Offer value of $59.64 per share values Reynolds at around $86 billion
London-based British American Tobacco PLC (BAT), one of the world’s five-largest tobacco companies, has reached an agreement to acquire North Carolina-based Reynolds American Inc. (NYSE: RAI), the second-largest tobacco company in the US, in a $49.4-billion takeover to create the world’s largest listed tobacco company, as reported by Bloomberg on January 17th, 2017.
BAT, which already owns a 42% stake in Reynolds, increased its earlier offer of $56.50 per share that it made on October 21st, 2016, by about 5.6%. Reynolds, the maker of Camel and Newport cigarettes, rejected the offer a month later. The new offer of $59.64 per share caps over three months of talks between the two companies and values Reynolds at around $86 billion.
BAT has agreed to pay $29.44 in cash and 0.5260 BAT shares for each Reynolds share, which is a 26% premium over Reynolds’ stock on October 20th, 2016, the day before BAT’s first offer. As shown above, Reynolds negotiated a higher cash portion in the final deal. The deal values Reynolds at 16.9 times earnings before interest, tax, depreciation and amortization, a higher multiple than for comparable industry deals. The transaction has been approved by the Boards of Reynolds and BAT and is expected to close in the third quarter of 2017.
Deal to bring in cost synergies for BAT
The deal will mark BAT’s return to the lucrative and highly regulated US market after a 12-year gap, making it the only tobacco giant with a large presence in US and international markets. BAT left the US in 2004 when it merged its subsidiary Brown & Williamson with R.J. Reynolds to form Reynolds American. The deal would also create a market leader with brands including Newport, Lucky Strike, Camel, and Pall Mall, and enable BAT to replace traditional cigarettes with next generation products (NGPs) such as Reynolds’ Vuse e-cigarette brand. The deal assumes significance since the US is the largest tobacco profit pool globally, excluding China, with the combination of affordable pack prices, relatively high disposable incomes and a growing market for NGPs underpinning the opportunity for profitable growth.
BAT has forecast a minimum of $400 million of annual cost synergies within three years. These synergies will be achieved by leveraging the scale of the combined business, increasing efficiencies and aligning to BAT’s Target Operating Model. Cost synergies exist in three main areas – procurement, product development and corporate costs of the combined group. The delivery of these synergy benefits, together with the opportunity for profitable growth in the US market, further supports BAT’s commitment to margin enhancement of 50-100 basis points on average, per annum.
BAT’s existing manufacturing footprint will be enhanced by the inclusion of the Reynolds Group’s high quality production facilities in North Carolina and Tennessee. BAT also stated that its manufacturing capabilities would be enhanced by the inclusion of Reynolds’ high-quality production facility in Tobaccoville. Reynolds is estimated to have between 2,000 and 2,300 local employees, the majority of which work at the Tobaccoville plant.
Once merged, the two companies would overtake Philip Morris International Inc. (NYSE: PM), the maker of Marlboro, Rothmans, and Benson & Hedges, as the world’s largest publicly traded tobacco company in terms of revenue. It would give BAT an initial foothold in the US, which will account for about 35% of the combined group’s revenue, according to Bloomberg.
Reynolds is well-positioned as the number two player in the US market, with three out of the four top selling cigarette brands and the benefits from the Lorillard acquisition. Reynolds has a 34% cigarette market share, with Newport the leading brand in menthol, Pall Mall the leading value brand and Natural American Spirit, the fastest growing premium brand. Reynolds’ American Snuff subsidiary also has a 33% share of the growing moist snuff segment, led by its Grizzly brand.
On the other hand, BAT has a successful track record of developing strong brands and growing market share through a focus on product quality and innovation, enabling it to build on Reynolds’ existing share growth momentum. BAT has a significant presence in emerging markets across South America, Africa, the Middle East and Asia and emerging markets will account for 60% of volume in the enlarged group. Over the last five years, revenue per pack in these markets has grown at more than twice the rate compared to developed markets. With generally low cigarette pack prices and expectations of continued growth in consumer disposable income over the long term, the future profit growth opportunity remains strong.
A possible corporate tax cut by President-elect Trump has prompted both companies to formulate a breakup fee of $1 billion should either side pull out of the deal. The transaction requires the approval of at least 50% of Reynolds shareholders in a vote that will exclude BAT. Centerview Partners, Deutsche Bank and UBS advised BAT on the deal, while Lazard, JP Morgan and Jones Day worked for Reynolds American.
Tobacco industry in consolidation mode
The BAT-Reynolds takeover could spark further deals in the already shrinking tobacco industry as more and more people quit smoking over health concerns and heavy taxes levied on tobacco and tobacco-based products. Last week, Imperial Brands PLC, the No. 4 publicly traded manufacturer, announced a global joint venture with China National Tobacco Corp., the state-run largest global tobacco manufacturer, which could lead to an eventual acquisition of Imperial.
There has been speculation of a reunification of Philip Morris USA and Philip Morris International in response to a potential Reynolds-BAT merger. Japan Tobacco Inc. buying Britain’s Imperial Brands PLC, and Philip Morris International re-merging with Altria Group Inc. eight years after splitting are the other plausible deals in the offing.
Reynolds’ stock stood at $58.00, gaining 0.55%, at the close on Wednesday, January 18th, 2017, having vacillated between an intraday high of $58.08 and a low of $57.84 during the session. The stock’s trading volume was at 25,967,386 for the day. The Company’s market cap was at $82.36 billion as of Wednesday’s close.