Chairman’s Letter
Value Management
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Management Report
Value Management
“Our goal is to steadily increase Bayer’s enterprise value and generate high value-added for the benefit of our stockholders, our employees and society as a whole in every country in which we do business.”
Werner Wenning, Chairman of the Board of Management of Bayer AG
Cash value added-based system
One of the prime objectives of the Bayer Group is to sustainably increase enterprise value. In 1994 we became one of the first German companies to embark on the development of a value management system, which we introduced throughout the Group in 1997. The system is used for the planning, controlling and monitoring of our businesses. Our primary value-based indicator is the cash value added (CVA), which shows the degree to which the cash flows needed to cover the costs of equity and debt and of reproducing depletable assets have been generated. If the CVA is positive, the company or business entity concerned has created additional value. If it is negative, the anticipated capital and asset reproduction costs have not been earned. Gross cash flow (GCF) and CVA are profitability indicators for a single reporting period. For a year-on-year comparison we therefore use the delta CVA, which is the difference between the CVAs of two consecutive periods. A positive delta CVA shows that value creation has improved from one period to the next.
Calculating the cost of capital
Bayer calculates the cost of capital according to the debt/equity ratio by the weighted average cost of capital (WACC) formula. The cost of equity capital is the return expected by stockholders, computed from capital market information. The cost of debt used in calculating WACC is based on the terms for a ten-year corporate bond issue.
To take into account the different risk and return profiles of our principal businesses, we calculate the cost of capital after taxes for each of our subgroups. In 2006 this was 7.5 percent (2005: 8.0 percent) for Bayer HealthCare, 7.0 percent (2005: 6.5 percent) for Bayer CropScience and 6.5 percent (2005: 6.0 percent) for Bayer MaterialScience. The minimum return required for the Bayer Group as a whole was 7.0 percent (2005: 7.0 percent).
To take into account the different risk and return profiles of our principal businesses, we calculate the cost of capital after taxes for each of our subgroups. In 2006 this was 7.5 percent (2005: 8.0 percent) for Bayer HealthCare, 7.0 percent (2005: 6.5 percent) for Bayer CropScience and 6.5 percent (2005: 6.0 percent) for Bayer MaterialScience. The minimum return required for the Bayer Group as a whole was 7.0 percent (2005: 7.0 percent).
Gross cash flow, cash flow return on investment,
and cash value added as performance yardsticks
and cash value added as performance yardsticks
The GCF, as published in our cash flow statement, is the measure of our internal financing capability. Bayer has chosen this parameter because it is relatively free of accounting influences and thus a more meaningful performance indicator.
The profitability of the Group and of its individual business entities is measured by the cash flow return on investment (CFROI). This is the ratio of the GCF to the capital invested (CI). The CI can be derived from the balance sheet and basically comprises the property, plant and equipment and intangible assets required for operations – stated at cost of acquisition or construction – plus working capital, less interest-free liabilities (such as short-term provisions). To allow for fluctuations during the year, the CFROI is computed on the basis of the average CI for the respective year.
Taking into account the costs of capital and of reproducing depletable assets, we determine the GCF hurdle. If the GCF hurdle is equaled or exceeded, the required return on equity and debt plus the cost of asset reproduction has been earned. The CFROI hurdle for 2006 was 10.0 percent, while the corresponding GCF hurdle was €3,188 million.
Actual GCF came in at €3,913 million, exceeding the hurdle by a substantial 22.7 percent. Thus in 2006 we earned our entire capital and asset reproduction costs, and the positive CVA of €725 million shows we created additional value. Given the previous year’s CVA of €746 million, the Bayer Group therefore achieved a delta CVA of minus €21 million. With a CFROI of 12.1 percent in 2006 (2005: 12.5 percent), we thus almost equaled the previous year’s record level despite the acquisition-related increase in the capital invested.
The HealthCare and MaterialScience subgroups exceeded their target returns including asset reproduction. The CFROI for HealthCare declined from 15.5 percent in the previous year to 12.4 percent, due to the increase in capital invested associated with the Schering AG acquisition and also because of integration-related charges. MaterialScience achieved a CFROI of 15.6 percent (2005: 17.8 percent). The figure for CropScience dipped from 11.2 percent in the prior year to 10.3 percent in 2006.
The profitability of the Group and of its individual business entities is measured by the cash flow return on investment (CFROI). This is the ratio of the GCF to the capital invested (CI). The CI can be derived from the balance sheet and basically comprises the property, plant and equipment and intangible assets required for operations – stated at cost of acquisition or construction – plus working capital, less interest-free liabilities (such as short-term provisions). To allow for fluctuations during the year, the CFROI is computed on the basis of the average CI for the respective year.
Taking into account the costs of capital and of reproducing depletable assets, we determine the GCF hurdle. If the GCF hurdle is equaled or exceeded, the required return on equity and debt plus the cost of asset reproduction has been earned. The CFROI hurdle for 2006 was 10.0 percent, while the corresponding GCF hurdle was €3,188 million.
Actual GCF came in at €3,913 million, exceeding the hurdle by a substantial 22.7 percent. Thus in 2006 we earned our entire capital and asset reproduction costs, and the positive CVA of €725 million shows we created additional value. Given the previous year’s CVA of €746 million, the Bayer Group therefore achieved a delta CVA of minus €21 million. With a CFROI of 12.1 percent in 2006 (2005: 12.5 percent), we thus almost equaled the previous year’s record level despite the acquisition-related increase in the capital invested.
The HealthCare and MaterialScience subgroups exceeded their target returns including asset reproduction. The CFROI for HealthCare declined from 15.5 percent in the previous year to 12.4 percent, due to the increase in capital invested associated with the Schering AG acquisition and also because of integration-related charges. MaterialScience achieved a CFROI of 15.6 percent (2005: 17.8 percent). The figure for CropScience dipped from 11.2 percent in the prior year to 10.3 percent in 2006.
| Value Management Indicators by Subgroup | HealthCare | CropScience | MaterialScience | Bayer Group | ||||
| € million | 2005 | 2006 | 2005 | 2006 | 2005 | 2006 | 2005 | 2006 |
| Gross cash flow hurdle (GCF hurdle) | 690 | 1,536 | 935 | 1,000 | 610 | 649 | 2,368 | 3,188 |
| Gross cash flow* (GCF) | 923 | 1,720 | 964 | 900 | 1,254 | 1,166 | 3,114 | 3,913 |
| Cash value added (CVA) | 233 | 184 | 29 | (100) | 644 | 517 | 746 | 725 |
| Cash flow return on investment (CFROI) | 15.5% | 12.4% | 11.2% | 10.3% | 17.8% | 15.6% | 12.5% | 12.1% |
| Average capital invested (ACI) | 5,955 | 13,865 | 8,618 | 8,728 | 7,054 | 7,489 | 24,893 | 32,276 |
2005 figures restated
* for definition see Bayer Group Key Data
* for definition see Bayer Group Key Data
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