Tuesday 24 November 2015

Flag pole alert - part 3

The broker upgrades are coming thick and fast following Bryce Elder's piece on Imperial Tobacco late last week.

Yesterday, Citigroup upgraded Imperial Tobacco to a "buy" and now Exane BNP Paribas and Morgan Stanley have pieces out to clients on the topic. Below I have pasted the gist of the latest Exane note:

Merger Madness
Ever since the ABI/SAB offer was announced, the financial press has been rife with speculation that Imperial is next in line. While such stories have been recycled repeatedly over the years and much reporting looks ill informed, the sheer intensity of the reports raises questions. It seems like a good time to revisit our previous work on the anti-trust complexities and the chances of a deal.
Talk of BAT without JT makes no sense
Much of the speculation centres on BAT launching a bid. But BAT can't do this alone; JT would need to be involved. Even if it were (we have doubts) it would be in a position to drive a hard bargain on markets acquired. There are a number of complexities and questions to overcome.
Financially attractive, strategically questionable
Though the anti-trust specifics make value leakage/ dis-synergies likely, a deal would still create value through cost savings (previous big Tobacco M&A synergies 22-105% acquired EBIT). But buying a fragmented brand portfolio which would need to be further broken up is not 'on-strategy', and for JT to tie up its balance sheet for several years would require strong commitment.
What if it's true?
Putting our scepticism aside, a successful deal might be 15-20% EPS accretive for BAT, 20-30% for JT (with ROIC>WACC for both), though paying IMT shareholders a 25%+ premium would mean a stretched takeout multiple by historical standards.
True or not, it's a free option on a robust IMT investment case
Consolidation would be good for the entire industry. The initial upside though would likely be greatest at target IMT and if (as is our base case) a deal is not forthcoming we continue to see the stock as attractive based on the profit pool growth recovery in Europe and the resulting opportunity to show a consistency of growth delivery that has proved elusive for many years.



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