Citigroup sees 33% chance BAT will bid for Imperial Tobacco

“We now believe a takeover is more likely than we did before FT Alphaville reported on Nov 20 that ‘advisers to British American Tobacco’ have put together a group of banks ‘willing to support an offer’,” the bank said, adding that the new price target assumes a 33% chance of a bid.

Citi said that even without a bid, the underlying investment is decent, playing well to its strategists’ themes with a high and growing dividend and exposure to Europe, while the price-to-earnings ratio is much lower than other consumer staples.

In addition, it pointed to the company’s self-help initiatives, with cost savings from the US and from pricing power.

“We still believe that the most likely outcome is that BAT does not bid for Imperial in the next 12 months, essentially because we believe it doesn’t fit in with its strategy, and because it would be exceptionally hard to organise (for anti-trust reasons). However, there are some good arguments in favour of a bid.”

Citi said its “very simple” model suggests that if British American Tobacco retained about 50% of Imperial’s business, it would be mid-teens EPS enhancing.

It also said a deal would give BAT a bigger exposure to developed markets. However, if BAT wanted to do this it could have easily increased its stake in Reynolds when it helped finance the Reynolds takeover of the Lorillard assets and it decided against this.

Citigroup said that currently, BAT can’t offset its large UK costs for tax purposes, which partly explains why its tax rate is about 31%. If it were to buy Imperial, however, it would get a big UK profit, allowing it to offset its UK costs, potentially giving a benefit of £10-20m a year.

At 1020 GMT, Imperial shares were up 0.4% at 3,567p.