Bayer has become a case for the patient investor

Double whammy hits Bayer

Bayer shares plunged 18% yesterday on two bad news. The nightmare related to the Monsanto acquisition five years ago continues to haunt Bayer as a late verdict on Friday on Monsanto’s famous product Roundup opened up more risks for Bayer. In a worst case scenario, Bayer might have to pay up in litigation more than the $16bn already set a side on the balance sheet.

To make matters worse for Bayer, the company has been forced to halt a primary study on an experimental drug as it was not efficient enough relative to the benchmarks set forth in the study. In the pharma division, pressures are also going to increase over time as two of the division’s high revenue generating drugs are facing a patent expiry.

Can Bayer find a way out of its troubles?

As a result of all the uncertainty Bayer’s share price is down 68% from its high back in 2015 and is trading at levels not seen since 2012. This backdrop is obviously difficult for shareholders in Bayer and the question is whether there is a path to a more positive future?

The Monsanto litigation costs might go beyond $16bn, but it is an one-off item and thus not the going concern of Bayer. The failed phase 3 study of the drug asundexian is a significant setback for the equity case, because analysts were modelling the value of the pharma division on this drug to offset the expected decline in revenue and profitability from the patent expiries explained above. With Bayer’s 2-year forward EV/EBITDA multiple hovering just above 6x the company is valued at a deep discount (~33%) to the overall equity market, so there is a natural low level of expectations making it an obvious value case, but one has to be clear about the catalysts. Another key thing, or risk if you will, is that the market value has declined to $33.5bn which is below the net debt of the balance sheet which is dangerous territory to walk for any company. So what is the case and outlook for investors in Bayer?

The next year is likely another transition year with dark clouds hanging over the business so investors should be patient. Bayer still has a top notch crops science unit although the unit is expected to face headwinds in 2024, and is still very profitable. Analysts expect FY23 revenue of €47.9bn and EBITDA of €10.8bn and EBITDA has hovered steadily around the €11-13.5bn for six years in a testimony to the low variance in its operations. The potential catalysts from here is a potential split of the group to unlock value like we have seen from Siemens and GE in recent years. The next capital markets day is on 5 March 2024 and will likely be the key event where such an announcement might be provided to the market.

Analysts expect the dividend to be reduced to €2.15 for the FY23 which on a forward basis equates to an expected dividend yield of 6.3%. If we assume that Bayer does not need to issue equity capital and assume that Bayer can track average economic growth rates over the next 10 years then the real rate return expectation is 6.3% + 2% so roughly 8.3% annualised real rate return. That is roughly a 3%-point positive spread to the over equity market reflecting the uncertainty and risks related to investing in Bayer, and the risk that dividends could decline further in the future.

While it is a challenging time for Bayer the company has shown its ability to grow over many decades and build business value. A long-term investor in Bayer is betting on the company to settle the Monsanto litigation once and for all, maybe separating the businesses, and crops protection prices to stabilize and rise in the future. It will all require a lot of patience.