Ausser Ordnung

Bayer's Monsanto bid yields poor financial harvest

Bayer's Monsanto bid may yield a poor financial harvest. The German chemical group's rejected $62 billion for the US seed maker already appeared to violate one of its key management principles: sticking to projects whose returns beat their cost of capital. Upping the price from the current $122 a share to win over its intended partner would require heroic sales-growth assumptions to stack up.

Monsanto's top line could hit $13.7 billion for its fiscal year ending this August, according to the average estimate of Wall Street analysts. Assuming that Bayer can grow its top line by a chunky 10 per cent a year, revenue would hit $20 billion by 2020, allowing for a year or so to secure the necessary deal approvals. That's also the year when touted annual cost savings of $1.5 billion would fully kick in.

Apply Monsanto's average margins over the past five years, lump in the expected synergies and tax everything at 25 per cent, and Bayer's investment would throw off about $4.7 billion of operating profit before interest costs.

It would amount to a 7.5 per cent return on the $62 billion of debt and equity tied up in the investment - assuming Monsanto can grow sales aggressively. That's not far off the 7.6 per cent cost of capital that Bayer estimated for its business last year. The more relevant figure, though, is the cost of capital of the acquired business, which Morningstar estimates at 8.3 per cent. On that benchmark, Bayer falls short.

Boosting the offer to $135 per share - a price some analysts think could convince Monsanto to sell - would be even harder to justify. Using the same math, it would take over $25 billion of annual sales for Bayer to clear the value hurdle. That would require nearly doubling Monsanto's sales in less than five years.

There could, perhaps, be more costs to squeeze out - it's common for acquirers to lowball them. Bayer Chief Executive Werner Baumann may also reckon combining Monsanto's high-tech seeds with Bayer's crop sprays could bring in handsome extra rewards. It'll be tough, though, to reap enough from the investment to keep shareholders happy.