RBC Parses Reynolds-Lorillard Path to Approval
Tobacco experts weigh FTC’s “comfort level,” options, Imperial’s role
NEW YORK -- There has been a lot of noise recently about the potential deal between the No. 2 and No. 3 tobacco players, Reynolds American Inc. and Lorillard Inc. Will the U.S. Federal Trade Commission (FTC) approve the deal as-is, or require further divestitures? Or--as some have speculated--could the commission sue to block the deal entirely?
Nik Modi, senior tobacco analyst at RBC Capital Markets, recruited Darren Tucker, a former senior advisor to the FTC commissioner and current partner and deputy practice head of Morgan, Lewis & Bockius LLP, to discuss what’s likely going on with the merger.
“Based on the work I’ve done, I gather that the economic staff within the FTC is for the deal based on all the quantitative evidence,” Modi said during the RBC-hosted conference call. “But perhaps there’s some contention amongst the competition staff within the FTC, with some wanting to recommend a block for this deal and others for the deal going through.”
Modi believes a lot of the headlines from the past week had to do with FTC Bureau of Competition director Deborah Feinstein attempting to reconcile such differences of opinion. Tucker added that a meeting of the commission is not necessarily a sign that the deal will not garner approval as-is.
“Ordinarily, a meeting of commissioners is not a good sign,” he said. “Here it may just be reflective of the fact that someone within the agency has raised concerns, but the weight of the other viewpoints in the agency point in the other direction. There still would be the need for a commission meeting.”
At this point, Tucker said he does not have good intel on what direction the FTC is leaning in terms of a potential consent decree.
“We don’t know, for example, if the commission is trying to get more relief from the parties, or just to get more comfortable with the original package offered by the parties.”
This will have a big effect on the timing of the deal: if the FTC is inclined to accept the deal as-is, Tucker said any announcement could come any day now. If the FTC is looking for additional relief, it could take a few more weeks to negotiate.
Modi pointed out that additional divestures might not be required, as acquiring more brands might make the third player in this move—Imperial Tobacco—a weaker competitor against Reynolds and Altria.
“When you think about the tobacco category, the more consolidated in your portfolio, the better off you are,” said Modi. “The only way you can get any kind of brand recognition is on the back bar—so the more space you have for a given brand on the back bar, the more helpful. Imperial’s chances to become a legitimate third competitor are probably better with a smaller number of brands where they can allocate resources effectively.”
Tucker agreed. “I think the FTC is trying to get comfortable with what the parties already offered,” he said. “If there is some wrangling over the decree, it’s over some kind of behavioral remedy: for example, some kind of limitations on Reynolds’ everyday low price policy.”
Though both Modi and Tucker were optimistic the FTC would approval the deal in some form, Tucker said that if the FTC opts to take Reynolds to court to block the merger, the commission will face an uphill battle. “On the merits, as a pure anti-trust matter, I think the FTC should lose this case if they go into court.”
The main problem: the FTC would have to show how the deal would make the tobacco market worse.
“There’s already an oligopolistic industry, there’s already tight pricing … that’s kind of a given,” said Tucker. “It’s just not clear what story the FTC’s going to have that’s going to persuade a judge that things are going to get worse.”
That burden would be on the FTC: Reynolds would not have to show how the merger would make the tobacco industry more competitive (though Tucker and Modi both suspect a stronger Imperial will create a kind of maverick player in the tobacco market, which would improve competition).
Ultimately, Tucker predicted the worst case scenario would be a three-to-two vote in favor of the merger—with the more likely outcome being a five-to-zero vote to approve.
“I’m an optimist on this deal,” he said. “I’ve always felt that this deal had a good prospect of clearing the FTC with no more than minimal behavioral relief.”