Profitable smoke

This development is not new and first occurred in Sept. ’15.  It has only in recent weeks started making the rounds again indicating that the end game is near.

The beleaguered Lalit Modi, hounded by ED for alleged financial irregularities, is looking to sell his family’s (K. K. Modi group) 47% stake in the cigarette major Godfrey Phillips. Philip Morris Global Brands (PMGB), a subsidiary of global cigarettes major Philip Morris International (PMI), holds 25% stake in the company and may be open to the idea of buying out Modi family and taking a controlling stake in GP. Since Sept. last year, when this first got out, the stock of GP has more than doubled in the last few months from 557 to the current more than 1200.

Though ITC dominates the cigarettes market with an 80% market share, with brands like Wills Classic and Gold Flake, GP is a distant second with reasonably well known brands like Four Square, Red & White and Cavanders. Additionally, GP also manufactures and distributes Marlboro brand of cigarettes under licence from PMI. The company has also forayed into the pan masala segment under the Pan Vilas brand.

Lalit Modi has been out of the country for 5 years because of the alleged financial irregularities in IPL and ED has been investigating the matter for quite some time now. And because of his continued absence from GP board meetings, he had to lose his board seat as well.

However, this deal may not simply sail thru. This is because govt. has been discouraging FDI in this sector for quite some time now. FDI in cigarette manufacturing is no longer allowed; moreover, activity relating to these products, including wholesale cash and carry and retail trading, are governed by restrictions laid down in the FDI policy. Smoking has been under the govt’s scanner for a while nnnow, so much so that there have been some far reaching measures such as ban on smoking in public places and sale of loose cigarettes, not to mention this being a favourite sector for the govt. to raise taxes annually. This has also led to the cigarette companies losing significant ground in the markets in the past few years, with the exception of ITC which, though earning a major part of its revenue from cigarettes, has other diversified interest as well which have served as a good hedge for it not to fall as much as its sectoral peers. So there may be a provision for special permissions to be taken by foreign companies if they do want to invest in manufacturing cigarettes here, and this condition may come under to PMGB’s rescue if the deal does go thru.

So in the current market turmoil, it may be a good idea to start accumulating this stock steadily. Once the news of Modi family’s interest in selling stake gets out, there may be other suitors also who may line up for the substantial stake, leading to a bidding war (remember Mangalore Chemicals and Fertilizers?). Already, the name of Japan Tobacco (JT), the world`s third-largest listed tobacco company and maker of popular brands like Camel and Winston, is doing the rounds, as a probable suitor for the stake on offer. JT surrendered its manufacturing licence and left India in 2011 after revised FDI regulations halted further foreign investments in the tobacco manufacturing sector, but has now been scouting for a re-entry into India. And even if there are no other suitors, the Lalit Modi family, by virtue of their controlling stake, would certainly expect a hefty premium over the market price. Also, since the stake on offer is more than 25%, it would inevitably invite an open offer from the acquirer. As has been seen earlier in numerous cases, the ultimate beneficiary would be the investor who latches on to it at a very early stage and enjoys the heady ride.

The caveat here is that the stock has more than doubled in the last few months since the news of stake sale has started circulating and a regular accumulation rather than a lump sum investment would be the way to go in such circumstances to minimize the risk, by averaging the net price of the total holding.

This is a tactical opportunity and should be viewed as such. Long term investment in a sector such as cigarettes is certainly not a winning proposition.