Deals

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

Brooke Sutherland is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

In the contest between cheap debt and financial discipline, cheap debt wins again.

Bayer's pursuit of U.S. seeds giant Monsanto was looking expensive even before it clinched the deal this week with a sweetened $57 billion bid ($66 billion including debt). The German life-sciences group is justifying the higher price partly on the basis that it will be accretive from the get-go.

When your borrowing costs are next to nothing, that logic can be used to justify almost any pricey acquisition.

From Cheap to Cheaper
The ECB's addition of investment-grade, non-bank bonds to its asset-purchase program has sent borrowing costs tumbling.
Source: Bloomberg

Bayer says its per-share earnings, using the company's preferred measure, will get a boost in the first year of the deal, and be enhanced by a double-digit percentage in the third. The magical feat is possible because it is paying all cash and funding this mainly with cheap borrowing -- in this low-yield world, Bayer is able to borrow at around 1 percent. True, there’s a $19 billion equity issue planned. Even so, Bayer will evidently get more of a gain from absorbing Monsanto’s earnings than it will pay on financing their acquisition. Talk about stimulus.

By standard deal metrics, the rationale is weaker. The offer for Monsanto’s equity is a premium of $17 billion-plus above Monsanto’s market value prior to Bayer’s interest emerging in May. Bayer envisages the takeover generating an Ebitda boost of $1.5 billion annually -- mostly from cost savings but partly from sales gains -- three years after completion. Disappointingly, Bayer unearthed no extra savings in due diligence. It’s hard to see these financial benefits covering the premium paid. Their net present value is around $12 billion, Bernstein analysts estimate.

What’s more, Bayer doesn’t see the deal covering its cost of capital for four years. Some analysts think it may take far longer. On this assessment of value creation, the payback is distant or non-existent. The mitigation may be that Monsanto's starting value was unduly depressed given the state of the agricultural industry right now, or that Bayer has under-cooked the synergies. This doesn't look like a case of a buyer discovering value in a neglected stock. But it's not unlikely that Bayer has more deal benefits up its sleeve than it has so far let on. 

Deal Chemistry
The tie-up between Monsanto and Bayer is just the latest mega-merger in the chemicals industry as cheap debt and a need for growth spurs consolidation.
Source: Bloomberg

For now, shareholders are taking nothing on trust. Despite climbing Wednesday after the deal was announced, Bayer's stock has underperformed the DAX index since merger talks first surfaced.

Diverging Reactions
While Monsanto shares have climbed on the prospect of a takeover, Bayer's stock has declined since its interest in a deal was reported.
Source: Bloomberg
Bayer shares are denominated in euros, while Monsanto's are denominated in dollars.

Investors are pricing in the apparent value destruction from the deal rather than the earnings boost. After all, overpaying is overpaying -- whether it's funded by cash, shares or anything else.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Chris Hughes in London at chughes89@bloomberg.net
Brooke Sutherland in New York at bsutherland7@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net