As the Smoke Clears, Altria Dips Into the Smokeless Tobacco Market
Altria Group (MO) has offered $10.4 billion for Stamford Connecticut’s UST Inc. (UST), makers of some of the most popular smokeless tobacco products in the market. Altria offered $69.50 per UST share for a deal that totals $11.6 billion after the assumption of debt. The rationale for this merger is fairly obvious. Industry-wide cigarettes sales have been declining by about 3% to 4% per year, while smokeless tobacco sales have been increasing by 6% to 7% a year according to The Wall Street Journal. Many state and local governments have increased smoking bans in the interest of public health, while some others have decided to increase “sin taxes” on tobacco to concurrently boost tax revenues and discourage smoking. Cigarette smoking has borne the brunt of the regulatory and public relations attention, while use of smokeless tobacco has been growing with little impediment. There is a prevailing mind-set, however baseless, that smokeless tobacco in somehow less dangerous than cigarettes. A high profile merger such as this one could awaken some to the dangers of smokeless tobacco.
Altria is particularly interested in gaining entry into the smokeless tobacco market, where UST has two of the most recognizable and popular brands: Skoal and Copenhagen. Copenhagen, a premium brand has experienced a slight decline in sales recently, mostly because its price is a little high for consumers in a tight spending environment. However, over the last 5 years UST has consistently grown sales by more than 3% per year. Altria has tried unsuccessfully to become a player in this space for many years, but has experienced significant barriers to entry with established brands already occupying a large portion of the market.
The proposed merger between the largest American cigarette maker and the largest American smokeless tobacco maker could raise the attention of antitrust regulators. With a new administration imminent (either likely more hostile to tobacco) we are not ready to comment on the possibility of the deal being blocked, but what we can comment on is the price offered for UST.
Altria offered UST a 29% premium to Thursday’s closing price. Based on a historical analysis of what the market has traditionally been willing to pay for a given level of sales and cash flow, MO may have overvalued UST. Over the last ten years the market has traditionally been willing to pay between 10.2x and 15.1x cash flow, but stock is now trading at about 16.2 times cash flow. The sales valuation metric is a similar story; normally UST trades between 3.04x and 4.6x revenue per share, but as of today that metric is 5.1x. Clearly, this does not take in to account cost savings and possible synergies between the companies. If UST were trading at the high end of these historically normal valuation ranges we would expect the price to be about $62.34. So, based on the current (post merger announcement) valuation we have UST rated a Sell, but Altria wants a large stake in the growth of smokeless tobacco and is willing to pay top dollar for it.
Ockham Research Staff @ September 8, 2008
