By Saabira Chaudhuri in London and Tripp Mickle in Atlanta
British American Tobacco PLC made a $47 billion takeover offer
for the roughly 58% of U.S. peer Reynolds American Inc. that it
doesn't already own -- a move that would create the world's largest
listed tobacco company by revenue and market value, and shows the
rising value the U.S. holds for the shrinking global tobacco
industry.
BAT already owns 42.2% of Reynolds, and is offering cash and BAT
stock worth $56.50 a share for the rest of the company,
representing a roughly 20% premium to Reynolds's closing share
price Thursday. BAT said it hadn't had previous discussions with
Reynolds's management about the offer before going directly to its
board.
Reynolds said Friday that it acknowledges BAT's proposal, and
its board will now evaluate the offer and respond. Analysts expect
negotiations between Reynolds and BAT ultimately will lead to a
higher offer price.
After years of spurning the U.S. because of mounting civil
suits, international tobacco companies are returning as they
confront declining cigarette volumes and expanding regulations
around the globe.
Last year, Reynolds completed its own $25 billion acquisition of
Lorillard Inc. after lengthy scrutiny by regulators. That deal
upended and further consolidated the U.S. tobacco industry,
prompting Reynolds to sell its Kool, Salem and Winston cigarette
brands and Lorillard's Maverick to Britain's Imperial Tobacco Group
PLC (now Imperial Brands PLC) for $7.1 billion.
Analysts say the elimination of No. 3 Lorillard gives Reynolds
and Altria Group Inc., the U.S.'s largest tobacco company by venue,
more pricing power that would allow them to offset declining
cigarette volumes with higher prices. The two companies have more
than 80% of U.S. cigarette market share.
The U.S. also offers legal protections to the tobacco industry
that aren't available overseas. Thanks to free-speech rights under
the First Amendment, U.S. companies are protected from
plain-packaging rules like the ones sweeping across Europe that
require cigarettes be sold in packages without signature logos and
colors.
Reynolds emerged from its Lorillard takeover as a much more
attractive company because it now has one of the strongest
cigarette brands in the U.S.: Newport. The menthol brand, which
accounted for almost all of Lorillard's $7 billion in sales in
2014, has been increasing its market share as smokers under 30
years old increasingly opt for minty-flavored cigarettes over
traditional smokes.
Beyond tobacco, a combined BAT and Reynolds would also be the
world's largest player in so-called next-generation products --
largely e-cigarettes and other vaping products. The two companies
already collaborate on this front, last year announcing a
technology-sharing agreement for their vapor products.
BAT expects the deal to lead to relatively modest cost savings
of $400 million, but said the deal would give it a major position
in the U.S. tobacco market in addition to high-growth emerging
markets across South America, Africa, the Middle East and Asia.
Despite that sprawling footprint, the deal is unlikely to face
antitrust issues.
"The two companies compete in different markets," said Lawrence
Hrebiniak, a management professor at the Wharton School of the
University of Pennsylvania. "There is no overlap of their
respective footprints, which will keep both U.S. and European
sheriffs off their backs."
BAT, the world's No. 2 publicly traded tobacco company by
volume, behind Philip Morris International Inc., owns cigarette
brands including Dunhill, Lucky Strike and Pall Mall. Reynolds, the
world's No. 6 by volume, owns Camel and Newport. The U.K. company
has been a shareholder in Reynolds since the U.S. firm was created
in 2004, and its stake accounts for a hefty chunk of BAT's
profits.
The announcement's timing took some by surprise, with Citigroup
analyst Adam Spielman noting that BAT could have bought Reynolds
before it bought Lorillard, when shares were 57% lower.
BAT Chief Executive Nicandro Durante said BAT's board regularly
reviews the shares of Reynolds it doesn't already own and had
determined that "current unique industry and market conditions"
made now a good time for the acquisition.
BAT's shares have jumped 13% since Britain's June 23 vote to
leave the European Union, while Reynolds's have fallen about 7.5%,
bringing the companies' price-to-earnings ratios more in line.
That, coupled with low interest rates, helped inform BAT's
thinking, according to a person familiar with the transaction.
The U.K. company's shares ended down 2.9% in Friday trading,
after trading higher most of the London session. Reynolds shares
were up 14.3% in midday New York trading.
The deal will hinge on the approval of Reynolds's board --
outside of BAT's own nominees -- which is expected to appoint a
seven-person committee to consider the deal, according to a person
familiar with the matter. Five people on Reynolds's 14-member board
are BAT nominees. BAT said it also expects the deal to seek the
approval of the majority of Reynolds shareholders outside of its
own stake. Reynolds's top 10 shareholders own about 20% of BAT.
"We would have preferred to present this proposal to the board
of Reynolds confidentially," Mr. Durante said. U.S. regulations
require the company to announce the merger proposal promptly, which
BAT said left it unable to hold prior negotiations with Reynolds
regarding the merger.
BAT's offer comes at a moment of transition for Reynolds, which
earlier this week said its chief executive, Susan Cameron, would
step down next year. The company has struggled with declining
tobacco volumes as well as slowing sales of e-cigarettes.
Merging with BAT -- which has stronger revenue-growth prospects,
according to analysts -- could brighten Reynolds's outlook now that
it has digested the Lorillard deal. The Winston-Salem, N.C.-based
company reported results that fell short of analyst estimates for
the quarter ended June 30.
Meanwhile, London-based BAT, with its more diversified
footprint, has successfully grown its cigarette volumes. On Friday,
it reported organic revenue growth for the first nine months of the
year at constant rates of exchange of 6.2%, with cigarette volumes
up 0.9%.
BAT's offer increases the likelihood that rival Philip Morris
could merge with Altria, Wells Fargo analyst Bonnie Herzog said in
a note. She added that she believes Philip Morris won't "idly sit
by" as its competitor increases in size and gains access to the
lucrative U.S. market.
Philip Morris and Altria spokesmen declined to comment.
--Natalia Drozdiak in Brussels contributed to this article.
Write to Saabira Chaudhuri at saabira.chaudhuri@wsj.com and
Tripp Mickle at Tripp.Mickle@wsj.com
(END) Dow Jones Newswires
October 21, 2016 13:18 ET (17:18 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.
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