Börsen-Zeitung, April 18, 2015, page 11
THE CFO INTERVIEW : MARCUS KUHNERT, MERCK: "A
conservative financial policy is part of our DNA"
The CFO talks about borrowings for the Sigma-Aldrich acquisition, the most
favorable time window for the acquisition, and the discussion with rating
agencies
- Mr. Kuhnert, Merck is preparing to complete the US$ 17 billion acquisition of
Sigma-Aldrich. How much progress have you made with the financing
following the hybrid bond and dollar bond placements?
There are different components. We will raise US$ 2 to 3 billion in cash, which will
come from our own liquidity. On top of this there are bank loans of around US$ 4 to 5
billion. We will draw on these at a relatively late stage, meaning shortly before the
closing, which we continue to expect to see mid-year. The rest will be covered by
bridge financing. Our main banks have given a loan guarantee, which we will replace
and refinance via capital market elements by the end of the second quarter.
- Exclusively through further bonds?
Refinancing comprises three elements. The first is the hybrid bond of € 1.5 billion
issued in December 2014. The bond amounting to US$ 4 billion followed in midMarch of this year. The final element will be a bond that closes the financing gap so
as to completely cover the purchase price.
- Will you be refinancing bank loans of US$ 4 billion via the capital market?
No. The bank loans are distributed across our 19 relationship banks. The charm of
this financing is that repayment is very flexible. We are striving for a balanced
maturity profile as of the first repayments as early as the second half of 2015, and
then over a time frame up to 2017. We want to very aggressively reduce our debt
within two to three years in order to stabilize our rating, as well as to regain financial
scope for further acquisitions.
- Couldn't you also achieve this type of structuring with bonds?
The bank loans are slightly more flexible and as regards interest rates comparable
with bonds, if not even slightly more favorable.
- Which investors did you address with the first bonds and which ones did you
reach?
With the hybrid bond, the clear focus was on Europe. Logically, the dollar bond was
then targeted to the United States. Before that, we went on a roadshow in the United
States in order to familiarize investors even more with the company. The equity side
already knows us well.
- Is the refinancing going to take place mainly in dollars?
No, mainly in euros. However, in recent months we had already converted a
significant amount of cash into dollars when the exchange rates were still more
favorable. Plus, the dollar bond serves as a natural hedge. The remaining amount
has been hedged.
- How did you hedge?
We covered nearly US$ 10 billion of the purchase price using currency hedging
instruments. In September 2014, we first used options to hedge when we were in a
position to assume with great certainty that the deal would take place. We then sold
these with a profit of € 100 million shortly before signing the acquisition agreement at
the end of September. Afterwards, owing to the further increase in the likelihood of
the transaction taking place following the signing, we entered into forward exchange
contracts. These will run until the date of the expected closing. As a result of the
further appreciation of the dollar, the value of forward exchange contracts has
meanwhile increased to a four-digit million figure.
- But those are just accounting profits.
At the end of the day, measured against the dollar exchange rate on the date of the
closing, this will help us to lower the goodwill from the transaction since we can use
the hedging gain to offset this.
- How much will this amount to?
It's difficult to say since we don't know what how the exchange rate will develop. As I
said, today the amount would exceed € 1 billion.
- At what dollar exchange rate will the acquisition thus be taking place?
At around US$ 1.30 per euro.
- Those are of course ideal conditions for Merck. Was there no attempt by the
counterparty to renegotiate the price?
That is not possible. The point in time was very favorable for us. We had a time
window in autumn of last year that we were fortunately able to make use of.
- What's the thinking behind the staggered financing maturities?
We want to have a balanced maturity profile, meaning not too much accumulation of
risk in the early years, but nevertheless a rapid reduction of debt.
- The hybrid bond has a term of 60 years.
That’s right. However, we could also repay at earlier points in time. It was also
important to us to be able to deduct the interest for tax purposes. Here, the term is a
decisive parameter: 60 years are the limit. The design is also important so that the
rating agencies recognize half of the borrowed capital as equity.
- With the pre-financing of the purchase price, Merck has a great deal of
liquidity in its treasury. How are you investing these amounts in times of
negative interest rates?
In bonds of other companies and in money market funds. However, the interest rates
paid are not negative.
- What will the debt level look like after the acquisition?
After the closing, we will have around € 12 billion in net financial debt on our balance
sheet. Including the equity portion of the rating agencies from the hybrid bond, the
ratio to the operating result EBIDTA will be more than 3. This is a range that we don't
want to remain in for longer than necessary. At the end of 2017 we want this to return
to below 2.0. Then it will be possible to discuss smaller to medium-sized acquisitions
again. Excluding acquisitions, this key performance indicator will decline further by
the end of 2018. That's because we also expect that Sigma- Aldrich will deliver a high
level of cash flow.
- Doesn't the ongoing phase of low interest rates give you reason to set your
debt ratios more aggressively?
As a family-owned company, we are committed to a conservative financial policy; it is
part of our DNA. Our investment grade rating is to be maintained under all
circumstances. The criteria for assessing financial decisions do not change per se
with interest rates. In the case of long-term projects, we need to achieve a return on
the cost of capital as quickly as possible. To me, this is the most important financial
indicator for investment and acquisition decisions.
- How are you making your calculations then?
The business plan is based on realistic assumptions. The assumptions for terminal
value, meaning the final value of the payments, are the same as those that we use in
the annual report for the impairment tests.
- It is also quite common to include as much as possible in goodwill or
indefinite-lived intangible assets during first-time consolidation.
We're not doing that. We amortize well over 95% of the intangible assets on our
balance sheet. That will also be the rule for Sigma-Aldrich.
- You talk about an appropriate business plan. What does the reality check look
like if you look at how the businesses are performing right now? Do you still
feel comfortable with this?
We feel comfortable and believe that it will be possible to realize the ambitious
synergies of € 260 million.
- How are you going to leverage these synergies?
We expect considerable savings by optimizing the production network and the supply
chain. The second topic is marketing and selling, where Sigma has an excellent ecommerce platform, through which we also want to market a significant portion of our
portfolio.
- Is it even possible to transfer the business? This would require an overlap of
customer groups.
The product portfolios are complementary, the overlaps are very limited, however the
types of customer do not differ. The e-commerce platform should therefore work for
our products as well. The third area for synergies is the combination of administration
and infrastructure.
- In terms of sales and earnings, what will the currency mix look like after the
Sigma acquisition? Will you have to hedge even more in the future?
The distribution of currency exposure at Sigma is relatively similar to the situation for
the Merck Group. Sales in U.S. dollars will grow, however in that currency region we
will also incur more costs. Generally, in terms of our hedging strategy we tend to be
conservative; we primarily attempt to reduce risk.
- As regards working capital: with the consolidation of AZ and the acquisition
prior to Sigma, there has been a significant shift in working capital. Is this also
to be expected with the consolidation of Sigma?
We don't know exactly yet, however we assume that the trend will be for net working
capital to increase slightly. During the integration we want to avoid inventory
shortages so as not to hinder business continuity. Incidentally, Sigma has an
unbelievably good supply chain. The company is capable of supplying customers
worldwide with 60% to 70% of its product range within 24 hours. Achieving this
requires a relatively high level of inventories. We will make every effort to counter this
on the receivables side.
- What do you consider the optimum relationship of working capital to sales for
the Group?
Most recently, it was 22% to 23% - I see further potential for improvement here.
- Reducing debt is in the foreground, scope for smaller acquisitions exists,
however money will also be need for investments. Building up the
pharmaceutical pipelines also costs a lot of money. Will the cash-rich Life
Science business sector cross-subsidize the pharmaceutical business?
There will be no cross-subsidization. We generate cash flow in the Group which we
use to strengthen all our businesses. This year, we plan to make investments worth
€ 600 million. The coming years will also see investments of this magnitude. In order
to do this, we will continue to ensure that the early-stage pharmaceutical pipeline is
filled via in-licensing agreements and collaborations. That will serve to secure the
future.
- So the principle of each segment financing its own growth does not apply?
There are clear rules on capital allocation and clear guidelines on the valuation of
financial investments. In this way, we ensure an efficient capital market within the
Group.
- Does the decision concerning capital allocation within the Group include
premiums or discounts for the business sectors?
Not for the business sectors. Instead, we target the business-specific cost of capital.
For country risks, we assign discounts or premiums to the cost of capital. If
investments are made in high-risk countries, premiums are added to the weighted
average cost of capital.
- Merck says that China and Brazil are among its key growth markets. How
would you assess the current situation in Brazil? There are a lot of unanswered
questions there.
We are keeping a very close eye on developments there in order to be able to
evaluate possible negative implications at an early stage. However, there is no doubt
as to the strategic importance of this market.
- You steer the company based on adjusted EBITDA, but some other key
figures are also being named. This is a bit confusing. What are you
communicating to your investors?
The most important indicator used to steer operating business is in fact EBITDA pre
exceptionals. We use this to assess the operating performance over time. Here, there
is a very strict definition of exceptionals to ensure comparability. Organic growth is
also important to us. The third indicator used to steer operating business is business
free cash flow, an indicator that is focused more strongly on cash flow and takes
account of balance sheet items which, if changed, have implications on cash.
- So cash flow is the measure of all things?
Every business has to surpass a minimum amount of business free cash flow,
otherwise there will be no variable bonuses.
- Then there are also key indicators to assess specific projects?
Here we take into account dynamic key figures, since the most important criterion
from a long term perspective is that our return exceeds our cost of capital. We look at
the net present value and the internal rate of return - also taking into consideration
the repayment period.
- Did you also use this to convince the rating agencies of the Sigma-Aldrich
acquisition?
The discussions with the rating agencies were very positive. Usually two dimensions
are considered. They were very convinced by the strategic dimension, as Sigma
operates in a large market, which is growing steadily. Not much can go wrong here in
the next five to ten years. The second dimension relates to the planned development
of the financials - right down to EBITDA and the financial liabilities. We received a lot
of plus points as the Life Science business is very profitable and is delivering stable
cash flows.
- The rating agencies reacted differently to the huge acquisition. Moody's
dropped their rating by one level, while Standard & Poor's merely changed its
outlook to negative, although its rating was a level higher. What in your opinion
is the reason for this adjustment, which has now been downgraded by two
levels?
It is due in part to different methodical approaches. But I also think that Moody's is
generally more critical of pharmaceutical companies. Moody's actually used to rate
Merck higher than Standard & Poor's. Our aim is still to get back to the initial status.
We are happy with the ratings A and A3. We also try to eliminate volatility in the
rating as far as possible.
- How much does it cost you in financing costs if the rating is downgraded a
level?
Given the current interest environment it doesn't make much of a difference.
However, if Moody's had downgraded our corporate rating by two notches, the hybrid
bond would no longer have been investment grade. We would have felt this, so it
had to be prevented from the outset.
- Will contact with the bondholders play a bigger role in Investor Relations in
the future?
The Investor Relations team already works closely with the Treasury team, which
looks after the bondholders and rating agencies at Merck.
- The two most recent acquisitions have considerably strengthened the nonpharma business. Has the shareholder base changed due to this rebalancing?
Only relatively insignificant changes have been observed. The percentage of U.S.
investors has risen slightly, by about two percentage points. Investors from this
region now own just under 50% of the free float.
---The interview was conducted by Sabine Wadewitz and Claus Döring.
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THE CFO INTERVIEW - ABOUT MARCUS KUHNERT In top shape
swa - Dr. Marcus Kuhnert is carrying on the tradition of athletic CFOs at Merck. Until
a few years ago, Kuhnert, who was born in Chicago, Illinois (USA) and brought up in
Germany, played soccer regularly (striker, midfielder, defender) and still plays now
from time to time. However, with signs of wear and tear over the years keeping the
46-year-old from playing at a high level, he now prefers to exercise on his bike or the
elliptical machine.
Kuhnert also has to be in top shape for his job at the Darmstadt-based family-owned
company. Joining the pharmaceutical and chemical company in southern Hesse on
August 1, 2014, Kuhnert didn't have much time to learn the ropes. Just two weeks
after taking up the position, he had to present the half-year financial report - which he
did with effortless ease. Last summer he also became a father for the third time. And
then in September Merck announced the largest acquisition in the company's history:
the purchase of the life science specialist Sigma-Aldrich for US$ 17 billion.
Kuhnert stands for conservative accounting policies and financing, typical of a familyowned company. This guiding principle is one that Kuhnert, who holds a diploma and
a doctorate in business administration and mechanical engineering, has internalized
after holding various executive positions at the consumer goods company Henkel.
In the interview, Kuhnert leaves no question unanswered. The CFO does, however,
refuse to predict whether he and his favorite soccer team Eintracht Frankfurt will
outperform the CEO and 1. FC Köln, of which CEO Karl-Ludwig Kley is an avid
supporter, at the end of the Bundesliga season.
(Börsen-Zeitung, April 18, 2015)