BRITISH AMERICAN TOBACCO PLC.

Strategic Analysis (December 1998),
post-Zurich Demerger and pre-Rothmans Merger,
realized by György CSIZMADIA

MBA, Instituto de Empresa, Spain.

This article is NOT designed to provide any recommendation about BAT and its activities. 
It only expresses the views of the author and was written without contacting that Company.

1. History
2. Size
3. Ownership

II. The Environment

1. Low Technology Business
2. Social Context
3. Competition and collaboration

III. The Organization

1. Structure
2. Strategy
3. Leadership
4. Culture

1. Profit Forecasts
2. SWOT Assessment and Recommendation

E. The News: Jan. 11, 1999: BAT acquires Rothmans for $7.5B in stock. Check CNN Report. 
 
 

A. Presentation

I. Description of the Company

1. History: Oligopolistic roots

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1890: USA: Buck Dukes establishes the American Tobacco Company, which will soon monopolize the entire US tobacco industry.

1894: USA: Brown & Williamson formed as a partnership in Winston-Salem, making mostly plug, snuff and pipe tobacco.

1901: UK: The largest British tobacco companies unite to combat Buck Duke's take-over, forming the Bristol-based Imperial Tobacco Group.

1902: In an end to the war, Imperial Tobacco Group and American Tobacco Company agree to stay in their own countries, and unite to form the British American Tobacco Company (BAT) to sell both companies' brands abroad.

1911: "Trustbusters" break up American Tobacco Company. The US Supreme Court dissolves Buck Duke's trust as a monopoly and in violation of the Sherman Anti-Trust Act (1890). The major companies to emerge are American Tobacco Company, RJ Reynolds, Liggett & Myers Tobacco Company (Durham, NC), Lorillard and British American Tobacco Limited.

1927: USA: British American Tobacco Limited acquires Brown & Williamson.

1940-1945: USA: Cigarettes are included in GI's C-Rations. Tobacco consumption is so fierce a shortage develops. By the end of the war, US cigarette sales are at an all-time high.

1976: UK: BAT Industries is formed when Tobacco Securities Trust Company Limited (TST) merges with British American Tobacco Company Limited.

1994: BAT Industries agrees to buy American Tobacco from American Brands for $1 billion.

1998: On June 12, company shareholders approved a $37-billion plan to merge BAT’s financial services arm with Swiss insurer Zurich Group. BAT's tobacco operations—second largest in the world after Philip Morris—will be spun off into a new company called British American Tobacco Plc. later this year.

2. Size

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British American Tobacco Plc. was formed as a result of the separation of BAT Industries' insurance and financial services business (which was merged with Zurich Insurance to form The Zurich Financial Services Group). Consequently, British American Tobacco Plc. is now the holding company for a group of companies engaged in the manufacturing, marketing and sale of tobacco products. British American Tobacco Plc. operates globally and employs over 164.000 people worldwide.

3. Ownership

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Publicly traded with 92 % held by institutional investors. The people who have declared substantial ownership are Threadneedle Investment Management Limited (5.45%), Lazard Asset Management Limited (0.11 %), the company directors (0.1%) and Prudential Investment Corporation (0.03 %).

II. The Environment

1. Low Technology Business: Tobacco is mainly a Marketing Business


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The production processes are extremely automated. It is not a big deal to change the formulation of the products and it has happened various times due to image problems.

Filtered cigarettes and low-tar formulations are good examples. In 1952 the Reader's Digest published "Cancer by the Carton," an article detailing the dangers of smoking with enormous effect. Similar reports began appearing in other periodicals, and the smoking public began to take notice.

The tobacco industry responded in forming the Tobacco Industry Research Council (TIRC) to counter the growing health concerns. With counsel from TIRC, tobacco companies began mass-marketing filtered cigarettes and low-tar formulations that promised a "healthier" smoke. The public responded, and soon sales were booming again.

More recently, BAT launched the Actron Filter. Unlike ordinary filters, the Actron filter contains four ‘air channels’ helping Barclay to become BAT´s number one premium priced cigarette in several markets. Same with Fresh & Light, a Barclay line extension offering a fresh taste and clear aftertaste (well, this is what BAT says).

2. Social context: Legal Successes of the US activists

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The tobacco industry now seems vulnerable in the USA. For decades, even as the health dangers of smoking became widely known, it successfully fought off legal challenges. But anti-tobacco forces kept pushing to ban tobacco and today, the US State laws and legal precedents hold manufacturers more liable for the effects of their products.

Besides that, the old legal defense of "contributing negligence" which prevented lawsuits by people with some measure of responsibility for their own condition -- is no longer viable in most jurisdictions. Instead, a defendant can be held partially liable and forced to pay a corresponding percentage of damages.

The notion of "strict" liability has also emerged; this means a defendant can be found liable whether or not they are found negligent. If a product such as tobacco causes harm, the company that produced it can be held responsible, even if it wasn't aware of the potential danger.

As a result in recent years, cigarette-makers changed tactics and have decided to settle individual lawsuits, not fight them -- a strategy designed to keep profits up and investors happy.

Furthermore, tobacco companies on November 20, 1998 agreed on a very large settlement of $206 billion and agreed to be submitted to advertising and marketing restrictions. In exchange the industry gets a cover in all 46 US states that have reimbursement claims as well as those that have not sued.

3. Competition and collaboration

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There is a fierce competition for global market shares accompanied by huge marketing spending.

In the USA, BAT´s market share is in decline. It comes from 18 % in 1995 then 17.3 % in 1996 and 16.1 % in 1997. It is difficult to know to which measure the market is not self-regulated. The Tobacco Industry Research Council (Council for Tobacco Research called CTR) was created to counter the growing health concerns and to defend the tobacco industry as a block.

I wonder to which extent it doesn´t play the executive role of a cartel. This association was so effective that the provisions of the 1998 general settlement provide the dissolution of all Tobacco-Related Organizations.

In the world, BAT Industries Plc. is the world’s second-largest cigarette manufacturer after Philip Morris with a 13 percent market share. The group's cigarettes are available in some 180 markets. BAT owns some 250 brands. The major international brands include Lucky Strike, Benson & Hedges, State Express 555, John Player, Silk Cut, Barclay and Kent.

In 1997 i.e. before the demerger (see the strategic description of the company), BAT generated $39.7 billion of revenues where Europe accounts for more than 25%. The revenues from tobacco represented 62% alone.



III. The Organization

1. Structure

British American Tobacco Plc. is located in London and was formed when BAT Industries Plc. separated its insurance and financial services operations from its tobacco business creating two new companies: Allied Zurich Plc. and British American Tobacco Plc.

BAT Industries tobacco operations now operate as British American Tobacco, the holding company of a group of companies that manufacture, market and sell tobacco products

2. Strategy

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• Growth in the emerging markets to surpass Philip Morris

The reduction in national monopolies in parts of Europe, the former Soviet Union, Latin America, China etc. has led to the opening up of new competitive markets for British American Tobacco.

Due to these changes, the potential market has tripled creating a huge opportunity according British American Tobacco. Beside that, while the overall market is still growing slowly, there will be stronger growth in Latin America, Eastern Europe, and Asia, as these regions gain in prosperity. In order to continue to capitalize on this opportunity, BAT wants to continually improve its focused and differentiated brand portfolio. This means mammoth marketing abroad.

• Mitigate the exposure to U.S. tobacco litigation.

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The Chairman, Martin Broughton, is qualified by CNN as "the tough-talking tobacco executive". He wanted the 1998 settlement but not at any price.

4. Culture

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The company has its roots in the Anglo-American tobacco monopoly created by "Buck" Duke, the founder of the modern cigarette industry. When the U.S. government broke up Duke’s operation under the Sherman Antitrust Act, BAT came into its own and established a foothold in the U.S. market by purchasing Brown & Williamson Tobacco in 1927.

The culture is kind of secretive as a result of the problems with the governmental authorities it has experienced since its foundation and also due to the nature of the products sold. I would qualify the culture and attitude of BAT as defensive (like its competitors) trying constantly to gain social legitimacy.

B. Analysis

1. The strategy of BAT is extremely good as indicated by all the profit forecasts

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Earnings Growth -
-	Last 5 Years	This Year	Next Year		Next 5 Years		P/E
-	-	(Dec 98)	(Dec 99)		-		(Dec 98)
British American Tobacco	n/a	6.30%	15.20%		7.30%		8.2
TOBACCO	12.00%	-10.00%	12.70%		12.90%		13.8
S&P 500	13.90%	1.60%	3.80%		7.20%		25.6
Earnings History	------
-	Jun 1997	Sep 1997	Dec 1997	Mar 1998			Jun 1998
Estimate	0.78	0.96	0.74	0.76			0.82
Actual	0.8	0.62	n/a	0.7			0.56
Difference	0.02	-0.34	n/a	-0.06			-0.26
% Surprise	2.56%	-35.42%	n/a	-7.89%			-31.71%

Source : Zacks Investment Research

The management has realized that the US operations were becoming marginal. Martin Broughton would have recently said that the life expectancy of Brown & Williamson was in years) due to the increasingly costly restrictions, legal threats and social climate against the smokers (Americans account now only for 4 % of the smokers worldwide).

2. SWOT Assessment

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Strengths:

• The strategy of isolating the non-tobacco business from the tobacco business is very intelligent.

• The internationalization strategy since BAT will not have to worry about similar legal problems as in the USA.

I would say the nature of the business is the weakness of BAT. As long as they won´t sell a non harmful product there will always be people to criticize and attack the company.

Opportunities:

The emerging markets. There are no strict rules in those markets relating to advertisement. That is why the international sales are surging.

Threats:

• Attempts to cancel the BAT demerger.

• Another threat, limited to the USA, is the level of profits that can be sustained in the face of mounting litigation claims and the validity of the ring-fencing defense to protect the UK assets.

• Anti-tobacco regulations in the emerging markets.

Obviously, the volatility of the emerging markets has to be taken into consideration (cash management). A gradual move of the production units might be useful in terms of cost control and parallel evolution of the geography of the production to the geography of the consumption.

C. Exhibit

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Comparison with the competition.

Market Capitalization (USD, millions):

British American Tobacco (BTI): 28.068

Philip Morris (MO): 132.536

RJR Nabisco (RN): 9.257

UST Inc. (UST): 6.438

Gallaher Group ADS (GLH): 4.949

Swedish Match (SWMAY): 1.593

Brooke Group (BGL): 382

Schweitzer-Mauduit (SWM): 286

800-JR Cigar (JRJR): 221
 
 

P/E Ratio :

Price/Sales Comparison :

D. Newspaper References

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Courrier International nº420, 19/11/1998: Marketing: A l´Est, les fabricants de cigarettes réinventent la charité.

L´Echo 30/07/1998: Avant d'être 100% tabac, BAT affiche un bénéfice en recul

CNN 23/11/1998: Tobacco companies set wholesale hikes that will boost prices by 45 cents a pack.