Danareksa Cigarette Sector: Last man standing

The latest news
On Thursday, BAT acquired an 85% stake in Bentoel Investama (RMBA) for US$494 million. The deal is valued at Rp873/share and translates into 24.1-22.0x PE08-09F and 3.4-3.1x PBV08-09F. These are relatively high multiples compared to RMBA’s peers. This acquisition once again demonstrates the attractiveness of Indonesian clove cigarette producers to foreign investors after Phillip Morris acquired HM Sampoerna in 2005 in a deal worth Rp10,600/share (translating into 23.4-19.5x PE04-05 and 10.2-9.6x PBV04-05).

Good for the minority shareholders
Given the high price paid by BAT, the minority shareholders of RMBA shall benefit from the deal as BAT must hold a tender offer for the remaining 15% RMBA shares. The tender offer price will be the same as the acquisition price since BAT acquired RMBA at a premium to its historical trading price. The company has failed to make a major breakthrough in the cigarette industry and has always stood in the shadow of its larger rivals. Its 1Q09 results also disappointed. Judging by Phillip Morris’s acquisition of Sampoerna, we don’t expect BAT to make significant changes to RMBA’s business model. There will be synergy, but BAT is still paying a high premium for the shares we believe. And a lack of share liquidity after the tender offer will reduce the appeal of the shares. Thus, at Rp873/share we advise investors to take profits in the tender offer scheduled to be completed by the end of August. Upside from the current trading price is 8%.

What’s next?
The acquisition shows that foreign companies recognize the strong growth prospects of the Indonesian cigarette market. As such, other Indonesian cigarette companies might be targeted in the future. Yet after BAT’s acquisition of Bentoel, the only public cigarette producer remaining is the industry heavyweight Gudang Garam. With its high market share the company may hold great appeal to potential suitors. Trading at a relatively low valuation of 9.5-9.0x PE09-10F and 1.3-1.2x PBV09-10F, the shares are attractive and we maintain our BUY recommendation on the company.