Reynolds American, Lorillard Merger Talks Advance

Analyst now pegs deal's probability at 90%, despite Cameron's downplaying

Reynolds American (RAI), Lorillard Merger (CSP Daily News / Convenience Stores / Tobacco)

WINSTON-SALEM, N.C. & GREENSBORO, N.C. -- Reynolds American Inc. is in active discussions to buy Lorillard Inc. in a complicated, three-way transaction that could see British American Tobacco PLC (BAT) take a major role to back a potential merger, according to Reuters, citing people familiar with the matter.

The proposed deal, which is in its late stages of talks, would combine the second and third-largest U.S. tobacco companies, putting brands such as Reynolds' Camel and Lorillard's Newport under one roof.

The companies are working to finalize agreement--the subject of much industry speculation--within weeks, but the talks could still take longer given the complex structure, the people told the news agency, asking not to be named because the matter is not public and they were not authorized to speak with the media. Representatives for Reynolds and BAT declined to comment, said the report, and Lorillard could not be immediately reached for comment.

Reynolds, in which British American Tobacco has a 42% stake, has a market capitalization of $31 billion, while Lorillard has a market capitalization of $21 billion.

Wells Fargo analyst Bonnie Herzog, who previously pegged the likelihood of the merger at 80%, said in a research note, "We are reiterating our prior conviction that an RAI-LO combination remains highly likely--dare we say 90% probability? Given the current market environment where both targets and acquirers are being rewarded, we continue to believe this will be a value creating transaction for both RAI and LO shareholders."

She said Reynolds American could Lorillard for $80 per share. "We believe BAT will contribute capital to help finance the deal and maintain its existing 42% stake in RAI in the combined entity. Further, we believe the return of Susan Cameron (Ivey) as CEO is a positive catalyst for the stock as she leads the company into its next generation of growth."

She also speculated that Reynolds American could spin off its Santa Fe Natural Tobacco Co. Inc., "which we believe is worth $4.7 billion as a standalone business [and] is underappreciated."

Earlier this month, at a Goldman Sachs investor conference, Cameron, downplayed such speculation. "I don't see BAT as a stealth predator. I see them as a partner," she said, according to Bloomberg.

She also said investors shouldn't speculate that her sudden, surprise return to the Reynolds American helm after leaving three years ago means a deal is more likely; predecessor Dean Delen decided to retire a bit sooner than planned strictly for family reasons, prompting the board to ask her to take over again.

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Greensboro, N.C.-based Lorillard, through its Lorillard Tobacco Co. subsidiary, is the third largest manufacturer of cigarettes in the United States. Newport, Lorillard's flagship premium cigarette brand, is the top-selling menthol and second largest selling cigarette in the United States. In addition to Newport, the Lorillard product line has four additional cigarette brand families marketed under the Kent, True, Maverick and Old Gold brand names. These five brands include 41 different product offerings which vary in price, taste, flavor, length and packaging. Lorillard, through its LOEC Inc. subsidiary, is also a leading U.S. e-cigarette company with its blu eCigs brand.

Winston-Salem, N.J.-based Reynolds American Inc. is the parent company of R.J. Reynolds Tobacco Co., with cigarette brands including Camel, Pall Mall, Winston, Kool, Doral and Salem; American Snuff Co. LLC, with smokeless tobacco brands Grizzly and Kodiak; Santa Fe Natural Tobacco, which manufactures and markets Natural American Spirit 100% additive-free natural tobacco products, including styles made with organic tobacco; and Niconovum AB, which markets nicotine replacement therapy products in Sweden under the Zonnic brand name.