Industryweek 13962 Reynolds 1

A Trump Tax Cut Could Add $8.2 Billion to Reynolds Price Tag

Jan. 11, 2017
“Trump’s tax proposals give Reynolds more ammunition to negotiate a bump to the offer,” said Owen Bennett, an analyst at Jefferies. 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.

When British American Tobacco Plc (IW 1000/201) 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 counterbids 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 U.S. corporations. Trump wants to cut the rate to 15%, while House Republicans are seeking 20%.

For Winston-Salem, N.C-based Reynolds, which makes almost all of its $6 billion profit domestically, that’s a boon. For BAT, it’s 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,” said Owen Bennett, an analyst at Jefferies.  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’s 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 amortization.

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 U.S. smoking industry, BAT wouldn’t gain full access to Reynolds’ heated tobacco technology and thus would risk falling further behind 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 canceling 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 finalizing a deal with BAT. The analyst expects a clearer picture to emerge within 90 days of Trump’s inauguration on Jan. 20.

However the U.S. corporate tax policy is formulated, the expectation is that a Trump administration heralds a friendlier business environment, according to Wintergreen Advisers CEO 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.”

By Sam Chambers

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