Efficient Market Hypothesis (EMH) and Financial Markets

The assignment discusses the Efficient Market Hypothesis (EMH) and its three forms: weak, semi-strong, and strong. It provides a case study on British American Tobacco Plc after the announcement of acquiring Reynolds American Inc., and analyzes how the market reacted to this information. The document also includes technical analysis of British Tobacco Plc's stock price movement using RSI, Volume, and MA indicators.

GLOBAL FINANCIAL
MARKETS

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................4
Analysis of Acquisition event.....................................................................................................4
Valuation of both organization (Reynolds American Plc. and British American Tobacco Plc.)5
Efficient market Hypothesis........................................................................................................9
1. Representing charts for event with application of various technical indicators for gauge of
market reaction............................................................................................................................9
2. Discussing efficient Market hypothesis theory.....................................................................14
3. Discussing technical analysis................................................................................................15
CONCLUSION..............................................................................................................................16
REFERENCES..............................................................................................................................17

INTRODUCTION
Financial markets is playing very important role in global picture. The present report is
giving brief discussion of merger of British American tobacco and Reynolds American Inc.
Analysis of Acquisition event
British American Tobacco Plc had proposed for acquiring 5738% of Reynolds American
Inc which was not owned on prior basis. There specific aim was to provide products of next
generation as along with this it had also acquired a UK e-cigarette organization as Ten Motives.
There main motive is to become fast and world's biggest tobacco company in mainstream of its
business. By the approval of both shareholders, as British American Tobacco had directly back
market of US as it created absence from past 12 year. The objective of this merger is to raise
development of vapes and e- cigarettes.
There is presence of agreement which had been established for holding of new publicly
organization which is Reynolds American Inc. as it has 150 million shares which are
outstanding. There was deal that it would own 42% along with existing shareholders of Reynolds
Tobacco along with agreement which would help for transferring all liabilities of master
agreement and simultaneously balance of cash had been recovers on payment obligations of past
which had been accrued. In the same series, there was contingent amount on closing the
transaction, but $750 million was average approx in that specific year. The payment of $400
would be paid by Reynold American Inc. to British American Tobacco Plc. For all future and
existing litigations related to business of United States. In the same series, this specific
combination would consolidate both second and third largest organization of tobacco in U.S
(Reynolds American, 2017).
There merger was planned for attaining strategic ambitions for long term perspective in
U.S. as it had improved cash flow along with earning per share for fulfilling completion of 1st
year. The Reynold American Plc had continued paying dividend of $3.80 which is annualized.
The merged organization had Board of 5 directors from British American Tobacco Plc and 6
from Reynold American plc. According to its recommendation there would be the annual
dividend through payout policy of net income of 75% and at end of practical implications of
ownership of 42% which is directly included by BAT for substantial repurchase agreement of
share along with programs by Reynolds American Inc.
Feature of primary transaction Acquisition of stake of equity

Date of Announcement 21/10/16
Date of applying bid 20/10/16
Agreement definitive date 16/01/17
Closed date 25/07/17
Participants of Sell side Industry Headquarters
Reynolds American Inc. Tobacco United States
Participants of Buy side
British American Tobacco plc
Valuation of both organization (Reynolds American Plc. and British American Tobacco Plc.)
 Multiples
British American Tobacco Inc.
Valuation Multiples based on Current Capitalization
Fiscal Period
12 months
Dec-31-
2015A
LTM
12 months
Jun-30-
2016A
12 months
Dec-31-
2016E
12 months
Dec-31-
2017E
12 months
Dec-31-
2018E
Total Enterprise
Value /Total Revenue
8.1x 8.2x 7.38x 6.59x 6.09x
Total Enterprise
Value /EBITDA
16.2x 15.3x 18.72x 16.69x 15.70x
Reynolds American Plc
Valuation Multiples based on Current Capitalization
For the Fiscal Period
Ending
12 months
Dec-31-
2015A
LTM
12 months
Sep-30-
2016A
12 months
Dec-31-
2016E
12 months
Dec-31-
2017E
12 months
Dec-31-
2018E

Total Enterprise
Value/Total Revenue
9.4x 7.8x 7.77x 7.47x 7.18x
Total Enterprise
Value /EBITDA
23.8x 17.3x 16.25x 15.19x 14.40x
DCF OF BRITISH AMERICAN TOBACCO
Unlevered Free Cash Flow Calculation
Calendar Year Ending December 31,
2011 2012 2013 2014 2015 2016
(2011-
2016)
CAGR
EBIT 5253 5578 5780 5036 4934 4828
-
0.0354556
801
Plus: Non-
deductible
Goodwill
Amort. 0 0 0 0 0 0
5253 5578 5780 5036 4934 4828
-
0.0354556
801
Less:
Provision
for Taxes -1680.96 -1784.96 -1849.6 -1611.52 -1578.88 -1544.96
3572.04 3793.04 3930.4 3424.48 3355.12 3283.04
-
0.0354556
801
Plus: D&A 477 443 16.7 402 440 15.4

(excl. non-
deductible
GW
amort.)
Less:
Capital
Expenditur
es -510 -664 -574 -529 -483 -449
Less:
Increase in
Net
Working
Capital 0.5 0.61 0.03639 -0.664 1.225 -2.358
3539.54 3572.65
3373.1363
9 3296.816 3313.345 2847.082
-
0.0551728
25
DCF Analysis
(2012-2016):
EBITDA Multiple
Method
Total Enterprise
Value
Terminal
EBITDA Multiple
7.5 8 8.5
Discount 0.1 35026.96 36525.86 38024.77
Rate 0.11 33728.00 35160.59 36593.18
(WACC) 0.12 32493.25 33863.01 35232.78

Implied Perpetuity
Growth Rate
Terminal
EBITDA Multiple
7.5 8 8.5
Discount 0.1 0.02 0.02 0.03
Rate 0.11 0.03 0.03 0.04
(WACC) 0.12 0.04 0.04 0.05
DCF Analysis
(2012-2016):
Perpetuity Growth
Method
Total Enterprise
Value
Terminal
Perpetuity Growth
Rate
0.03 0.035 0.04
Discount 0.1
38555.518599754
1
40692.436527806
5
43185.507443867
7
Rate 0.11
33992.786934216
7
35555.671183658
9
37341.824611592
9
(WACC) 0.12
30435.343147770
6
31617.939279601
3
32948.359927910
9
Total Equity
Value

Terminal
EBITDA Multiple
7.5 8 8.5
Discount 0.1 34943.57 36442.47 37941.37
Rate 0.11 33644.61 35077.20 36509.79
(WACC) 0.12 32409.85 33779.62 35149.39
Total Price Per
Share
Terminal
EBITDA Multiple
7.5 8 8.5
Discount 0.1 997.7830711069 1040.5829698327 1083.3828685585
Rate 0.11 960.6923956325 1001.5987968082 1042.5051979839
(WACC) 0.12 925.4350651744 964.5476081926 1003.6601512108
Total Equity
Value
Terminal
Perpetuity Growth
Rate
0.03 0.035 0.04
Discount 0.1
38472.124599754
1
40609.042527806
5
43102.113443867
7
Rate 0.11
33909.392934216
7
35472.277183658
9
37258.430611592
9
(WACC) 0.12
30351.949147770
6
31534.545279601
3
32864.965927910
9

Total Price Per
Share
Terminal
Perpetuity Growth
Rate
0.03 0.035 0.04
Discount 0.1 1098.54 1159.56 1230.74
Rate 0.11 968.25 1012.88 1063.88
(WACC) 0.12 866.67 900.44 938.43
ASSUMPTIONS
(1) Assumes net debt of $83.4mm.
(2) Assumes outstanding diluted shares of 35.021 million.
Tax Rate 32.00%
Net Debt 83.394
Shares 35.02
Efficient market Hypothesis
1. Representing charts for event with application of various technical indicators for gauge of
market reaction
It had been elaborated by British American tobacco PLC that there was increment of
margin from pre tax as compare to 2017's four fold on benefits which had been gained by its
acquisition of Reynolds American Inc. The net income was GBP 37.53 billion which got raised
from GBP 4.65 billion from the year before. This could be elaborated that income must be
attribute for this specific acquisition of Reynolds American whose output as GBP 23.29 billion
pounds along with tax credit which is deferred from reform of US tax. The income with context
of operation was GBP 6.48 billion as compared from year before as GBP 4.66 billion. The

acquirer organization had framed innovative strategic portfolio of brands which is directly
combined in portfolio which are existing to Global Drive Brand portfolio along with brands
which are strategic and contributing to Reynold American Inc. as it decreases risk products.
Illustration 1: British Tobacco Plc (Bar graph)
(Source: British Tobacco Plc, 2018)

Illustration 2: British tobacco plc (Candle)
(Source: British Tobacco Plc, 2018)
Illustration 3: British tobacco plc (Line)
(Source: British Tobacco Plc, 2018)

Illustration 4: British American Tobacco Plc (October 2016)
(Source: British Tobacco Plc, 2018)
Illustration 5: Appropriate technical analysis with RSI, Volume and MA (British American
Tobacco Plc.)
(Source: British Tobacco Plc, 2018)
2. Discussing efficient Market hypothesis theory
Efficient market hypothesis theory is also known as Random Walk theory which is
considered as specific proposition of prices of stock which replicates availability of information
along with valuation of both organizations. By applicable this information, profits could not be

earned in access aspect (Chen and et.al., 2015). It helps in dealing with different exciting and
fundamental issues with respect to finance as a reason for price fluctuations in security markets
along with its methods.
There are three forms of Efficient market hypothesis such as:
 Weak form efficiency
 Semi strong form efficiency
 Strong form efficiency
Weak form: The hypothesis of efficient market asserts the present or current which is
fully incorporating information which consist of prices of past only. In this, prices of security are
arguably with public as information is available in easy way. It is also replicated as technical
analysis.
Semi Strong form: It helps in suggesting the present price which is fully incorporated
along with publicly available information. It does not consist of previous prices but data which is
reported in various financial statements (DeFusco and et.al., 2015). It had huge requirement of
market analysts which are existing as in this various financial economists are capable to
comprehend its implications of its financial information.
Strong form: It incorporates both public and private information. The main variation
among strong and semi string efficiency as absence of capability of generating profits in
systematic aspect as information on trading has not been known publicly on proper time
(Gozluklu, 2017). The main objective of strong form is for anticipating market in unbiased
aspect, developments in context of future and incorporation of stock price informations which is
evaluated in informative along with subjective way as compared to its insiders.

3. Discussing technical analysis
The above analysis has been depicting stock price movement of British Tobacco Plc after
the announcement of acquisition of Reynold American Inc. by 58%. It is considered as Strong
form of EMH as it had replicated its whole information in private and public as well (Hasan and
et.al., 2016). In simple words, it could be elaborated by incorporating and building weak form of
EMH along with its semi-strong. There is presence of assumption that prices of stocks are
reflecting each information and any investor will be not capable for margin above the average
investors even with presence of new information. After announcement market had under reacted
by after applying this bid its stock prices had raised up that signifies that market has reacted
which had given positive outcome. In this aspect, investors were very conservative and given
huge reliance on prior beliefs and they under-react.
CONCLUSION
From the above report it could be concluded that financial markets had reflected in
present scenario in very effective aspect. It had shown importance of efficient market hypothesis
with its three form and above scenario is of strong form.
Illustration 6: British Tobacco (Technical analysis)
(Source: British Tobacco Plc, 2018)