Rolls-Royce: questions remain despite £671m bribery settlement

https://www.theguardian.com/business/2017/jan/17/rolls-royce-bribery-settlement

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For Rolls-Royce, the company, the book is now almost closed. It has apologised “unreservedly” in court for the bribery and corruption in its midst in the period 1989 to 2013. It will pay £671m in penalties, the lion’s share in the UK. It has changed its senior management. And, under the terms of the deferred prosecution agreement (DPA) with the Serious Fraud Office, it will improve its behaviour on pain of getting properly whacked.

But the affair cannot be left to lie there. Read the statement of facts in the case, and consider the words of Sir Brian Leveson in the high court as he approved the DPA, to appreciate the size of this scandal. Rolls-Royce’s internal investigation, we learn, involved disciplinary proceedings against 38 individuals in its civil aerospace, energy and marine divisions, leading to 11 employees leaving the company during the disciplinary process and six being dismissed. Others have suffered sanctions short of dismissal.

That is a sizeable tally but naturally understates matters since disciplinary proceedings could only be taken against those still on the company’s payroll in 2013 and afterwards. The corruption spanned three decades, remember. And look at Rolls-Royce’s review of the intermediaries it used to win contracts in foreign markets. The company examined 250 relationships and suspended 88 intermediaries.

If that suggests a past culture where corruption was completely out of control, so do the words of the judge in his concluding remarks: “My reaction when first considering these papers was that if Rolls-Royce were not to be prosecuted in the context of such egregious criminality over decades, involving countries around the world, making truly vast corrupt payments and, consequentially, even greater profits, then it was difficult to see when any company would be prosecuted.”

Leveson nevertheless approved the DPA because he accepted that Rolls-Royce is “no longer the company that once it was” and its new board and executive team has sought “to clear out all the disreputable practices”. That seems pragmatic and correct: there is no point in destroying Rolls-Royce, damaging its suppliers and undermining the UK’s defence capabilities.

But two questions still loom large: who, at the top at Rolls-Royce, knew what was going on and when? Tuesday’s documents contained no names but, again, the judge’s remarks were powerful. He referred to “most serious breaches” of the criminal law “some of which implicated senior management and, on the face of it, controlling minds of the company”. Note, too, the detail that the company, after starting its own investigations in 2013, supplied the SFO with “a report concerning conduct Rolls-Royce had known about since 2010 and previously (under different leadership) decided not to notify”.

Until the controlling minds at Rolls-Royce in the relevant period explain their conduct, consider this tale incomplete. A company regarded as the UK’s finest has been disgraced. Now we need to know who let it happen.

BAT’s Reynolds takeover shows Big Tobacco is far from burnt out

It’s amazing now to recall that when British American Tobacco sold its US subsidiary Brown & Williamson to RJ Reynolds in 2004, taking a 42% stake in exchange, the deal was worth only $3bn (£2.42bn at current rates). Wind forward to the present day and the numbers have become extraordinary. BAT is now buying the remaining 58% of the restyled Reynolds American, owner of Camel and Newport, for almost $50bn.

One must adjust for the $4.7bn BAT injected to maintain its 42% holding after Reynolds’ takeover of Lorillard, another US fags firm, in 2015. Even so, the inflation in valuations shows what a wonderful investment Big Tobacco became once the threat of ruinous class-action litigation was removed. That era began with a grand settlement with 46 US states in 1998 and was later cemented by various rulings that limited punitive damages.

The share prices tell the story. Back in 2004, Reynolds’ shares traded around the $8 mark, versus a valuation of $59.64 in Tuesday’s deal. BAT’s shares, in the same period, have improved from £9 to £46 with barely a wheeze along the way. There is cash – and plenty of it – in selling to customers who tend to remain loyal until they kick the habit or die. And, in the age of low interest rates, there have been easy opportunities to spice up returns to shareholders via the use of debt.

Is there any mileage left, though? BAT is betting there is because it is buying Reynolds at almost 17 times its earnings, thought to be the highest price ever paid for a large tobacco firm. That ratio looks aggressive, especially as promised cost savings of $400m are small in the context of the deal. But BAT chief executive Nicandro Durante could probably justify the punt on four grounds.

First, the effective oligopoly in the US market means cigarette prices can continue to be increased gently. Second, there’s a chance Donald Trump will cut corporate taxes, which would do wonders for Reynolds’ bottom-line earnings. Third, the cigarette giants are well on the way to controlling the vaping market (which “satisfies different consumer moments”, in BAT’s grim language), so the threat of major upheaval in earnings is slight. Fourth, it’s hard to go too far wrong in cigarettes; it will take five years to achieve returns in the US that beat the cost of capital, thinks BAT, but it can be confident of getting there eventually.

In short, this mega-deal suggests Big Tobacco’s winning run can continue for some time yet. It didn’t seem possible in the litigation-heavy fog of 2004; now it seems probable.