Why British American Tobacco’s $49 Billion Purchase Of Reynolds American Makes Sense… And Doesn’t

Last year, British American Tobacco made an offer to take full control of Reynolds American, Inc. On Tuesday, that offer was finalized. BAT already owned 42.2 percent of Reynolds, and that offer caused shares of Reynolds to spike up about 20 percent. Since then, shares have remained level, and the finalized offer has seen shares tick up a bit more. But for the long term, was BAT wise in targeting an American tobacco company?

British American Tobacco Purchased Reynolds American for $49 Billion

The tobacco industry in America has been under fire for years. In fact, British tobacco companies have avoided American tobacco companies because of civil suits, bad publicity, and an overall growing bias against cigarettes in the U.S. So what changed for BAT to bring them stateside?

To be honest, while tobacco catches flak in the states, the U.S. is still a tobacco haven. In Europe, more and more countries are not allowing companies to sell cigarettes with logos or branding. As a result, brands have a harder time attracting new customers and have seen dwindling sales numbers. In America, however, cigarette companies are protected by the First Amendment, and don’t have to face the same plain-packaging rules as overseas.

BAT already owns Pall Mall and Lucky Strike cigarettes, and will now have full control over Reynolds brands, including Camel and Newport cigarettes. The merger will also allow BAT to save roughly half a billion dollars in technology costs for next generation products such as e-cigs and vaping products.

This acquisition creates the world’s largest listed tobacco company by revenue and market value, and gives BAT full control over a foothold into the U.S.tobacco market. However, is this market healthy? Currently, about 15 percent of adults over 18 smoke tobacco. But that number is down from 21 percent in 2005. There is a direct correlation between smoking and education, and smoking and poverty. The more educated an adult is, the less likely s/he is to smoke cigarettes. In fact, according to the CDC, only 7 percent of adults with a college degree smoke cigarettes, while 34 percent of adults with a GED smoke. And 26 percent of adults below the poverty line smoke. With a surging dollar and the U.S. economy on the rise, could BAT’s new market be shrinking?

Watch the news report from Zero One for the details on this merger:

With more tobacco taxes and regulations on the way in the U.S., BAT’s purchase could take a hit. But for now, the move makes a lot of sense and offers the company a new revenue stream to explore.

Shares of British American Tobacco plc (BTI) and Reynolds American, Inc. (RAI) are both up slightly on the news. Expect that to continue in the short term, but fall back down sooner rather than later.

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