Big tobacco is about to get even bigger. In October, British American Tobacco (BAT) announced a $47 billion bid for the 58 percent of Reynolds American that it does not already own. Although Brexit has weighed on some British companies, BAT is unencumbered because most of its revenue is earned overseas.
Many investors expect the deal to go ahead, although BAT might need to puff up its offer. BAT would then be the world's largest tobacco company by sales and profits.
As in other volume businesses — such as beer, for example — some of the merger logic is simply to cut costs. BAT reckons consolidation would generate $400 million in annual savings. However, it also underscores two big, long-term changes for cigarette-makers.
The first is that America has become an attractive market for tobacco firms, and buying Reynolds, whose brands include Camel and Newport, is the easiest way for BAT to grow there.
Not long ago, America seemed stale and overrun by lawsuits, and cigarette firms quarantined their American businesses. In 2004, BAT sold Brown & Williamson, its American subsidiary, to R.J. Reynolds. That gave BAT its stake in the newly dubbed Reynolds American, but shielded the firm from lawsuits. In 2008, Altria, another tobacco giant, split into two: Altria, which sells cigarettes in America, and Philip Morris International, which peddles tobacco elsewhere.
Cigarette-makers remain subject to a vast settlement reached with American states in 1998, but fears of huge class actions have proved overblown. "The damages they've had to pay in the cases they've lost — in the tobacco company context — have been very small," said stockbroker James Bushnell of Exane BNP Paribas.
Meanwhile, other countries have become less hospitable. In Europe, for example, governments are demanding plain packaging devoid of even company logos.
The second change is potentially bigger. Tobacco firms are in fierce competition to create safer products. Buying Reynolds gives BAT more R&D clout and a larger portfolio of "reduced-risk" items, including e-cigarettes.
Philip Morris International, which spends nearly twice as much on research as BAT, reckons its new e-cigarette, iQOS, might add more than $1 billion in profit by 2020.
So more deals may be simmering: Wells Fargo's Bonnie Herzog predicts that BAT's move will prompt Philip Morris to bid for its former parent, Altria.
Copyright 2013 The Economist Newspaper Limited, London. All Rights Reserved. Reprinted with permission.
