Bayer: Forget about Monsanto

In 2012 (using the year ended 6/30/12 data), Microsoft was trading at 12.5x trailing earnings of $2.00. And this didn't account for the $7.16/share in net cash they had on the balance sheet. Net that out*, and shares were trading at 8.9x earnings.

The concern at that time had to do with the Windows segment. iPhones, Apple in general, and Androids were all chipping away at the once dominant Windows operating system. Would people even be using desktops in the future?

To account for this, I decided to net out the Windows segment from operating earnings - pretend it didn't exist. So I took full year operating income of $21.7B and subtracted off $11.9B to get $9.8B in ex-Windows income. Adjust income taxes (proportionally), and you're left with $7.9B in net income, and EPS of $0.93.

Without Windows, Microsoft was trading at 27x earnings. Adjusted for cash*, the company was trading at 19x earnings, which wasn't bad considering the growth potential of Servers / Cloud. I was very confident that Windows was worth more than $0 to the operating income line, so this analysis gave me the confidence to continue holding my MSFT shares (which I had bought in mid-2009 and was becoming disgusted with by 2012).

While this type of analysis - looking at a company's weak point and leaving it for dead - is just a form of semantics, it helps me get my hands around the fundamentals, and is also a way to make sure it really is an attractive valuation.

Today, I'm seeing a similar situation in Bayer (BAYN.DE, or the ADR in the US BAYRY). Bayer closed on the acquisition of Monsanto in the summer of 2018. Almost immediately, they walked into the glyphosate (Roundup) buzz saw when, in August 2018, a California jury awarded $289 million in a single cancer lawsuit.

To say this has weighed on Bayer's share price is an understatement. Since summer 2018, shares are down -40%. The market cap of the entire company is now 62B euros ($68B), which is roughly what they paid for Monsanto.

So here is my thesis on Bayer: remove the crop science unit (mostly Monsanto) - assume it goes to $0 EBITDA. 2019 EBITDA was 11.5B euros. Crop Science was 4.8B euros, so net (Pharma and Consumer health) EBITDA was 6.7B euros.

Enterprise value is 97.5B euros (61.6B market cap, debt of 39.1B, cash of 3.2B).

This is an EV/EBITDA (netting out the companies larges division - Crop Science) of 14.6x. Compare that to another health care company with three large divisions: Johnson & Johnson (Pharma, Consumer, Medical Devices), which is trading at an EV/EBITDA multiple of 14.0x today (Glaxosmithkline is at 11.6x, while Novartis is at 13x)

Today we can buy legacy Bayer for the same value as Johnson & Johnson, and get Monsanto for free.

While Bayer has been cheap for a while, what really got me interested was the announcement recently that they are in talks to settle 40-70% of the outstanding 125,000 glyphosate lawsuits. I think this is a major step forward for the company.

Also, anecdotally, none of the farmers I talk to are overly concerned about the cancer risk of glyphosate. Most view it as a chemical used to kill living organisms (plants), so of course you need to use precautions. But on the whole they continue to use it as a primary weed control device. Their biggest complaint isn't the cancer risk, but the fact that they've used so much glyphosate over the years that weeds have built up an immunity to it, and they're being forced to use other, more dangerous chemicals (like Paraquat).

Caveats:

• I don't view Bayer as on par with JNJ. JNJ's Consumer division has better brands that Bayer does. It may not be the best comparable stock.
• Bayer is a pharmaceutical stock. I've read up on their patents, pipeline, and portfolio. Most seem to think it has good potential, but let's be honest - I have no idea what I'm talking about on the pharma potential. 
• The company will have major litigation expense going forward. Maybe Monsanto is worth less than $0? That's a risk I'm willing to take. 

Bottomline, I think Bayer is trading at too steep a discount for the quality of their underlying assets and earnings potential. Happy to hear feedback.



*I'm not a big fan of doing net of cash valuations as, in my experience, $1 cash is rarely worth $1 of share price, but I'll break my own rule in this example.



Harvest Investor © 2020. All rights reserved. The content and ideas contained in this blog represents only the opinions of the author. The content in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. No content shall be construed as a recommendation to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author may hold positions in the securities and companies mentioned on this site. Any position disclosed on this site may be modified or reversed without notice to you. The content herein is intended solely for the entertainment of the reader, and the author.