Is there value to be found anywhere in today's perilous stock market? Well, everything's risky, but a lot of the smart money is investing in Monsanto Co., the St. Louis-based chemical company that owns the sugar substitute NutraSweet.
The Bessemer Trust, for example, owns almost 1 million shares, says Stanley Nabi, the trust's executive vice president for investment. Bessemer invests old family money, chiefly that of the Phipps family, which made its fortune founding the American steel industry. Old money, long vision supposedly. Why is it attracted to Monsanto?
"I have value here," says Nabi. "Monsanto's earnings are understated. The company, because of its accounting of the Searle acquisition, is generating enormous cash flow, and I think it will do a repurchase of its own stock." Nabi believes that Monsanto stock, which was selling in July for $83 a share and closed in Tuesday's wild market at over $96, is worth more than $130 a share. "I'd buy it myself for that," he says.
Nabi is not alone in his enthusiasm. Investment analysts such as Paul Leming of Morgan Stanley and Stephen Leeb, publisher of the Investment Strategist newsletter, are bullish on Monsanto because they expect the company to attract a takeover bid or, more likely, repurchase its own shares--which has the effect of increasing reported earnings per share and, usually as a consequence, lifting the stock price.
Not a word in their analysis, you'll note, about Monsanto's masterful chemistry--it invented Astroturf, for example--or its agricultural chemicals that have increased crop yields around the world. Does the market admire Monsanto for the kind of competitive effort American business needs, or merely for creative accounting?
Chemistry Logical Step
For a bit of both. The story at Monsanto today is that Chairman Richard Mahoney, in the top job since 1985, is changing the 86-year-old company to, as he sees it, give it products to take it into the 21st Century--and using creative accounting to help the process along.
Two years ago, Mahoney acquired G. D. Searle, the Chicago pharmaceutical company that developed the artificial sweetener aspartame--the basic ingredient of NutraSweet. He didn't buy Searle for the sweetener, though, but for its abilities in biogenetic chemistry. Mahoney, 53, a chemist by training, saw biochemistry as the logical next step for Monsanto, a leader in agricultural chemicals and animal feeds. The future in that business, he believed, lay in laboratory duplication of substances occurring in nature--as Monsanto is now developing a hormone to increase milk yields in cows and a similar hormone to reduce the fat in pork.
But he paid a $2.75-billion price for Searle, a big premium over the stated value of its assets and a sum that put Monsanto deeply into debt. Under conventional accounting rules, the premium paid for Searle would have been depreciated--without any deduction for taxes--over 40 years. But Monsanto didn't follow convention. Instead, it assigned more than $1 billion of the Searle purchase price to the value of its patent on the sweetener, aspartame, which expires in 1992. Monsanto then could take a tax-deductible annual depreciation charge of around $180 million on that patent. This enabled it to lower its taxes and use the extra cash to rapidly pay down its debt. The drawback was that higher depreciation reduced its reported earnings last year by more than $1 a share. That's why investors call Monsanto's earnings "understated"--meaning there is more cash-earning ability in the company than is evident in its reports.
And investor interest has been rising because, as of July, the company's debt was paid down to reasonable levels once again. Which means that any cash flow not needed for research and development or plant expenditures is available for increased dividends or stock repurchases.
What has happened here is that Uncle Sam's tax law has helped a major company make a transition and also created potential opportunity for shrewd investors. The transition for Monsanto is toward greater emphasis on pharmaceuticals and biochemistry. There the cash flow helps with research expenditures, where the company now spends $600 million, or 8% of its sales, where it used to spend 3% on traditional chemical research.
But the company also will have cash to spare because it is able to spend less on building plants. Basic petrochemical refineries are in oversupply, and any new ones are likely to be built in oil-producing countries.
What that means, says Morgan Stanley's Leming, is enough surplus cash flow to buy back 15 million to 20 million of its shares over a five-year period. Monsanto officially says it's following no timetable but acknowledges it's considering a share repurchase.
It's either that, after all, or face an almost certain takeover bid--financed by loans or bonds that are made affordable to corporate acquirers by the tax-deductibility of interest. Truly, Uncle Sam's tax law creates opportunity for all.