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Holding News - RJR to Buy BAT's US Business

Contributed by mm | October 27, 2003 3:35 PM PST

After market close, RJR announced that it will merge with Brown & Williamson Tobacco Corp., the US arm of British American Tobacco p.l.c. Under this definitive agreement:

- NewCo will have around 150m outstanding shares. RJR shareholder will own 58% of the company and BAT will own 42% of the company.

- NewCo will have a combined revenue of $10b and over 30% of the US cigarette market (2002 number)

- RJR intends to maintain its $3.80 annual dividend.

- Deals to be closed in mid-year 2004.

In s separate interview of BAT Chairman Martin Broughton, Martin mentioned that the NewCo will save another $500m on top of the $800m due to RJR major reconstruction announced earlier. He also mentioned Susan Ivey will replace Andy Schindler to be the CEO after the transition period; Andy will be CEO during the transition and Chairman of the combined operation since day one.

Initial news says RJR is up more than 8% on the news.

Personally I believe this is good news for RJR. The synergy between the No. 2 and No. 3 in the market is tangible. Barring any regulatory approval issues, this deal should unlock substantial value for shareholders.

I'm raising my RJR price target to $50. I'll conduct an in-depth quantitative analysis afterwards.

Before this announcement, S&P set RJR target price at $65.30 on September 24, 2003. Smith Barney set the target at $43 (September 17, 2003). Lehman Brother target is $43.00 (September 17, 2003).

This Post Has Received 2 Comments. Share Your Opinions Too.


mm Commented on October 27, 2003

On a 9/12/2003 Smith Barney research report on BTI, it predicts the merger of RJR and BAT's US operation. Here is the summary of that research report:

* If British American Tobacco were to take over RJ Reynolds (RJR - $38.86; 1H), we believe it would benefit the stock:
* Assuming a 30% takeover premium and $80 million of synergies, we estimate it would be 12% EPS accretive in 2004 (before goodwill)
* It would be value creative as well
* By creating a larger competitor, the combined entity would be less disadvantaged vs. Philip Morris in the U.S. market
* We believe it would be more value creating for BAT if it sold its U.S.
subsidiary to RJR and took an equity stake in the enlarged RJR
* We retain our Buy/Medium Risk (1M) rating on BAT and $22 ADR target price

Also it mentions the regulatory risks of the merger:

Together the two companies would have about 32% of the U.S. cigarette market (in 2002, RJR's share was about 22% and BAT's about 10%), with a
higher share in the menthol category. We regard it as quite likely that the FTC would require a combined entity to dispose of one or more of the
brands. This would probably reduce the economic attractiveness of the deal a little.


mm Commented on October 28, 2003

Smith Barney raised price target from $43 to $55 after the announcement. It also says:

- RJR and BAT announced a combination of their U.S. businesses, forming a new publicly traded holding company, Reynolds American Inc. Since the
merger is a stock-for-stock deal, RJR shareholders will receive one share of the new company for each one of its existing shares.

- Overall we believe this merger is very positive and expect RJRs stock to trade
up on this news. Based on our calculations, we believe the new Reynolds American Inc. could have 04 earnings power of at least $5.75 per share, excluding the $500 million annualized savings. Therefore, we are increasing our price target on RJR to $55, representing an expanded P/E multiple of 9.5x.

- Major positives of todays announcement include: 1) a financially stronger entity, 2) increased efficiencies/annual cost savings of $500M, 3) increased scale resulting in an enhanced competitive position, and 4) an even more attractive 75% dividend payout ratio. We reiterate our Buy rating on the stock.


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