Reynolds-Lorillard Merger Could Create New Power Player

Herzog predicts Reynolds may divest brands to avoid anti-trust issues

Melissa Vonder Haar, Freelance Writer

Bonnie Herzog

Bonnie Herzog

NEW YORK -- An acquisition of the Greensboro, N.C.-based Lorillard Inc. by the Winston-Salem, N.C.-based Reynolds American Inc. would certainly create one massive tobacco power player, but could it also launch another tobacco company into the Big Three?

Bonnie Herzog, managing director of tobacco research at New York's Wells Fargo Securities, predicts a merger between two of the top three tobacco companies might ultimately involve a third tobacco company in an effort to avoid concerns by the U.S. Federal Trade Commission (FTC).

"We think Reynolds could act pre-emptively by involving a third party in its potential acquisition of Lorillard to address any potential FTC anti-trust issues," Herzog wrote in a research note. "Reynolds is likely to divest brands and could be 'shopping' them already."

Specifically, Herzog suggested that Reynolds might be looking at a buyer for its Kool and Winston and Salem brands (which account for 5% the total market share) and would target a company that currently holds a 2-4% market share. She added that this could create "a third viable player."

It wouldn't be the first time a merger launched a smaller player into the Big Three.

"Interestingly, a three-player transaction would create a competitive environment similar to what it looked like when Reynolds and Brown & Williamson Tobacco Corp. combined 10 years ago," said Herzog. "At that time, a much smaller Lorillard became the third-largest player, holding around 8.6% of the U.S. market."

As for timing for the merger (and related brand divestments), Herzog believes it "could be around the corner" for two reasons: menthol and the recent return of Susan M. Cameron (Ivey) as Reynolds' president and CEO.

"We don't believe the menthol overhang is a roadblock," she said. "And we think a deal could make more sense before (and if) the FDA makes a potential recommendation on menthol."

"We believe Susan Cameron was enticed out of retirement to take Reynolds to its next level of growth," Herzog continued. "Further, since Cameron has given a two-to-three year commitment to running Reynolds, we think this could suggest a deal needs to happen sooner rather than later."