Bayer is shifting to the next phase of its development. The recent past has been dominated by the integration of Schering and more recently by group-wide cost cutting. This process has been accelerated somewhat in order to help mitigate the effects of the weak dollar. In 2008E, restructuring will continue to be a driver of EPS growth. Looking further out, we believe it will be the development of the Pharma portfolio that will play an increasing role in the value of the shares. Portfolio change may also be a key driver given the synergies available from potential healthcare consolidation, the low metrics accorded to pharma at present and the high valuation of crop science assets. Furthermore, cash generation is likely to be very strong and without portfolio change, the company could end 2010 with net debt of â¬2bn. This strong position would mean acquisition firepower could be up to â¬20bn to finance external growth (depending on the cashflow of any acquired asset). With regard to organic growth prospects, there are three key points to note: 1) Bayer has a notable patent challenge to its Yasmin franchise. Nonetheless, the overall generic risk is among the lowest of all the large European pharma names over the next five years. This will help sustain EBIT. 2) The R&D pipeline is starting to mature. On a risk-adjusted base, we see the products currently in PII that are planned to move into PIII over the next 18 months together with the PIII portfolio as worth about â¬15 per share. If Bayerâs development success proves to be in line with the average, there is scope for a re-rating over this period. 3) Crop Science is booming at present and this is likely also to be a significant contributor to incremental EPS growth. The modest valuation metrics, solid EPS growth and strong cashflow offer an attractive base. Should Bayer be able to develop the potential of its pipeline in line with the pharma industry average, we believe there is scope for sustained mid-term outperformance. Valuation â Price Target Increased to â¬65 We believe fair value, based on a range of metrics, is somewhat over â¬70 per share. This value tries to take into account the cyclicality of Materials, the Pharma pipeline and the robust growth we believe Crop Science will deliver in the medium term. Given the risks attached to the group and the uncertainties surrounding drug development, we have set the price target at about a 10% discount to our view of its fair value. https://www.citigroupgeo.com/pdf/SEU15634.pdf