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THIRD WORLD NETWORK
BIOSAFETY INFORMATION SERVICE 18 January 2005
We bring to you an updated report on Monsanto by Innovest Strategic Value Advisors. The report states that Monsanto's venture into genetic engineering continues to face many risks that may jeopardize the company's future prospects. According to Innovest, Monsanto faces business constraints in the form of market rejection by consumers, producers, and farmers; significant legislative hurdles to commercialization; uncertainty in the face of human health and environmental impacts stemming from the company's products; and finally, significant risk exposure from potential contamination of the human food chain by both approved and unapproved genetically engineered traits. Even if the company is a good actor with respect to safety and control during product development, problems stemming from actions by a competitor could impact the company's profitability. This updated report also points to the fact that lack of regulatory oversight on the part of the US authorities means that Monsanto's claim that the company's operations have low risk and that its products are thoroughly reviewed by regulators during development and prior to commercialization, is a fallacy. The report also points out that Wall Street has been somewhat overly optimistic with respect to Monsanto's valuation over the latter half of 2004. In April of 2003 Innovest estimated a 2004 EPS of $1.26 and the Wall Street consensus at that time was a more bullish $1.43. Actual EPS at year end 2004 was $0.99. The report adds that Monsanto is overvalued with respect to current profit potential in the short term and that its long term value is at risk.
With best wishes,
Innovest Strategic Value Advisors, a financial services firm based in New York, London, Paris and Toronto, analyzed investor risks related to Monsanto's genetic engineering (GE)[1] business strategy. Partly owned by State Street Global Advisors and the Dutch pension fund ABP, Innovest is a leader in analyzing the financial impacts of environmental, social and corporate governance issues. Investors use Innovest's best-in-class ratings, ranging from AAA to CCC, to minimize risk and maximize return potential. In nearly every industry sector, companies with above average scores, taken as a group, outperformed below average firms by 300 to 3000 basis points per year in the stock market. Innovest has maintained its CCC Intangible Value Assessment™ rating for Monsanto, the lowest rating. This rating has been maintained over the past several years and is based on a regular review of environmental, social and corporate governance risk factors. Monsanto's performance on these factors was compared relative to peer companies in the MSCI index Specialty Chemicals sector. This implies the firm has above average risk exposure and less sophisticated management than peers. As a result, it will likely underperform in the stock market over the mid to long-term. This report represents an update of a similar report published in April 2003 and covers the business risks and profit potential of Monsanto's genetic engineering (GE) businesses. It aims to uncover for investors and stakeholders the following: What is the current state of Monsanto's GE businesses? How profitable are they? Where is the value for investors? And what risks remain under-reported or undefined that might impact that value in the future? This executive summary is intended to provide an overview of the report contents and it is recommended that readers seeking more in-depth analysis consult the chapters below for more detail. Monsanto & Genetic Engineering Monsanto has developed two main products through its GE program over the past twenty years, insect resistance using the Bacillus thuringiensis, or Bt bacteria genes, and herbicide resistance - specifically to Glyphosate or "Roundup", as the product is known commercially. These genetically engineered traits have been commercialized in various forms in soy beans, corn, cotton and canola. Monsanto's Share Price (Year
end 2004) and Long Term Value This implies that Monsanto is overvalued with respect to current profit potential in the short term. Therefore, long term value is the only real value inherent in the stock. Innovest's analysis of Monsanto, detailed in the chapters below, strongly implies that this long term value is at risk. As a result investors should seek greater transparency from the company regarding the risks associated with its business model and should be aware of the following outstanding risks to Monsanto's business plan over the next few years, which the company does not fully address in its AR or 10K filing to the SEC. LACK OF REGULATORY OVERSIGHT Closer examination of the regulatory environment for genetic engineering in the United States shows a significant lack of oversight that places the risks taken by the industry squarely onto shareholders. Currently, the regulatory situation for GE crops in the U.S., the major market for both developers and sales, consists of a patchwork of outdated regulations and voluntary guidelines which have been widely criticized by the scientific community. Regulatory oversight of genetically engineered (GE) crops in the United States is divided between three federal regulatory agencies, the Food & Drug Administration (FDA), the Environmental Protection Agency (EPA) and the United States Department of Agriculture (USDA). Since the first introduction of these new crops in the early 1990s, there have been no new laws passed to regulate GE crops. Instead, all regulation has fallen under pre-existing laws. The Food & Drug Administration (FDA) only has voluntary requirements for Monsanto's herbicide resistant products. While the Environmental Protection Agency is tasked with regulating Bt crops, the only applicable laws are those for pesticides which do not deal with any of the larger ecosystem impacts, or properly integrate with the FDA's regulations on food. In most cases, regulatory oversight has been limited to voluntary guidelines. The FDA does have the ability to regulate a GE product as a food additive, which is a fairly rigorous process. However, the way FDA determines whether a new GE product should go through the food additive review process is not apparent as there are no clear guidelines in place to determine when a product might be selected for the food additive review. The only time a GE product has gone through the more rigorous food additive review is when the marketers of the GE Flavr Savr tomato specifically requested that their product go thorough this analysis. Since then, no GE product has gone through a food additive review, all have gone through GRAS review. In 2003, a committee of the National Academy of Sciences (NAS) and the Institute of Medicine conducted an assessment of the safety of genetically engineered foods[1] in which it made a number of recommendations that implied that proper safety procedures for GE crop development were not currently in place. The nature of the NAS and Institute of Medicine recommendations[2] strongly contradict Monsanto's portrayal to investors of thorough oversight and review by regulatory agencies of its Seeds and Traits operations. The committee recommended that changes that result from genetic engineering undergo an appropriate safety assessment (implying that current assessments were inadequate); that the extent of an appropriate safety assessment should be determined prior to commercialization (implying that current assessment was not extensive enough); that the appropriate federal agencies determine if evaluation of new genetically modified (GM3) foods for potential adverse health effects from both intended and unintended compositional changes is warranted by elevated concern (implying that federal agencies were not making such determinations); and for those foods warranting further evaluation, the committee recommended safety assessments be conducted prior to commercialization and that there be continued evaluation postmarket where safety concerns are present (implying that such evaluations were not currently being done and that regulatory capacity was not in place). Furthermore, the committee recommended four safety assessment actions: that standardized sampling methodologies, validation procedures, and performance-based techniques for targeted analyses and profiling of GM food be developed and employed; that tracking of potential health consequences from commercially available foods that are genetically modified, including those that are genetically engineered, be developed and improved; that a significant research effort should be made to support analytical methods technology, bioinformatics, and epidemiology and dietary survey tools to detect health changes in the population that could result from genetic modification and, specifically, genetic engineering of food; and that research is needed to determine the relevance to human health of dietary constituents that arise from or are altered by genetic modification. The fact that the "Starlink" corn contamination case, which cost the developer Aventis over $1 billion to remediate, was discovered by a private non-governmental organization rather than government regulators is a strong reminder of how this situation places heightened risks on shareholders. MARKET GROWTH However, in-depth analysis of the economic gains in these markets by the industry has been slight and it appears that acres planted in the developing world have not yielded any significant revenue to date. This is particularly true for Argentina despite the almost complete market penetration of Roundup Ready soy there. The problem of "value capture" primarily affects soya and cotton because these plants are non-hybridized, meaning the seeds can be replanted year after year without yield loss. The same cannot be said for corn where yield loss of over 50% on replanted seeds is not uncommon. Argentina typifies the value capture conundrum. While over 95% of soy planted in that country is Roundup Ready, Monsanto was forced to shut down its operations there in 2004 because it could not earn revenues. The acres planted and penetration numbers touted by the marketing department suggest booming profits. However, the balance sheet reveals a quite different story of political wrangling ending in little, if any, profit. MARKET REJECTION North American farmers' concerns over the salability of GE wheat caused Monsanto to abandon that product in 2004. In addition, concern over contamination liability led Monsanto to abandon is pharma-crop R&D pipeline in 2003. At present, commercially viable GE products provide no proven nutritional benefits to consumers. However, they do pose various environmental and human health risks. As a result, many consumers refuse to buy GE products once labeling makes them aware that GE ingredients are being used. Foreign markets, especially those with labeling requirements, have seen strong market rejection. In the US, where labeling is not required, outright rejection has been minimal so far, although significant support for labeling has developed. Foreign Market Rejection The Cartagena Protocol on Biosafety came into force in 2003. This will impose substantially greater documentation and risk assessment costs on GE exporters. The Protocol will also likely hold GE seed manufacturers liable for contamination and other problems caused by GE seed use. In the wake of the $1 billion StarLink loss, it may be difficult or impossible to get insurance for GE-related losses. For example, NFU mutual, the largest UK farm insurer, refuses to insure such losses. These restrictions will make it more difficult for GE products to compete with non-GE varieties in the 103 countries that are signatories to the Protocol. To avoid losing market share, food exporters will likely demand non-GE crops from US farmers. This was the case with GE wheat which reinforced the trend against the commercialization of GE food crops with a sizable portion dedicated to human consumption. However, a main constituent element in the recent (year end 2004) share price rise for Monsanto was the decision in May of 2004 by the EU to lift a five-year moratorium on new licenses for GE crops. Seventeen Bt corn varieties, all derived from Monsanto's MON 810 maize (trade name "Yieldguard)[2], were listed for the first time in EU seed catalogs in September of 2004. Whether this will result in actual sales to European farmers remains to be seen since 70% or more of EU consumers oppose GE crops and the EU rejected looser labeling for GE content in Sept. of 2004[3]. In addition, farmers may have difficulty insuring their GE crops in the European market since many insurers have stated publicly that they will not insure against risks from GE crops. Most European food manufacturers and retailers have implemented policies to ensure that no GE ingredients are used in their food products. Companies pursuing such policies include Nestlé, Unilever, Heinz, ASDA (Wal-Mart), Carrefour, Tesco and many others. Beyond Europe, there has been strong opposition to GE crops in Asia, Africa and other developing regions. Domestic Market Rejection Several of these polls also found that a significant percentage of Americans would not eat GE foods if they were labeled as such (the Time poll found 58% would not eat them). If labeling requirements were imposed in the US, it appears highly likely that a significant number of consumers, perhaps as high as 30% or more, would stop eating GE foods and demand non-GE alternatives. As in Europe, many food manufacturers would probably choose to carry only non-GE foods, rather than going to the expense of pushing two separate lines through the same distribution channels. Many companies in the mainstream food industry and many countries have spent the last 2-4 years implementing non-GE policies to the extent of arranging new contracts with new or existing suppliers, implementing Identity Preservation (IP) systems for their ingredients, and labeling their products as non-GE. Adding new crops for human consumption to its existing portfolio may be difficult and their failure can be very costly. Monsanto lost $60 million alone in 2004 or 0.24 EPS due to the abandonment of GE wheat. These losses are certainly higher if the R&D costs prior to 2004 for development and testing of GE wheat are considered. The fact that farmers, Monsanto's main customers, successfully organized boycotts[4,5,6] against GE wheat is instructive as to the pressure they were under from global export markets. A major part of the risk in Monsanto's genetic engineering program is the fact that it is dealing with the genetic structures of the four or five most important food crops for humanity. Risks, even remote ones, have compelling gravity given the obvious importance of food crops. Lack of complete knowledge is a problem for investors. For developers of GE crops it is the problem. Monsanto is also exposed to risks taken by competitors such as Aventis CropScience and ProdiGene. Missteps by these companies could seriously impact Monsanto's business in GE seeds. ENVIRONMENTAL AND HUMAN
HEALTH RISKS Inevitable Environmental
Contamination In another contamination case, GE corn designed by ProdiGene to produce pig vaccine recently contaminated corn and soy beans food crops in Iowa and Nebraska. Regulatory leniency limited ProdiGene contamination costs to $3 million and allowed the firm to stay in business. However, further contamination could occur and costs to the firm could rise since GE material from pig vaccine corn may have transferred to food crops. In another case, GE corn contamination has been found in Mexico, where GE corn growing is not allowed. A NAFTA commission has concluded that if left unchecked GE corn threatens to displace native Mexican varieties which have significant value to the corn industry given the genetic diversity of corn in the region. A second commission recommended better regulation of biotech corn. Monsanto began admitting in 2002 that research and development of GE crops will result in the spreading of GE traits to non-GE crops.9 This is a major admission for the industry and implies that the risk of contamination and negative impacts is very high going forward. The company's 2002 annual report (as well as subsequent reports) acknowledge concerns about research and development of both traditional biotechnology as well as pharmaceutical proteins appearing in food crops. This implies that the company is aware of the possibility that both approved GE traits as well as unapproved traits still in the development process could end up in the human food supply-chain. The level of environmental and human-health risk, and therefore financial risk, cannot be understated. The relevance of this admission to shareholders is apparent in the abandonment by the company of bio-pharmaceutical crops from the research and development pipeline due to perceived risks associated with their development and commercialization. Human Health Risks Since these firms have a large financial stake in seeing GE crops commercialized, there is a risk that safety testing done by them is biased. Therefore, many scientific panels have recommended that safety and environmental testing be done by regulators and not the industry. Other safety concerns include the fact that safety testing is usually not done over the long-term or over multiple generations. As a result, long-term impacts on human health may not be discovered until impacts have already happened. Many scientists are concerned that the GE process can have unintended consequences such as creating new toxins and proteins which could cause allergic reactions and other human health problems. An example of unintended consequences includes antibiotic resistant marker genes which are used in the production of many GE seeds. Some medical authorities have found that these genes may pass on antibiotic resistance to bacteria in the gut, thus making the bacteria resistant to clinically important antibiotics. As a result, the EU is phasing them out in 2008. The United Nations CODEX Alimentarius Committee has also recommended that they be phased out. In the US however, there appears to be no plan to phase them out. HISTORICAL RISK LIABILITIES Monsanto has the highest risk exposure relative to peers in the specialty chemicals sector(defined by Morgan Stanley's MSCI Index). Significant numbers of organochlorine contaminant (dioxins, furans and PCBs) related liabilities could, as they have in the past, result in burdensome court cases and expensive payouts. Monsanto has manufactured many high-risk chemicals in the past which still persist in the environment or comprise the significant site liability which Monsanto remains liable for. Currently Monsanto is liable for some 89 hazardous waste sites in the U.S. This does not include site liability outside the U.S. or similar potential liability from Solutia which the company may also be liable for. The company faces significant and expanding liabilities and reputational risks associated with its historical production of Agent Orange. Tens of thousands of U.S. and foreign national troops who served in Vietnam and were exposed to Agent Orange have filed suits against manufacturers seeking restitution for injuries caused by the chemical (which was contaminated with the most toxic form of dioxin, TCDD). In a possibly even more significant development, Vietnamese citizens have filed a suit in New York seeking damage claims on behalf of those injured by exposure to Agent Orange in that country. According to Dr. Arthur Galston, Professor Emeritus at the Yale School of Forestry and Environmental Studies, who spoke at a Yale University conference, The Ecological and Health Effects of the Vietnam War, "the use of Agent Orange as a defoliant and herbicide in Vietnam was the largest chemical warfare operation in history, producing considerable ecological as well as public health damage."[12] It has been estimated that over a million Vietnamese may have died or were injured due to exposure to Agent Orange. Monsanto was the largest producer of Agent Orange with 29.5% of production. In previous settlements over Agent Orange liabilities, Monsanto paid a larger portion (45.5%) of damage awards since its product was contaminated to a much greater degree with dioxin then competitors. CONCLUSION However, the development of non-GE traits in the R&D pipeline, as well as improved approach to genetic modification (as opposed to genetic engineering) such as "marker assisted breeding" techniques, may provide future value alternatives for shareholders. This report provides much additional guidance on the topics discussed in this executive summary. This includes an overview of the GE crop market, a detailed description of Monsanto's GE-focused strategy and the large risks it poses to consumers, theenvironment, food manufacturers and investors.
1 In this report "GE" refers specifically to genetic engineering techniques and "GM" refers to the broader category of any type of genetic modification of organisms. 3 GM, or genetically modified refers more broadly here to all methods of genetic modification and not just genetic engineering. Throughout the report, "GM" has this meaning, whereas "GE" refers specifically to the process of genetic engineering.
1 Committee on Identifying
and Assessing Unintended Effects of Genetically Engineered Foods on Human
Health, Board on Life Sciences Food and Nutrition Board Board on Agriculture
and Natural Resources SAFETY OF GENETICALLY ENGINEERED FOODS APPROACHES
TO ASSESSING UNINTENDED HEALTH EFFECTS; 2003, THE NATIONAL ACADEMIES PRESS
Washington, D.C.
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