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No time for puffery

21 Oct 2016 By Kevin Allison

John Boehner, the former speaker of the U.S. House of Representatives, may find his month-old gig as a board member at Reynolds American doesn’t last as long as he expected. British American Tobacco is offering $47 billion for the 58 percent of the Camel maker it doesn’t already own. At an enterprise value of 16 times the last 12 months’ EBITDA, that’s a decent price. Tobacco enthusiast Boehner and his colleagues may struggle to smoke out a noticeably better deal.

The second-biggest U.S. tobacco group said on Friday it would consider the cash-and-share offer from its overseas peer, which already owns 42 percent of the company. BAT’s offer is worth $56.50 a share based on Thursday’s closing prices. That’s around a 20 percent premium to where Reynolds’ stock traded before the bid was announced. That’s no knockout, but the fact that the two companies have long been considered likely merger partners means there may already have been some kind of takeover premium baked into the target’s worth.

Viewed through a value lens, BAT looks more generous. Reynolds only paid around 13 times EBITDA for smaller U.S. rival Lorillard in a deal that closed last year. BAT is offering a higher multiple, and handing the majority independent shareholders of Reynolds a premium worth more than double the roughly $3 billion up-front value of the anticipated $400 million a year in savings – calculated after tax and on a conservative multiple of 10.

That’s not the only reason for Reynolds’ independent directors to take BAT’s opening salvo seriously. The UK group’s 42 percent stake means they can’t count on a credible rival bid emerging. Third-quarter earnings earlier this week weren’t as good as Wall Street expected. The company also announced a transition at the top, with Debra Crew set to take over from Susan Cameron as chief executive in January. That could further filter Reynolds’ appetite for playing hardball.

Longer term, higher U.S. interest rates could take some of the hot air out of tobacco companies’ rich valuations as their allure as dividend stocks wanes. Boehner was known in Congress for a propensity to burst into tears, but even if Reynolds can’t squeeze much more out of BAT, it wouldn’t be something to cry over.


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