U.S. Philip Morris Wants To Buy Canada’s Rothmans

by Mr. Cheap

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It was recently announced that Philip Morris put in a generous offer to buy Rothmans (of which Mr. Cheap is a little less than a majority owner).  On news of the offer, Rothmans stock shot up above $30 / share then sank back to a bit below it (to $29.71 as of the holiday weekend).  We received a reader’s question (from Mike’s sister!) asking what’s going to happen to Rothmans stock.  I’ll write up what I’ve read and my understanding of the process, please feel free to correct me if I get anything wrong and I’ll update the post (I’m certain many of our readers understand the process better than I do).

To start with, a share of stock is partial ownership of a company.  When an offer is made on an entire company, the person putting up the offer is sayings “I’ll give you $X for the whole thing”.  If the company rejects the offer, then its business as usual.  If the company accepts the offer, its ownership is transfered to whoever purchases it.  This can be another company (as in this case with Philip Morris), some legal entity (as in the case of the BCE buyout by the Ontario Teachers Pension Plan, or an individual (I don’t have an example of this, can anyone suggest when this has happened recently?).

When the offer is made, shareholders get to vote on whether to accept it or not.  More than 50%A certain number (usually 2/3rds – thanks MoneyGrubbingLawyer!) of the shareholders by VALUE (remember, you get one vote PER SHARE, not per person) must agree to the offer for it to go through.  Since there wouldn’t be much reason for the average shareholder to accept less than the current stock price (if they wanted to sell, they could sell it at the current price on the open market), the person trying to acquire the company usually needs to offer a premium (higher price) above the current price of the stock.

If the offer is approved (I’ve never actually gone through this personally), my understanding is at some point every share of the company is bought at the agreed upon price, the cash is transfered to the previous owners, and 100% ownership in the company is acquired by the purchaser.

If you’re in the minority that doesn’t want to sell, its tough luck.  Usually part of a corporation’s articles of incorporation will allow majority rules in situations like this.

This is the opposite of when a holding company sells another company that it owns (as Philip Morris did with Kraft and as GE wants to do with its appliance business).  In this case they package it up as a separate company, sell it to someone else who wants it, and it now exists as a separate entity (and the selling company now has a bunch more cash).  They can even do any IPO and sell the newly created company directly to the public.

There are all sorts of business, legal and tax reasons why a company would want to purchase another company (or sell part of itself).

After the purchase goes through, and the cash has been received, for the previous shareholder its as if they had chosen to sell the stock.  They are liable for capital gains if the price its acquired at is higher than their purchase price (which is likely if they bought it years ago).  This is why BCE shareholders were squawking so much about the acquisition, they knew it was going to lead to a hefty tax bill for them.

Currently the board of directors at Rothmans has recommended that shareholders accept the offer, which is a good sign.  The price went ABOVE $30 briefly, because there was a feeling that a higher price may be forthcoming if enough shareholders didn’t bite at $30.  The famous Canadian investor Stephen Jarislowsky (author of “The Investment Zoo“)’s company owns 13% of Rothmans, and he’s known for holding out for high prices before approving sales.  Conversely, the price will sometimes be lower than the buyout price, which reflects both that the payment will be in the future, and investors’ concern that the deal won’t go through (thanks Preet!).

If shareholders push for a juicier offer, and its not forthcoming, the stock may sink back to its previous level and we can continue as before.

As I said in the introduction, please highlight anything I’ve got wrong, as I’m not 100% sure about this information.

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{ 17 comments… read them below or add one }

1 Nurseb911

In this situation I would still sell ~$30. You might get more, but you might get a lot less. The risk involved is almost unknown and if you had bought recently you’d be looking at a nice gain. When you consider the bill needed to be paid to settle the lawsuits I didn’t hesitate to sell out of my position (I used it as a charity dividend play) in the face of many unknowns.

2 Four Pillars

Interesting – so what did you buy it at?

Mike

3 WhereDoesAllMyMoneyGo.com

Sounds like you hit all the major points as far as I know. I would mention that normally the price of the stock will trade at a discount basically equivalent to the risk-free rate until the deal closes unless there is transaction risk (a la BCE).

The logic is that if the shares started trading at $30 with 6 months before the transaction closes (example, and assuming that $30 is the deal price), then you could sell and put the money in a high interest savings account (or T-bills) and collect risk-free interest until then, thereby coming out ahead.

If the stock trades higher than the risk-free discount amount, then it indicates that the market thinks there is a chance at a higher offer or competing bid. If it trades lower, then the market is expecting that the deal may not go through.

Short term aberrations will still occur though for the normal trading reasons.

4 MoneyGrubbingLawyer

You’ve got the process right for the most part, although I would note that in most cases (including this one, as I recall), approval of two-thirds of the shareholders is required, not 50% + 1. I would also add that it’s not uncommon for takeovers to proceed with share exchanges, where shareholders receive shares of the purchasing company rather than cash.

5 Mr. Cheap

Nurse911: I had no problem owning ROC before this offer was made, so I still don’t. If the deal falls through, I’ll be happy to just keep collecting my dividend payments.

Mike: I bought at an average price of $21.73 between May 15 – June 16th 2007. There was a dividend increase in November which pulled the price up sharply. If I’d sold on close on Friday I’d have gotten a 36.72% return (although this is the only stock in my portfolio that isn’t in the red, so don’t be too envious of me ;-) )

6 ThickenMyWallet

What?!? No comment on the fact this came out the same day ROC was fined heavily?

ROC did freeze the dividend payment.

If no one launches a lawsuit for a greater valuation by mid-Sept, I suspect what you see is what you get.

7 MoneyEnergy

Interesting. I just read Jarislowsky’s “Investment Zoo.” Didn’t know he held that much of Rothman’s, but it makes sense, I guess. I wonder though if it is HE that holds that personally, or whether it’s Jarislowsky Fraser as an institutional holder.

8 Mr. Cheap

TMW: I think lawsuits are pretty much business as usual with tobacco companies.

I missed that they were suspending the dividend (curse their oily hides!). Thanks for pointing that out.

9 Mr. Cheap

ME: I’m pretty sure its JF as an institutional holder.

10 telly

“I bought at an average price of $21.73 between May 15 – June 16th 2007. …(although this is the only stock in my portfolio that isnt in the red, so dont be too envious of me )”

Cheap, looks like you and I are in the same boat! :( I bought ROC back in Oct. at $22.50. Everything else in my non-reg. Questrade account is down since I opened it last summer (except for BNS which is only up ~5%).

I can’t even afford to buy a pack of smokes!

11 Mr. Cheap

telly: lol How are you thinking about handling the buyout? Any interest in selling soon? How do you feel about the suspended dividend?

12 telly

I actually hadn’t given it a thought until I read this post! I knew the dividend was suspended but figured I’d just wait until the deal went through although this post (and the responses to it) are making me rethink my position.

There are definitely other companies I’d be happy to pick up right now.

It’s just too bad I’m diversified and only own 50 shares!

13 Mr. Cheap

There is a recent Globe article with more info about the takeover, and Rothmans just paid off $150 million of debt.

14 telly

MC: I ended up selling my shares last week just after the earnings report (a huge loss due in large part to the settlement charges) was reported. It didn’t end up affecting the share price but it motivated me to cash in and take my winnings home. :)

Maybe I was too early.

15 Mr. Cheap

telly: I can understand the temptation. JF only owns a small portion of the company (and Altria already owns a big chunk of it), so there might not be THAT much leverage to improve the deal. And as you and the Globe article say, the big loss due to the settlement charges will pull down the stock price if the deal doesn’t go through.

Selling definitely doesn’t seem like the worst idea in the world (you might even be able to pick them back up cheap if the deal falls through and the stock sinks back to $25 / share).

16 telly

Thanks Cheap!
That’s a good point. If the deal doesn’t go through, I’ll definitely pick up ROC again (although I would think it’d likely trade higher for a bit).

17 Mr. Cheap

Apparently the offer was accepted by 68% of the shareholders and the buyout will be occurring on Friday.

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