Imperial Brands (LSE: IMB) has long been the subject of takeover speculation. As big tobacco tries to grow in an ever shrinking market, consolidation is the only option, and as one of the smallest players in the tobacco space, Imperial Brands appears ripe for the picking by a larger peer.
Indeed, the company is less than half the size of London-listed peer British American Tobacco and compared to cigarette behemoth Philip Morris, Imperial Brands is a relative tiddler with a market capitalisation of £37bn compared to Philip Morris’ $150bn.
However, as the threats of regulation and legal constraints have weighed on the tobacco sector for much of the past three decades, consolidation has been limited among the industry’s largest players. But now, it would appear that the tobacco M&A market is coming out of its slumber.
Waking up
British American’s offer to acquire the part of Reynolds American it doesn’t already own is the second large tobacco merger in two years. During June of last year Reynolds forked out $27.4bn to acquire smaller domestic peer Lorillard Inc. And after these two mergers, City analysts now believe there could be further deals in the works.
Imperial Brands is by far the most likely candidate to be the first to succumb to such a deal. Imperial is small and well diversified with a relatively small but not insignificant market share in most international tobacco markets.
In Europe for example, Imperial has a 16% share of the tobacco market, close to Japan Tobacco with an 18% share. But British American is stronger there with a 21% share of the European tobacco market, and Philip Morris controls 38%. Within Russia, it’s Japan Tobacco that controls more than a third of the market. Imperial has a share of only 10% and British American is second in that country with a market share of 21%. In Indonesia, Imperial controls 28% of the tobacco market through its Gudang Garam subsidiary. Japan Tobacco has no exposure to the region, Philip Morris has a market share of 35% and British American controls a small-but-significant 8% of the market.
These different market shares point to plenty of potential but also imply it’s more likely Imperial will be broken up than acquired as a whole by one single company. This scenario may lead to best returns for shareholders.
Shares on offer
There’s one big reason why Imperial could be the next to succumb to bid and that’s price. Sterling’s decline against the dollar since the end of June has essentially put all UK assets on sale making them more attractive to overseas buyers. In dollar terms, Imperial’s market value is currently around $47bn, down from $57bn using the January pound-dollar exchange rate. To put it another way, sterling’s devaluation has essentially cut 18% off Imperial’s asking price. It also means overseas bidders could more likely afford a price to which shareholders would agree.
So overall, as the tobacco M&A market thaws out, Imperial looks like it could be the next company to succumb to a larger peer thanks to its presence in emerging markets and near-20% discount.
