Rumors of BAT Takeover of Reynolds Gain Steam

Source from:  Winston-Salem (NC) Journal  07/18/2014

The rumor mill about Reynolds American Inc.'s future appears to have spun back to the early speculation involving its largest shareholder, according to British media outlets.

The Daily Mail of London reported Wednesday that British American Tobacco Ltd. may be willing to spend up to $75 a share, equating to $23.3 billion, to buy the remaining 58 percent of Reynolds stock (310 million shares) that it doesn't own.

Stephen Pope, managing partner of Spotlight Ideas of London, said a BAT offer may need to range between $76.77 and $81.81 a share, or $23.8 billion and $25.4 billion, to buy all of the remaining Reynolds stock.

By comparison, the competing speculation — that Reynolds is planning to buy rival Lorillard Inc. — has that purchase price estimated at between $18 billion and $29 billion. Wells Fargo Securities analyst Bonnie Herzog said Reynolds may need to pay up to $80 a share to get Lorillard's board of directors to agree to be sold.

It is likely BAT would have a major say, if not have to provide funding, for Reynolds to pull off buying Lorillard.

The speculation led investors to send Reynolds' share price up 2.2 percent, or by $1.36, to close at $62.67. At $75 a share, the rumored BAT offer would provide a 19.7 percent premium.

BAT acquired 42 percent of Reynolds' shares July 30,2004, as part of Reynolds spending $4.4 billion to buy BAT's U.S. subsidiary, Brown & Williamson Tobacco Corp. BAT also gained five Reynolds board seats in the deal.

The next largest shareholder of Reynolds is Invesco Ltd. at 6 percent, or 30.4 million shares.

Although speculation about a BAT takeover of Reynolds began shortly after BAT gained the stake, rumors began heating up in March - about five months before a 10-year moratorium on BAT buying additional Reynolds shares ends July 30.

Officials with BAT, Reynolds and Lorillard have declined consistently to comment on deal speculation. That includes Susan Cameron, who returned May 1 as Reynolds' chief executive and president. Some analysts have said Cameron's return is evidence that one, if not both, transactions will take place.

In April, BAT chief executive Nicandro Durante said at the company's annual shareholder meeting that the July 30 expiration of the moratorium "doesn't change anything."

"You would always go to the board; we'd never go to Reynolds with a hostile takeover. Reynolds' management agrees with us," Durante said according to a Bloomberg News report. "In five years' time, will I go for Reynolds? We look at it on yearly basis. Not only Reynolds, we look at all the investments in the world, we have a lot of minority stakes."

The Daily Mail, citing a Citigroup analyst, said BAT could boost its annual earnings per share between 10 percent and 13 percent through buying Reynolds. Reynolds reported fiscal 2014 net income of $1.72 billion, up 35 percent, and adjusted earnings at $3.13 a share.

The Winston-Salem Journal has reported, as did the Daily Mail, that for BAT the most attractive parts of owning Reynolds would be having a U.S. subsidiary again and gaining access to Reynolds' electronic cigarette brand Vuse, which began national distribution in June.

"A takeover would allow BAT total freedom to deploy Reynolds intellectual property on e-cigarettes," the Daily Mail reported.

Another slice of speculation has BAT and Reynolds working out a deal to where BAT gains access to Vuse technology, while Reynolds obtains global distribution channels for the e-cig product.

Otherspeculation, which could be competing or complementary, has a potential Reynolds-Lorillard deal being aided by a possible attempt by BAT rival Imperial Tobacco Group PLC to free up resources to buy Reynolds' non-growth brands, such as Kool, Winston, Salem and Doral. Analysts say Reynolds needs to sell those non-growth brands to gain federal regulatory approval to buy Lorillard.

"My sense is that BAT will operate in the background and use its influential holding to push Reynolds into conducting a vigorous and ruthless in-house brand analysis so that anything that is not delivering a high hurdle rate of return on capital will be dispensed with," Pope said.

"Then (BAT) will make an offer, perhaps it is going to inject capital anyway to allow the acquisition (of Lorillard) to be financed in the most cost effective way."

Herzog rates the odds of a Reynolds purchase of Lorillard at 90 percent, in part so that Reynolds could gain access to the Newport and blu Ecigs brands. CNBC reported July 3 that deal could be announced by the end of July.

Lorillard's share price has risen 26.7 percent — from $49.76 to $63.01 — since rumors of the potential deal surfaced March 3. Reynolds' share price has risen 24 percent, or from $50.54 to $62.67.

Herzog said Wednesday that if even BAT were to take over Reynolds, she still believes a purchase of Lorillard would follow, although the offer at that time may shrink to the mid-70s per share.

"We encourage investors to take advantage of any short-term drops in Lorillard stock should a BAT/ Reynolds transaction be announced," Herzog said.

There could be a major workforce difference in the impact of BAT taking over full ownership of Reynolds compared with a Reynolds purchase of Lorillard.

Having BAT with majority ownership of Reynolds would not necessarily mean significant changes to Reynolds' operations in Forsyth, primarily because BAT, with headquarters in London, lacks overlapping U.S. operations.

"That's definitely better than a domestic acquirer, since BAT will always maintain production capability in the U.S. market to take advantage of the superior tobacco quality of the crop that's available here and to stay close to the American market," said Tony Plath, a finance professor at UNC Charlotte.

"That means far less likelihood of layoffs, plant closings and corporate restructurings, and a far more secure future for those folks that still have jobs with Reynolds in the Triad."

However, the cost of combining Reynolds and Lorillard could include the closing of a manufacturing plant, whether in Tobac-coville or Greensboro, and the elimination of hundreds of Triad jobs.

Both companies have become tight-lipped about their manufacturing workforces.

It is likely Reynolds has between 1,100 and 1,200 manufacturing employees of its overall 2,000 to 2,200 workforce in Forsyth County.

It had 1,355 production jobs in March 2012 before it announced it would cut 540 job positions, mostly local, in its latest consolidation effort. Some jobs were re-created through hiring workers back at a lower salary or by outsourcing some work.

Reynolds said May 23 it would create 200 full-time jobs at its Tobaccoville plant to handle Vuse production.

According to the latest Reynolds annual regulatory report, as of Dec. 31 it had 3,700 R.J. Reynolds Tobacco employees, 550 with its American Snuff Co. LLC subsidiary and 350 with its Santa Fe Natural Tobacco Co. subsidiary. Altogether, it has 5,200 full-time and 90 part-time employees.

According to the latest Lorillard annual regulatory report, as of Dec. 31 it had 2,900 employees, the bulk of whom are based in Greensboro, although it has a major warehouse facility in Danville, Va. About 1,110 of its employees are represented by one of two unions, which could signify a production workforce of900to950.

As with most potential major corporate deals, there are four major negotiating areas: purchase price; who would run the combined company as chairman and chief executive; where it is based; and what is the surviving name or new name.

In this scenario, analysts said Reynolds likely would remain based in Winston-Salem and keep its name. The carrot for Lorillard management could be for Murray Kessler, its president and chief executive, and other top executives gaining high-level positions within Reynolds.

Herzog said that while gaining Federal Trade Commission approval will be challenging, "we believe the FTC would ultimately approve a combination taking cues from the beer industry, though it is likely brands would need to be divested."

Pope said Reynolds is likely willing to sell off the non-growth brands "given it is keen to occupy a strong position in the e-cigarette market." Enditem