What the Industry Is Saying About RAI & BAT Merger

WINSTON-SALEM, N.C. — As predicted by industry watchers, Reynolds American Inc. (RAI) and British American Tobacco (BAT) have finally reached a deal to merge.

BAT made a non-binding offer to acquire the remaining roughly 58 percent of RAI common stock it does not currently own for $47 billion in October. Within weeks, RAI formed a transaction committee made up of independent directors to evaluate the bid, as CSNews Online previously reported.

Then there was silence, leading some to speculate on what could be holding up the deal: a better offer, a new incoming U.S. president, or a change in tax policies?

Winston-Salem-based RAI broke its silence on Jan. 17 by revealing it had accepted a new bid from BAT, equally about $49 billion. 

Calling the higher price tag "expected," Bonnie Herzog, managing director of tobacco, beverage and convenience store research at Wells Fargo Securities LLC, said the revised offer is on the low end of average historical 'bump-ups' in bid and offers; however, it makes sense given BAT's "sizeable pre-existing ownership stake" in No. 2 tobacco company in the United States and the strength of its original offer. 

On the subject of U.S. corporate tax reform, Herzog sees relatively low risk that shareholders vote down the deal given the $1B break-up fee and the benefit both sides would see if any corporate tax reform materializes, she said. 

"We believe the revised offer reflects BAT/RAI's global potential to compete in reduced risk products (RRPs) including procurement, [research and development] and other cost considerations," Herzog said, adding Wells Fargo Securities expects the deal will be approved relatively quickly given the companies' existing close relationship and lack of geographic overlap which could lead to antitrust risks.

She added, "BAT's timing is opportune given its ambitions in vapor/RRPs, which could benefit from RAI's momentum with VUSE Vibe in the U.S. and promising heat-not-burn CORE platform in Japan." 

Key positives in the deal, Herzog explained, include:

• BAT will have full ownership of the lucrative U.S. market, complementing its existing presence in high growth emerging markets;
• Significant synergies/cost savings above the original $400-million synergy target;
• The creation of the world's largest listed RRP company with better aligned incentives and greater investments in RRPs; and
• Geographic diversification. 

As Vivien Azer, director and senior research analyst at Cowen and Co., explained, the transaction increases BAT's exposure to the U.S., which represents the largest market in terms of dollar sales, excluding China. 

"BAT acquires the No. 2 player in the U.S. market with the No. 1 menthol brand — Newport — and three out of the top four brands," Azer said, adding London-based BAT will also now have access to RAI's next generation technology, including VUSE. VUSE holds over a 40-percent share in the U.S.

The synergies, according to Azer, are expected to be derived from procurement, product development and corporate costs, and support the company's initiative to deliver margin expansion of 50 to 100 basis points per year. 

With RAI and BAT moving ahead with its planned tie-up, could more tobacco moves be on the horizon? According to Herzog, the merger does increase the likelihood of Philip Morris International acquiring Altria Group Inc. as scale becomes increasingly critical as the industry consolidates.

"We don't expect PM to sit idly by as BAT becomes the world's largest global tobacco and RRP company," she added.