Demerger calls increase after BAT freezes dividend

Institutional investors attacked a decision by BAT yesterday to hold its interim dividend only a week after the tobacco and financial services giant paid US$1.7bn (pounds 1bn) to buy a cigarette company in Mexico. Following the dividend freeze which accompanied disappointing half-year tobacco profits, institutions said they would be increasing pressure on BAT to demerge its financial services business from the tobacco side.

BAT blamed the decision to peg the interim dividend at 10p on uncertainties surrounding the proposed $368bn (pounds 225bn) settlement of US tobacco litigation.

The news left the group's shares, already weak following delays over finalising the US settlement, 20.5p lower at 519.5p.

Mark Allanson, investment manager at Barings Investment Management, said that he was puzzled by BAT's decision, given last week's deal in Mexico. "It did seem rather unnecessary given the company has just spent pounds 1.7bn on this business and another pounds 20m closing a factory. After that, the cost of a 0.5p increase on the dividend pales in significance. I don't get the impression that the company has really explained this."

Another leading fund manager, who declined to be named, said: "Our first question when we meet them will be what are you doing? What exactly is your long-term strategy? Do you want to be big in tobacco or big in financial services? I am mystified about why they bought the tobacco business. BAT will now yield less than Gallaher and Imperial. If the company wants people to buy the shares this is not the way to go about it."

Barings and other investors said they would be calling for BAT to release value in the company by demerging the tobacco and financial services businesses. Another investor who also did not want to be named said: "What this does do is put the spotlight on the sense of splitting up the company. A financial services business would not be subject to capricious changes in dividend policy. The tobacco business always will be."

They said that comments from Martin Broughton, chief executive, that other some other countries like Israel were trying to organise US-style litigation settlements further illustrated the risk of tobacco.

Although Lord Cairns, chairman of BAT, reiterated that the company was open minded about a demerger, Mr Broughton was more cautious. He said that the Government's proposals to abolish foreign income dividends made demerging the tobacco business, which makes almost all its earnings outside the UK, more difficult, though "not necessarily" prohibitive.

He also said that a straight demerger led to "certain financial inefficiencies", suggesting that it was unlikely to happen unless BAT could make an acquisition.

Mr Allanson was also concerned about the group's current trading. "A bigger reason for complaint is that the underlying businesses are not performing as well as they appear. BAT looks like it is drifting back into the days of not generating real value for shareholders."

BAT's half-year results to June showed pre-tax profits down 5 per cent to pounds 1.2bn after a pounds 61m currency hit and tobacco profits flat at pounds 800m.

Lord Cairns said that with Congress yet to approve final details of the industry-wide legal settlement, uncertainty over the potential hit to the company, currently estimated at $1.7bn, and on cash flows had led to the decision: "We are in a valley of uncertainty. It would be misleading to indicate that it's business as usual for dividend. We must wait until the mists lift before setting an appropriate course for the dividend."

However, he said that by the full-year payout in March, the situation would be clearer. The company promised that full-year payout would "not be less than last year's 16p".

Mr Broughton said that whether there would be a settlement in the US at all was uncertain: "We are really awaiting a decision from Clinton. It is abundantly clear that he wants a settlement. The question is whether it is this settlement. If he loses any settlement that would be really very damaging [to him]. The more he delays the less likely he will get Congress approval this year ... or at all."