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Mega-merger could be precursor to wave of consolidation
Thursday 27 Oct 2016 Author: William Cain

The tobacco industry looks poised for further M&A as British American Tobacco (BATS) makes its long speculated move for US tobacco giant Reynolds American (RAI:NYSE) through
a proposed merger (21 Oct) which values the business at $93bn (£76bn). In particular Imperial Brands (IMB) could now be in play.

Surprise move

UK-listed BAT already owns 42.2% of the US supplier of Pall Mall and Newport brands and a tie-up between the two companies has always been considered a longer term possibility.

But the timing of the deal was described as a ‘surprise’ by investor Guy Ellison, head of UK equities at Investec Wealth Management.

Investment bank Berenberg also seemed shocked, saying a deal had not been anticipated in 2016 or 2017.

‘The timing is a surprise, but the strategic rationale makes perfect sense, pivoting BAT further towards the high value US market, consolidating some strong brands and Reynold’s position in next generation tobacco,’ said Ellison.

‘Despite relatively modest synergies, the deal is still seen adding value for shareholders in the first full-year after completion. The ball is now in the court of Reynold’s board and shareholders to consider the offer.’

Imperial Brands now in play?

BAT’s decision to launch the deal now may have been driven by Reynolds’ acquisition last year of parts of rival Lorillard for $27.4bn, which consolidated its market share in the US.

Another catalyst, according to analysts at investment bank Jefferies, is the availability of
low cost debt financing to companies with good credit ratings.

‘This may pave the way for further consolidation in the sector,’ adds Jefferies analyst Owen Bennett.

‘Given the attractiveness of the US market (both cigarettes and vapour), we believe Japan Tobacco (2914:TYO) would want greater exposure and Philip Morris International (PMI:NYSE) also.

‘Logical deals therefore could be JT buying Imperial Brands and PMI coming back in to merge with Altria.’


$93bn merger proposal

Shareholders in Reynolds, number two in the US market behind Marlboro supplier Altria (MO:NYSE), are being offered $47bn for the shares BAT does not already own.

Valuing Reynolds at $65.50 a share, BAT is proposing to pay $20bn in cash and to issue $27bn of shares to Reynolds shareholders.

Including BAT’s 42.2% stake, the deal values Reynolds at a total enterprise value of $93bn compared to a trailing 12 month earnings before interest, tax, depreciation and amortisation (EBITDA) result of $5.7bn, a multiple of 16.3.

The offer still needs to be approved by Reynolds’ shareholders and meet necessary regulatory hurdles before it can go ahead. (WC)

Disclosure: The author owns shares in BAT

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