BAT & RAI Strike A Deal

BAT/RAI Reach Definitive Agreement - Offer Revised to $59.64/Share (Parity) As We Expected – BAT/RAI Deal Likely Increases the Probability of a PM/MO Combo – As expected, BAT sweetened its bid for the remaining 57.8% of RAI that it does not currently own, effectively taking its offer $3.00 above the original $56.60 parity price (based on BAT’s closing price on 10/20/16 of $118.13). The revised offer represents a +26.4% premium to RAI’s closing price on 10/20/16 ($47.17) and 6.6% premium to 1/13/17. The revised offer represents an EV/EBITDA (LTM) multiple of 16.9x vs 13.1x that RAI paid for Lorillard in 2015. While on the low end of average historical ‘bump-ups’ in bid/offers (+5-15%), we believe it makes sense given BAT’s sizeable pre-existing ownership stake in RAI and the strength of its original offer. On the subject of U.S. corporate tax reform, we see 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. Bottom line - we believe: (1) the revised offer reflects BAT/RAI’s global potential to compete in reduced risk products (RRPs) including procurement, R&D and other cost considerations; (2) the deal will be approved relatively quickly given the companies’ existing close relationship and lack of geographic overlap, i.e., antitrust risk (U.S./Japan); (3) the deal increases the likelihood of PM acquiring MO as scale becomes increasingly critical as the industry consolidates; and (4) 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. We reiterate our Outperform rating on RAI and believe the risk/reward is positive with limited downside since we expect the deal to receive required antitrust given minimal direct overlap, and close in 3Q17.

Key Positives of Deal: (1) Provides BAT with full ownership of the lucrative U.S. market, complementing its existing presence in high growth emerging markets; (2) Significant synergies/cost savings above the original $400MM synergy target; (3) Creates the world’s largest listed RRP company with better aligned incentives and greater investments in RRPs; and (4) Geographic diversification. Concerns/Risks: (1) BAT is the only logical buyer of RAI which limits upside to the offer price; and (2) Cultural/integration risk.

Probability of PM/MO Combining Even Higher In Our View – Applying the BAT/RAI deal multiple of 16.0x FY16E EBITDA to a potential PM/MO combo suggests MO is worth at least $76/share, which we believe PM could fund at 60/40% stock/debt. We don’t expect PM to sit idly by as BAT becomes the world’s largest global tobacco & RRP company. We believe this increases the probability that PM will acquire MO as discussed by Reuters without PM/MO comment.
Go to top