Brexit Fuels British American Tobacco's Bid for Reynolds American
October 21 2016 - 10:13AM
Dow Jones News
By Ben Dummett
LONDON--Britain's vote to exit from the European Union has been
a key factor behind British American Tobacco's decision to initiate
a $47 billion takeover bid of Reynolds American Inc., despite the
general slowdown in U.K. deal-making.
A tie-up between the two tobacco giants has long been rumored
because of BAT's existing 42% stake in its U.S. rival. But BAT's
decision to approach Reynolds' board is in part a reaction to its
rising stock price, the falling pound and cheap debt which has made
it easier to finance the deal in the aftermath of the Brexit
vote.
The move comes as the year-over-year value of U.K. outbound
mergers and acquisitions activity fell 63% to $23.8 billion since
the Brexit vote on June 23, according to Dealogic. U.K.
multinationals are financially well positioned among British
companies to grow through acquisitions amid an uncertain domestic
economic environment created by the vote.
The British pound has sold off sharply against the euro, U.S.
dollar and other currencies since the vote. That has hurt the
profits of many small and midsize British-based companies that
generate revenue in the domestic currency but rely on imports for
supplies. The currency weakness, though, has had the opposite
effect on BAT and other U.K. multinationals, which generate a big
part of their income abroad in foreign currencies.
That trend is evident in BAT's stock price, which had gained
more than 12% since Brexit and before it announced its offer
Friday. Further, Reynolds' stock price had fallen about 7.5% over
the same period of time, bringing the valuations of each more in
line with historic norms, people familiar with BAT's thinking
said.
Ahead of the offer announcement, BAT traded at about 19.5 times
projected 2016 earnings, compared with just over 20 times for
Reynolds.
Cheap debt financing is also a key driver behind BAT's move. BAT
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.
That will require BAT to pay about $20 billion in cash toward
financing the transaction. Still, by striking now, BAT benefits
from the availability of low interest-rate debt.
In a global economic environment where interest rates remain
under pressure, BAT will be able to take advantage of relatively
low bond yields still prevalent in the U.S. where it expects to
raise most of the financing, according to a person familiar with
the transaction.
"Debt is cheap so actually the cost of capital is very
reasonable," said another person familiar with BAT's offer.
BAT's shares were trading up 2.6% in midafternoon trade in
London, a sign that investors support the deal's strategic merits.
Assuming a transaction proceeds, it would create the world's
biggest publicly listed tobacco company measured by operating
profits. The combined company's operations would stretch across the
U.S., South America, Africa, the Middle East, and Asia where
cigarette makers are betting population growth and rising
disposable income in these regions will offset the health warnings
and antismoking regulation in Europe and North America, to continue
to boost cigarette sales overall.
BAT said it would drop its takeover pursuit of Reynolds if the
U.S. company opposes a friendly transaction. But BAT signaled
Friday that support from its own shareholders for the deal gives it
an advantage in bringing Reynolds to the negotiating table because
of the companies' shared investor base. Among the top five
shareholders of BAT and Reynolds three are the same, including,
BlackRock Investment Management, Vanguard Group and Capital
Research & Management Co., according to FactSet
"There is substantial overlap in the shareholder registers of
our two companies," BAT Chief Executive Nicandro Durante, noted in
his letter to Reynolds' board of director outlining the deal
merits.
Saabira Chaudhuri contributed to this article
Write to Ben Dummett at ben.dummett@wsj.com
(END) Dow Jones Newswires
October 21, 2016 09:58 ET (13:58 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.
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