Philip Morris International (NYSE: PM) might be the world's largest, publicly traded tobacco company right now, but with the next major industry merger not likely to receive much if any antitrust opposition, the global distributor of Marlboro cigarettes is about to be relegated to the No. 2 spot. It shouldn't have much effect, however, on its still being a powerful dividend payer in your portfolio.
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A giant with global reach
The long-anticipated tie-up between British American Tobacco (NYSEMKT: BTI) and Reynolds American (NYSE: RAI) is now officially in negotiations, after the latter confirmed it had received a $47 billion offer for BAT to acquire the remaining 58% of its stock that it doesn't already own.
More than two years ago, it was rumored that BAT was in the market to make a big buy in the U.S., and it was assumed it would either be Reynolds, which it already owns 42% of, or Lorillard, after which it might then go after Reynolds. Even tiny Imperial Brands was thought to be in the running.
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But Reynolds did the heavy lifting for BAT, purchasing Lorillard last year for $29 billion. With much of the hard integration work already completed, British American can focus on becoming a heavy hitter in the U.S. and taking on rival Altria (NYSE: MO).
Exploring new frontiers in smoking
A BAT-Reynolds merger will join together global cigarette brands such as Camel, Lucky Strike, Newport, and Pall Mall. It will also put British American in the forefront of the electronic cigarette and vaping markets as it takes Reynolds' Vuse brand to new markets.
Late last year, Reynolds signed an agreement with BAT to collaborate globally on R&D, regulatory, and scientific and manufacturing issues for next-generation vapor products, including Vuse and BAT's European e-cig maker CHIC Group that it bought a year ago.
Despite new FDA regulations that may hamper or even kill the e-cig market in the U.S., international opportunities for sales abound. Philip Morris and Altria have similarly signed cooperation agreements on vapor products, and Philip Morris is rolling out its Marlboro-branded HeatSticks, an innovative e-cig that uses real tobacco for flavor rather than a flavored e-liquid, as is typical in many other electronic cigarettes. It quickly captured 3% share of the Japanese market just months after it was introduced there.
BAT is also developing a similar e-cig, the iFuse, which heats liquid nicotine and then also draws it through tobacco for flavor.
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Legal risks decline
International tobacco companies have largely avoided the U.S. market because of the propensity for lawsuits to be filed against them. Philip Morris was expressly carved out from Altria to protect it from the litigation risk. But as global volumes decline and regulation of tobacco products becomes more strict in many foreign markets -- the Philippines, for example, is about to impose a broadly defined ban on smoking in public places that will include e-cig and vaping devices -- the U.S. is not the same risk it once was. Rumors that Altria and Philip Morris will reunite have even been floated, and that kind of speculation will probably pick up.
The combined British American and Reynolds would have around $27 billion in annual sales, surpassing the $26 billion Philip Morris generates. China's state-owned National Tobacco would still be the world's biggest, however. Together, BAT and Reynolds would employ almost 56,000 people globally.
This isn't over yet
Reynolds American was created more than a decade ago, when, in exchange for accepting the liabilities of Brown & Williamson, BAT merged those operations in the U.S. with R.J. Reynolds, obtaining the 42% stake it currently holds.
While the merger will put pressure on Philip Morris, it will probably also serve as the catalyst that pushes the tobacco giant to make its own M&A play. Consolidation has been rampant in the industry, and while the number of players shrink, it doesn't appear the activity will end with this latest deal.
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