In the wake of its $66bn-acquisition of Monsanto Co, Bayer risks starving its lucrative drugs business of the resources it needs to grow.
Funded with a combination of debt and equity, the deal announced on Wednesday will transform Bayer into the world’s biggest supplier of seeds and pesticides. It’ll also leave the German company with little scope for acquisitions to boost its most profitable business: pharmaceuticals. That could hamper the unit’s growth as patent expiry looms for its best-selling heart medicine.
“It obviously becomes a different company now,” said Andrea Williams, head of European equities at Royal London Asset Management Co, which manages £1.3bn ($1.7bn) in European stocks, including Bayer shares. “The danger is the pipeline is somewhat empty, so they probably need to do some deals.”
Bayer will largely rely on borrowed funds to pay for the deal, but says it’s committed to maintaining its current credit rating in the long term.
That combination means it’ll need to focus on paying down debt, not doing more acquisitions to boost its pharmaceuticals and consumer-health businesses, Jefferies Group analysts wrote in a report.
The tack toward agriculture comes amid increasing pressure for global drugmakers. Thanks to sluggish economies and growing scrutiny on pharmaceutical prices, returns on research and development investments at major life-science companies were at their lowest last year since at least 2010, Deloitte found in a study. Even as the market gets tougher, Bayer’s pharmaceuticals have delivered profitability ahead of agriculture – a unit known as CropScience – in recent years. In the second quarter, pharmaceuticals accounted for about 35% of sales and 45% of earnings before interest, taxes, depreciation and amortisation. Taken together, Bayer’s consumer-health and pharmaceutical divisions form Germany’s biggest drugmaker and rank among the top 10 in the world.
To hang onto that position, Bayer has boosted spending on pharmaceutical research and development, which hit 17% of the unit’s sales last quarter. The industry is also fed by acquisitions, however, especially when blockbuster medicines reach the end of their life cycle, as will happen to Bayer soon: its heart drug Xarelto loses patent protection in 2020. Companies rely on licensing as well as takeovers to catch up where their own in-house research has lagged.
For Bayer, one such area is cancer. In his previous position as strategy chief, Chief Executive Officer Werner Baumann told analysts last year the company’s efforts weren’t enough to satisfy its ambitions to fight cancer. Bayer is using partnerships to catch up in immuno-oncology, where Baumann said the company hadn’t invested enough 10 to 15 years ago. Two years ago, Bayer spent $2.9bn to buy Norway’s Algeta, adding a prostate cancer drug as well as technology to link radiation therapy with a biologic treatment. Deals in that size range could be harder to achieve in the future.
“The hurdles would be very high,” said Markus Manns, who helps oversee about €275bn ($309bn) in assets at Union Investment, one of Bayer’s 15 biggest shareholders, in Frankfurt. “While they might have the financial capacity, they probably won’t have the management capacity to do another deal right away.”
That’s partly because the Monsanto transaction will probably face a lengthy antitrust review by regulators in the US and Europe. Some European Parliament members have already started online petitions claiming the combined company would dominate the seed market. Bayer expects some of the two companies’ businesses would need to be sold, a person familiar with the talks said before the deal was complete. Baumann said he expects to be able to close the transaction at the end of next year.
Bayer could free up some financial firepower by selling off peripheral enterprises elsewhere in its life-science unit. The company is already working with JPMorgan Chase & Co on a potential sale of its dermatology business, which could fetch more than 1bn euros, people familiar with the matter said.
At least one shareholder who had called on the company to do more to develop new drugs now says it makes sense to buy Monsanto. That’s because Bayer will vault to the No 1 spot in seeds, something it couldn’t hope to do in the health-care industry with a deal the same size, said Joachim Kregel, who represents independent investors at the German shareholders association SdK.