The real reason Big Tobacco is getting even bigger

21 October 2016:

British American Tobacco said on Friday that it has offered to buy U.S. tobacco giant Reynolds American in a $47 billion deal that would create the world’s largest publicly traded tobacco company.

British American Tobacco — the London-based owner of cigarette brands such as Lucky Strike and Pall Mall — owns 42 percent of the shares in Reynolds and has offered to buy out the remaining 58 percent. The proposal comes as U.S. companies are dealing with plummeting use of tobacco products, and seeking to recapture some of that market with new tobacco products like e-cigarettes.

The merger would “create a stronger, truly global tobacco” company, British American Tobacco wrote in a press release. T The new company would enjoy a “leading position in the US tobacco market” and “significant presence in high growth emerging markets across South America, Africa, the Middle East and Asia,” the company wrote.

The proposal values Reynolds at $56.50 per share, a premium of 20 percent over the stock’s closing price on October 20.

Vivian Azer, an analyst with the Cowen Group, said that tobacco companies are currently in a strong position. In the US, “tobacco profits have accelerated for three consecutive years,” she said. She attributes that primarily to the ability of tobacco companies to raise prices in order to compensate for a diminishing number of customers.

The deal also would help the combined company capitalize on a growing customer base. British American Tobacco said that the merger would also create “a world class pipeline of vapour and tobacco heating products,” such as e-cigarettes.

That product pipeline has become increasingly important for tobacco companies. A smaller share of adults smoke traditional cigarettes today than at any point in the past half-century. As the market for traditional cigarettes in developed countries has shrunk rapidly, e-cigarettes are becoming more popular.

Because of the economics of addictive goods, tobacco companies have been reliant on their heaviest users for most of their profits. But that kind of heavy, pack-or-more-a-day use is becoming more rare too. CDC data shows that the share of adults smoking 30 or more cigarettes a day has has dropped by nearly half in the past 10 years.

“Global tobacco demand is subject to a number of potential headwinds,” Cowen Group analysts Vivian Azer and Aaron Grey wrote Friday in a research note on the merger, pointing to “increased awareness of the risks associated with traditional tobacco use, and resultant regulatory actions (e.g., indoor smoking bans, enlarged textual or graphic warnings, and / or plain packaging).”

The trend for e-cigarettes — battery-operated devices that heat liquid infused with nicotine and various flavors — has been much different. For instance, the number high school students who report using e-cigarettes on at least one day in the past month tripled between 2013 and 2014 to 13.4 percent, according to the CDC.

Though the rise of e-cigarettes has been a small bright spot for the industry, they are still a niche market. Only 3.7 percent of adults use them regularly, according to the CDC.

The research is unclear, however, on how the growth of e-cigarettes could alter Big Tobacco’s bottom line. Some studies have shown that people who use e-cigs reduce their overall tobacco intake, while others have found evidence that for young people, vaping can be a steppingstone to regular cigarette use.

Further muddying the waters is evidence that most teens who use e-cigarettes opt for flavored products that are free of nicotine. How that might affect their later chances of tobacco use remains unclear.

A merger between Reynolds American and British American Tobacco would allow the companies to consolidate their work on e-cigarettes, potentially leading to new products that are more attractive to consumers.

“With the U.S. representing one of the best profit pools in global tobacco (industry profits were up 10% last year), BAT will not only gain access to this attractive market, but also to RAI’s intellecutal property pipeline” on new technology, Azer and Grey write in their research note.

It would also give the new tobacco giant a larger global footprint, enabling it to better tap into foreign markets where tobacco use is increasing.

According to the World Health Organization, 1.1 billion humans — 14 percent of the world’s population — smoked tobacco last year.

“A BAT/RAI combination would catapult BAT to become the largest listed global tobacco company in terms of sales and operating profit,” Wells Fargo analyst Bonnie Herzog said in a research note. The sheer size of the company might make mergers more appealing to other players in the industry — most notablyPhilip Morris and Altria, she wrote.

Source: https://www.washingtonpost.com/news/wonk/wp/2016/10/21/the-real-reason-big-tobacco-is-getting-even-bigger/