British American Tobacco, the world's second biggest cigarette maker, last night kicked off a European acquisition drive with the 2.3bn (1.6bn) purchase of ETI of Italy.
BAT trounced rival offers from the Franco-Spanish Altadis and a consortium of Italian businessmen to seal the deal, paying 800m more for the former state monopoly than the market was expecting.
The move catapults the UK maker of Lucky Strike and Dunhill to the number two position in Italy, behind Altria, the US group that owns Philip Morris. It sets the stage for a showdown with the US company because ETI manufactures its best-selling Marlboro cigarettes as well as distributing all of its other brands.
The level of BAT's bid, delivered to the Italian government yesterday morning, caught analysts by surprise. One sector watcher called the price "excessive" but Chris Wickham, at Lehman Brothers, said: "While the price might seem high, strategically it's the right thing to do. Europe is the most exciting place to be in the world tobacco industry."
Martin Broughton, BAT's chairman, defended the company from suggestions it had overpaid, saying: "We got a good deal at a fair price." Admitting "the price is higher than the market had been expecting", he added: "It reflects the detailed information we have received, the discussions we have had with ETI's management and our view of the long-term prospects for the business and synergies that can be achieved."
City sources said Altadis, which in June bought the former Moroccan tobacco monopoly, had bid 1.51bn, while the consortium of Italian businessman known as Imprenditori Associati offered 1.52bn. Analysts had tipped Altadis as the most likely to succeed because it stood more of a chance of retaining the lucrative Philip Morris contract, given that it already distributes the North American company's cigarettes elsewhere in the world.
Sources close to the negotiations said BAT's last-minute decision to team up with the Italian business magnate Franco Bernab and the trade body Confcommercio had helped to tip the process in its favour - that and the full price. BAT was forced to find a new partner after Swedish Match, the loose tobacco maker, pulled out of a joint bid in April. A BAT spokesman said Mr Bernab, the former boss of Telecom Italia and the oil and gas group ENI, and Confcommercio would be tasked with ensuring the independence of ETI's distribution arm, Etinera, which distributes every cigarette sold in Italy. Neither is an equity partner, he added.
The contract with Philip Morris runs until January 2005 and can only be axed with one year's notice. The spokesman said distribution accounted for 20 per cent of ETI's operating profits last year, half of which came from Philip Morris cigarettes.
BAT has been under pressure from investors to make an acquisition for some months. The deal, which will be funded from existing company resources, is expected to enhance earnings from day one, before goodwill amortisation, the company said. It expects to reap annual cost savings of 35m by 2007.
Analysts said yesterday's deal could herald the start of an acquisition spree in Europe. BAT is known to be keeping a close eye on the pending sale of two state-owned Serbian tobacco businesses. The disposal of Tekel, the Turkish state tobacco and alcohol monopoly, is also due within months.
The acquisition, which requires approval from the European Commission, takes BAT's Italian market share from 5 per cent to 31 per cent, behind Philip Morris's 61 per cent.
ETI's best-known brands are MS and Sax. After cost-saving programme, comprising factory closures and about 5,000 redundancies, the group is expected to report operating profits of 190m in the year to the end of September, up from 145m a year earlier.
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