[Intl-tobacco] ENEWS: Expect Further Tobacco Consolidation In Europe In 2000. (fwd)

[Robert Weissman]

Expect Further Tobacco Consolidation In Europe In 2000.
Source: Salomon Smith Barney (Reg. Required), Thursday, 1/27/00
Philip Morris Cos Inc(MO)#
Rating: 1S
19990406 

Salomon Smith Barney ~ January 27, 2000 

--SUMMARY:----Tobacco


*** The recent speculation of a sale or partnering agreement of the German
cigarette manufacturer Reemtsma is, in our view, both appropriate, and
realistic given the recent fall in European tobacco equity valuations.
***Two factors lead us to conclude that Reemtsma may be an integral part
of one large tobacco M&A transaction in Europe in 2000.

**1)While Reemtsma's premium West brand is one of the most successful in
Europe, the company faces increasingly intense competition from Philip
Morris; the recently enlarged BAT; & a number of national producers.

**2)We think that Reemtsma's owners may take their cue from Rothmans'
owners who recognized that the success of Rothmans was more assured within
BAT, than outside.

***We anticipate intense competition to merge with Reemtsma, & would place
in pole position, Altadis & JT; followed by Imperial, & lastly, Gallaher.















--OPINION:------------------------------------------------------------------
EUROPEAN TOBACCO INDUSTRY CONSOLIDATION - REEMTSMA IN THE SPOTLIGHT.



Following the recent market comment concerning a sale or merger of the
German cigarette manufacturer Reemtsma, we have provided below a number of
observations of the European tobacco industry.



1) THE EUROPEAN TOBACCO MARKET HAS BECOMING INCREASINGLY COMPETITIVE AND
ORGANIC REVENUE GROWTH FOR THE NATIONAL MANUFACTURERS IS TOUGH TO ACHIEVE.
Given that the overall E.U. cigarette is essentially flat, volume growth
for virtually all manufacturers has to be generated by winning or
acquiring new market share.  Furthermore, given the proposed E.U.
regulations on tobacco advertising the entire region is becoming darker in
terms of marketing, thereby likely to make it more difficult for the
smaller manufacturers to win new share through aggressive advertising or
brand imagery.  Of course price based competition remains possible, but
tobacco discounting, unless carefully controlled, can imperil the equity
of premium or sub premium brands.  By way of example, RJR's "Winston"
brand was discounted to varying degrees and at different rates in
different markets.  As a result, over the long term, prior to Japan
Tobacco acquiring RJR International, the discounting may have harmed more
than helped that brand.



2) PHILIP MORRIS, WITH ABOUT 37% OF THE OVERALL EU MARKET HAS TREMENDOUS
MOMENTUM, AND IS ENJOYING ANNUAL MARKET SHARE GROWTH OF AN ESTIMATED 1.5%.
By way of example, within the E.U., between 1995 and 1998, the volumes of
PHILIP MORRIS grew by 25.6 billion cigarettes, or 4.3% of the overall
market.  During that same period, only the enlarged BAT (with Rothmans
International) and the German manufacturer REEMTSMA experienced net volume
growth.  BAT's volumes grew by 1.1 billion cigarettes, while REEMTSMA'S
grew by an estimated 100 million units.



In short, virtually the total volume gains of Philip Morris equated to the
volume losses of most of the other European tobacco manufacturers. By way
of example, SEITA's volumes fell by 6.5 billion cigarettes; RJR's volumes
fell by 6.1 billion cigarettes; The ITALIAN MONOPOLY'S brands fell by 5.8
billion cigarettes; TABACALERA's volumes fell by 2.9 billion cigarettes;
GALLAHER's volumes fell by 2.2 billion cigarettes; and, IMPERIAL'S volumes
declined by 1.9 billion units.  These numbers do not however tell the
whole story.  Tabacalera's trends were improving, (largely as smuggled
volumes into Spain subsided) and Imperial and Gallaher, both enjoyed
growth in the RYO (Roll-Your-Own) segment.



3) BOTH PHILIP MORRIS AND BAT MAY ENCOUNTER E.U. COMPETITION LAW
PREVENTING A PURCHASE OF REEMTSMA. The market share of PMI (Philip Morris
International) within the EU is already 37% and rapidly growing.  In
Germany, its market share is 40.4%. As a result, it is essentially barred
from acquiring new volume in Europe in any manner except by organic
growth.  Remember, that E.U. competition authorities watch both national
and EU market shares when considering M&A activity.  BAT's market share in
Germany, at almost 20% may also bar its potential purchase of Reemtsma --
BAT's overall EU share is about 13%.



4) ALTADIS & JAPAN TOBACCO MAY BE THE MOST LIKELY PURCHASERS OF REEMTSMA,
FOLLOWED BY IMPERIAL -- AND THEN GALLAHER. >From a competition or
regulatory point of view therefore, neither BAT nor Philip Morris are
likely purchasers of Reemtsma.  By contrast however, ALTADIS (the merged
business of SEITA & TABACALERA) has an overall EU market share of about
13%, and just 3% of the German market.  JAPAN TOBACCO, through its
purchase of RJR International has just 6% of the overall EU market, and
has no more than 10% market share in any individual market apart from
Greece (about 11%) and the Netherlands (about 15%.) Both companies are
eager to grow their European operations; Altadis would essentially benefit
from acquiring Reemtsma for cost cutting purposes, as well as Reemtsma's
toe hold in Eastern Europe.  For Japan Tobacco/RJRI, we think that
Reemtsma would bring growth skills that did not appear to exist under the
former RJRI as well as a supplementary management team with a strong
reputation.  Japan Tobacco has not yet announced its formal restructuring
plan for RJRI, but given that it has surplus capacity, we would expect the
announcement of sought after factory closures and headcount reductions.  
Such goals are however difficult to achieve when it enjoys few economies
of scale, and smallish volumes in virtually every European market.  We
estimate RJR's volumes in Germany in 1998 at 6.6 billion cigarettes
representing net sales in that country of approximately $295 million.



5) A DEAL WITH REEMTSMA WOULD LIKELY BE ON A FRIENDLY AGREED BASIS.
Reemtsma is a privately held company owned by Tchibo Holding AG.  Its 1999
accounts are not publicly available but in 1998 we understand that it
enjoyed net sales of $4.3 billion and net income of $190 million, implying
a net margin of 4.5%.  We estimate that in Germany in 1998 it enjoyed a
22% market share and a 6% share of the overall EU market.  Its key brands
are "WEST;" "DAVIDOFF" and "CABINET."  Within the German market, its share
fell by 120 basis points between 1995 and 1998.  During 1999, both BAT and
Philip Morris became more aggressive within the German market, although
PMI's share fell approximately 0.9% to 40.4%.  The key brands of PMI in
Germany are "Marlboro" and "F6" while BAT's key brands in the German
market are "HB;" "Lord;" "Lucky Strike;" and, "Golden American."  Japan
Tobacco's are "Camel" and "Club" while Seita's brand in Germany is
"Gauloises Blondes" with a 3%+ market share.  It is also worth noting that
within the EU between 1995 and 1998, Reemtsma's "West" brand was the only
premium brand with volumes over 10 billion to record a market share gain.  
(In 1998, West's volumes were 15 billion cigarettes.)



CONCLUSION -- A LIKELY DEAL DESPITE RECENT PRICE FALLS. We reiterate our
view that European tobacco consolidation will likely gather momentum
during 2000 with Reemtsma forming the core of that activity.  Reemtsma's
management is strong and its brands largely successful.  The decision of
Rothmans owners to sell Rothmans International to BAT was in our opinion,
a recognition of the importance of scale within the international tobacco
environment.  It is quite possible that the owners and management of
Reemtsma, while under no particular pressure to sell, have reached a
similar conclusion.  All the potential acquirers (or partners) we have
named above have the financial strength to acquire Reemtsma if the tobacco
valuations of the last two years were still intact.  But they have fallen.  
(From their 52 week highs, the Altadis stock price is down 39%; Austria
Tabak is down 34%; Gallaher is down 47%; Imperial Tobacco is down 38%; and
Swedish Match is down 24%.) As a result, the enthusiasm for all four
manufacturers will have grown.  The rather larger question is whether or
not Reemtsma's owners will feel comfortable entering into an equity
transaction at a time of depressed tobacco valuations.  Watch this space.

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