Otto Bayer demonstrating his invention - Polyurethan

Bayer is a global pharmaceutical and biotechnology enterprise based in Germany. Founded in 1863, Bayer is well known for its Aspirin brand, under which it sells acetylsalicylic acid. The company is also famous for being the first to promote new materials such as polyurethanes and polycarbonates. Bayer is one of the TOP 20 largest pharmaceutical companies in the world.

Bayer's business comprises three segments: Crop Science, Pharmaceuticals and Consumer Health.

Crop Science is a segment of the production of genetically modified seeds and herbicides. Its share in revenue is about 50%, in EBITDA about 45%. Crop Science segment is an integrated Monsanto business.

In 2018, Bayer acquired the agrochemical corporation Monsanto for $63 billion, and became the world's largest producer of genetically modified seeds, as well as pesticides and herbicides. This transaction significantly changed the company’s business profile.

Glyphosate, the most common herbicide used under the trade name Roundup to control weeds in the United States, was synthesized in Monsanto laboratories in 1970. The trade name for glyphosate, Roundup, refers to the circle of wagons used by American settlers to shoot back at Indians. But its use has long been hampered by its non-selectivity. It means that along with weeds, glyphosate also destroyed crops.

The breakthrough came when Monsanto produced genetically modified soybean (1996) and corn (1998) seeds that were resistant to Roundup. As a result, in the late 90s Roundup sales grew by 20% every year. By 2007, glyphosate-resistant soybeans were used on 90% of US crop area.

Monsanto's developments were protected by patents, but they expired by the time of the deal with Bayer, for Roundup (glyphosate) in 2000, for Roundup-resistant soybean seeds in 2014.

However, this solid business with strong market position and competitive advantages became the epicenter of endless litigation, the consequences of which Bayer underestimated when deciding to buy Monsanto.

In 2015, IARC (International Agency for Research on Cancer), part of the World Health Organization, concluded that while glyphosate has relatively low toxicity to animals and humans, it may cause a certain type of cancer, non-Hodgkin's lymphoma. Glyphosate was listed by IARC as “probably carcinogenic to humans”.

US and EU regulators didn’t support this decision and allowed to continue the glyphosate usage. But this did not save Monsanto and Bayer from numerous lawsuits of Roundup buyers. 167 thousand lawsuits were filed in the United States, a significant part of which were settled in 2020 for $9.6 billion.

Unfortunately, in 2021, the court rejected Bayer's proposal to limit payments for similar claims in the future to $2 billion, so about 54 thousand claims are still pending, on which court decisions will gradually be made.

Of the last 18 Roundup-related lawsuits, Bayer won 11. But in the seven lost cases, plaintiffs were awarded total compensation of more than $4 billion.

Bayer appeals all court decisions to reduce the amounts to be paid. One of these appeals has already been successful. In November three plaintiffs in Missouri were awarded a total of $61 million in actual damages and $1.5 billion in punitive damages. But in March the latter amount was slashed to about $500 million.

At the end of 2023, the company's reserves for payments for claims related to the use of Roundup in the United States amounted to 5.7 billion euros. But analysts believe that at least another 6 billion euros will be required to settle all claims.

Bayer product portfolio

Pharmaceuticals is a segment of the production of prescription drugs. Its share in revenue is about 40%, in EBITDA about 45%.

40% of the Pharmaceuticals segment revenue comes from two drugs sales: Xarelto (an anticoagulant approved by the Food and Drug Administration in 2011) and Eylea (a biologic for ophthalmology). Unfortunately, the underlying patents for Eylea will expire in 2025 and for Xarelto in 2026.

Though Bayer has promising developments in the pipeline (for example, the prostate cancer drug Nubeqa, its sales doubled in 2023), the company suffered a major setback in late 2023. The new anticoagulant drug, asundexian, developed to replace Xarelto, appeared less effective than competitors' drugs and its clinical trials were stopped.

Consumer Health is a segment of the production of over-the-counter (nonprescription) drugs, including the well-known Aspirin, Claritin and Aleve (naproxen). Its share in revenue and EBITDA is about 10%.

Activist investors offer the company to sell this segment to reduce leverage. With segment EBITDA 1.4 billion euros per year and a multiple of 7x, Bayer could receive about 10 billion euros from its sale. As a result, the company’s leverage would stabilize around 3x.

Bill Anderson, CEO

But as for now, Bayer management doesn’t support this idea, as it plans to improve profitability and reduce debt by cutting jobs and dividends. In addition, such a sale would lead to the realization of a large capital gain and tax payments.

Despite significant risks such as billions of dollars in Roundup claims and uncertainty over its prescription drug portfolio, Bayer's financial profile is unlikely to deteriorate significantly over the next two years.

The amounts to be repaid in the next three years (4.3 billion euros in 2025, 3.7 billion euros in 2026) exceed the company's FCF, but Bayer (BBB/Baa2/BBB) has no problem with refinancing. In 2023, the company placed three new issues of bonds in euros (with a total volume of 3 billion euros) and five issues in dollars (with a total volume of 5.75 billion US dollars). In addition, the company has an undrawn credit line of 4.5 billion euros.

So, Bayer is going through challenging times. High leverage, lack of growth points, expiration of important patents, uncapped payments for litigation. But we believe the situation will remain manageable in the next two years. Even if the company spends all money saved on dividends to pay litigation costs, its leverage will remain around 4x. Sale of Consumer Health segment may be a good option if debt markets are closed.