The Investment Column: Hold on to Gallaher as takeover talk grips sector

Give Torex the benefit of the doubt despite concerns; Chrysalis worth holding on consolidation hopes
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The Independent Online

Takeover speculation again gripped the tobacco sector this week and the "hot money" is betting on a bid for Gallaher from Japan Tobacco (JT). Although the rumours have done the rounds of City dealing rooms in the past, it seems that a deal to diversify its earnings is now more important than ever for the Japanese group.

The local market accounts for 75 per cent of JT profits and the latest market data indicates that smoking is fast declining in this part of the world. Its position is further undermined by reports that the government is looking to halve the number of smokers in Japan by 2010 in the hope of reining in rising medical costs.

JT itself has made no secret of its interest in making a major acquisition. It certainly has the balance sheet to finance a deal and of all its options in Europe a tie-up with Gallaher, the company behind the Benson & Hedges, Mayfair and Silk Cut brands, makes most sense.

The purchase of Gallaher would give it access to seven markets where it is currently not active - a bid for Imperial Tobacco would give it less - and in four of these countries Gallaher already enjoys a number one position in terms of market share. On the cost savings front, a JT/Gallaher combination also comes out superior when compared with alternatives. Analysts estimate the combined group, with its improved scale in the European regions and a jump to a number one market position in the key growth market of Russia, could achieve cost savings of 5 per cent per annum.

On its own, Gallaher is not a very enticing investment proposition. In the UK, from where the group gets 50 per cent of its profits, it is up against falling volumes as smokers are increasingly shunning its premium brands in favour of cheaper alternatives. And, in the coming years, the UK is set to become even more challenging as government-imposed smoking bans come into effect. But this state of affairs is likely to make the company increasingly receptive to a takeover approach and, given the present mania for M&A deals, an offer - probably from JT - might not be far away. Hold.

Give Torex the benefit of the doubt despite concerns

Torex Retail came out with a list yesterday of 40 contracts it secured in 2005 worth £36m in total. The provider of software to retailers was forced into the disclosure after criticism from investors over a lack of detail in a previous statement.

Torex, which sells a wide variety of technology to retailers ranging from store tills to back-office systems, also boasted that it is enjoying good growth in North America and that its order pipeline is stronger than ever. After last year's acquisition spree, the City was also happy to hear that these new businesses have been fully integrated and absorbed.

Nevertheless, concerns remain. The market has long been awaiting news on a previously flagged contract from Argos. Yesterday's statement made no mention of it leading to fears the contract may have gone to a competitor.

On the acquisitions front, Torex plans to do more deals over the coming year. This worries Numis Securities. It would rather see the group focus on growing the business organically and warns that making acquisitions is a risky operation. The broker does have a point - when purchases go wrong it usually ends up being very costly for the acquirer.

Torex's reply to these concerns highlighted the impressive track record of its management team when it comes to integrating acquisitions. At this stage investors should give the company the benefit of any doubt, especially given the lowly rating of its shares. They trade at just 13 times forecast earnings for 2006, which is far too conservative for a company which is tipped to deliver a near 80 per cent rise in profits for that year. Buy.

Chrysalis worth holding on consolidation hopes

In recent years, the great promise of the radio industry has turned into pretty dismal reality. Consolidation has produced one deeply challenged sector leader, GCap Media, and poor advertising revenues seen across the sector.

Chrysalis, one of the main radio players, reported yesterday that ad revenues were down 2 per cent for the five months to the end of January. That is much better than the industry as a whole over the period, which was down 7-8 per cent. Although Chrysalis trading was positive for September and October, it showed a 6 per cent decline for the remaining three months. That's hardly encouraging. However, as the company goes forward it will find itself up against increasingly favourable comparatives and should soon start to register growth.

The other half of Chrysalis, a music business, performed much more strongly. At 160p, Chrysalis shares are worth holding only because it may well be involved in sector consolidation.