Shares of Japan Tobacco crash to lowest within six months post the company's consent to pay approximately $5 billion for international rights concerning a division of Reynolds American, Inc.(NYSE:RAI) the Natural American Spirit. Price of each share fell by a sharp 6.7 percent to touch 3,695 Yen by trading close in Tokyo. It marks the lowest level from March 20. In contrast, there was a rise of 2.6 percent by benchmark Topix.
Rationale of the deal
This deal is created to surpass the Tokyo headquartered Japan Tobacco's influence beyond the slowly shrinking Japanese market. It will also reduce the debt of Reynold's after the $25 billion Lorillard LLC(NYSE:LO) acquisition in June. This agreement provides Japan Tobacco the rights to a brand that has a loyal following among the younger smokers. This purchase, however, is done at a price almost 300 times pretax profit of Natural American Spirit in the non United States markets in 2014.
Reynolds makes Camel cigarettes and expects to receive about $3.5 billion post taxes from this deal. Nik Modi of RBC Capital Markets said this sale will permit the Winston-Salem headquartered company to pay back the Lorillard debt faster than what the investors expected. This quick payment will reduce the annual interest by about $150 million. It will also increase the earnings by about seven cents per share in 2017.
Cigarettes sold by Natural American Spirit are priced higher compared to other brands as a few of its products are prepared with additive-free blends and organic tobacco. The blends contain only water and tobacco. Cheaper priced cigarette brands use additives like corn syrup and glycol for cigarette flavoring.
Labeling “organic” and also “additive free” has assisted Natural American Spirit to push sales at a times when consumers are prone to buying organic groceries. Anti-tobacco groups however have criticized this “additive free” description. They say this label misinforms that the brand is safer than other brands.
According to Satoshi Fujiwara of Nomura, the acquisition can be classified as overpriced. He said that the higher price could be justified if one considers the medium term. Factors like better operating margins if production is started within the company are also taken into consideration.
Japan Tobacco is not new to the acquisition game. It successfully bought all rights linked to Winston and Camel in 1999, along with a number of other cigarette brands applicable outside the United States. Rights were purchased from Reynolds' predecessor, RJR Nabisco for approximately $7.84 billion at today's rates.