Description

Executive Summary

At current levels around $102.00, Monsanto (“MON”) shares represent an attractive investment opportunity with 1.25x MoM upside to the $128.00 all-cash offer by Bayer (“BAYN”) if the deal closes in one year’s time whilst there’s limited downside of 0.87x to the unperturbed share price, excluding some buffer from the $2bn break fee that could limit downside to 0.92x.

I’ve analyzed the deal from a number of perspectives, including (i) BAYN’s ability to financing the acquisition, (ii) potential regulatory roadblocks, (iii) BAYN’s M&A track record, and (iv) MON’s valuation and the economics of this investment to conclude that BAYN is very likely to complete the acquisition, whereas current share price implies a <33% probability of completion.

There’s an obvious hard catalyst in form of deal completion in 11-20 months’ time, although interim milestones such as approval from CFIUS or antitrust authorities may result in the shares trading higher. Key risks are antitrust authorities blocking the merger altogether or requiring BAYN to divest businesses representing revenue in excess of $1.6bn, although in the former case, MON would be entitled to a $2bn break fee, whilst in the latter case, MON won’t be entitled to the break fee.

I regard this trade as a good cash-alternative, which is something I’m very fond of given the volatile market environment we are facing. I’ve been intrigued that there have been a number of what I saw as higher-probability merger arbitrage situations emerging over the past 12-months in the large cap space, such as RDSB / BG (1.15x upside even 6 months prior to closing) or ChemChina / SYNN (1.2x prior to CFIUS approval, which appeared reasonably likely). This has been quite a welcome change compared to the prior 2-3 years where spreads in both small and large cap deals were almost non-existent. I’m suppose LPs reduced allocations towards merger arbitrage strategies following a few lacklustre years, which is now resulting in compelling merger arbitrage trades in the large cap space at least. Given that this deal is so large that BAYN may struggle at the last mile if capital markets froze, I would leave myself the option open to at least partially close the trade prior to deal completion, subject to news flow and, of course, the advent of higher reward investment opportunities that market routs tend to throw up.

Analysis Highlights

1. Ability to finance the acquisition: well feasible although it’s a huge deal in both absolute and relative terms (4/5)

BAYN has a strong ability to obtain funding for the MON deal given its IG-rating and the fully underwritten $57bn bridge financing obtained from a roster of international banks. The MON acquisition is anticipated to have an EV of $66bn comprising ~$9bn of net debt and $57bn for the MON equity, which BAYN intends to finance using $19bn of equity and incremental debt of $47bn. Clearly, this is a huge deal, even for BAYN which has a market cap of €75bn and €20bn in debt (half of which are pension obligations), but given the $57bn bridge facility has been fully underwritten by BAML, CS, GS, HSBC, and JPM, only a complete market meltdown will reasonably endanger Bayer’s ability to fund the deal. S&P has already indicated that this deal could lead to a ratings downgrade of up to 2 notches to BBB, which still comfortably puts BAYN in IG-territory despite is ~4x pro forma leverage.

2. Probability of obtaining all regulatory approvals: likely despite some product overlap, however it’s unclear how regulators will view this deal in light of other deals in this industry (3/5)

Whilst BAYN’s and MON’s product offerings are reasonably different so allay most antitrust concerns, questions remain with regards to the herbicide businesses. The acquisition will be subject to the usual large-cap, inbound US acquisition scrutiny, most importantly CFIUS as well as the US and EU antitrust authorities. BAYN has been touting the complementary nature of their two product portfolios, and broadly speaking, it’s fair to say that MON’s key seeds business has little overlap with BAYN’s seeds business, to the extent that it should cause antitrust concerns.

Quantitatively, my biggest concern is the herbicide business, where BAYN derived $4.4bn of revenue compared to Monsanto’s $5.1bn, which mainly comprises glyphosate sales. Arguably, glyphosate has been becoming more commoditized with Asian players looking to expand production capacities, but the risk remains here that in the scenario where some antitrust authority orders the divestiture of some of BAYN’s herbicide business could bust through the $1.6bn revenue limit for mandatory divestitures as per merger agreement. If this were to happen, BAYN could technically walk away from the deal without having to pay the $2bn break fee.

Another potential risk is also how regulators will view horizontal M&A across the product spectrum. The argument would be that consolidation even across different products could harm competition, particularly in light of the large number M&A deals in progress involving the behemoths in the agrichemicals space. I find the risk here hard to assess because of a lack of precedents (that I’m aware of at least) of an industry that’s simultaneously seeing 3 large and complex deals involving the top 5 players.

3. M&A track record: BAYN is a serial acquirer of both private and public companies (5/5)

BAYN is no stranger to large M&A deals, having consummated a number of large deals in the past including two take-private deals, which should give some comfort around BAYN’s seriousness in completing the MON deal, whilst the MON CEO will unlikely want to scupper this deal given a lack of alternatives. BAYN has acquired numerous businesses over the past few years, with the larger and more noteworthy ones listed below. It is not obviously huge sample but reassuring that (a) BAYN frequently engages in M&A (complete list is here), and (b) BAYN has not failed to complete take-private deals in the past. With the BAYN chairman Werner Wenning and current CEO Werner Baumann being “Bayer-lifers”, I would expect them to be highly motivated to pull off this acquisition.

I think the MON CEO Hugh Grant is unlikely to try to torpedo the deal after the board has moved to recommend the BAYN offer. BAYN is paying a pretty hefty price, particularly given the challenges that the agrichemicals industry is facing right now and there’s next to no other strategic to expect another bid from. DuPont and Dow Chemical are busy with themselves whilst BASF has made some noise that they’d be interested in Syngenta should the ChemChina deal fail without indicating any interest in MON.

4. Valuation considerations: BAYN’s bid fully values MON but MON shares offer attractive risk-reward at current prices (4/5)

BAYN is admittedly paying a fairly full price for MON, but at the current share price, the risk reward is quite compelling with 1.25x upside within a year assuming completion by the end 2017. The 17x multiple that BAYN is paying is at a small premium to what ChemChina is bidding for Syngenta and also at a small premium to what MON last bid for Syngenta before the deal fell apart.

At current share price levels, one conservatively looking at 1.25x+ upside if the deal goes through and 0.87x downside if MON was to drop to the unperturbed share price, implying a ~33% probability that this deal will go through. Note that MON is allowed to continue to pay its $0.54 quarterly dividend and also, the BAYN break fee of $2bn represents ~$4.50 of value per share, which should further limit one’s downside to around 0.92x.

5. Other terms and conditions

The merger agreement looks pretty standard and doesn't have a lot of conditionality, but BAYN won’t have to pay the $2bn break fee under all circumstances. The deal is agreed to close by September 14, 2017, but subject to extension to June 14, 2018 if not all regulatory approvals have been obtained. The merger agreement contains standard reps & warranties and contains a non-shop provision for MON’s board. If MON was to withdraw from the deal, it will have to pay BAYN $1.85bn plus up to $150mn in cost cover, whilst BAYN will have to pay Monsanto a $2bn break fee if it cannot obtain regulatory approval for the deal. However, there are two important wrinkles in the break fee payable by BAYN: if either (i) CFIUS shoots down the deal, or (ii) anti-trust authorities demand BAYN to sell off businesses representing more than $1.6bn in revenue or other businesses that would have a “material adverse effect”, then BAYN will not be required to pay the $2bn break fee.

Overall, the BAYN / MON deal scores 16 / 20, which is very good for my internal maximum score of 18 for large cap deals, because they inherently come with some degree of funding risk and some arbitrary risk of political intervention. In light of the <33% probability of success priced by the market and 1.25x profit potential, I would recommend buying MON shares.

Catalyst

Deal completion, CFIUS and other antitrust approvals.