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Japan Tobacco to Buy Gallaher for $14.7 Billion

Japan Tobacco said on Friday it would buy Britain's Gallaher Group for $14.7 billion in the biggest-ever foreign acquisition by a Japanese company.

The takeover could help Japan Tobacco offset declining cigarette sales in Japan and reinforce its position as the world's third-largest tobacco firm behind Marlboro maker Altria Group Inc. and British American Tobacco Plc

"JT wants to boost its global market share with one big purchase," Fitch Ratings analyst Satoru Aoyama said. "We might say it is a strategy to survive."

Japan Tobacco said it agreed to pay 11.40 pounds per share for Gallaher, the maker of Benson & Hedges and Silk Cut cigarettes. The deal values Gallaher at 7.49 billion pounds ($14.7 billion) and is worth 9.75 billion pounds ($19.1 billion) including Gallaher's interest-bearing debt.

"They are paying a pretty full price," said Marc Desmidt, head of the Japanese large-cap equity team at Merrill Lynch Investment Managers. "But they do get good growth in emerging markets and they are getting very strong cash flow."

Shares in Japan Tobacco, which makes Mild Seven cigarettes and owns the Camel, Winston and Salem brands outside the United States, rose 3.1% to 597,000 yen on Friday.

Japan Tobacco, 50 percent owned by the Japanese government, offered cash for all of Gallaher's shares. It said it would use a combination of cash reserves and loans from Merrill Lynch to fund the purchase.

The Nihon Keizai business daily reported that Merrill may extend up to 1.5 trillion yen ($12.7 billion) in bridge loans to finance the deal.

Gallaher trades at a forward price-to-earnings ratio of 17.6, compared with 14.6 for British American Tobacco and 15 for Imperial Tobacco, ranked fourth in the world.

Fitch's Aoyama said he was "concerned" about the financial burden on Japan Tobacco but added that "it would not necessarily damage the company."

Overseas cigarette sales have been Japan Tobacco's main source of profit growth. It bought RJR Nabisco's non-U.S. tobacco business for $7.8 billion in 1999, and in 2005 international sales volume overtook Japanese volume for the first time.

In Japan, where Japan Tobacco has a two-thirds market share, cigarette sales fell 1.3% in the six months to September from a year earlier to 2.02 trillion yen. Sales volume fell 4.7% to 140 billion cigarettes.

Global Profile

Japan Tobacco said it was aiming to complete the acquisition in the first half of 2007 and would make Gallaher a wholly owned subsidiary.

The deal is worth about 50% more than telephone operator NTT DoCoMo Inc.'s $9.8 billion takeover of AT&T Wireless Group in 2000, the previous record for a Japanese international acquisition.

Gallaher earns 70% of its profits from the shrinking cigarette markets of Britain, Ireland, Austria and Sweden. To offset this fall it has been expanding into Russia, Kazakhstan and Ukraine, and earnings there have risen sharply.

In Europe, Japan Tobacco is strong in Spain, France and Italy.

"As far as JT's share price is concerned, this deal would likely support continuous growth," said a Japan-based analyst who asked not to be named.

"I'm sure JT does not want to pay this much, but it has probably judged that it would be better to pay than to lose Gallaher to another company."

The takeover is Japan Tobacco's first big deal under CEO Kimura, 53, who ran the company's Geneva-based international operations for seven years before taking his current position in June.

Analysts said the success of the RJR Nabisco acquisition, which lifted Japan Tobacco's global profile and is bringing in profits, has reassured executives that even a pricey takeover of Gallaher will benefit the company.

Analysts said the offer would likely satisfy Gallaher shareholders. Japan Tobacco is in a strong position, they said, given its hefty cash pile of 1.22 trillion yen ($10.4 billion) and the low cost of raising capital in Japan.

Japan Tobacco could sell off Gallaher's German and Austrian distribution businesses to Altadis for $1 billion to get around any antitrust problems, analysts said.

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