Cigarette Bonds

BAT's $25 Billion Lucky Strike

BAT should have no difficulty in raising its $25 billion.
At Closing, May 25th
3869.00 GBp

It's enough to give any treasurer a smoker's cough: launching the third-biggest fundraising ever during the August lull, in an industry that's been roiled by regulators, by a company that's just suffered a two-step rating downgrade.

Not a problem for British American Tobacco Plc.

It's in the process of raising $25 billion in what may be the largest corporate bond offering of the year. The maker of Lucky Strikes wants to refinance its 42 billion-pound ($55 billion) buyout of Reynolds American -- a deal which will give it No. 1 position in tobacco-related products globally.

BAT Ballpark

Existing six-year euro debt yields a bit more than 1 percent

Source: Bloomberg

The offering should eclipse AT&T Inc.'s $22.5 billion offering just two weeks ago, which saw investors order as much as $60 billion of the securities. BAT will want to get orders for at least as much, if not more.

It shouldn't be a struggle for a tobacco company. Like hardened smokers, investors have a craving for yield. So expect BAT to offer buyers a healthy premium over comparable debt. The summer slowdown leaves the playing field empty, something that should play in BAT's favor.

Deals of this size will feature prominently in the corporate bond indexes so investors are almost obliged to buy them -- though ethical bond funds will sit this one out. The extra spread on offer from the new issue also offers tantalizing out-performance potential in an otherwise moribund credit market.

With corporate spreads edging ever closer to record lows, investors are starved of product. Moreover, the European Central Bank is still buying. It now holds more than 103 billion euros in corporate debt. The effect on BAT is indirect -- the ECB can't hold its bonds -- but the relative scarcity of equivalent BBB debt has the effect of tightening spreads on BAT's bonds.

One fly in the ointment was the two-notch downgrade from Fitch Ratings on Friday to BBB from A-. This was largely due to the increased leverage from assuming Reynolds's debt, but with free cash flow of more than 2 billion pounds each year, the ratings company doesn't have wider concerns on the debt. Furthermore, the move just brings Fitch into line with S+P's BBB+ and Moody's Baa2 ratings.

Last month, shares of tobacco companies slumped after the U.S. Food and Drug Administration committed to reducing the level of nicotine in cigarettes to non-addictive levels. BAT was down almost 11 percent at one point, its biggest one-day drop for 17 years, before rallying to end July 28 with a 7 percent slide.

Vapor Trails

U.S. market share of total spending on electronic smoking devices

Source: Information Resources via Bloomberg Intelligence

The FDA move, though, may work in BAT's favor by driving more Americans to alternative technology such as vaping and heat-not-burn devices. The global vaping market is worth $12.3 billion, according to data compiled by Euromonitor. North America accounts for 36 percent of global sales, and Reynolds has almost as much of the U.S. market for electronic smoking devices as its next three biggest rivals put together, according to data compiled by Bloomberg Intelligence analyst Duncan Fox.

With such demand from yield-starved credit investors, BAT should be able to pull off the deal of the summer.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the authors of this story:
    Marcus Ashworth in London at
    Mark Gilbert in London at

    To contact the editor responsible for this story:
    Edward Evans at

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