The Totally Benign Reason Monsanto Wants to Acquire Syngenta

Source: Paul VanDerWerf/Flickr.

How far would you go to woo someone you just couldn't get your mind off of? Would you fly halfway across the world on a whim to meet with them? Confess your love in local newspapers? Threaten to pursue a close friend? Offer to change your name? (If I changed my name every time a girl turned me down...)

All of these tactics and more can be found in the acquisition playbook being used by agricultural technology leader Monsanto (MON) as it pursues a merger with Swiss counterpart Syngenta (NYSE: SYT).

As one would expect from any move involving one of the world's most hated and misunderstood companies, much has been said about the potential acquisition. Monsanto is one of the world's largest seed developers, while Syngenta is one of the world's largest manufacturers of agricultural chemicals. Surely this is just another step toward Monsanto controlling the global food supply, right?

Not quite. In fact, there's one totally benign reason Monsanto wants to acquire its counterpart. But first, we need to understand an important market dynamic.

Divergent growth paths
On paper, the acquisition would actually make Monsanto financially weaker. The company has been growing more quickly, is better at turning sales into earnings, and has a much more impressive pipeline -- ranging from the Internet of Things, to an input-slashing microbials platform, to bee health products, and more -- than Syngenta. Much of this can be observed in just two charts.

The first chart shows total annual revenue of both companies from 2011 to 2014. Syngenta held a firm lead until the 2013 fiscal year (Monsanto's fiscal year ends in August), when its growth slowed significantly.

MON Revenue (Annual) data by YCharts.

The second chart shows each company's annual operating income for the same period. As you can see, Syngenta hasn't enjoyed the same success as Monsanto in converting top-line sales into bottom-line profits. It's important to note, however, that Syngenta hopes products in the current pipeline can restart growth.

MON Operating Income (Annual) data by YCharts.

These divergent financial growth paths taken by Monsanto and Syngenta since 2011 can be explained by a simple market reality: Genetic traits (and agricultural biotech products in general) generate higher margins than agricultural chemical products and can more easily keep generic competition at bay. Consider Monsanto's financial results from last year, where the agricultural productivity segment includes all herbicide sales:

Source: SEC filings.

It's not readily apparent, and seems counterintuitive at first, but the difference in value between genetic traits and agricultural chemicals explains why Monsanto wants to acquire Syngenta's leading chemical business.

Good intentions
While Monsanto remains on track to double 2014 EPS by the year 2019 (an impressive feat for a $50 billion company) through new product and platform launches, there are some headwinds for its legacy business. The first soybean and corn seeds genetically modified to tolerate herbicide applications and launched in the late 1990s have already begun to lose patent protection. The proliferation of Monsanto's Roundup-Ready trait, which makes herbicide-tolerant, or HT, crops withstand glyphosate (which itself lost patent protection years ago), puts the company in an uncomfortable position with an interesting dose of uncertainty.

Unlike healthcare biotech, there are few, if any, agricultural biotech companies ready to manufacture generic versions of seeds. And the fast pace of innovation makes early seeds far less competitive than the latest products. This partially insulates Monsanto, but farmers can now, for the first time, use biotech seeds without paying technology fees or signing licensing agreements. Open-source, HT soybean seeds originally developed by Monsanto are now available from University of Arkansas. More are coming.

In addition to eventual (albeit muted) generic competition, the proliferation of Monsanto's Roundup-Ready trait faces pressure from natural selection. While the ease of using glyphosate and HT crops has transitioned agriculture away from much less friendly herbicides, the over-reliance on a single herbicide has led to the emergence of HT weeds (a cause and effect that existed long before GM crops were commercialized). This has created a market opportunity for new herbicide formulations and HT traits, as evidenced by Dow Agrosciences' new Enlist Weed Control System, which is expected to be an instant blockbuster.

These factors point to a rather benign reason for Monsanto's interest in Syngenta's chemical business. Combining the market-leading biotech tools of the former with the agricultural chemical line-up of the latter could lead to multiple never-before-seen HT crops. That could potentially move agriculture away from its over-reliance on a single herbicide and reverse and ultimately maintain HT weeds. In the long run, it would be better for investors (more growth), farmers (more planting options and fewer HT weeds), and the environment (fewer chemical inputs from fewer HT weeds). What's so sinister about that?

What does it mean for investors?
This benign explanation is further supported by Monsanto's willingness to offload its glyphosate business (which would also appease antitrust hawks) and its backup plan to pursue the acquisition of Bayer's agricultural chemical division if the bid for Syngenta fails.

Of course, neither move would help to dissipate the public's general distrust and misunderstanding of Monsanto. It's likely things will only get worse in the short term by acquiring more agricultural chemical products. Then again, investors have never been affected by public opinion.