Five Thoughts: Scandinavian Tobacco Group’s Acquisition of Agio

We rate cigars, not cigar M&A deals, but I’d have to give Scandinavian Tobacco Group’s (STG) planned acquisition of Royal Agio Cigars a pretty decent score. The companies announced earlier today that STG has agreed to buy the Dutch-based maker of Panter and Mehari’s—two little cigar brands that are popular in Europe—for €210 million ($232.61 million).

The deal is subject to both regulatory approval, as well as approval from work councils, a form of union, at Agio, but is expected to close in the first half of next year. While Agio is not a large player in the premium, handmade cigar business, it generated nearly $150 million in sales last year and just sold for more money than any cigar company of recent memory.

STG competes with Agio on the machine-made size of the business and also. to some degree in the handmade cigar space. It is the parent of General Cigar Co., Cigars International, Thompson and others. Agio has a relatively young handmade cigar business—under the Balmoral and San Pedro de Macorís brands—and a relatively new U.S.-based distribution operation.

On paper, the agreement looks pretty smart: STG will scoop up a decent bit of market share in some key European countries and can likely find ways to make the machine-made cigar operations between the two companies operate more efficiently. Furthermore, due to Imperial Brands, plc’s decision to exit the cigar business, STG likely didn’t have to bid against its largest competitor. It pays less than a dozen times EBIDTA for a strong brand and knocks a key competitor off the board.

For most readers of this site, Agio still isn’t the biggest of names, but it’s $230 million deal, a lot of money for this business. And I’ll admit that when I woke up to the news, I had a few initial thoughts.

WHAT DOES THIS TO DO STG (THE STOCK PRICE)?

As I’ve mentioned a couple of times lately, STG’s stock price is struggling. Today’s announcement didn’t show investors thought this was a saving grace as the stock fell 1 percent in trading today, so a relatively indifferent position. Despite high profile acquisitions and cost-cutting, STG’s stock has struggled lately. From the STG side, the company feels like it is being unfairly expected to deliver dividends like a publicly-traded cigarette company.

The company says that Agio generated €124 million in revenue in 2016, €129 million for 2017 and €133 million last year. It netted €18 million in EBITDA, a measure of profit, in 2018.

STG will pay an 11.67x multiple on EBITDA, though more interesting, the company says that it expects the Agio deal to be “EPS (Earnings Per Share) accretive,” by year two, basically meaning that the deal will take a year to be net positive for shareholder’s dividends.

The company hasn’t said how much debt it will take on to help finance the deal. For reference, STG reported having cash or cash equivalents of DKK 284.6 million (€38.1 million) at the end of Q2 2019.

If we go any further, the numbers and acronyms are going to go above my head—I walked by the Wake Forest business school, I never went in it—but the real questions are the one above—what do the shareholders think?—and, what happens if this doesn’t work?

STG Won’t Be Buying Imperial’s Cigar Division(s)

My first thought upon reading the news was: woah, I guess STG is officially out of Imperial.

Imperial Brands, plc—STG’s biggest rival in the cigar space—is trying to get out of the cigar business. You can read more about that here, but in short, the company has put Altadis U.S.A., JR Cigar, a 50 percent share of Habanos S.A., stakes in various local Cuban distributors, two cigar factories, Casa de Montecristo and more up for sale. Analysts at Jefferies estimate that Imperial could generate $1.3-2 billion from the sale of the premium business.

Over the last couple of months, Imperial has heard bids in person, first in Europe and then more recently in the New York/New Jersey area.

As expected, STG bid. For years, the company has made no secret that it would love to own its largest U.S. competitors and a stake in the Cuban cigar business.

But given how much debt STG already has on its books—around $425 million—it seems almost certain that STG won’t be buying the Imperial cigar assets after today’s news unless investors are really willing to boost the debt, which seems unlikely.

Separately, a source told halfwheel that STG didn’t make the final list of bidders for the Imperial assets.

How Many People Have STG/Swedish Match Acquisitions Laid Off In the Last Two Decades?

Companies are not people. And companies don’t have souls.

What STG is doing—just like it has done countless times before, i.e. outside of the Toraño deal—make sense. But STG and its predecessors have a fairly lengthy list of cigar companies that they have purchased, which have led to consolidations and loss of jobs.

It hasn’t announced what it will do with Agio—and I suspect that the layoffs will be a lot less than most of the U.S.-based acquisitions—but the company or its predecessors have now acquired:

• El Credito Cigars/La Gloria Cubana (1999)*
• General Cigar Co. (2000)*
• CAO (2007)
• Cigars International (2007)*
• Latin Cigars (2009)
• PipesandCigars.com (2013)
• Toraño (2014)
• Thompson Cigar (2018)
• Royal Agio Cigars (2019)

*These acquisitions were made by Swedish Match, which was separate from STG until 2008. In 2009, the companies merged divisions to create the modern STG, though Swedish Match exited the partnership in 2017.

While STG probably employs more people in the cigar business than anyone else today, it also is almost certainly the leader in the modern era for laying off people in the cigar business. Some of them—particularly the CAO employees—were laid off twice, once with CAO and again with Toraño.

I’m not putting it out to cast STG as some sort of big bad wolf, rather, there are positive parts of capitalism and the are some negative ones, this bullet point highlights the latter unless you are a consultant.

Balmoral is Likely to Get Lost

Agio has tried to sell cigars in the U.S. for years and it has struggled. In the early 2000s it was distributing its own products, Davidoff and Drew Estate each were brought on as distributors at various points and then Agio once again took back distribution in 2017.

It’s been much more aggressive. There’s an in-house team, a fair bit of marketing push and a portfolio of handmade cigars—all introduced over the last handful of years—that is probably now too big.

But Agio will at some point become just another stop on the General Cigar Co. brand portfolio tour. Perhaps it fares better than Toraño, but Agio wasn’t bought for its U.S. handmade cigar business and General’s patience in trying to promote brands other than CAO, Cohiba and Macanudo isn’t that high, and understandably so.

The Balmoral and San Pedro de Macorís brands will get an initial boost and if sales don’t respond well, General will move on to one of the other dozens of names in its extensive portfolio. Compare that to J. Cortès’ purchase of Oliva—whose portfolio and staff is almost identical to where it was pre-sale—and it’s going to be much different.

I’m guessing that General won’t ax the brands immediately—it took a while for Toraño to go away—but the company’s Agio C.T.C. factory in the Dominican Republic is a bit of a different story.

It’s located in San Pedro de Macoris, hours away from General’s massive factory in Santiago or even its smaller factory in Moca, which it ironically was founded by the Henri Wintermans company, which was established by the brother of the person who started Agio. For context, Agio’s factory employs close to 900 people, General Cigar Dominicana employs nearly 2,200. Perhaps the factory remains open for a few years, but it’s challenging to see the economic sense of keeping the factory open in the long run.

WHAT’S NEXT FOR STG FIRST STARTS WITH WHAT HAPPENS WITH IMPERIAL

I’ve already gotten the texts from those in the industry: A.J. (Fernández) is next, Davidoff is next, Famous (Smoke Shop) is next, Plasencia is next. Maybe? Probably not. Certainly not all of them.

If I had to guess, the next move will come from Imperial, probably in late Q1 2020, before the unofficial May 2020 deadline the company set for itself, though more recently the company said an announcement would be made before December.

STG has looked at buying many companies, it’s made offers on some, like Oliva, that were rejected. And I don’t think it’s going to stop making offers for companies, but it would seem wise to wait and figure out what happens with Imperial, so you at least know who you are playing chess—or maybe Monopoly—against.

It’s a very different scenario if Imperial’s sale fizzles and the British company still owns a cigar business it tried to sell versus the mythical deep-pocketed buyer from the East now in charge of Romeo and Montecristo.

And once we know the answer to that, we’ll understand how the game will be played going forward because at the moment—even if seems like it’s not winning—STG is sort of the only one in the room playing this game.

Update (Sept. 18, 2019) — Francisco Batista of Agio has clarified that the company’s factory in the Dominican Republic employs more than 850 people, not 220 like the company’s website states.