Any Imperial Tobacco Takeover Would Face Major Hurdles

Source from:  Reuters 11/27/2015

Britain's Imperial Tobacco (IMT.L) has been the object of intensifying takeover speculation, but hopes of a deal for the maker of Gauloises and Davidoff cigarettes could be snuffed out by the huge complications facing any bidder.

Imperial's shares have touched all-time highs in recent weeks, as press reports suggested that British American Tobacco (BATS.L) or Japan Tobacco (2914.T) were coming closer to pulling the trigger on the long-mooted deal, which analysts see as the last big trade in a shrinking and consolidating market.

With the world smoking less each year due to growing health consciousness, greater regulation and economic weakness, competition in "Big Tobacco" is stronger than ever.

Record levels of dealmaking, particularly brewer AB InBev's (ABI.BR) $100-billion-plus bid for SABMiller (SAB.L), has many bankers and lawyers salivating over further consolidation in the consumer sector.

But antitrust issues, strategic considerations, financing constraints and Imperial's strong stock price could confound willing players.

"I think on a five-year view Imperial gets taken out because in declining industries, the law of consolidation gravity says a number four player with an 8 pct share becomes a victim eventually," said Jefferies analyst Martin Deboo.

Imperial Tobacco, BAT and Japan Tobacco declined to comment. Imperial has been consistently silent, leading some analysts to believe no approach has been made, since Britain's Takeover Panel would likely require disclosure of such a move.

GEOGRAPHIC CARVE-UP

Imperial's business includes Davidoff, Winston and Kool cigarettes, Drum tobacco, blu e-cigarettes and Rizla rolling papers.

All the international tobacco companies will have markets where buying Imperial would take their share over regulators' monopoly thresholds, so analysts say any takeover is likely to be a carve-up where different companies take different parts.

For example, Philip Morris International (PM.N) would have trouble in European markets like Germany and France, while JTI would struggle in Britain and Spain, Morningstar analysts say. BAT owns a 42 percent stake in U.S. tobacco company Reynolds American (RAI.N), which could prevent it from owning Imperial's U.S. business.

Furthermore, that U.S. business is skewed toward lower-priced brands, which means it may fit better with Liggett Vector Brands (VGR.N), which also plays at the value end of the market, rather than Philip Morris, BAT or JTI, which focus on the premium sector.

Imperial lacks a blockbuster like Marlboro and is therefore naturally more of a local operator, analysts say, more valuable for its scale and distribution benefits than its brands.

The only company that could buy Imperial -- whose market value is $51 billion -- without antitrust issues is China National Tobacco (CNT), the world leader by volume.

The intentions of the state-controlled firm are unclear but some Chinese companies have shown interest in British assets.

VALUATION

Then there's the price. Any deal to buy Imperial could top $67 billion, assuming a 30 percent takeover premium, plus $17.5 billion in debt.

Imperial shares are up 27 percent this year to around 36 pounds, representing an enterprise value of over 11.5 times its EBITDA. That's "bang in line" with the average transaction multiple for tobacco deals in developed markets, said Morningstar analyst Philip Gorham.

Imperial's emerging markets footprint could command a higher multiple, Gorham said, but he warned that Japan Tobacco, the more likely buyer in his view, is "going to find it difficult to create value" if it pays a premium.

Japan Tobacco has less debt, relatively speaking, than BAT, and is therefore seen as being more able to finance a big deal. But it has been under pressure from activist investor The Children's Investment Fund (TCI) to return cash to shareholders, rather than do big deals.

BAT is financially more constrained, since it recently spent $2.45 billion to buy out Brazil's Souza Cruz and $4.7 billion to maintain its stake in Reynolds as Reynolds acquired Lorillard, raising its debt/EBITDA levels beyond its target of 1.5-2.5 times.

Ultimately, any buyer aside from CNT would probably seek an agreement with other companies on selling them some of Imperial's assets before striking. Otherwise it could struggle to complete sales required to meet competition concerns at a decent price. Enditem