British Australian Tobacco Ltd (BAT) announced a bid to take over a small pharmaceuticals company Commo Pharma Ltd (CPL) for $3.40 in cash for each share in Commo Pharma Ltd. CPL is currently trading at $2.90 per share. While CPL rejected the offer at $3.40 per share, CPL’s management indicated it would be willing to consider offers above $3.80 and would recommend any such offer to CPL’s shareholders. BAT’s management estimates that the net present value of this acquisition would be positive at any price up to $4.10 per share in CPL. However, if BAT made any offer above $3.40, it would have to borrow cash to partly fund the acquisition. Given BAT’s credit rating, borrowing at fixed interest rates would be more costly than borrowing at current variable interest rates. Furthermore, BAT would only be able to borrow at variable interest rates due to an existing debt covenant with its current lender which expires at the end of next year.

Considering the above scenario, outline your strategy for British Australian Tobacco Ltd (BAT):

a) How would you structure BAT’s offer to CPL? (Note: You may wish to also consider current economic and market conditions in your answer.)

b) What may motivate BAT to acquire CPL?

c) What challenges may BAT’s management face post acquisition?