Fitch Puts Bayer AG on Rating Watch Negative
OREANDA-NEWS. Fitch Ratings has placed Bayer AG's (Bayer) 'A' Long-Term Issuer Default Rating (IDR) on Rating Watch Negative (RWN).
The rating action follows Bayer's announcement yesterday that it intends to launch a formal offer to acquire US-based chemical company Monsanto Company (A-/Stable) for USD62bn (approximately EUR55bn) including debt. Should the transaction go ahead at the conditions offered or with a revised higher offer, Fitch will likely downgrade Bayer's IDR, senior unsecured and subordinated ratings by a minimum of two notches. Headroom at the 'A' IDR is already low and the acquisition would cause an increase in leverage and business risk for the combined group.
We calculate pro-forma credit metrics for a post-acquisition Bayer that remain comfortable for an investment grade rating thanks to the company's intention to issue approximately EUR14bn of equity and to our projection of post-completion free cash flow in the region of EUR2.5bn to EUR3.0bn. However, a downgrade into the 'BBB' category is likely.
KEY RATING DRIVERS
Strategic Rationale of the Transaction
Fitch views the proposed merger as improving Bayer's position in the crop science industry, where the combination will create a leading player. Also, the combination of Monsanto's strength in seeds compliments Bayer's strength in crop protection. The transaction would address higher competitive pressure in the rapidly consolidating agricultural supply industry, a process that is being driven by declining crop prices and structurally reducing income generation in the farm sector.
Different Company Profile
The transaction would improve business risk for Bayer's crop science business. However, the diversion of capital from pharma and consumer health could impair the long-term prospects of these businesses. We calculate that the more cyclical crop science business would take the place of the more stable pharma operations as the largest contributor to sales. Crop science's EBITDA would reach over 50%, up from its current contribution of under 25%. Nonetheless, the acquisition would be margin enhancing as Monsanto's EBITDA margin is approximately 30% while Bayer's is approximately 20%.
Shift in Capital Allocation and Risk Appetite
Fitch views the proposed acquisition as indicative of a change in focus of Bayer's strategy under new leadership, with a potential shift away from favouring the healthcare business. We also observe more aggressive financial policies to pursue M&A-driven growth, effectively sacrificing the historical commitment to a 'A' rating, at least in the short term. The transaction will also divert resources away from the pharma and consumer healthcare business. This could impair the competitiveness of two business exposed both to significant growth opportunities and competitive pressures.
Despite the likely elevated financial risk profile immediately after completion, Fitch views Bayer as having sufficient strategic options to manage leverage down, including scope for a full divestment of Covestro (still 64% owned), or further full or partial business separations. We also note Bayer's historical use of hybrid debt to manage financial risk, which could be an option to manage leverage. We believe that these strategic options, together with still satisfactory free cash flow generation and debt serviceability ratios support the group's investment grade rating.
Fitch's expectations are based on the agency's internally produced, conservative rating case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Although subject to shareholder approval, key Fitch forecast assumptions for the merged group include:
- Successful completion of the acquisition of Monsanto in 2017 at the terms of the offer announced by Bayer on 23 May 2016
- Successful issuance of EUR14bn equity during 2017
- Progressive achievement of EUR1.5bn synergies by 2020
- Maintenance of a 30% to 40% dividend payout
Upon completion of the transaction, we will likely downgrade Bayer's ratings by at least two notches. The final ratings will depend on pro-forma leverage on completion and on the degree of visibility and credibility of a sustainable de-leveraging path using cash flow and potential divestment proceeds.
Positive rating action is currently not envisaged. If the transaction does not proceed, Fitch will review the implications of the company's more aggressive financial policies with the potential consequence of a one-notch downgrade.
LIQUIDITY AND DEBT STRUCTURE
Bayer has access to funding sources spanning bonds, bank debt and commercial paper. The group has a EUR9bn syndicated credit facility, of which EUR6.2bn was undrawn at end-2015. Bayer's cash position was EUR1.8bn at end-2015 and the agency assumes minimum free cash flow generation of EUR2bn per year over the four year rating horizon. Debt facilities are not subject to financial covenants.
SUMMARY OF FINANCIAL STATEMENTS ADJUSTMENTS
Fitch assumes EUR200m as non-readily available cash in its rating calculation to allow for intra-year working capital swings.
FULL LIST OF RATING ACTIONS
Long-Term IDR: 'A' on RWN
Short-Term IDR: 'F1' on RWN
Senior unsecured debt: 'A' on RWN
Subordinated debt: 'BBB+' on RWN
EUR1.3bn hybrid bond due 2075 (DE000A146JN) assigned 'BBB+', on RWN