Fitch: Bayer, Monsanto Deal Structure Reflects Financial Risks
Bayer's final rating will be determined by the proportions of senior and subordinated/hybrid debt (which will depend on market conditions and investor appetite) and by the specific features of the hybrid debt (which will determine how much equity credit it receives). Depending on the level of the final IDR, we would expect Bayer's subordinated debt to attract a crossover (BBB-) rating at best. We placed Monsanto's 'A-' IDR on Rating Watch Negative on Wednesday to acknowledge that such a downgrade of Bayer post-merger would probably result in a subsequent equalisation of Monsanto's IDR with its eventual parent if Bayer is deemed to have strong influence over Monsanto's financial policy.
The equity contribution is structured to support Bayer's existing equity value and to manage dilution by using a combination of a rights issue and mandatory convertibles. Although its commitment to maintain dividends has limited any impact on its share price, an unchanged dividend policy does little to strengthen the balance sheet in the context of a fairly leveraged acquisition. Monsanto's share price, however, is well below the offer price of USD128. We believe this reflects investor concerns about regulatory approval.
While the combined company will not have a large overlap in its customer markets after the merger, recent consolidation (Dow Chemical/Dupont and ChemChina/Syngenta) has led to a significant reduction of consumer choice. We therefore expect intense regulatory scrutiny, particularly in the US and the EU, which is largely opposed to genetically modified crops as developed by Monsanto. We believe that the high break fee of USD2bn reflects Monsanto's concern over these risks.
Bayer has expressed a strong belief in the strategic rationale of the deal and is paying an 18.6x EV/EBITDA multiple, which we consider a full price particularly given some recent softness in Monsanto's performance. The impact on Bayer's business profile will be mixed. It is shifting focus from a healthcare-orientated company with a below average business risk profile towards the more cyclical agri-business. But this will be balanced by better scale and diversification.
Bayer faces execution risks as it attempts to deliver an ambitious integration plan balanced against maintaining its focus on capital allocation, as the healthcare business also offers growth and investment opportunities and is subject to strong competition.
Bayer has said it wants to return to the 'A' rating category in the medium term. We believe it has a variety of strategic options to achieve this, including divestments (its 64% Covestro stake is considered non-core). However, a successful integration of Monsanto and the delivery on the anticipated medium-term EUR1.5bn cost synergies will be key to supporting free cash flow generation and a return to a higher rating, especially if the dividend policy remains unchanged.