At the Crossroads

Source from:  worldtobacco.co.uk 26 July 2007 07/27/2007

The French tobacco market is astir and it's quite possible that such iconic brands as Gitanes and Gauloise, part of the Franco-Spanish Altadis group with some 30% of the French cigarette market, will no longer be independently owned by the year-end. The British company Imperial Tobacco announced a takeover bid for Altadis in March and was promptly turned down. A second, higher, bid from the UK company was similarly rebuffed in April. But Imperial is unlikely to be so easily thwarted and industry analysts say it may now come back a third time, if necessary appealing to shareholders over the resistance of the Altadis board. At the same time British America Tobacco (BAT) is in talks with a number of private equity firms, including the pan-European buy-out firms PAI Partners and CVC Capital, apparently with the intention of launching its own bid for Altadis. Beyond this there have been rumours of a counter-bid from the market leader in France, Altria, whose Philip Morris International subsidiary increased its share of the French cigarette market to a record 42.7% in 2006. Such a bid however would push Altria's market share up to close to 75% that seems bound to raise eyebrows amongst French and European Union (EU) competition regulators. These developments come along at a time of relative calm for the French tobacco market after the heavy pounding that cigarette manufacturers took three years ago when the French government raised excise taxes sharply. "Basically the market's been as flat as a pancake for the last few years," says Jonathan Leinster, tobacco industry analyst at UBS Limited (UK), a leading London investment bank. France had been a stable market for years, he explains, then suddenly in 2003/4 "the French government became very aggressively anti-tobacco and shoved up the tax on cigarettes quite considerably." In fact there were three hefty tax rises of 10%, 20% and 10% in January 2003, October 2003 and January 2004 respectively "and this meant that from being basically an 80 bn unit market France shrank to being a 54/55 bn unit market between 2002 and 2004." Since 2004 there has been a marginal return of volume because "although the duty-paid market dropped from 80 to 54 bn, some of that volume was lost to cross-border trade with Belgium where cigarettes became comparatively a lot cheaper, or to illicit (ie smuggled) trade." Some of that cross-border trade has now started to decline, a consequence in part of the fact that prices in France have been flat ever since January 2004. "So there have been over three years of no price increases and while nobody expects any increases now, with the new government we can't be sure what will happen," says Mr Leinster. Moreover while French prices were unchanged over this period, prices in Belgium and other neighbouring countries were increased and some governments imposed limits (two kilos) on the amount of tobacco that could be legally brought into France by an individual. In 2006 some 55.7 bn cigarettes were purchased in France (up by 1.8%) with a value of Euro 13.3 bn. But the relatively stable overall performance of the market masks a sea-change in French tastes with American-blend or "blonde" cigarettes, such as Altria's Marlboro, increasingly taking marketshare from the traditional "black" tobacco cigarettes now almost exclusively made by Altadis and which have slumped in popularity since 2002. In 2006 more than 90% of sticks sold in France were American-blend. This trend has almost certainly contributed to the weakness in Altadis's share price in the past year or so and turned the company into a bid candidate. All eyes are now on the new government and its intentions towards tobacco though one reason the industry thinks it unlikely that taxes will go up again soon is opposition from the powerful tobacconists lobby. "They are worried that volume will decline again," said Mr Leinster. Also there are complications about pricing within the industry. "Currently Marlboro is priced at five euros and Philip Morris, the market leader, doesn't want anybody else to take the five Euro price point," he said. Cigarettes in France at present are mostly priced at either five euros a pack or ?.50 a pack. "France has banned all cigarette packs under 20 (per pack) so you can't buy tens or twelves or sixteens. What Philip Morris didn't want to happen is that they move to ?.50 and allow cheap cigarettes to move up to ?. There has been quite a lot of resistance to moving the prices," Mr Leinster said. Demand for cigarettes in France is only peripherally price-driven however. When taxes went up in 2003/4 there was a noticeable switch to cross-border purchasing of cheaper cigarettes in areas close to the Belgian border but far less evidence that smoking was reduced in places where this option did not exist, such as Paris. After taxes and pricing policy, the major uncertainty will be the commitment of the new government to the campaign against smoking on health grounds. Somewhat to the surprise of many observers (and to many French MPs who were refused a debate on the matter in the National Assembly), the French prime minister at the time Dominique de Villepin announced last October that the government would, by edict, ban all smoking in enclosed public places from February 1st this year. The law defined public places as stations, universities, museums, government offices and shops, among other things, though not streets or private premises such as houses or hotel rooms. The law did allow for establishments to offer dedicated, closed and ventilated rooms to smokers but stipulated that "no service can be delivered to this smoking room and the presence of employees is forbidden for an hour after the last customer leaves." Given such constraints the smoking rooms could hardly be profitable for any but the largest and grandest of eating places. The Union of Hospitality Trades (UMIH) said that fewer than 3% of restaurants and bars could afford the investment involved in setting up sealed smoking areas. Following vigorous protests from 'Horeca' (hotels, restaurants and caf? establishments the smoking ban was relaxed to allow them, along with some bars, almost an extra year - until January 2008 - to adapt. Smokers defying the new law would be fined ?5 (GBP?0) with a fine of ?50 on the premises where the smoking occurred. Some 175,000 agents including police officers, public transport security personnel, doctors and public health inspectors have been recruited as part of a contingent of "cigarette police" to enforce the ban and impose the fines. The consequences of smoking were "an unacceptable reality in our country in terms of public health," said M de Villepin who added that the state would fund a third of the costs of anti-smoking treatments, such as nicotine patches. More significantly, the government said it would allow tobacco retailers an increase from 6 to 6.5% over the next four years in the fixed mark-up on cigarette sales they get from the state. It has also offered a leave of indemnity to "ruined business" owners who agree to leave the business: from 2008 this will be extended to 300 establishments per year, about twice the present rate. Industry observers say the combination of the smoking ban and the financial incentives will spell the eventual demise of most of the 30,000 quintessentially French bar-tabacs (selling both alcohol and tobacco) and put cigarette retailing into the hands of a relatively few powerful organisations. The tobacco ban itself brings France into line with a handful of other European countries who have already acted to restrict smoking. Many people, both inside and out of France, are frankly a bit astonished that such a day has come. In popular mythology Frenchmen and women are seldom seen without a cigarette and it had been widely thought that France would have been the last country in Europe to actually legislate against smoking. But it seems to have been a myth that the French smoke more than others and that they would actively resist legal measures to curb the habit. Professor Bertrand Dautzenberg of the Office Fran?/FONT>ais de Pr巚ention du Tabagisme (OFT) said initial polls in March showed that 78% of French people were "very happy" with the way the ban was handled and only 8% took issue with it. M Joseph Osman, managing director of the OFT, told World Tobacco that "in all places the situation has been very well accepted by workers and has considerably reduced the number of cigarettes they are smoking while at work." There had been little or no resentment at the law, he said: "statistically between 75-80% are very happy, even those who are smokers." If the pattern seen in Ireland, Italy and Switzerland is repeated in France then there will certainly be a diminution in smoking as a result of the ban though it may not be drastic and it will not necessarily affect the market share of tobacco companies, nor their profitability. One effect of a ban is to raise the barriers to market entry for newcomers and to that extent reduce competition. Another is to make it easier to raise prices and increase profit margins. The key factor in such a situation is distribution. Altadis holds a virtual monopoly in French tobacco distribution, tightly controlling a network of 36,000 tobacconists. No doubt this also largely explains the attractions of the company as a take-over target for other tobacco firms, even at the very time that the French smoking ban is coming into effect and tobacco firms are supposedly out of fashion. Enditem