BAT looks to U.S. for growth, agreeing to pay $49.4 billion for
full control of Reynolds
By Saabira Chaudhuri in London and Jennifer Maloney in New York
British American Tobacco PLC agreed to take full control of
Reynolds American Inc. in a $49.4 billion deal that marks renewed
interest among international players in the U.S. tobacco
market.
BAT, which already owned 42.2% of Reynolds before Tuesday's
announcement, said it saw the U.S. as the largest tobacco profit
pool outside of China -- with affordable pack prices, high
disposable income and a burgeoning market for e-cigarettes and
other alternative products combining to create opportunities for
growth.
Reynolds holds a 34% share of the U.S. cigarette market,
trailing only Marlboro maker Altria Group Inc. The deal will give
BAT brand Kent an opportunity to expand in the U.S., and Reynolds's
Newport a chance to grow overseas, Reynolds Chief Executive Debra
Crew said in an interview.
The BAT-Reynolds deal is subject to antitrust review but hasn't
been expected to face big hurdles. The two companies compete in
different markets, with little of Reynolds's business outside the
U.S. BAT, apart from its existing stake in Reynolds, doesn't have
much business in the U.S.
The U.S. market has come a long way since 1998, when a landmark
tobacco settlement hit cigarette makers with huge legal liabilities
that led to $200 billion in costs over the years. More recently,
tobacco companies have pushed through price increases, and the
industry's steady dividends have lured investors amid low interest
rates. Follow-on litigation after the 1998 settlement hasn't been
as damaging as expected.
As legal risks faded in the U.S., tobacco regulations expanded
around the globe, prompting international tobacco companies to
return. In the U.S., the First Amendment protects companies from
rules being adopted in Europe and elsewhere that force cigarette
makers to use plain packaging or apply graphic warning labels.
The U.S. cigarette market has grown to $94 billion in retail
sales in 2015 from $71 billion in 2001, according to Euromonitor
International, a market-research firm, as steadily rising prices
more than offset a decline in cigarette volumes -- which fell to
269 billion sticks from 413 billion sticks over the same period.
U.S. sales of vapor products, including e-cigarettes, totaled $3
billion in 2015.
Both BAT and Reynolds in recent years have poured money into
alternatives like e-cigarettes and so-called heat-not-burn devices.
Unlike e-cigarettes, which contain nicotine-laced liquid,
heat-not-burn devices heat tobacco to a high temperature,
vaporizing it.
Ms. Crew said the merger would allow Reynolds to expand its Vuse
e-cigarette overseas and combine their R&D efforts with
BAT's.
BAT in December launched a heat-not-burn device in Japan called
Glo, which resembles an iPod. Reynolds briefly distributed a
cigarette-shaped device called Revo and continues to explore
heat-not-burn technology, executives said.
After the deal is completed, emerging markets will make up 60%
of the new company's footprint by sales volume, BAT said Tuesday.
Sales volumes have continued to climb across parts of the
developing world, bucking the trend seen in developed markets and
making these particularly lucrative for cigarette companies. BAT
said revenue per pack from emerging markets has grown at more than
twice the rate in developed ones over the past five years.
The deal will give Reynolds, based in Winston Salem, N.C.,
access to faster-growing emerging markets in South America, the
Middle East, Africa and Asia where BAT has a strong presence.
The acquisition, with brings together other brands like Camel,
Dunhill and Pall Mall, increases the likelihood of Philip Morris
International Inc. acquiring Altria -- from which it was spun off
in 2008 -- said Wells Fargo tobacco analyst Bonnie Herzog. "Scale
becomes increasingly critical as the industry consolidates," she
wrote in a note Tuesday. "We don't expect [Philip Morris] to sit
idly by as BAT becomes the world's largest global tobacco"
company.
The two businesses hold the same portfolio of cigarette brands,
which are sold by Altria in the U.S. and Philip Morris
elsewhere.
Altria declined to comment. Philip Morris said it has no plans
to cooperate with Altria beyond an existing agreement to jointly
sell e-cigarettes and other smokeless products.
Separately Tuesday, Altria said it bought Sherman Group Holdings
LLC, the closely held maker of Nat Sherman cigars, for an
undisclosed sum.
BAT said Tuesday it is paying $29.44 in cash and 0.5260 of an
ordinary share -- totaling $59.64 for each Reynolds share --
valuing its U.S. peer at more than $85 billion. The deal comes
after BAT said in October that it had made an offer for Reynolds
valued at $56.50 a share, or about $47 billion for the stake it
didn't own. The agreed price represents a premium of 26% over
Reynolds's closing price the day before BAT made its October
announcement.
BAT shares closed 3.8% lower in London Tuesday, while Reynolds
rose by 3.1% in New York.
Reynolds's board considered the prospect of the incoming Trump
administration pushing corporate tax cuts, Executive Chairman Susan
Cameron said during a call with analysts. In a separate call, BAT
Chief Executive Nicandro Durante said it had been "impossible to
consider the potential impact" of any change to the U.S. tax
code.
The two companies haven't yet discussed who will helm the
combined business, Ms. Cameron said in an interview.
BAT and Reynolds have a longstanding relationship. BAT has been
a Reynolds shareholder since 2004, which had given it access to the
U.S. market without having a direct presence.
The deal is subject to a breakup fee of $1 billion payable by
either company should its board fail to recommend the transaction
to shareholders or withdraw its recommendation. BAT could be forced
to pay a $500 million breakup fee if antitrust authorities ask it
to sell assets it doesn't agree to.
Three new Reynolds shareholders will join the company's board
once the deal closes, expected in the third quarter of 2017.
Centerview Partners, Deutsche Bank AG and UBS Group AG are
advising BAT.
Weil, Gotshal & Manges LLP and Moore & Van Allen PLLC
are lawyers for Reynolds's transaction committee and Goldman Sachs
Group Inc. is its financial adviser. Jones Day is legal counsel for
Reynolds and J.P. Morgan Chase & Co. and Lazard are financial
advisers to the company.
Write to Saabira Chaudhuri at saabira.chaudhuri@wsj.com and
Jennifer Maloney at jennifer.maloney@wsj.com
(END) Dow Jones Newswires
January 18, 2017 02:48 ET (07:48 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.
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