UK's BAT maps tobacco road to growth

LONDON Thu Feb 28, 2008 11:47am EST

LONDON (Reuters) - British American Tobacco, the world's No 2 cigarette group, is setting the agenda for growth in the cigarette world with bolt-on acquisitions and savage cost cuts as the era of mega tobacco deals comes to a close.

The maker of Kent, Dunhill and Lucky Strike cigarettes (BATS.L) has announced two medium-sized deals in the last seven days and a massive five-year cost-cutting program as its Chief Executive, Paul Adams, said the era of big deals was at an end.

The world's four biggest tobacco groups now controls around 80 percent of the global cigarette market, excluding China, and any further consolidation between these top four now looks distinctly unlikely for anti-trust reasons, analysts say.

The top four -- Marlboro-maker Altria (MO.N), BAT, Japan Tobacco (2914.T) and Imperial Tobacco (IMT.L) -- will now look to organic growth, state privatizations and smaller deals probably in emerging markets to keep volumes rising, while cost cutting and share buybacks will help boost earnings.

"There are not the transformational deals out there, big transformation deals are gone," said BAT's Adams, adding that BAT can hit its financial targets through organic growth.

Over the last ten months, the world's fifth and sixth biggest cigarette groups, Britain's Gallaher and Franco-Spanish Altadis, have succumbed to takeovers from Japan Tobacco and Imperial Tobacco in a last flurry of big deals.

BAT has had its share of transformational deals, taking over Rothmans in 1999 and then merging its U.S. arm with R.J. Reynolds to create Reynolds American (RAI.N) in 2004, in which BAT owns 42 percent, to cut its exposure to U.S. litigation.

For the future, analysts say the big four will eye up state monopoly players in Egypt and Algeria, if or even when they come up for sale, while attention will also focus on Altria when it spins-off its business outside the U.S., Philip Morris International (PMI), set for March 28.

PMI will remain the world's largest cigarette company making 850 billion cigarettes in 2007 and will be a major player in western Europe with its number one positions in large markets such as France, Germany, Spain and Italy.

The group has already indicated it will set a big share buyback program of $13 billion over two years and a high dividend payout ratio of 65 percent of available earnings.

BAT has also indicated big returns to shareholders with a 750 million pounds ($1.5 billion) buyback in 2007 and aims to pay out a similar 65 percent of earnings as dividends by 2008 reflecting the lack of big acquisition opportunities worldwide.

The group has temporarily scaled back its buyback program for 2008 to 400 million pounds reflecting its two acquisitions over the last seven days as it mops up medium-sized targets in Turkey and Scandinavia.

Last Friday, BAT agreed to pay $1.72 billion for Turkey's state-owned cigarette maker Tekel to see PMI and BAT control almost 80 percent of the world's eighth biggest tobacco market and be an outlet for their global brands Marlboro and Kent.

Earlier on Thursday, BAT agreed to buy the cigarette business of Denmark's privately-owned Skandinavisk Tobakskompagni in a deal worth 2 billion pounds to give BAT control of 60 percent of all cigarettes smoked in Scandinavia.

The two deals will added 32 billion and 30 billion annual cigarette sales to BAT's 2007 sales of 684 billion and edge it closer to PMI, but more importantly for BAT's Adams, both will enhance earnings immediately, lead to 90 million pounds of cost savings and were struck at what he calls reasonable prices.

BAT paid 11.4 times historic earnings for Tekel and 11.2 times for its Scandinavian deal, well below the 14.2 times Imperial forked out when it paid 12.6 billion euros for Gauloises-maker Altadis in January, and the 13 times Japan Tobacco paid in a 7.5 billion pound deal for Benson & Hedges maker Gallaher in April.

On the costs side, BAT has cut its cost base by just over one billon pounds in the five years to end-2007 and is embarking on another round of cuts of 800 million pounds in the five years to 2012 as it seeks out greater efficiencies at its 47 factories and across its near-54,000 global workforce.

(Editing by Andrew Callus)

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