When British American Tobacco Plc bid $47 billion last year to buy the 58% of Reynolds American, Inc. that it doesn’t own, the coast was clear. BAT’s existing stake nullified the threat of counter bids, and regulatory issues looked non-existent. Then Americans voted in Donald Trump.
The president-elect and the Republican-controlled Congress want to slash the 35% tax rate for US corporations. Trump wants to cut the rate to 15%, while House Republicans are seeking 20%.
For Winston-Salem, North Carolina-based Reynolds, which makes almost all of its $6 billion profit domestically, that’s a boon. For BAT, it is a major headache because the resulting higher earnings for Reynolds would justify an increase of as much as $8.2 billion in the bid, according to analysts.
"Trump’s tax proposals give Reynolds more ammunition to negotiate a bump to the offer," Owen Bennett, an analyst at Jefferies, said by phone. Bennett estimates that a 25% corporate tax rate would increase the fair value of Reynolds by about $5 a share, while a cut to 15% would boost it by more than $10 a share.
BAT is offering cash and stock that is worth about $55.39 a share for Reynolds holders. The proposal, when it was made, valued Reynolds, including net debt, at 16.3 times earnings before interest, tax, depreciation and amortisation. That would be among the highest multiples ever paid in a tobacco merger, according to data compiled by Bloomberg. For London-based BAT, increasing the price may be unpalatable, but allowing the deal to slip through its fingers could be costly.
Besides missing out on milking more profit from the $116 billion US smoking industry, BAT wouldn’t gain full access to Reynolds’ heated tobacco technology, and thus would risk falling further behind Philip Morris International, Inc. in the race to develop newer alternatives to smoking.
Reynolds rejected BAT’s initial offer and was seeking a higher price, people familiar with the matter said in November. Representatives for BAT and Reynolds declined to comment.
BAT isn’t the only company grappling with Trump’s imminent presidency. The president-elect’s tweets have targeted companies such as Boeing Co. and United Technologies Corp. Trump cowed Ford Motor Co. into cancelling a $1.6 billion Mexican expansion plan.
For Reynolds, a knee-jerk reaction is less likely. RBC analyst Mirco Badocco expects the company to await clarity on how and when Trump’s tax proposals would be implemented before finalising a deal with BAT. The analyst expects a clearer picture to emerge within 90 days of Trump’s inauguration on 20 January.
However the US corporate tax policy is formulated, the expectation is that a Trump administration heralds a friendlier business environment, according to Wintergreen Advisers chief executive officer David Winters.
"Reynolds is more valuable than it was two and a half months ago, and the deal has gotten more complicated," Winters, who owns shares in both companies, said by phone. "It’s a critical asset for BAT."
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