EUR 850.00 For Business Accounts Only

Morningstar | Trimming Narrow-Moat Merck KGaA's Fair Value Estimate on Pending Versum Deal

After taking a fresh look at Merck KGaA following the Versum acquisition announcement, we are trimming our fair value estimate for the firm and boosting our uncertainty rating. Merck has offered a full valuation for Versum, which has cut into our fair value estimate slightly. Our new high uncertainty rating also recognizes Merck's increasing exposure to the cyclical semiconductor end market and the ongoing risks surrounding Merck's healthcare portfolio and display solutions business. Strategically though, we view the semiconductor material business as attractive, and we have maintained our narrow moat and stable trend ratings for Merck, despite the pending transaction.

The Versum acquisition should add another attractive business to narrow moat Merck. On a pro forma basis, semiconductor solutions will represent about half of the performance material segment’s sales, which accounts for about 23% of pro forma sales. We view the semiconductor solutions business as attractive due to intangibles surrounding its proprietary products and significant switching costs for users, semiconductor manufacturers. The company’s other segments--life sciences (38% of sales) and healthcare (39% of sales)--contribute to Merck's narrow moat, too. Merck's life science products benefit from intangible assets and switching costs due to regulatory and reproducibility factors. Within healthcare, Merck relies on intangible assets, such as patents, brand names, and reputation, as its moat source.

From a valuation perspective, Merck's stock recently traded near our fair value estimate. With its increasing exposure to the cyclical performance materials segment, which is affected by demand in semiconductors, televisions, and automobiles, and its relatively concentrated biopharmaceutical business, we see high uncertainty around Merck KGaA's cash flows, up from medium. With this increase in uncertainty, we believe the margin of safety required to invest in Merck's shares has also grown.