Reynolds American
Reynolds American
September 11, 2016
Viacom
Viacom
February 15, 2018
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British American Tobacco

Consumer Goods   |   United Kingdom

British American Tobacco

Investment: Short
Status: Exited (Q2 2018)

Summary

We disclosed a short position in British American Tobacco (“BAT”) on August 2, 2017. Our thesis is grounded in structural headwinds and transaction mispricing: the world’s largest listed tobacco group is overlevered on legacy assets at the very moment regulatory, tax, and rate pressures are accelerating.

Following its acquisition of Reynolds American in July 2017, BAT is exposed to slowing cigarette volumes, increasing excise burdens, weak merger synergies, currency headwinds, and intensifying regulatory action in the United States. The Food and Drug Administration has signaled its intent to lower nicotine levels to non-addictive ranges, a move that would fundamentally undermine cigarette economics. In March 2018, the FDA also proposed restrictions on menthol flavoring, threatening a product category central to BAT’s cash flow. At the same time, the company faces an investigation by the UK Serious Fraud Office regarding alleged bribes in East Africa, further elevating governance risk.

Since BAT’s acquisition of Reynolds American, its shares have significantly underperformed both peers and the broader market. From July 2017 through April 19, 2018, BAT’s share price declined by roughly 33 percent, erasing more than £46 billion (~$64 billion) in market value. The transaction, which valued Reynolds at approximately $86 billion versus our own assessment of closer to $60 billion, is on track to be one of the most overpriced and ill-timed acquisitions in financial history.

BAT today trades as if it can seamlessly integrate Reynolds, sustain legacy volumes, and absorb mounting regulatory shocks. We believe that assumption is overly optimistic. The company’s balance sheet leverage magnifies downside risk, and the premium paid for Reynolds has already impaired shareholder value on a historic scale.

We exited our short position in April 2018.

(This thesis is archived and reflects our views at the time of publication.)

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