Menthol Ruling Boosts Reynolds-Lorillard Deal?

Financial analyst breaks down what FDA panel decision means for Reynolds, Lorillard and Imperial

Melissa Vonder Haar, Freelance Writer

Menthol Cigarettes

ALEXANDRIA, Va. -- The fact that Reynolds American Inc. seemingly put all its eggs in the menthol basket, divesting the majority of all non-Newport brands in its acquisition of Lorillard Inc., seemed a somewhat ballsy move if only because the U.S. Food and Drug Administration (FDA) is still considering some kind of limitation or outright ban of menthol flavors in cigarettes. Also on the line (though to a lesser extent) is Imperial Tobacco Group PLC, which is set to acquire the Kool and Salem menthol brands from Reynolds and Lorillard.

While Imperial was able to protect itself from any future litigation tied to its acquired brands by including an indemnity clause with Reynolds and Lorillard, there is no way for any of the companies to protect themselves from what the FDA might choose to do with menthol.

Which could be nothing, as many industry analysts have suggested.

However, last July, the FDA issued an “Advance Notice of Proposed Rulemaking” to collect further comments and information on the use of menthol in cigarettes. This announcement followed the release of a Tobacco Product Scientific Advisory Committee (TPSAC) report on the scientific effects on menthol in cigarettes, which found that “removal of menthol cigarettes from the marketplace would benefit public health in the United States.”

Yet, in a timely decision, U.S. District Court Judge Richard Leon ruled last week that the FDA did not properly ensure there were no conflicts of interest concerning members of the TPSAC panel and ordered the agency reconstitute the panel (full story here). The court further barred the FDA from using the original TPSAC report as a basis for any menthol regulations.

According to financial analyst blog The Motley Fool, this decision will make it increasingly difficult for the FDA to enact menthol regulations.

“Although the agency says it's conducted independent research into the question and reached many of the same conclusions, and will fund even more research into menthol's impact on smoking cessation and attempts to quit, as well as looking at the levels of menthol in cigarettes, with the flawed study tossed and the agency barred from relying upon it, it could be harder to defend imposing restrictions in the future,” wrote Motley analyst Rich Duprey. “Considering this judge has sided with tobacco companies in the past, such as on mandating graphic image warnings labels, a lawsuit landing before him over new rules targeted specifically at menthol cigarettes might find him equally sympathetic.”

Which stands to be a big boost to for the companies involved in the Reynolds deal, especially Reynolds itself: Motley reports that Newport accounts for 85% of Lorillard’s total tobacco revenues, owning 37% of the menthol and 12% of the total cigarette market.

“Imperial can probably breathe easier that its investments in the menthol cigarettes now won't become undone later, and the new Reynolds-Lorillard company can focus on its Newport brand without additional angst that a key driver of revenues will be snuffed out,” Duprey wrote. “Investors in all the related parties can also relax knowing that at least this part of the merger likely won't have a monkey wrench thrown into the works.”