the class action settlement in its current form is highly favourable to Bayer and therefore the current re-writing of the settlement is going to be about presenting something that is acceptable to the judge and will be deemed fair and ethical, while not compromising on Bayer’s need for finality as the success of the whole settlement effectively depends on this.
The valuation impact, if any, is going to be minimal in any case. The judge has made no mention of the sum allocated to future plaintiffs. However, if funds allocated to future plaintiffs are increased, the additional sum won’t exceed ~€1-2bn, given the €1.25bn currently allocated to future plaintiffs and the numerous press reports over past months that the sum expected to be allocated to future plaintiffs was $2bn of the rumoured $10bn total settlement. This stands against a gap to fair value (to the aforementioned fair value per share of €98) of €42bn.
It is also very important to note that the class action agreement as it stands now is extremely favourable to Bayer, and even though this is the case both the mediator, Ken Feinberg, and the plaintiff lawyers that negotiated this deal were on board with the terms and structure of the settlement. While it is true that some plaintiffs’ lawyers that weren’t involved in the negotiation of the settlement for future plaintiffs raised concerns about the terms of the agreement, the involvement of Feinberg and those representing future plaintiffs in designing the settlement is an indication that the issue at hand is less one of bridging the gap between the two sides – a difficult task the success of which is inevitably ridden with immense uncertainty - but one of making concessions to allow the agreement to be more robust on metrics of fairness and ethicality. In addition, the fact that the starting point is already an agreement which is highly favourable to Bayer means that we expect changes to bring about an agreement that is more balanced.
We are therefore highly confident in Bayer’s ability to achieve both finality and limit the total litigation liability within a range very close to the current $10.1-10.9 bn and we think that the share price reaction to date is explained by the fact that from the market’s point of view these setbacks equate to a return to complete uncertainty about whether a settlement with a reasonable valuation and with finality is achievable in the first place.
Bayer has since preempted the hearing on the preliminary approval of the class action agreement that was to be held on the 24th of July by withdrawing the agreement with the aim of addressing the Judge’s concerns before resubmitting it. Our base case is that within the next couple of months Bayer, together with the mediator leading the settlement and the plaintiffs’ lawyers, come up with an agreement acceptable to the Judge, allaying the market’s concerns about finality. The only remaining unknown would then be how positively the market reacts and over what period of time, which will largely be determined by the management team’s success in communicating the settlement and its finality.
The worst-case outcome would be if the only acceptable shape for the future plaintiffs’ settlement to take for Judge Chhabria is such that it would inevitably prevent Bayer from gaining finality. This could be due to the introduction of a clause which requires the reconvening of the Science Panel in the future to reassess the state of the science around glyphosate, for example. There are methods through which Bayer can mitigate the risks associated with the lack of finality that such new terms could introduce to the settlement with future plaintiffs. Bayer, for example, has always had the option of putting a label on Roundup informing consumers of the fact that there’s been a study (IARC 2015) which found glyphosate to be a probable carcinogen or alternatively Bayer can restrict use of the substance in non-industrial use settings. In other words, there are numerous ways for Bayer to achieve finality by compromising on its unwavering stance on the product in a way which would have a negligible value impact on the company, given that glyphosate is a commodity and genericized low-margin product.
The 27th of August court hearing headed by Judge Vince Chhabria about the progress of the Roundup settlement brought up news which was concerning to the market about the fact that Bayer hadn’t yet signed the settlement agreements it had announced as part of its settlement with 75% of current cases on the 24th of June, and that it had terminated one of them. This news appeared to confirm the market’s concern about the achievability of a settlement altogether reflected clearly in the share price. However, we believe that this interpretation of events is a fundamental misunderstanding of the dynamics at play behind the scenes. What we believe the market is missing is the fact that Bayer has no incentive to settle any current cases – especially the most meritorious and high value ones that formed part of the 75% settled from current cases – while it hasn’t finalized negotiations surrounding the class actions agreement for future plaintiffs. By settling with current plaintiffs before reaching an agreement about the settlement structure for future plaintiffs, Bayer would be giving up a significant lever of power that it holds in the form of the sometimes up to approx. $20m payouts to leading plaintiffs, especially that some of the lawyers that opposed the first version of the class action agreement for future plaintiffs were those representing some of the leading current plaintiffs. By making it’s acceptance/finalization of the agreed settlements with current plaintiffs implicitly conditional on whether an acceptable agreement can be reached for future plaintiffs, Bayer is incentivizing all players to cooperate on all parts of the settlement.
Therefore, we believe that any market concern about Bayer balking at its settlement agreements with some of the leading law firms is misplaced. This seems to be confirmed by additional recent news of Bayer settling with some of the very same plaintiffs/law firms which previously complained of Bayer walking away from reached agreements.
Bayer is currently trading on 7.4x 2021 Consensus EV/EBITDA which we think is too cheap for the leading player in the agrochemical field with the strongest R&D capabilities and most exciting pipeline. Putting this into context, Bayer’s lost 45% of its market cap since the Roundup litigation started.
For more detailed views on valuation please see the 2 previous Bayer write-ups on VIC, but our view is that once the litigation overhang is removed i.e. once there’s a settlement with the vast majority of the current plaintiffs and once some sort of finality is achieved when it comes to future plaintiffs (see above for reasons for conviction in both), the market’s focus will return to fundamentals which will lead to a re-rating of the shares of anywhere between 50-100% in the short-to-medium term.
Settlement with vast majority of current and future plaintiffs
Potential revival of calls for a break-up of the company’s pharma and agrichemicals divisions (begun by Elliott at the end of 2018)
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