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Analysis: Bayer immune to pharma's breakup bug?

Board members of Bayer AG attend the annual general meeting in Cologne April 27, 2012. REUTERS/Ina Fassbender
Board members of Bayer AG attend the annual general meeting in Cologne April 27, 2012. REUTERS/Ina Fassbender

By Ludwig Burger and Frank Siebelt

FRANKFURT (Reuters) - Investors banking on Bayer to embrace a trend in the pharma sector to split off non-core units may be too far ahead of the curve.

The diversified German healthcare group has an unusually high threshold for selling its odd-one-out MaterialScience unit, which is the world's largest maker of chemicals for insulation foams and transparent plastics for DVDs and car lights.

Bayer, whose bulging pharmaceuticals business could soon dwarf its plastics unit, has been billed as an overdue candidate to follow a global trend in healthcare to divest slower growing and maturing operations.

But banking sources have cautioned that a breakup could be a long way off because Bayer feels it would sell MaterialScience only at a knock-down price and cause outrage over job cuts.

MaterialScience unit head Patrick Thomas told Reuters that the parent holding is "a committed owner" but Bayer investors - seeing businesses elsewhere in the industry getting sliced and streamlined - are eager for clues what could challenge Bayer's commitment.

Abbott this year split off drug development into AbbVie, while Pfizer parted with its animal health unit Zoetis - and the biggest U.S. drugmaker on Monday took another step towards a potential breakup by internally separating its commercial operations into three business segments.

In Europe, the CEO of GlaxoSmithKline told Reuters in June that divestments at Britain's biggest drugmaker would far exceed acquisitions as it divest non-core operations.

Such moves have been welcomed by investors. Abbott shares, for example, outperformed the sector and the wider market significantly after it unveiled its planned split in 2011, while Pfizer and GSK have both enjoyed a re-rating, helped by hopes that their more focused businesses will be better able to leverage a number of promising new drugs.

Many analysts hope that Bayer, the inventor of polyurethane foams and synthetic rubber, can soon shed its so-called conglomerate discount, which Goldman Sachs puts at about 14 percent.

Fund managers prefer single-industry stocks over cross-sector companies like Bayer to create the desired mix in their portfolios.

A divestment of MaterialScience "is inevitable given the significant conglomerate discount it generates," analysts at Jefferies wrote in May. Brokerage Exane BNP Paribas echoed that a refocus on life science was "very likely".

"As the pharmaceuticals unit grows and MaterialScience falls behind further in relative terms, management might increasingly see the company as a pure life science or healthcare play," said Olaf Toelke, in charge of European healthcare credit ratings at Standard & Poor's.

These market participants point to the unit's declining contribution to group core earnings, now at 15 percent after almost a quarter in 2007.

New drugs such as stroke preventer Xarelto and eye drug Eylea are expected to generate billions in additional sales. That has inflated the share price by 40 percent over the past 12 month and marginalized the plastics unit further.

But financial sources familiar with the company caution that the price the unit could fetch is well below what management thinks the business could be worth after a reorganization.

MaterialScience is not earning its cost of capital, which Bayer put at 7.1 percent in 2012, but Bayer says it is determined to restore the unit's capital return to higher levels by 2015.

Not earning its cost of capital implies the unit's hypothetical standalone market value would decline. The unit posted only a 5.7 percent return on its capital last year.

MaterialScience is trying to raise prices, boost the rate of capacity use and cut costs. To cut its fuel and power bill, for instance, it is spending about 250 million euros ($332 million) on a new German plant for the production of padding foam chemicals, which is 60 percent more energy efficient than the facilities it will replace.

The sources added that the market also tends to underestimate the fallout from any job cuts in Germany after a divestment.

MaterialScience employs almost 5,500 of its 14,500 global staff in its domestic market, where laws are more protective of workers than in the United States or Britain.

In addition, there is currently no large takeover target on Bayer's radar that would justify hiving off MaterialScience to raise cash, they said. The group has been focusing on small and medium-sized buys.

A Bayer spokesman pointed to previous comments from Chief Executive Marijn Dekkers that all Bayer units need to be world-class and that MaterialScience lived up to these standards, declining to comment further.

But Dekkers, who previously oversaw the merger that created U.S. lab equipment maker Thermo Fisher, has contributed to raising hopes of a split-off by portraying MaterialScience as an outsider among its sister units.

He has highlighted synergies from the common genetics behind Bayer's healthcare, veterinary drugs and plant science operations, omitting the plastics unit. He has also said any larger takeovers would be in life sciences, not plastics.

One source familiar with the company said Dekkers may eye an exit in the long run but feels under no pressure from the current round of healthcare demergers to follow suit.

($1 = 0.7539 euros)

(Editing by David Evans)

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