Glenboden M & A Originations

Japan Tobacco’s acquisition of Gallaher triggers a new global consolidation round

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Origination Status group acquisition recommended offer in December 2006;
Asset Gallagher plc (UK), no. 5 international tobacco player with 3% global volume share,
Buyer Japan Tobacco International, no.3 international tobacco player with 8% global volume share;
Seller Gallaher public shareholders;
Buyer Rationale increased global market share, stronger position in high-margin markets and in CIS;
Seller Rationale acceptable valuation for management to recommend to shareholders;
NBs JTI will remain internationally no. 3, after this deal, behind Philip Morris and BAT.
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When Glenboden worked on the privatisation of the Polish tobacco sector in 1992-6, the interested buyers were: Philip Morris International, RJ Reynolds International, Japan Tobacco, Seita, Tabacalera, BAT, Rothmans, Imperial Tobacco, Reemtsma. Those 10 companies have been consolidated down to five, in a decade. But then maybe that’s not so much, or so quick, for a business that should disappear completely in the longer term.

For sure, the addition to JTI of Gallaher, with its no. 1 or 2 positions in the UK, Ireland, Austria, Sweden and Kazakhstan, will alter the balance of power in global tobacco and cause another merger in its wake. Our tip is for BAT to acquire Imperial Tobacco next.

This looks like one of those ‘10x plus’ EBITDA valuation multiples, that are common now. Also the ‘standard’ 30% premium to rumour-free share price was probably referenced (27% to be precise).

One thing less relevant is net sales value; x3,5 P/S has to be seen in the context of excise and customs duties that can on average be >67% of total sales revenue in tobacco. Tobacco is a business with stable >20% operating margins, relatively low ongoing investment and no growth story, so its valuation mix has to be dominated by the P /EBITDA number.

Management has cited how perfectly complementary the two businesses are. Maybe, but that’s just the headline. JTI is already a strong European tobacco business (the legacy of its predecessor, RJ Reynolds International), and premium brands can be produced and economically transported across the continent.

As for Gallaher’s much-vaunted CIS business, JTI already has a competing market share in Russia and Ukraine (and a much bigger share in their premium segments).

Add to that JTI’s focus on developing its ‘global flagship brands’ (Camel, Winston, Salem) and we conclude that this deal is mostly about ever-stronger cashflow through cost synergies, brand portfolio rationalisation and JTI having a greater presence in high-margin developed countries (especially the UK).

There are plenty of Gallaher brands to reduce down in the CIS, for example, to increase efficiencies. On top of that, JTI hasn’t made an acquisition for seven years, since its transformational RJ Reynolds International acquisition. So, they hand a cash mountain to consume.

Analysts speculate that Philip Morris International, BAT or private equity might make a competing bid for Gallaher. We think they won’t.

PMI has been in splendid isolation for quite a while, now; just buying national players with the end-game of everyone smoking only Marlboro one day. As for private equity, we think a full valuation, plus the fact that no-one wants to diversify into a sector where they’ll inherit litigation risks and uncertainties, will outweigh the temptations of such a cash-generative business.

As for BAT, who’s always been more interested in building regional brands, of which Gallaher has many - we don’t think they’ll fight with JTI; instead they’ll try to restore the balance of power by snapping up Altadis or, more likely, Imperial Tobacco, both of which have 3-4% global market share. If not then maybe they’ll try a smaller deal, like buying the other half of House of Prince in Scandinavia.

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Size (€ mln) 13.050
Sector tobacco
Asset Quality global no.5 branded
Seller large plc
Buyer large plc
P/S 3,5
P/Ebitda 13,0
Type enterprise value
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