Monsanto Chemicals of India: Hold

Recommendation: Hold

Aarati Krishnan

Monsanto India stock fared much better than other agchem stocks over the past six months.

A recent restructuring exercise, consolidating the various business interests of the parent within the listed company, and robust first quarter performance in a difficult period appear to be behind this. But with the global parent in a state of transition, investors in the stock need to watch out for changes in strategic direction over the next two years.

AFTER A difficult agricultural year and a couple of quarters of lacklustre financial performance, MNC agrochemical stocks have been at the receiving end over the past six months. The stock price of the market leader, Aventis CropScience, dropped 46 per cent since March 2000, while Cyanamid Agro and Bayer India lost 45 per cent and 38 per cent respectively.

Monsanto Chemicals of India (Monsanto India) appears to have been the exception. The stock lost barely 7 per cent since March 2000, outperforming the broad market over that period. The stock's valuation, at around 30 times the 2000-01 earnings, also appears to be at a premium to agchem stocks.

Consolidation, the driver

The key has been the US-based parent's move this March to consolidate its agri-business interests in India within the listed company. On March 15, Monsanto India announced a series of acquisitions from three other unlisted subsidiaries of its parent.

The listed company proposed the acquisition of the entire share capital of Monsanto Technologies (a seed company which was a 100 per cent subsidiary of the parent); the marketing and distribution infrastructure and rights for the entire range of the parent's products, present and future, from Monsanto Enterprises (the marketing arm of the US parent); and the agriculture business-related assets from Monsanto India Private Limited (another wholly-owned subsidiary).

The acquisition was to be paid for through a preferential offer of additional equity by Monsanto India to the parent. After the acquisition, Monsanto Technologies was to be merged with the listed company. The restructuring, aimed, in the company's own words, at making Monsanto India an ``integrated agri-business company'' was approved by the FIPB on April 11, and the merger was put through on June 27.

Intangibles add up

The restructuring effort appears to have its pros and cons. On the one hand, it brought several intangible benefits to Monsanto India's shareholders. The acquisition of the marketing and distribution rights for Monsanto products from Monsanto Enterprises gives the listed company access to distribution/marketing infrastructure and access to the parent's new product pipeline; benefits earlier enjoyed by the group company. This marks the transition of Monsanto India from a pure manufacturing company to an integrated agrochem company with backward and forward linkages. This could give the listed company better control over its distribution margins and infrastructure.

The integration also reduces the possibility of a conflict of interest between the listed company and the parent's wholly-owned subsidiaries operating in India. The merger of Monsanto Technologies with the listed company brings the seeds business into the latter's fold, which could become a platform for biotech-related enhancements to Monsanto India's product portfolio.

Both factors should help the listed company command a better valuation on the bourses. Despite the controversy generated, its first-mover advantage in biotechnology-based agchem products has been the key revenue driver for the parent, Monsanto Company, US, in recent years. Since Asia is being viewed as the next big market for genetically-modified crops, it would be better for the shareholders if the listed company gains access to new product launches by the parent in this area.

Grey area is shape of finances

As with all transactions involving unlisted group companies, it has been quite difficult to judge the financial implications on the listed company of these moves. With the financial position of Monsanto Technologies largely unknown, it is difficult to foresee what shape the listed company's finances would take after the merger.

The exact nature and value of the `agri-business-related assets' acquired by Monsanto India from the group companies is still unclear. Since the transactions took effect from April 1, this will be apparent only from details published in Monsanto India's 2000-01 balance-sheet.

Well-structured transactions

However, there are a couple of confidence-inducing aspects to the transaction. All the above acquisitions have been paid for through a fresh issue of shares by Monsanto India to group companies, and the valuation of the listed company's stock for the purposes of the deal appears to have appealed to the listed company's shareholders.

For the purposes of this restructuring, one Monsanto India share was valued at Rs 1,480. This was at a considerable premium to the prevailing stock price of Monsanto India at the time (Rs 891 per share) and helped arrest a fall in the stock price (from Rs 2,000 levels in October 1999 to Rs 891 at the time of the announcement).

This valuation helped in restricting the expansion in Monsanto India's equity capital as a result of the restructuring (the expanded equity capital after the restructuring, at Rs 4.30 crores, from Rs 2 crores, is still small viewed in relation to its profitability and scale of operations). The preferential offer, followed by the merger, has also had the effect of pegging up the shareholding of the US parent, Monsanto Co, in Monsanto India to 72.17 per cent from 39.97 per cent.

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Strong quarter

The complete financial implications of the restructuring and merger can be gauged only from the full financial details to be made available in Monsanto's 2000-01 balance-sheet. However, in this respect, the first set of quarterly performance numbers that Monsanto India announced after the restructuring (which took effect from April 1) also appears free of unpleasant surprises.

For the quarter ended June 2000, Monsanto India has reported a net profit of Rs 12.18 crore on a turnover of Rs 99.82 crore (Rs 9.37 crore on Rs 64.52 crore for the corresponding previous quarter). This translates into per share earnings of around Rs 30 for the full year on the expanded equity base.

These numbers incorporate the additional staff costs, expenses and depreciation from the acquisition of agriculture-related businesses of the group companies and the additional revenues from the merger of Monsanto Technologies. As this quarter represents the peak period of agrochemical sales for the company, it can be taken to be fairly representative of Monsanto's financial performance for the year.

This, in itself, probably elicited a positive response from the stock market, as Monsanto's main competitors, such as Aventis CropScience, Bayer India and Cyanamid Agro, closed the June quarter with a sharp drop in net profits. With negligible presence in the cotton insecticides segment (the dominant target market for agrochemical companies), Monsanto India would probably be better able to overcome the debilitating effects of the recent floods in Andhra Pradesh than most other competitors. Monsanto India's traditional area of focus has been herbicides for foodgrains, soyabean and horticulture crops, prospects for which appear steady this year. This could help to make Monsanto India a desirable investment option within the spectrum of agrochem stocks this year.

Global reality check

However, investors in Monsanto India need to keep a close watch on the global developments. The arms of multinational agrochemical companies operating in India draw heavily on their parent's products and research to keep up a stream of new launches here. This has been the main reason for the premium valuation they command over domestic agchem companies. Hence, a change in management or strategic direction of the parent could determine the future prospects for the stakeholders in the Indian company.

In this respect, a few jolts could be in store for Monsanto India shareholders over a three-year period. The merger of Monsanto Company, US, with Pharmacia Upjohn in December 1999, is seen largely as a move by Monsanto, US, to delink its profitable and relatively steady pharma business from its cyclical and riskier agchem business. The merged entity -- renamed Pharmacia Corporation -- subsequently spun off the agrochemical operations into a new company (Monsanto), with Pharmacia Corporation holding a stake in it.

Recently Monsanto lined up an IPO to raise funds to repay debt owed to Pharmacia Corp. Further, while Pharmacia has decided to retain the remaining 86.3 per cent stake in the agchem operations for now, it has not ruled out the possibility of entirely divesting or spinning off this stake after two years. Monsanto, US, in its present form, is the second largest player in the global agchem markets and it continues to be an extremely strong contender in this market. However, such a spin-off and a change in management would undoubtedly have implications on the quantum of funds available for Monsanto's research efforts, its product portfolio and strategic direction. This would affect the Indian company as well.

Overall outlook

Given its financial performance this year and the positive spin-offs from the recent consolidation, the Monsanto India stock would appear to have the potential to move up. However, investors need to keep a close watch on the global developments, and review their position in the event of a change in the company's management.