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II. 1. Discounted Cash Flow Valuation II. 1. A. Model Choice In order to decide whether we use the FCFF method or the FCFE one, we have to analyse de capital structure of the firm. To do so, we will refer to the total Debt to Equity Ratio of the last three years of the company:

It’s seems that Bayer’s capital structure is stable when looking at the figures; the leverage doesn’t really fluctuate over the last five years. Knowing this, we will choose the FCFE model for our discounted cash flow valuation.

II. 1. B. Key assumptions

II. 1. C. DCF Valuation Step 1: Discount rate calculation As the cash flows as cash flows to Equity, the discount rate is the cost to capital. The formula is the following: Cost of Equity= Risk-free Rate + Equity  The risk-free rate We then search the risk-free rate. We’ll take here the german 10Y bond to estimate our rate, since german bond is usually the reference for European firms that have their financial statements published in the same currency. Compared to other european bonds, the german bonds are usually more liquid and less credit risky. The 25th of january 2019, Moody’s rating of the german 10Y bond kept at the same level Aaa with a stable outlook. We consider that the risk-free rate will also remain stable.

Per consequence, we consider the risk-free rate is -0,009.  Beta coefficient For the beta coefficient, we weighted it between Bayer’s 3 main business units: Drugs (Pharmaceuticals), Chemical and Financial Services (non-bank & insurance) by % to Bayer’s total Sales to compute the firm’s unlevered beta:

Bayer’s -levered beta is 1,19.  Market Risk- Premium To compute the market risk premium, we calculate the weight of sales by region compared to our total earnings. Then, we take the average by regions of Damodaran’s database of country riskpremiums, updated in January 2019:

Finally, Bayers market risk premium is 8,5%.

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Cost of Equity

Because here we are in a FCFE model, we only need the Cost of Equity. Our discount rate is 10,13% Step 2: Estimating the current earnings and cash flows Here we estimate the current earnings and cash flows on the asset, to equity investors because we chose the FCFE model. For the current Earning we took the figures of the 2018’s financial statement. Standard Adjustments Using Moody’s methodology we modified Bayer’s financial statements for 2018. We checked that no financial expenses we in the operating expenses, then we reclassified the operating leases as financial expenses and we counted them as debt. We reclassified the R&D expenses as capital expenditures. For the hybrid bonds we classified some of them as equity (for the ones who’s maturity were 2074 and 2075) and others as debt. Finally, we reclassified the pension plan expenses. Tax-rate The tax-rate we computed with the figures of last year’s financial statement is 26,19%. Adjusted Capex To calculate our adjusted CapEx, we start with the CapEx given in the financial statement of the company. Then we take out the D&A also given in the financial statement, and finally we add the acquisition of other firms, which here is highly significative with Monsanto’s acquisition at 59 million $.

FCFE Finally, we can compute the current earnings following the FCFE method using the formula:

FCFE= NI * (1-δ)* (NCE*ΔNWC)

The negative free cash-flow to equity in 2018 is almost entirely due to Monsanto’s acquisition. Step 3: Estimating the future growth in EBIT Growth We tried the two different approaches: Historical Approach We compute the growth of the net income and then we do an arithmetical average. We tried to do also the geometrical one, but in 2018 we have a negative growth of the net income, partly due to Monsanto’s acquisition, that doesn’t allow us to do such calculation. The arithmetical growth on the past three years is 21,95%. The growth seems too high to us, and it may seem that the approach is too volatile to be used. Fundamental Approach With this approach we compute the growth with the reinvestment rate and the return on capital on the last 3 years and we use the following formula: Expected growth = reinvestment rate (RR) x return on capital (ROC) To calculate the RR avec the ROC we have the following formulas: RR= [Net Capital Expenditure + ΔWC]/ EBIT x (1- tax rate) ROC = EBIT (t) x (1- tax rate)/ [Book Value of debt (t-1)+ Book Value of equity (t-1)] Because the variation in Net CapEx was too important in 2018 with Monsanto’s acquisition, we decided to take the average of CapEx, WC, EBIT to calculate the reinvestment rate. We took also he ROC average.

Finally, with the method we have an expected growth of 6,33%. Although pharmaceuticals is a mature market, the Monsanto’s acquisition shows us that Bayer has the ambition to have an important growth in the next year. This ambition is also confirmed in the introduction of their annual report, where they expect to have a growth of 3-4% in European countries as well as United States and 6-7% in emerging ones. This growth is justified by the synergie of both firms, becoming a big player in the agrochemicals sector. These synergies were estimated to 256 millions € by the leaders just before the acquisition, in may 2018. Step 4: Calculating the terminal value We may now compute the terminal value with this formula: Terminal value= expected CF/ [required return- expected growth] As we saw in the example with Nestlé, we take the expected CF in 2027. After calculations, we find the the terminal value of our firm is 101 405 € millions. Step 5: Estimating the firm value We now compute the actualisation of our future cash-flows from 2018 up to 2027 with the follow formula: CFn/ (1-discount rate)^n Then we will have Firm value = Somme ( Cfn/(1-discount rate)^n ) + Terminal Value/ (1-discount rate)^n

Conclusion We calculate with this method that Bayer’s value is 55 700 million €.

Comparing to the Market value of the company, we have the stock share price that is today at 61,5€ per share and 932.55 million of shares in 2018. This means the market capitalization of the firm is 62* 932.55 = 57 351 million €. Then we searched on Thomson Reuters the market capitalisation up to date on the 12 of april 2019 and the Enterprise Value:

Because we computed the FCFE and not the cash flow to the firm, the figure to whom we compare our calculation is the Market Cap and not the Enterprise Value, which isn’t very far from what we calculated with the method of the discount cash flows.

II. 2. Relative valuation To measure Bayer’s relative valuation we need to find peers to whom we can compare. In Thomson Reuters, we found the following list: -Novartis (CH): Swiss competitor in the pharmaceutical industry, 4 biggest company in terms of revenues, Novartis had 53 166M$ of sales in 2018 and a market cap of 209 332M$. -Roche (CH): Swiss competitor in the pharmaceutical industry, Roche is the 2nd biggest company in revenues with 56 846M CHF in 2018 and a market cap of 234 06M $. -Sanofi (FR): French competitor in the pharmaceutical industry, Sanofi is the 5 biggest company in revenues with 34 463M€ in 2018 and a market cap of 108 535M $. -AstraZeneca (GB): Anglo-Swedish competitor in the pharmaceutical industry, AstraZeneca is the 12 biggest company in revenues with 22 090M$ in 2018 and a market cap of 103 326M $. -GlaxoSmithKline (GB): English competitor in the pharmaceutical industry, GlaxoSmithKline the 6 biggest company in revenues with 30 821M GBP in 2018 and a market cap of 102 207M $. -Novo Nordisk(DK): Danish competitor in the pharmaceutical industry, its revenues are of 111 831M DKK in 2018 and it has a market cap of 97 840M $. th

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For each one of them we will compute the earnings ratios to compare them with Bayer. Here is the final recap of the firm value with a low/high/mean valuation:

First, it seems that the firm valuation through PE is low, this might be due to the evolution of earnings per share that was dramatically low this year for Bayer as we may see in the following chart:

Another point that we may consider here is the high volatility of earnings for one year to the next one. Because of this, we decide that it might not be the most useful tool for our relative valuation. In comparison, Bayer’s Sales, Ebit and Ebitda are much more stable:

Here the pharmaceuticals industry is a mature sector were firms have to invest in their research and technological advancements, thereby it would be more relevant to take EBIT or EBITDA rather than Sales. Here we can see that Bayer’s EBITDA is around 10 billions€ when EBIT is at 3,9 billions€. This impressive gap suggests us that depreciation & amortization is an important figure in their income statement, and we may not asses well the enterprise value if not taking it into account. This is why we will focus on the EV with the EBIT ratio. Bayer’s current EV is slightly above the mean figure ( 93 153 M€ to 88 781 M€).

II. 3. Final Value Estimate and Recommendation We used to methods to estimate Bayer’s enterprise value: the FCFE method to have the value of equity of our firm and its market capitalisation, and the relative valuation comparing to 6 others firms of the pharmaceutical sector. We decided to focus the relative valuation on the EV with the EBIT ratio. Then, to compare it to out DCF value, we subtract the bridge (=minority shares + debt + preferred equity - cash and cash equivalents). Then we divide our different figures by the number of shares Bayer currently has, 932,55 million:

It seems that the DCF valuation is above the mean entreprise value but is less than the current share price. Although its huge loss in the last 6 months of Bayer’s market capitalization, the price is above the industry average price. The concern here about Bayer’s next evolution might mostly be about the judicial decisions of the next months. Indeed, Bayer’s major changes in the last months was due to court decisions that declared Monsanto, the firm they bought during the summer 2018, to be guilty with its Roundup product of favorising cancer to its users. More than 9000 other cases are waiting, which might endanger Bayer’s legendary stability that was a reason for it’s surprisingly high share price value. Financial analysts have been progressively more cautious with their advice to buy Bayer shares with for example Deutsche Bank or Kepler Cheuvreux that downgrade their advice to buy into an advice to hold. More globally, here’s the transition in the last 3 months:

Although Bayer tries on the last months to reassure its investors with an exceptional note the 27th of february 2019 on the structure of their debt and with a positive forecasts on the new synergies the firm will gain with Monsanto’s acquisition, the firm has environmental threats that are hard to estimate. Because of this last point and the fact that most of the share figures we computed are below the current share price, our recommendation would be to sell Bayer’s shares....