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A Match for European Tobacco Giants?

British cigarette maker Imperial makes a bid for Franco-Spanish rival Altadis, maker of Gauloises, in a bid to counteract falling sales

Cigarette companies have been taking some serious knocks in Europe. Restrictions on tobacco advertising, widespread public smoking bans across the continent, and ever-rising taxes are discouraging people from lighting up. No wonder companies are looking to join forces. On July 18, Britain's Imperial Tobacco (ITY) announced a $22.3 billion offer for its Franco-Spanish rival Altadis (ALDS.PA), a merger that would make it the world's fourth largest tobacco company.

A potential deal between the companies has been under discussion since 2004, and in March Imperial offered to buy Altadis for €45 per share, or about $60 at the time (see, 03/15/07, "A Tobacco Giant Arises in Europe"). That offer was subsequently topped by Luxembourg-based private equity firm CVC Capital, but Imperial's latest bid, at €50 ($69) per share could carry the day.

If the deal goes through, it will be the latest in string of mergers among European tobacco companies looking to boost revenues and squeeze costs as their businesses come under increasing pressure. Reduced smoking rates are hitting companies' bottom lines and creating excess production capacity across the continent. Imperial hopes the merger will produce cost synergies of an estimated $413 million by 2009—presumably via plant closings and head-count reductions—helping it battle dwindling margins and intense competition from rivals.

Trip to Marlboro Country?

The merger also will give Imperial greater scale across Europe and around the world. Chief Executive Gareth Davis told analysts on July 18 that the combined company would have 46% market share in Britain, 28.5% in France, and 27% in Germany. Citigroup figures Imperial's share across the whole of Europe and the former Soviet Union will be 16.6%, vs. 10.5% prior to the merger.

The announced deal, which has the support of the Altadis board, may not be the final word, however. Analysts say that other tobacco companies, including Marlboro-maker Altria (MO), British American Tobacco (BTI), and Japan Tobacco (2914.T) could make rival plays for Altadis. CVC Capital or another private equity shop also could up the ante. Though Altadis is known to favor merging with another tobacco company, its board would be obliged to consider all higher offers.

"The ball will be in private equity's court to see if its business case stacks up at a higher price for Altadis," Dresdner Kleinwort analyst Charles Manso de Zuniga says in a research note.

How does the math add up for Imperial's bid? Pretty well, according to JP Morgan analyst Erik Bloomquist. About 45% of the purchase price will be in the form of stock, and financing the remaining $12.3 billion won't substantially raise the company's 5.4% debt cost. Imperial also will benefit from the expected sale of $898 million in non-core assets, as well as cost savings in production, purchasing, and sales.

Have a Cigar

Best of all, Imperial gets its hands on Altadis' lucrative cigar business. The Franco-Spanish company owns the Montecristo and Don Diego brands and is the world's largest cigar producer. Incorporating this high-margin business will give Imperial a leg up on rivals, especially in the U.S. and emerging economies, where cigars continue to be very popular.

Still, even after the merger Imperial will lag well behind rivals in Europe. According to Citigroup research, Altria commands 33.9% of the European market, while BAT has 20.1%. Japan Tobacco, which snapped up British cigarette maker Gallaher Group in December, 2006, for $19 billion, now has a 20.9% share (see, 12/15/06, "Japan Inc.'s Buying Tour Reaches Britain").

Imperial needs Altadis in its quiver to stay in the competition, so the next three months will be crucial. Spanish stock market authorities have eight weeks to approve the deal, and then other companies will have a month to put forth rival bids if they wish. Executives at Imperial will be biting their nails—or smoking more cigarettes—for a few months to come.

Scott is a reporter in BusinessWeek's London bureau.

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