Imperial Tobacco shares have been supported in recent weeks by renewed talk of a possible bid for the cigarette company.
Rivals BAT and Japan Tobacco have been mentioned as possible predators but analysts at Barclays, while agreeing there are strategic attractions in such a move, have concluded that a bid may not happen in the short term. They said:
The current speculation follows recent consolidation in global beer and has reignited a debate that has been around for a number of years, namely: will the multi-national tobacco industry consolidate from four to three.
We [conclude] that despite the longer-term strategic rationale, a short-term move is unlikely. After the strong 26% and 14% outperformance against the market and staples [sector] in the year to date, a tough first quarter trading print ahead and concerns around plain packaging regulation in France and the UK likely to intensify in the near-term, Imperial shares may be due a pause for breath.
However, with many investors suffering from FoMO syndrome (fear of missing out), M&A share price support is unlikely to be extinguished any time soon and we reiterate our equalweight on Imperial Tobacco.
As far as the reasoning behind a bid is concerned, Barclays said:
The industrial rationale for Imperial being acquired is strong: with a 5% or so global share, the group is the smallest of the big international tobacco companies and is just half the size of global number three Japan Tobacco. Imperial also over-indexes in the still fragmented European region, providing scope for a potential acquirer (or acquirers) to benefit from in-market consolidation synergies and more effective route-to-market leverage. Previous tobacco industry M&A has driven cost savings of between 6% and 15% as a percentage of acquired sales and our analysis suggests earnings accretion of 3% to 16% in year three if BAT were to take over the group. Moreover, many investors highlight that when it comes to consolidation, although it is impossible to predict the exact timing, there is “no smoke without fire.” In staples, Scottish & Newcastle, Allied Domecq and Gallagher were subject to up to a decade of take-over speculation, but eventually all were acquired.
So the question remains, why now? A number of factors point against a deal being imminent in our view:
1) Imperial’s share price is at all- time highs;
2) Imperial’s £4.6bn acquisition of US assets is arguably a hindrance rather than attraction to potentially interested parties like BAT and Japan Tobacco;
3) Structuring a deal may be complex, with anti-trust issues likely to require the divestment of individual markets and/or brand licenses;
4) Both BAT and Japan Tobacco have actively pursued their own M&A agendas over the past 12 months. BAT has spent $7.9bn reinforcing its ownership of Reynolds and buying out the Souza Cruz minorities in Brazil, while Japan Tobacco recently spent around $5bn on the international rights to Natural American Spirit. As a result, balance sheet leverage is now 2.6 times at BAT, above the top-end of its 1.5 to 2.5 times target range;
5) Although earnings accretion on a deal may be attractive for BAT, sizeable accretion could simply be derived from reinstating a share buyback programme;
6) Our analysis suggests generating returns above weighted average cost of capital could take 6 to 7 years. Economic value added factors have not stopped consolidation in beer, but a BAT/Imperial deal is hardly compelling on this metric.
Imperial shares are currently up 5p at £35.63.
