British tobacco giant offers to buy rest of Reynolds American it doesn't already own

By Saabira Chaudhuri in London and Tripp Mickle in Atlanta 

British American Tobacco PLC made a $47 billion offer to take full control of Reynolds American Inc. -- a move that would create the world's largest listed tobacco company by revenue and market value, while highlighting the value the U.S. holds for a shrinking global tobacco industry.

London-based BAT already owns 42.2% of Reynolds, and is offering cash and 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 broached the offer with Reynolds management before going directly to its board.

Reynolds, which is based in Winston-Salem, N.C., said Friday that its board will evaluate the offer and respond. Analysts expect negotiations between Reynolds and BAT will lead to a higher offer price.

After years of distancing themselves from 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 made its own acquisition, clinching Lorillard Inc. after lengthy scrutiny by regulators. The $25 billion 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 has given Reynolds and Altria Group Inc., the largest U.S. tobacco company by revenue, more pricing power that can be used to offset declining cigarette volumes. The two companies have more than 80% of the U.S. cigarette market.

The U.S. also offers legal protections to the tobacco industry that aren't available overseas. New requirements that cigarettes be sold in packages without signature logos and colors have been spreading in Europe and elsewhere. Thanks to free-speech rights under the First Amendment, tobacco companies are protected from such plain-packaging rules in the U.S.

The Lorillard deal also strengthened Reynolds's U.S. standing by handing it one of the strongest cigarette brands in its home market: Newport. The menthol brand, which accounted for almost all of Lorillard's $7 billion in sales in 2014, has been building 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 acquisition to yield relatively modest cost savings of $400 million.

The deal is unlikely to face antitrust issues because 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 [geographic] 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 such cigarette brands as 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 took on its current form 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 the Lorillard deal, when the stock was trading at less than half its recent levels.

BAT Chief Executive Nicandro Durante said BAT's board regularly reviews its Reynolds holdings 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 -- which makes it cheaper to borrow money to fund a takeover -- 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 rose 14% to $53.78 in New York trading.

The deal will hinge on the approval of Reynolds's board -- excluding BAT's own nominees -- which is expected to appoint a seven-person committee to consider the offer, according to a person familiar with the matter. Five of the board's 14 members are BAT nominees. BAT said the deal would also need support from 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 tied its hands.

BAT's offer comes at a moment of transition for Reynolds, which earlier in the week said its chief executive, Susan Cameron, would step down next year. A person familiar with BAT's thinking said its representatives on Reynolds's board supported Ms. Cameron's successor, Debra Crew, as heir apparent when the former PepsiCo Inc. executive joined Reynolds two years ago.

BAT, with its more diversified geographic reach, has increased its cigarette volumes. On Friday, it reported 6.2% growth in revenue for the first nine months of the year excluding foreign-exchange fluctuations and other effects, with cigarette volumes up 0.9%.

A deal would mark a reversal for the global tobacco industry, which split from the U.S. in the 2000s. In 2004, BAT merged U.S. unit Brown & Williamson Tobacco Corp. with R.J. Reynolds Tobacco Holdings Inc. in a $4.2 billion deal that created Reynolds American. Four years later, Altria spun off its international business as Philip Morris International., a move designed in part to insulate the fast-growing, lucrative non-U.S. business from American regulators.

BAT's move increases the likelihood that rival Philip Morris could merge with Altria, Wells Fargo analyst Bonnie Herzog said in a note. She said Philip Morris is unlikely to "idly sit by" as its competitor bulks up and takes aim at 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 22, 2016 02:47 ET (06:47 GMT)

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