Global Resistance to GE Imperils Monsanto's Future

Business Week
June 12, 2000

Rocky Ground for Monsanto?

By Amy Barrett in Philadelphia

The new spin-off must sell investors on ag biotech

Not long after taking over as chief executive officer of Monsanto Co. in
1995, Robert B. Shapiro instituted a program he called the two-in-the-box
system. The idea was to pair up a technology or science expert with a
business or marketing manager to share one job. Shapiro's hope was that the
marriage of those managers in dozens of key positions would speed
Monsanto's rollout of pharmaceutical or biotechnology products. It was the
sort of bold management stroke that showed how, under Shapiro's leadership,
Monsanto came to be run more like a high-tech startup than the agriculture
and drug giant it was.

These days two-in-the-box, like much of Shapiro's grand plan for Monsanto,
is history. Battered by a massive backlash in Europe and growing
controversy in the U.S. over its genetically modified seeds, and loaded
down with the debt it used to buy up several seed companies, Monsanto was
compelled to merge with Pharmacia & Upjohn in a $30 billion deal completed
in March. Fred Hassan, Pharmacia's chief executive officer, lusted after
Monsanto's pharmaceutical operation, Searle. But he was a lot less
interested in the controversial agricultural business. That's why the
combined company, Pharmacia Corp., plans to sell up to 20% of the ag
operation, called Monsanto Co., to the public later this summer. Analysts
anticipate it will unload the rest in the next two years. DOWNSIZED
AMBITIONS. The spun-off Monsanto will have a considerably more modest
vision than its predecessor. Shapiro had pulled together cutting-edge
science in agriculture, pharmaceuticals, and nutrition with the goal of
creating everything from breakthrough drugs to heartier crops and
disease-fighting foods. Under the old culture, the future payoff from
Monsanto's science was all that mattered, and current earnings were less
important. But the new ag-focused Monsanto will need to convince Wall
Street -- and a skeptical public -- that agricultural biotechnology is not
a dead end. And it has to motivate employees to concentrate on mundane
tasks such as cutting costs and delivering steady earnings growth. ''It
went from a time when everything was possible and there were no limits to
one where priorities matter and costs matter,'' says one current executive,
who declined to be named. ''That's a very different place.''

Even with such downsized ambitions, the new Monsanto faces plenty of
hurdles. For one thing, the U.S. patent on its single biggest product, the
$ 3.2 billion Roundup herbicide, expires later this year. That could put
price pressure on Roundup and lead to loss of market share as rivals market
copycat products. Sales had been growing close to 20% in recent years,
thanks to acquisitions and moves by farmers to scoop up products such as
herbicide-resistant soybeans. But SG Cowen Securities Corp. analyst Ian C.
Sanderson expects the global backlash against genetically engineered foods
-- combined with a weak farm economy -- will mean revenue grows just 8%
this year, to $ 5.7 billion.

In Europe, where mad cow disease has left consumers particularly nervous
about the food supply, widespread protests against what critics called
''Frankenfoods'' led to a 1998 European Union moratorium on the approval of
new genetically engineered seeds for planting. Meanwhile, the controversy
picked up steam in the U.S. last year as grain processor Archer Daniels
Midland Co. asked farmers to segregate genetically modified crops from
conventional products. Some food companies, such as Gerber Products Co.,
have gone on record saying they won't use bioengineered ingredients. And
the uproar has delayed rollout of genetically modified seeds in Brazil.

At the same time, Monsanto will have to convince Wall Street that its
current management team, led by CEO Hendrik A. Verfaillie, can manage in
the new environment. Verfaillie is a 24-year Monsanto veteran who worked
his way up in the herbicide business. A native of Ardooie, Belgium,
Verfaillie is best known for having led efforts to boost sales of Roundup
outside the U.S. While he is a longtime Shapiro ally, Verfaillie is said by
some industry insiders to speak with less of Shapiro's almost evangelical
zeal about the future of biotechnology.

That may prove to be a wiser approach in this environment. But it also
means Verfaillie is an unknown commodity to many large investors. ''The
persona of Monsanto is very much the persona of Shapiro,'' says Roger E.
Wyse, managing director at Burrill & Co., a merchant bank that specializes
in life sciences. ''The rest of the management team has been less
visible.'' Both Verfaillie and Shapiro, who is now nonexecutive chairman at
Pharmacia, declined to comment for this story. They cited the quiet period
surrounding the public offering.

Such questions surrounding the company could result in a cool reception to
the spin-off. ''Our overall view is to stay away,'' says Dr. Faraz Naqvi, a
portfolio manager and biotechnology investor at Dresdner RCM Global
Investors who took a look at the offering. Speaking of the backlash against
genetically modified crops, he warns, ''We think it may get worse.'' Others
who hold a less dire view still find little temptation in the deal. ''The
science is as good as ever,'' says Delaware Management Co. Senior Portfolio
Manager John B. Fields, who studies the sector closely and doesn't expect
to buy into the spin-off. ''But the payoff keeps getting pushed further and
further into the future.''

To fight that attitude, the new Monsanto needs to prove it can deliver
solid earnings growth now. The reconstituted company will have four main
lines: crop protection chemicals such as Roundup; seeds for crops such as
corn and soybeans; designer genes that can be inserted into seeds; and
growth hormone for boosting dairy production. SG Cowen's Sanderson expects
the new Monsanto to generate 13% average annual growth in operating income
through 2003, bringing this year's total to $ 730 million. That would be an
improvement over the weak results of the last two years, when hefty
acquisition costs were a drag. CRASH DIET. But to hit those numbers, the
new Monsanto will have to be much leaner. Late in 1998, the company went on
a crash diet in the wake of its $ 6.5 billion buying spree for seed
companies and biotechnology. Those deals gave Monsanto valuable access to
seeds in which it could insert its crop-protecting genes. But they also
saddled the company with more than $ 6 billion in long-term debt at the end
of 1998, up from less than $ 2 billion the year before. To pay some of that
tab, Shapiro sold off the nutrition businesses, including the NutraSweet
unit, raising $ 1.7 billion.

In a further bid to streamline, the company is promising Wall Street it
will save $ 225 million over the next three years by integrating the
operations of the six seed outfits it bought in 1997 and 1998. Monsanto
develops genes to do things such as ward off bugs or withstand strong
herbicides. About 6% of sales come from selling those genetic traits for
use in the company's own seeds or in those of other seed manufacturers. Now
that Monsanto owns some of those companies outright, it must integrate the
gene trait development with seed development.

As the consumer backlash gained momentum in late 1998 -- and Monsanto's
stock fell nearly in half, from a high of 63 -- the company scaled back its
research ambitions. Now it has refocused R&D exclusively on the major
crops: wheat, cotton, soybeans, and corn. Gone is work on genetically
modifying a variety of fruits and vegetables, as well as futuristic
projects such as producing biodegradable plastics from plants. Going
forward, the agriculture research budget is expected to be $ 600 million
annually, down from $ 695 million last year. SG Cowen's Sanderson says that
lower level of spending is adequate and makes sense given the tough market
conditions: ''The near-term outlook for the business has changed quite
dramatically.''

The cost-cutting effort becomes more critical as Monsanto's core Roundup
franchise comes under fire. The U.S. patent on the popular herbicide, which
generates more than 50% of the new Monsanto's sales, expires in September.
Monsanto already is cutting Roundup prices. In countries outside the U.S.,
this strategy has proved effective, driving up volume sales enough to
offset lower prices. Still, the patent expiration means that business is
likely to see slower growth. DESIGNER GENES. That puts more pressure on
Monsanto's genetically modified seeds, which carry a hefty price premium.
But analysts aren't expecting many breakthrough products for at least a
couple more years. In the meantime, Monsanto probably will step up its
introduction of seeds that contain two added genes -- for example, one that
kills insects and another that resists herbicides. SG Cowen's Sanderson
expects Monsanto's revenues from these designer genes to be flat this year,
but accelerate in 2001 and 2002.

Any expansion, of course, could be derailed if the backlash against
genetically modified foods is not contained. Protests in Europe have
effectively blocked the sale of genetically modified seeds for planting
there. Analysts had expected Monsanto to start selling soybeans that can
withstand Roundup, dubbed Roundup Ready soybeans, in Brazil last year. But
consumer protests delayed the rollout. Alain Godard, chief executive
officer of competitor Aventis Crop Science, warns that it will be a
devastating setback for the whole industry if Brazil ends up blocking the
designer seeds. If that happens, ''I think [genetically modified seeds]
will be delayed in large parts of the world...for five or ten years,'' he
says. And while markets such as China and India are promising, Godard warns
that their weaker patent-protection rules may limit profits.

In the meantime, U.S. farmers also have cooled on the high-tech seeds. The
economics remain compelling: With Roundup Ready soybeans, for example,
farmers can hit fields once with the potent herbicide, instead of applying
a host of herbicides serially. But some farmers worry that the backlash
will limit their ability to sell crops in markets such as Japan and Europe.
Novartis Seeds Inc. CEO Edward T. Shonsey figures U.S. farmers are planting
5% to 10% fewer biotech crops this year than last. Warns Gary S. Goldberg,
CEO of the American Corn Growers Assn.: ''I don't see a sign that this will
turn around soon.''

Monsanto, along with other industry players, is fighting back. These
companies, including Aventis, DuPont, and Novartis, have launched a $ 50
million advertising and information campaign aimed at convincing consumers
of the value of agricultural biotechnology. The goal is to highlight the
benefits of genetically modified crops, including the opportunity for
reduced use of pesticides and, ultimately, the production of
health-promoting foods. And many in the industry believe the recent move by
the Food & Drug Administration to tighten oversight of biotech foods will
help calm consumer fears. But Michael K. Hansen, research associate at
Consumer Policy Institute, part of Consumers Union, thinks the awareness
campaign may backfire: ''As more information comes out, you will see people
become more and more concerned.'' ON A MISSION. Along with damage control
on the outside, Verfaillie will have to find ways to mend Monsanto's
corporate culture. Shapiro persuaded employees that they were on a mission
to improve human health and help feed the world's growing population
without devastating the environment. He challenged them with changes such
as ''two-in-the-box'' and moving senior managers -- himself included --
into cubicles to improve communication. Says one former executive: ''There
was a real sense of a noble purpose, a sense of Camelot.''

And for the first few years, Shapiro's vision paid off handsomely. Within
three years, Roundup Ready soybeans accounted for over 50% of U.S. soybean
acreage, says PaineWebber Group Inc. analyst Andrew W. Cash. But it soon
became apparent that Shapiro was taking huge risks. He mounted an
ill-conceived public-relations campaign in Europe to head off growing
criticism over genetically modified seeds. But the effort seemed only to
throw fuel on the fire. ''We bought too many companies, paid too much
money, and we didn't pay attention to the grassroots [opposition],'' says
former Vice-President Michael W. Winkel, who left in early 1999 to join
printer R.R. Donnelley & Sons Co.

A deal to merge with American Home Products Corp. would have given Monsanto
much-needed scale in its promising drug business, but that collapsed in
1998. Shapiro implemented a cost-cutting initiative and began selling
assets. Now, as Monsanto prepares for its second act as an independent
company, Verfaillie and his team must redefine Monsanto's mission. Then
they'll have to prove that the scaled-down vision can still deliver for
investors.