Introduction

Since 2015, the German company Bayer AG (OTCPK:BAYRY, OTCPK:BAYZF) has lost considerable value.

Data by YCharts

I bought my first position during the first drop in 2015/2016 and bought some more last year. Now, about 2.5 percent of my portfolio consists of shares in Bayer. Actually the share in my depot would be larger, but the shares are in the double digits in the minus. I would have bought more for a long time, but I have set myself a ban because I wanted to avoid investing in a possible barrel without bottom. At the beginning of next year, my freeze on buying ends. Bayer is currently at the top of my shopping list. I believe that the company offers an excellent investment opportunity for patient long-term investors. In this article I want to tell you why this is so and when I plan to buy more shares.

Analysis

So yes, Bayer bought the probably most hated company in the world. As far as ethical issues are concerned here, they have already affected Bayer as a pharmaceutical company before. I think it’s perfectly okay not to invest in a company for ethical reasons. That concerns pharmaceutical companies, gun manufacturers, tobacco companies, gambling companies, etc. I do not want to present here the arguments for and against such an investment, because they are generally known and here on the Seeking Alpha Platform is not the right place for it. I would therefore like to confine myself to the operational level. And from the side, I still consider the merger thesis to be valid and in no way endangered. There are several reasons for this:

First of all, Bayer has an extremely broad portfolio. It consists mainly of the following three segments: Pharmaceuticals, Consumer Health and Crop Science (Bayer sold its Animal Health division, see below):

(Source: Bayer divisions)

Given that, last quarter was quite good from an operative perspective. Pro forma revenues of Crop Science, which assumes the acquisition of Monsanto as of January 1, 2018, increased by 5.7 percent on a currency-adjusted basis. Revenues from pharmaceuticals increased by 5.9 percent. The antibiotics Avalox/Avelox (revenue was up 32.8 percent) and Stivarga (revenue up 30.6 percent) performed particularly well. In the Consumer Health segment, Bayer grew by 3.7 percent.

Bayer expects sales of around EUR 43.5 billion, which corresponds to an increase of around 4 percent.

Bayer is also adjusting its portfolio to pay back debt faster and is making excellent progress. In August Bayer reached an agreement with Elanco Animal Health to sell its animal health business for EUR 6.8 billion. In addition, the sale of the 60% stake in Currenta was successful. Bayer expects the sale of Animal Health to be completed in mid-2020 and the sale of the Currenta stake to be completed in December 2019. The sale of the Dr. Scholl’s foot care business, is expected to be completed in November. The sale of the Coppertone brand to Beiersdorf (OTCPK:BDRFF) was completed in August.

From a fundamental perspective, Bayer is definitely worth investing. With an forward P/E ratio of 9.288 Bayer can be considered as being cheap (it is of course not as cheap as it was between March and June 2019):

Chart
Data by YCharts

I also expect the dividend to remain stable. This would result in a current dividend yield of 4 percent. It is covered almost three times by the expected cash flow. The profit is somewhat distorted by the Monsanto takeover and should therefore not be used for dividend stability. Therefore, the payout should be safe:

Addressing the Monsanto claims as the part with the biggest downside catalysts, it is true that Bayer has assumed significant legal risks with the over USD 60 billion purchase of Monsanto. Most recently, Bayer was faced with approximately 42,700 lawsuits in the USA alleging cancer risks from US seed giant products. Bayer lost the first three lawsuits in the U.S. courts and received high damages awards.

From my point of view as a lawyer, the downturn in the share price was a typical herd reaction. I believe that investors have overestimated the risks here because they are not familiar with the customs of such mammoth lawsuits. I’ll have to explain a little more about that. One is the amount of the fines. It is generally known that these can still be significantly reduced in other instances (as has already happened). The other is management strategy. The first thing to note is that nobody knows their own company as well as their own management. Before such a mammoth takeover takes place, an incredibly complicated and extensive due diligence takes place. Every email, every contract, everything is reviewed, evaluated and presented to the management by internal and external professionals. When it comes to proceedings at the courts and initial judgments, this development has certainly been part of the strategic simulation games. Anyone who believes that Bayer, as a German company, would dare such an acquisition-undertaking in complete good faith, without having expected the consequences that have now occurred, suffers even from a violent overestimation of his own abilities or has no idea how such transactions work (but probably both).

So what is the actual status of the proceedings? Apart from the existing conviction against which Bayer has appealed, all other proceedings have already been postponed this year. One of the reasons for this is that the parties to the dispute have more time to negotiate a settlement. The activist investor Elliott, who holds around two percent of Bayer, is keeping a close eye on the Bayer management. He had called for a fundamental revision of the process strategy and expects a “timely comparison with limited financial expense”.

The increase in the number of lawsuits is also due to the fact that law firms specializing in such lawsuits have recently increased their advertising significantly once again. From July to September alone, plaintiff lawyers spent more than 50 million dollars on this. That is about twice as much as in the entire first half of this year. The number of lawsuits, however, says nothing about their merits. Rather, I expect Bayer to conclude settlements at the end, as is customary in such cases.

This lack of knowledge and the anxiety and impatience of herd behaviour ultimately ensure that small investors sell at a loss and ensure cheap prices. These are then gratefully accepted by the big investors. This is also the case with Bayer. In April 2018, Bayer announced that it had struck a deal with Singapore’s state investment company Temasek under which it would issue shares with an entitlement to dividends as of January 1, 2017 at an at-market price. Together with its existing holding in Bayer, Temasek now owns about 4 percent in Bayer. While Temasek’s investment in Bayer AG is underperforming, management is confident about its future prospects.

Interestingly, at the height of the poor share price performance, a new stockholder invested heavily in Bayer this year. Hedge fund investor Elliott made its acquisition of Bayer public in June 2019. Elliott now holds a total of EUR 1.1 billion in Bayer (around two percents). Elliott also sees that Bayer is extremely undervalued. Paul Singer is also pushing for a break-up of the company. While I don’t think it’s very likely (management is extremely against it, and a majority for such a decision is not foreseeable at the moment), it shows that there’s a lot of value in the company.

Conclusion

I still consider the merger thesis to be valid and in no way endangered. There are several reasons for this. Accordingly, a company that is valued so favorably remains as it has not been for almost 10 years.

I will therefore base my repurchase decision on whether Bayer can at least keep its dividend stable as announced and whether this dividend is covered by cash flow. I assume so, but I can still wait the few months until management announces/confirms the dividend.

Bayer is part of my diversified portfolio. If you enjoyed this article and wish to receive updates on my latest portfolio research, click “Follow” next to my name at the top of this article, and check “Get email alerts”.

Disclosure: I am/we are long BAYZF, BAYRY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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2019-12-12