NEW YORK -- Much of the conversation around the soon-to-be finalized deal for Reynolds American Inc. to acquire Lorillard Inc. has focused on what the acquisition means for Reynolds and Lorillard’s flagship Newport brand. But there’s another player in the mix too: U.K.-based Imperial Tobacco Group PLC is set to catapult to the third largest U.S. tobacco company with its acquisition of five brand divestitures from Reynolds and Lorillard.
The question is: How will Imperial perform?
A recent Wells Fargo “Tobacco Talk” survey shows retailers are uncertain about Imperial’s prospects post-merger, with 62% of respondents suggesting Imperial will lose cigarette share due to less-than-optimal shelf space or retail placement and servicing of new its brands (which include Winston, Kool and Salem from Reynolds and Maverick and blu eCigs from Lorillard).
That said, Wells Fargo senior tobacco analyst Bonnie Herzog recently outlined provisions within the merger that should help Imperial survive and thrive once the deal goes through.
“There is language in the merger agreement which we think was incorporated to give Imperial a ‘fighting chance’ at laying a strong foundation for the first 17 months post deal-completion to secure strong shelf space at retail,” Herzog said in a research note. “We think the FTC carefully reviewed this language and how it could impact healthy competition in the industry.”
Per the merger agreement, there is an “initial period” in the two months after the deal closes where Reynolds cannot “present or negotiate a new or modified retail cigarette contract,” followed by a “subsequent period” of three months where Reynolds and Imperial can share and negotiate new contracts with retailers. These new contracts cannot actually be implemented until the end of the subsequent period (five months after the merger goes through).
“After (that), there is a 12 month period during which Reynold’s new or modified retail cigarette contract would mandate that Reynolds ‘requires’ shelf space equal to Reynolds’s share of market (SOM) or eight square feet (whichever is greater),” Herzog continued. “While Imperial’s new or modified retail cigarette contract would mandate that Imperial ‘requires’ equal to its SOM or a minimum square foot requirement to be determined by Imperial’s sole discretion, whichever is greater.”
Additionally, the merger agreement stipulates a “shelf space payment” of $7 million to Reynolds by Imperial.
“We interpret this language as meaning that Imperial can expand its shelf space to greater than would be warranted by its SOM for 12 months after the initial and subsequent periods where it can effect better visibility for its brands at retail and thus attempt to gain awareness, trial and share,” said Herzog.
Besides contract provisions, it would appear that Reynolds did due diligence to prove that the Winston brand specifically could thrive and grow under Imperial. Herzog said retail contacts reported that Reynolds performed a test on Winston in 2012, increasing the brand’s marketing and promotional support. The result was a “small surge” in Winston sales.
“We believe Reynolds performed this test on Winston in an effort to ‘prove’ that it has brand equity and can therefore show some signs of life and take share if given a ‘little love,’” Herzog said. “We believe this ‘evidence’ was provided to and considered by the FTC to show that Imperial has the ability to maintain and possibly grow its share as it focuses on and increases support behind Winston.”
The Reynolds-Lorillard-Imperial deal is scheduled to go through on June 12, 2015.
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