Back in May, when a merger of two tobacco giants was mere speculation, a CSP tobacco survey suggested that retailers were incredibly divided on whether combining the second- and third-largest cigarette players would be good for their tobacco sales.
In a case in which certainty breeds uncertainty, retailers seem to be even more divided now that Reynolds’ $27.4 billion acquisition of Lorillard is official: In a July RBC Capital Markets/CSP tobacco survey, 27% of retailers expressed positivity about the deal’s effect on business, 31% were negative and a whopping 42% were mixed.
Wells Fargo analyst Bonnie Herzog believes some of the mixed responses can be attributed to the fact that the deal is far from final. Yes, Winston-Salem, N.C.- based Reynolds and Greensboro neighbor Lorillard have agreed to terms. And Bristol, U.K.-based Imperial Tobacco Group PLC has entered a $7.1 billion purchase agreement to acquire a number of brands being divested by both Reynolds and Lorillard. But with the U.S. Federal Trade Commission (FTC) and Reynolds’ board still needing to approve the merger, even optimists predict it will be at least early to mid-2015 before everything’s set in stone.
“With anything, when there’s change and uncertainty, that brings some anxiety,” Herzog says.
And, as Lorillard CEO Murray Kessler has learned, it also brings a lack of under - standing about the full terms of the deal.
“When I talked with retailers, the thing that surprised me was, despite the information that’s out there, there was still a good degree of confusion about the details of the transaction,” he says. Many he spoke with thought it was a flat-out “Reynolds buys Lorillard” transaction, with limited awareness of Imperial’s role.
There’s little question that the addition of Lorillard’s Newport, the No. 2 U.S. cigarette brand (and top-selling U.S. menthol brand), will make Reynolds a much more dominant competitor in the cigarette market, and in a far stronger position to compete against Altria across all segments. The uncertainty lies in whether a stronger Reynolds will be good or bad for retailers.
Some, such as Kocolene Marketing LLC’s Andrea Myers, believe the history books show this kind of merger will not be retailer-friendly. “Every time we’ve seen consolidation, it usually doesn’t benefit retailers,” says Myers, president of the Seymour, Ind.-based retailer. “I’m concerned that less competition will impose more restrictions on retailers.”
Others are hopeful, with one survey respondent hinting at the Marlboro Man in the room: “Maybe [Reynolds] will be large enough to go up against the big bully in the industry.”
For her part, Herzog remains cautiously optimistic for retailers and investors alike. “I do think there are going to be opportunities,” she says. “The idea would be that Reynolds will become a stronger No. 2 and be a better competitor in the marketplace.”
Time will tell. But here’s a look at some of the potential pros and cons, and what retailers think about this “big” tobacco deal.
CONTINUED: The Pros
Pros: A True Competitor
Survey respondents and other retailers optimistic about the Reynolds deal mostly zeroed in on how an improved No. 2 player should pose a bigger threat to tobacco’s longtime top dog, Altria Group Inc.
“This should be a plus for the retail com - munity,” says Steve Monaco, director of category management for Tedeschi Food Shops, Rockland, Mass. “Altria will need to look over their shoulders more often and pay more attention to their competition.”
Kessler agrees, citing that after such a big investment, Reynolds will want to continue Newport’s winning ways. “They’ve spent $27 billion and will want to do everything in their power to grow those brands, making this a success,” he says. “There’s no doubt in my mind that this means more competition for Altria.”
And that would benefit retailers. It’s no secret that many have criticized Altria’s contracts, and some hope that a stronger No. 2 could eventually force the Richmond, Va.-based leader to lessen its grip.
“Altria has had way too much control for far too long as it relates to the c-store industry,” responded one surveyed operator. “Maybe if Reynolds and Lorillard combine, they will have enough horsepower to effectively combat some of the ridiculous programs that Altria has put in place for our industry.
“Any time you allow a manufacturer to not only dictate what you pay for a product but also dictate what you sell the product for, it is a recipe for disaster,” the retailer said, alluding to Altria’s Marlboro Leadership Price (MLP) contract option.
(Editor’s note: While MLP remains controversial, CSP research has shown that roughly as many retailers support the program as those who oppose it.)
Altria aside, there are operators who are happy about the Reynolds and Lorillard combination if only because it means fewer players and sales reps to deal with.
“The combination of Reynolds and Lorillard will mean one less contract that will need to be scrutinized for shelf placement and allowances,” says Monaco.
“It’s much easier to deal with two vendors instead of three,” agreed another merchant.
And with only two power players, it may also be easier for tobacco retailers to control shelf space. “It will help stream - line contracts for merchandising space in stores,” predicted one pro-deal retailer. “It will also make it easier to obtain the best deal from both Altria and Reynolds.”
CONTINUED: The Cons
Con: Altria 2.0?
While those who fall on the “negative” side agreed that the combined Reynolds-Lorillard could better compete against Altria, these retailers also believe a more powerful Reynolds could result in stricter contracts across the board.
Kessler believes this will not be the case. “Whether Reynolds is a 25% share today or a 32% afterwards, Altria’s still a 50% share,” he says. “It’s pure speculation that Reynolds is going to have more leverage and, therefore, more restrictive programs.”
“Retailers were mixed on this,” Herzog says. “It depends on the retailer and their particular relationships with those companies. We’re going to have to wait and see how Reynolds and Altria each react.”
Several surveyed retailers argue that Reynolds will look to dictate greater space requirements. “This is not viewed as a positive,” said one respondent. “Reynolds will impose their strategy and marketing concepts on the Newport brand, contract payments for fixture space will be eliminated and buy-downs will most probably be reduced or canceled altogether.”
This fear that Reynolds may morph into an Altria clone led roughly 54% of those surveyed in May to predict that the merger would significantly reduce competition in the cigarette segment. As one such retailer said, it’s simple math: “Less manufacturers equals less competition.”
This would be bad news for retailers selling higher-margin value and subgeneric cigarettes, according to Frank White, director of retail operations for Wheeling, W.Va.-based Tri-State Petroleum.
“This is going to put pressure on retailers to eliminate other brands that deliver greater margin dollars,” he says. “Brands like Sonoma from Imperial or Liggett from Liggett-Vector generally allow greater cents-per-pack profit due to the Pall Mall EDLP contracts. Once the space work is done, what is left for higher profit items like these and the specialty premium items like Djarum?”
Which raises a seemingly absurd question: Could a more competitive Reynolds ultimately be a net positive for Altria, putting the vast majority of the power in the hands of just two companies?
“A lot of retailers we’ve surveyed think this might actually be good for Altria,” Herzog acknowledges.
All of which ignores the fact that, out of the combination of the current No. 2 and No. 3 tobacco companies, a new Big Tobacco player will emerge in Imperial. After all, to gain FTC approval, Reynolds has divested a number of viable brands.
This, perhaps, interests Herzog more than anything else in this landmark deal. “The bigger question for me is: What’s going to happen now with the third player?”
CONTINUED: The Unknown
The Unknown: Imperial
For the majority of retailers who remain uncertain as to what—if any—effect this deal will have on their business, Imperial’s status as a newly minted Big Tobacco player remains the biggest question mark.
“Imperial’s addition of the Winston, Kool, Salem (and) Maverick brands along with the addition of blu to their folio really piques one’s interest,” wrote one survey respondent. “Especially with the addition of the existing Lorillard field sales team ... . Depending on the strategy adopted, this could have a long-term positive impact.”
Two big positives for Imperial (and potentially retailers)? The somewhat surprising inclusion of Lorillard’s market-leading e-cigarette blu in the divestiture, and Imperial’s slightly less surprising inheritance of much of Lorillard’s sales force.
Herzog readily admits she was caught off-guard by blu’s sale—she had thought Reynolds would keep blu as part of a broader vaping strategy, focusing on both blu and its own Vuse. “I think it probably was something that Imperial needed for them to feel good about buying the (other) brands as a package,” she says.
“I am shocked at the move in spinning off blu, as it has great market share,” White says. “But I am sure Reynolds considers Vuse to be a better mousetrap."
Herzog agrees that giving up blu hints at Reynolds’ confidence in Vuse, now being rolled out nationally. But she predicts the decision could be a win-win situation.
“The blu choice only highlights how much Reynolds must believe in Vuse’s superior technology,” she says. “It’s not fully rolled out, but I’m optimistic that Vuse could do even better (than blu). Having said that, I’m well aware that blu is continuing to improve.”
The biggest reason to celebrate the Imperial part of the deal, as far as most retailers are concerned, is the fact that they may be able to continue working with a popular Lorillard sales team. “It’s a big component of how Imperial views this investment,” Kessler says of the sales team. “It’s not just in the brands, but the people.”
Back in May, many retailers who opposed the then-rumored merger lamented this potential loss.
“Lorillard has always been Switzerland,” wrote one opponent. “Their culture has provided us with genuine consultants.”
“Lorillard has been relatively retailer-friendly; that will be lost in the merger,” said another.
“I’ve heard that as well,” Herzog says of such concerns. “It’s not only the sales people but the Lorillard philosophy and strategy that retailers prefer.”
It’s a philosophy and strategy that Imperial stands to inherit, thanks in part to the fact that former Lorillard CEO Marty Orlowsky will immediately take on the title of executive chairman designate over Imperial’s newly expanded U.S. business.
“That was [Orlowsky’s] sales force,” Herzog says. “Selling Newport is going to be different than selling Winston, but I’d imagine that a lot will stay in place.”
Speculation aside, it’s nearly impossible to anticipate the broader effect this merger might have on retailers until the deal is approved by both the FTC and the Reynolds board, and until the market has time to absorb the shifting landscape.
“The next six months will be interesting,” White says, echoing such sentiments. Or, as one survey respondent summed it up: “It’s too early to tell, but I am sure it will involve resets.”
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