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Industry expert warns of implications to Imperial Tobacco of BAT deal

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Written by: David Clensy | Posted 17 January 2017 13:27

Industry expert warns of implications to Imperial Tobacco of BAT deal

An industry expert from Hargreaves Lansdown has warned that Imperial Tobacco is increasingly “looking like a minnow swimming in a tank of big, hungry fish" after Dunhill and Lucky Strike firm British American Tobacco agreed a 49.4 billion US dollar (£40.8 billion) takeover of US rival Reynolds in a deal creating the world's largest listed tobacco company.

BAT, which currently owns 42.2 per cent of Reynolds, will pay 59.64 US dollars (£49.27) per share for the remaining 57.8 per cent of the company in an improved offer after originally tabling a 47 billion US dollar (£38.8 billion) approach in October.

The deal will bring together a raft of global brands under one roof, including BAT products Rothmans, Kool and Kent, and Reynolds' brands such as Newport, Camel, Pall Mall, Doral, Misty and Capri slims.

The offer comprises 25 billion US dollars (£20.6 billion) worth of BAT shares and 24.4 billion (£20.1 billion) US dollars in cash, valuing Reynolds at more than 85 billion US dollars (£70.2 million).

The sweetened deal represents a 26 per cent premium against the closing price of Reynolds' shares on October 20.

BAT is expecting to make at least 400 million US dollars (£330 million) in cost savings after the two companies merge.

Chief executive Nicandro Durante said: “Our combination with Reynolds will benefit from utilising the best talent from both organisations.

“It will create a stronger, global tobacco and NGP (next generation products) business with direct access for our products across the most attractive markets in the world."

Steve Clayton, fund manager at Hargreaves Lansdown said: “This is a big move, that makes a lot of sense for BAT. They already had billions tied up in Reynolds, now they will have billions more, but with full control of the company and its cash flows. The States is an attractive market, with good pricing dynamics, and BAT can also take Reynolds' portfolio of new generation tobacco products and sell them worldwide.

“We can't ignore the debts that BAT are taking on to fund the deal, and in the short term, the stock has become a bit more risky as a result. But tobacco is a very cash generative business and we expect the enlarged group to be able to pay the debts down quite quickly. In the process we should see earnings growth enhanced and maybe the potential for a faster pace of dividend growth too.

“BAT are now the clear global leader in the industry, just at the point where the new generation of reduced harm products could be set to create an inflexion point for sector growth. The sheer scale of the enlarged BAT raises the pressure on the remaining players to bulk up too, and attention is likely to turn to Imperial Brands, who look more and more like a minnow swimming in a tank of big, hungry fish."

A spokesman for Imperial Tobacco said: "We are focused on building on our strong track record of delivering sustainable shareholder returns. We do not comment on rumour or speculation."

The boards of both BAT and Reynolds will recommend the takeover to shareholders and have agreed a so-called break fee of up to 1 billion US dollars (£825 million) if either party pulls out or if the deal is blocked by regulators.

If given the green light, it is expected to complete in the third quarter of the year.

The agreement comes after Reynolds reportedly rejected BAT's initial offer in November.

The companies' combined earnings will be significant. BAT reported £5 billion in operating profit in 2015, while Reynolds reported pre-tax profits of 6.4 billion US dollars (5.3 billion).

The takeover is expected to help BAT gain a further foothold in the US, and give the new company a significant presence in high-growth markets including South America, the Middle East and Africa.

BAT is also planning to use the increased might to expand further in the vaping and e-cigarette market – where it is already the largest international company outside the US – adding Reynolds' popular Vuse vapour brand.

BAT has more than 200 brands sold in some 200 markets and employs over 50,000 staff worldwide.

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It claims to sell its cigarette brands to one in eight of the world's one billion smokers.

Reynolds is the second biggest player in the US market, with three out of the four top- selling cigarette brands.

The US firm has a 34 per cent 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.

It has factories in North Carolina and Tennessee.

BAT first invested in Reynolds through a deal which saw BAT's US subsidiary Brown & Williamson merge with RJ Reynolds in 2004, giving BAT its original 42 per cent stake in the US firm.

In 2014, BAT pumped 4.7 billion US dollars (£3.9 billion) into Reynolds in order to maintain its stake in the company following a mega-deal which saw Reynolds acquire sector peer Lorillard for 27.4 billion US dollars (£22.6 billion).

Back in November, Imperial Tobacco reported it has seen tobacco net revenue up 9.7 per cent over the last 12 months, with total adjusted operating profit up 10.4 per cent and dividend growth of 10 per cent. It's total tobacco net revenue went up to £7.167bn for 2016 from £6.251bn in 2015.

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