British American Tobacco PLC (LON:BATS) is proposing to take full control of American rival Reynolds American Inc (NYSE:RAI).
The London-listed cigarettes maker already owns 42.2% of Reynolds, and is pitching its offer for the rest of the shares at US$56.50 a share, versus last night’s closing price for shares of Reynolds of US$47.17.
BATS’ offer will be a mixture of cash and shares, with the cash element worth US$24.13. The total consideration for the remaining 57.8% of Reynolds would be US$47 billion, BATS said, of which around US$20 billion would be in cash and US$27 billion in BATS shares.
The UK company said the premium it is offering over the current share price of Reynolds is justified by modest cost synergies, and that the acquisition, if it goes through, would enhance earnings in the first full year of ownership.
“The transaction would create a broader, larger business, delivering more diversified sources of profit growth,” BATS claimed.
The merger would put some of the tobacco industry's best-known brands, including Rothmans, Dunhill and Camel cigarettes, under the same roof.
“While BAT states that this deal will be earnings accretive in its first full year, there has to be some concern about the implied economic profit return on a transaction which is valued at 16.3x EV/EBITDA [enterprise value/underlying earnings],” said Whitman Howard.
“BAT’s announcement is consistent with recent policy of buying out minorities in non-wholly owned subsidiaries. Given the cash generative nature of the business – an underlying £2bn to £2½bn annually pre buy-backs – transactions should remain a feature of the company going forward,” the broker suggested.
The proposed merger is subject to the independent directors of Reynolds, which is to say those not appointed by BATS in its role as major shareholder, giving the thumbs-up to the offer and shareholders subsequently doing likewise.
"We have been a shareholder in Reynolds since its creation in 2004 and have benefited from its growth in the US market. The acquisition of Lorillard in 2015 has further strengthened Reynolds's business,” noted Nicandro Durante, chief executive of BATS.
“The proposed merger of our two great companies is the logical progression in our relationship and offers all shareholders a stake in a stronger, truly global tobacco and Next Generation Products company. BAT is proud of its track record of consistent delivery for shareholders and this transaction would further strengthen that delivery in the future," Durante added.
The bid announcement accompanied an interim management statement for BATS that revealed revenue grew 8.1% on a constant exchange rates basis in the first nine months of the year, or by 10.2% using actual exchange rates. Organic revenue growth, which strips out the effect of acquisitions, was 6.2%.
Cigarette market share grew by four-tenths of a percentage points in the group’s key markets in the first nine months of the year.
“The excellent momentum of our Global Drive Brands continued, driving an increase in group market share. We have made significant progress in our Next Generation Products, both in terms of geographic roll-out and product development,” Durante said.
“The on-going transactional foreign exchange headwinds on our cost base remain a challenge, despite the translational tailwind as a result of recent movements in sterling. I remain confident that we are on track to deliver another year of good earnings growth at constant rates of exchange," he added.
Whitman Howard said the group’s overall organic business model shows little change.
“It continues to prioritise its 5 global drive brands and right now, given almost all profits are non-UK, benefits from reporting in sterling, which depreciated in value since June,” the broker noted.
Its preference in the sector is for Imperial Brands (LON:IMB), which it thinks offers better upside, “largely due to more significant internal changes on brands and costs and a historically broader approach to nicotine delivery – hand-rolling tobacco, cigars, e-cigarettes etc.”
It has a price target of 5,300p for BATS, and rates the shares a ‘hold’.
Shares in BATS were up 170p at 4,973p in early deals.
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