Jeremy Warner's Outlook: Investing in tobacco may be unethical, but it sure is lucrative, as Gallaher bears witness

Murdoch pays Malone a premium to exit; A powerful antidote to euroscepticism
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The Independent Online

For investors of an ethical leaning, tobacco has always been a pariah industry. Unfortunately for them, it has also been an extraordinarily lucrative one, as the ever onwards and upwards march in tobacco stocks bears witness. The one-time fashion among tobacco companies for diversifying away from the killer weed today looks a gloriously foolish mistake. Hotels, financial services, restaurants - whatever it was, it would surely have a better future than tobacco, they all figured.

As it turned out, none of these things was capable of protecting them against the growing wave of tobacco-related litigation. They also proved much better at selling death by the packet than almost anything else. In nearly all cases, these diversifications destroyed, rather than added to, value. Stripped of this acquired baggage, BAT, Imperial Group and others now thrive anew in their original form as pure tobacco plays.

In the developing world, where the value of life remains low, tobacco is still a growth industry. Restrictions on marketing spend in the developed West means that cigarettes sold in mature and declining markets drops straight down to the bottom line. Few businesses are as predictable and cash generative as tobacco.

Yet if the market is shrinking, the only way to keep the earnings rising is by cutting costs. This is what drives the present race to consolidate. Gallaher Group is regarded as one of the last big takeover opportunities left for the taking. It might also conceivably be possible to bid for Imperial Tobacco, though at more than twice the size of Gallaher in terms of enterprise value, it would be quite a bite.

Neither BAT, Philip Morris nor Imps will take the acquisition of Gallaher by Japan Tobacco lying down. Indeed, Gallaher makes much more sense for all these players than it does for JT, which is still largely reliant on its domestic market, where it dominates with more than 70 per cent of tobacco sales. Its international operations are patchy. Unfortunately, virtually everyone else would run into competition problems in one market or another. That doesn't make rival bids impossible. With negotiated disposals, anything is doable. Yet it does make the whole thing more complicated and time-consuming.

If JT can come up with a decent price, it might just succeed. Making the deal value-enhancing for JT's own shareholders may none the less prove problematic. The opportunities for synergies look limited. We live in an increasingly Stalinist world when it comes to health issues, which may make future revenue streams from tobacco not quite as secure as the markets assume.

Those who have swallowed their scruples and invested in tobacco stocks have had a fabulous run these past 10 years. JT may be about to provide a timely exit.

Murdoch pays Malone a premium to exit

Rupert Murdoch used to count John Malone as a friend, if genuine friendship is ever possible between rival media tycoons. Then Mr Malone raised his stake in News Corp to 17 per cent, a move Mr Murdoch regarded as distinctly unfriendly, and all engagements were cancelled. Now, after much sabre rattling on both sides, Mr Murdoch seems to have succeeded in lancing this potent threat to the future of the family dynasty. He's done it, moreover, in a manner which further strengthens his grip on the News Corp media empire.

Yet he has also had to pay a big premium to get Mr Malone to go away. Will other outside shareholders be entirely happy with a transaction whose primary purpose is much more that of entrenching the family's interest in News Corp than shareholder value? Does Mr Murdoch care.

Outside shareholders in all Mr Murdoch's companies have come to expect their interests to be ridden over roughshod whenever they come into conflict with those of the emperor. In this sense, Mr Murdoch has more in common with the business tycoons of Asia, whose attitude to the capital markets is that they should be used but not heard, than the West, where the mores of shareholder rights tend to be paramount.

Maintaining control so as better to pursue the Murdoch vision unencumbered takes priority over all else. Thus it was that the moment Mr Malone arrived uninvited on the share register, poison-pill arrangements were put in place that would massively dilute him if he increased his stake. Mr Murdoch had to be taken to court to force him to put these arrangements to a shareholder vote.

Similar concerns surround this latest manoeuvre. To be fair, the transaction as outlined is not wholly without commercial merit. In return for its 19 per cent stake, Mr Malone's Liberty Media will get News Corp's 38.6 per cent interest in the US satellite broadcaster DirecTV Group.

If that was where the asset swap ended, then it would seem a reasonable enough exercise, as the two stakes are worth roughly similar amounts. But actually Mr Murdoch is also paying $550m in cash and transferring three regional sports networks as well.

Both sides end up avoiding large amounts of capital gains tax by dealing in this manner. Even so, Mr Murdoch seems to be paying handsomely for the prize of getting rid of Mr Malone. The effect is also to raise his own, family stake in the company from 30 per cent to 36 per cent.

It is questionable whether at just 30 per cent Mr Murdoch could be said genuinely to control the company. In theory, it would always have been possible to take the company from him. But at 36 per cent, it becomes much more difficult. In essence, Mr Murdoch is using the company's money to strengthen his own position within it.

It will be interesting to see what safeguards he offers to buy off the likely shareholder protest if the deal as signed is in this unalloyed form. In less extreme but similar circumstances at BSkyB, he was forced to agree not to vote any increase in interest acquired through share buy-backs. He may have to do the same thing in this instance.

A powerful antidote to euroscepticism

British business seems to have turned almost universally eurosceptic in recent years, so the pamphlet published yesterday by Business for New Europe - "A Europe We Can Do Business With" - makes a refreshing antidote to the ill-informed prejudice that has come to characterise so much of what is said and written in this country about the EU.

The sponsors have persuaded an impressive 36 leaders from business, the City, and the professions to make the case for Europe, and a pretty compelling read it makes too.

Everyone has their own particular take, and most of them qualify their remarks with reference to the urgent need to pursue the reform agenda within the European Union. All are realists, and nobody is pretending there aren't huge challenges ahead. Yet the great thing about the EU is that, though it aspires to be a single market, it is self-evidently not a single economy, culture or country. It is this diversity which is likely to be part of its strength in the global economy now fast becoming the over-riding reality.

I hardly dare highlight one of these luminaries for fear of upsetting the others, but one of the best perspectives, spoken from the heart, as it were, comes from Charles Dunstone, chief executive of Carphone Warehouse. I couldn't put it any better, so I'll let him speak for himself: "There are some in the UK who think that we have the answers to everything, and that Europe can teach us nothing. These people affirm that we are Anglo-Saxon and highly competitive whereas our Continental neighbours are slow, old-fashioned and lazy. This is not what I find when I visit the Continent. We should be open to learning from our Continental partners in different areas, including in the sphere of business and economic policy. It is notable that the most successful countries in Europe at the present time are the Nordic ones - Sweden, Finland, Denmark. They have been able to become competitive in the global market place." Quite so.

j.warner@independent.co.uk

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