BAT’s Bid for Reynolds May Spur Final Wave of Big Tobacco M&A

  • Japan Tobacco buying Imperial Brands is one potential deal
  • Reunion of Philip Morris and Altria also considered possible

Why BAT's Reynolds Bid Is a Big Deal for Big Tobacco

British American Tobacco Plc’s plan to buy Reynolds American Inc. could herald a final wave of industry consolidation as rivals will need to link up to compete with the world’s largest listed tobacco company.

As the number of publicly traded big tobacco companies gets whittled down, only a few possible combinations remain. Japan Tobacco Inc. buying Britain’s Imperial Brands Plc, and Philip Morris International Inc. re-merging with Altria Group Inc. eight years after splitting up are the most plausible scenarios, experts say. Any future deals would be more complicated than previous combinations, though.

“This may pave the way for further consolidation,” Owen Bennett, an analyst at Jefferies, said. “Given the attractiveness of the U.S. market, we believe Japan Tobacco would want greater exposure and Philip Morris International also.”

BAT’s unsolicited $47 billion bid for full ownership of Reynolds proves that the historic reluctance to owning U.S. tobacco businesses due to legal liability has disappeared, according to Chris Wickham, an analyst at Whitman Howard. That, plus the quest for reduced-risk tobacco products, is changing the dynamics of tobacco M&A, as cigarette makers look for growth in the U.S., the world’s most profitable tobacco market and the region where electronic cigarettes have made the biggest impact.

Philip Morris split in two in 2008 to set free its faster-growing overseas operations while the U.S. business, renamed Altria, grappled with smoker lawsuits. As the combination of BAT and Reynolds would threaten Philip Morris International’s top ranking, the Marlboro maker may look to acquire Altria to reclaim its crown.

“We don’t believe Philip Morris would idly sit by,” wrote Bonnie Herzog, an analyst at Wells Fargo. Altria shares rose as much as 3.3 percent in New York Friday, the biggest intraday gain in more than a year.

U.S. Foothold

Imperial Brands, the U.K. maker of Davidoff and Lambert & Butler cigarettes, expanded its foothold in the U.S. by buying four American brands including Winston and Kool as part of last year’s $27 billion merger of Reynolds and Lorillard. Imperial’s shares have rallied in recent years on speculation it could be acquired, and the shares rose as much as 3.6 percent in London Friday.

Imperial is the “inevitable” target because it’s the smallest of the multinational tobacco companies, according to Rupert Wilson, an independent analyst. Japan Tobacco is the only one that could buy the Bristol, England-based company, though it would need to reduce its share of the U.K. market, he said. Together with Imperial, the Tokyo-based seller of Benson & Hedges smokes would control more than 80 percent of the cigarettes in Britain.

Japan Tobacco, 33 percent owned by the Japanese government, has said it aims to become the world’s No. 1 tobacco company. The company has sped up acquisitions of brands and products abroad to cope with an aging home market, and last year bought the international rights to Reynolds’s Natural American Spirit division.

The quest for less harmful alternatives to cigarettes has also inspired companies to cooperate. BAT and Reynolds have partnered to share so-called vapor technology, which supplies nicotine to consumers via aerosols, and Altria and Philip Morris also collaborate on next-generation research and development. The combination of BAT and Reynolds illustrates how prominent e-cigarettes and heated tobacco devices have become in the strategy of industry executives.

“In the medium to long-term reduced risk products will be very important and having a strong presence in the U.S. market will be key,” said Erik Bloomquist, an independent analyst. “That’s the next big profit pool.”

The U.S. will comprise 68 percent of the $26.2 billion global vapor market in 2019, according to researcher Euromonitor.

While most speculation revolves around publicly traded tobacco companies, some analysts, such as Jefferies’s Bennett, said China’s state monopoly, which sells almost half the world’s cigarettes in a market that’s closed off to foreign competition, might someday enter the fray. Philip Morris’s cigarette-alternative technology could interest China National Tobacco, while Imperial Brands could be a means to get distribution, he said.

“The wildcard is China’s national tobacco corporation,” Bloomquist said.

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