How About A Leveraged Buyout Of Imperial Tobacco Group plc?

We explore a leveraged buyout of Imperial Tobacco Group plc (LON: IMT).

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

british american tobacco / imperial tobaccoImperial Tobacco (LSE: IMT) shareholders must be rubbing their hands with glee. Takeover speculation has pushed the stock higher this week.

Imperial’s enterprise value is $61bn. Competitiveness must be preserved, so we rule out a merger or a blown-out offer from a larger rival, in spite of clear signs that M&A activity in the sector is back on the agenda. 

How about a leveraged buyout, however?

Passive income stocks: our picks

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick

If private equity strikes a benchmark deal, shareholders will be the obvious winners but Imperial bondholders, whose holdings are already a tad overvalued, will register a significant paper loss.

Leveraged Buyout (LBO)

It’s hard not to suggest private equity involvement when takeover talk emerges in the tobacco industry. It’s also impossible not to recall the dreadful outcome of the $30bn-plus buyout of RJR Nabisco in 1989.

In LBOs, the buyer loads a huge amount of debt onto the balance sheet of the acquired company, whose resulting capital structure is usually so stretched that equity capital can be as low as 15% of the total capital needed to run the business as a going concern. The reminder is debt or equity-like capital, which may or may not include repayments of the principal until maturity.

Under private equity ownership, the cash flow of the target is essentially used to reduce leverage, usually in less than five years, while the equity is expected to appreciate on the back of improved efficiency and growth.

Imperial believes it will be able to cut costs to the tune of £300m yearly over the medium term. As for growth, management is adamant the future is bright.

Imperial is not RJR Nabisco, but any possible buyer would have to bet that Imperial has turned the corner after three years during which its stock has underperformed the sector by 11 percentage points.

Credit, Leverage, Bondholders

LBOs are attractive when they are struck at low trading multiples. The stock of Imperial hit a record high this week. Its relative valuation is well above median, while its net leverage is above 3 times.

Another caveat is that Imperial can be bought out only if at least three private equity firms – say KKR, Blackstone and TPG — agree to work together, which heightens the deal’s execution risk.

Bad news for a buyout? No, really.

Estimates for revenues are not impressive, but Imperial is a defensive business, and its top-line will likely outpace inflation for years to come. Its unlevered free cash flow profile stands out: it has averaged £2 billion annually since 2009.

Moreover:

  • The syndicated loan market and the high-yield bond market would be supportive of net leverage as high as 10 times for the right target.
  • Credit market conditions are just as loose as they were seven years ago.
  • Borrowers are in charge: those with strong relationships can borrow as much as they want and on their very own terms.  

Assuming a low-ball bid at a 15% premium, Imperial’s market cap would be about $51bn, for an implied enterprise value of $70bn.

If the equity financing backing the LBO is just 20% of the purchase price, Imperial’s net leverage will surge to 10x. The promise of improved efficiency and better growth would allow bankers to suggest that net leverage would be lower at 8x, on a pro-forma basis.

The deal is do-able. Bondholders won’t be pleased.

Imperial has a large amount of long-term debt outstanding offering a gross yield in the region of 2% to 3%. Prices of Imperial debt have felt the strain in recent weeks and they are looking for direction. Bondholders tempted to sell out now may consider to re-invest proceeds in the stock, whose current valuation is still acceptable – whether or not a deal actually takes place.

5 Shares for the Future of Energy

Investors who don’t own energy shares need to see this now.

Because Mark Rogers — The Motley Fool UK’s Director of Investing — sees 2 key reasons why energy is set to soar.

While sanctions slam Russian supplies, nations are also racing to achieve net zero emissions, he says. Mark believes 5 companies in particular are poised for spectacular profits.

Open this new report5 Shares for the Future of Energy — and discover:

  • Britain’s Energy Fort Knox, now controlling 30% of UK energy storage
  • How to potentially get paid by the weather
  • Electric Vehicles’ secret backdoor opportunity
  • One dead simple stock for the new nuclear boom

Click the button below to find out how you can get your hands on the full report now, and as a thank you for your interest, we’ll send you one of the five picks — absolutely free!

Grab your FREE Energy recommendation now

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alessandro does not own shares in any of the companies mentioned.

More on Investing Articles

Young female business analyst looking at a graph chart while working from home
Investing Articles

After collapsing 28% today, are Bunzl shares too cheap to ignore?

A poor trading statement has sent Bunzl shares to multi-year lows. Could now be a good time to consider investing…

Read more »

Investing Articles

These 5 stocks could earn £1,600 of annual passive income in a £20,000 ISA

Harvey Jones shows how to generate a high and rising passive income by buying a balanced mix of high-yielding FTSE…

Read more »

Young woman holding up three fingers
Investing Articles

3 things I like about Greggs shares

Greggs shares have tumbled by more than a third over the past year. But this writer has no plan to…

Read more »

artificial intelligence investing algorithms
Investing Articles

Nvidia stock: beware the bear market rally

Andrew Mackie argues that investors should tread carefully before investing in Nvidia stock, as the worst of the sell-off could…

Read more »

Young black colleagues high-fiving each other at work
Investing Articles

Up 73% in one year, is this the best value stock in the FTSE 100?

A brilliant run of form suggests this FTSE 100 giant should no longer make the cut as a value stock.…

Read more »

Investing Articles

The best could yet be to come for UK shares! I’m buying these ones

Amid ongoing stock market turbulence, this writer's been adding selected UK shares to his portfolio. Here's why and what he…

Read more »

Top Stocks

4 UK stocks trading well below book value to consider buying

Sometimes, it pays to be contrarian: who says the UK market has priced a stock precisely right, anyway?

Read more »

Investing Articles

The S&P 500’s 12% off its highs. Is now a good time to buy US shares for an ISA?

Right now, a lot of British investors are wondering whether it’s a good time to buy US shares. Here, Edward…

Read more »