Enter BASF! – Spoiler or Another Consolidator? We Think the Latter More Likely

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Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

gcopley@/nlipinski@ssrllc.com

March 6th, 2016

Enter BASF! – Spoiler or Another Consolidator? We Think the Latter More Likely

  • Whether or not BASF is serious about a bid for DuPont, our “need to consolidate” thesis is alive and well – see our research last week (“Can We Talk” – Action is Imperative…and an Opportunity)
    • BASF sees the same value as Dow does with a DuPont deal – a necessary Ag consolidation and lots of potential cost cuts
  • We do not believe a BASF/DuPont deal can create as much value as DD/DOW
    • Not as much of a cost opportunity – mostly focused in the US
    • BASF unlikely to split out Ag
    • Possibly more regulatory scrutiny because of more direct business overlap
  • BASF should look at MON – and MON should consider selling to or “JV”ing with BASF
    • MON now much less expensive – still the better seed portfolio – achieves the same sort of portfolio opportunity that Dow/DD does and that MON/Syngenta promised
    • BASF might look at EMN to consolidate and optimize the rest of its portfolio – BASF plus MON plus EMN could create a platform to add and divide in the same way DOW/DD
  • DD shareholders should stick with the Dow deal – unless BASF offers a huge premium and a lot of cash to offset the risk of further delay and possible execution risk – DOW/DD can get to $90 (per DD share) in our view within 18-24 months
    • BASF offer would need to reflect that opportunity in some way
  • DOW should not get into a bidding war with BASF
    • If BASF wants to overpay Dow should take the break-up fee and look for other opportunities – such as MON, EMN, or a major consolidation move in ethylene
  • We would not own BASF given that the stock is not cheap and we cannot see how an expensive acquisition would be taken well, but we would probably own everyone else (DD has some arbitrage downside if the BASF rumor is quickly dispelled)
    • Owning MON would be a mistake if the company tries to make a dilutive acquisition, but the stock has now come down so far that the risk reward profile looks better

Exhibit 1

Source: Capital IQ and SSR Analysis

Overview

We would like to thank BASF (and/or Bloomberg) for helping validate our consolidation thesis so quickly! The rumor that BASF is also looking at a possible large consolidation move shows that there is broad concern about growth, competition and the length of various cycles on both sides of the Atlantic.

We believe that a BASF counter bid for DuPont is unlikely:

  • It would need to have a large cash component and be and at a reasonable premium – we do not believe that DD holders would take BASF equity over a US based Dow/DuPont equity without a cash component
  • DD is already at a very high multiple of declining earnings so it would likely be dilutive for BASF
  • The cost opportunity in the Dow deal far exceeds the likely opportunity with BASF
    • Need for headquarters on both sides on the Atlantic etc.
  • BASF would probably have more overlaps and more divestments to get the deal done
  • BASF would effectively have to pay Dow a $1.9bn break-up fee

We believe that there are other opportunities for BASF to bulk up in Ag and in the US:

  • If, as the article suggests, BASF’s initial foray was with the desire to consolidate and bulk up in Ag then BASF should be directing its focus towards Monsanto
    • Now much more attractively priced given its rebasing of fiscal 2016 expectations
    • We know Monsanto has been looking for opportunities in Ag and so the company should be open to discussions with BASF
  • Eastman is possibly another US bolt-on for BASF – again attractively priced and likely to offer significant cost and growth opportunities
    • BASF plus MON plus EMN – could create a platform to add and divide in the same way Dow and DuPont are suggesting

If a bid for DuPont comes we do not believe that Dow should panic – and we do not think that Dow should get into a bidding war:

  • Given the trajectory of DuPont’s earnings relative to Dow, and the very large cost cutting and streamlining opportunity presented by the deal, DuPont shareholders will want (should want) a huge premium and a lot of cash to walk away from Dow – so we do not think it will happen
  • But if it does Dow has options:
    • $1.9 billion is not a bad start
    • A deal with MON?
    • A consolidating deal in ethylene – LYB, CP Chem, – big global JV with Exxon?
    • Etc.

Has MON reached a bottom?

Monsanto reset the bar in terms of earnings expectations for 2016 ahead of an investor conference last week. EPS estimates for 2016, which were $6.70 in July of last year are now $4.70, and estimates have fallen 8% since the revised guidance last week. Maybe this is the bottom and Monsanto has made all the right adjustments to its estimates, but maybe not; the Ag market is fickle and the growing season is in front of us in the Northern Hemisphere.

Monsanto’s presentation last week can be read as a business update, but it also looks a bit like a prospectus to us. We do not believe that MON is ready to hunker down and ride it out after the failed bid for Syngenta – it would make a lot of sense for the company to still be interested in some sort of consolidation move. But the field has narrowed and the game has changed:

  • Syngenta is gone – and it would be very easy to conclude that the market structure could be damaged by the entrance of ChemChina
  • Dow and DuPont are combining (probably) and this creates an integrated “solutions” focused powerhouse
  • Even if BASF jumps in, BASF/DuPont is also an integrated “solutions” focused powerhouse – so the landscape is no difference for MON
  • MON is weakened because the earnings declines have taken the share price down and MON no longer has the same currency that it did when it bid for Syngenta
  • MON cannot bid for BASF, or DOW, or Bayer because the multiples and sizes are wrong (they could maybe buy Bayer’s Ag business alone or maybe Dow’s Ag business alone)

But MON could sell – to BASF – to Dow (if BASF gets DuPont) or possibly to a third party. The company has lots of free cash and a very high return on capital. We are in a depressed Ag cycle, but food demand continues to grow – so could this be an opportunity to pick up or combine with the premier technology portfolio at the bottom of the cycle.

The stock shrugged off a competitor’s downgrade following the presentation last week, which is perhaps an indication that we have reached a bottom.

The risk is that we go back to where we thought we were last week – no more activity in Ag post Syngenta and Dow/DuPont – no partners for MON and either we are not at the bottom of the cycle or the cycle is long. Even with the recent revisions, consensus has a recovery back towards trend beginning in the second half of this year as shown in the Exhibit 2. Earnings are down consistent with the cycle of 2009, but going back to our broader thesis – could the cycle be different this time?

Exhibit 2

Source: Capital IQ and SSR Analysis

On the flip side, confidence is already gone – Exhibit 3 – the earnings decline from 2008 to 2010 was completely shrugged off by the market – not this time.

Exhibit 3

Source: Capital IQ and SSR Analysis

But what is different is relevant and it likely explains why MON was looking for a partnership in the first place. In Exhibit 4 we show our regular net income versus trend chart for Monsanto. The fact that earnings are below trend is one of the reasons why the stock is weak, but the bigger concern for us is the slowing growth of the capital base as suggested in the trend line in Exhibit 4.

Exhibit 4

Source: Capital IQ and SSR Analysis

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