WINSTON-SALEM, N.C. -- Bringing a long-rumored and much-anticipated deal or deals one step closer to reality, Reynolds American Inc. on July 11 issued a statement saying that it "confirms that it is in discussions with Lorillard Inc. regarding a possible acquisition of Lorillard."
Speculation has been persistent and growing since March that a merger between Winston-Salem, N.C.-based Reynolds and Greensboro, N.C.-based Lorillard could be in the works.
A combined Reynolds-Lorillard could create antitrust issues and require the companies to divest some of their brands. It would also have major implications for the burgeoning electronic cigarette market, as well as the menthol segment.
As reported in a 21st Century Smoke/CSP Daily News Flash, the Reynolds statement, as well as a similar one issued by Lorillard, followed a required legal disclosure by Imperial Tobacco PLC describing discussions among the tobacco companies.
Imperial Tobacco "confirms it is in discussions with Reynolds and Lorillard to evaluate a possible acquisition of certain assets and brands owned by Reynolds and Lorillard," it said. "Imperial would proceed with an acquisition only if its terms met strict transaction criteria."
Bristol, U.K.-based Imperial is lining up $7 billion to buy some brands that Lorillard and Reynolds would sell off to head off any concerns raised by the U.S. government, people with knowledge of the matter told Bloomberg. They said a deal could come within a week.
Bonnie Herzog, analyst with Well Fargo Securities LLC, New York, who has long championed the deal, said the brands that Reynolds would most likely divest would be Winston, Kool and Salem, and possibly Misty and Capri; Lorillard could divest Maverick, Kent and Old Gold. "However, we do question Imperial's ability to finance a transaction this large," she said.
British American Tobacco (BAT), Reynolds' shareholder, is participating in these discussions, Reynolds said.
In its own statement, London-based BAT said, "If such a deal were to proceed, British American Tobacco expects to support the transaction by subscribing for additional shares in Reynolds American, with the aim of maintaining its existing 42% equity position in Reynolds American."
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There is no assurance that any agreement will be reached by any of the parties, all of the companies said, declining further comment.
A Reynolds-Lorillard deal would combine Reynolds' Camel and Pall Mall cigarettes with Lorillard's popular Newport menthol brand to create a more powerful No. 2 to U.S. industry leader Altria Inc., maker of Marlboro, said a Wall Street Journal report. Reynolds and Lorillard have a combined stock-market capitalization of more than $50 billion.
The potential merger faces significant risks, including tough antitrust scrutiny, the report said. The U.S. Food & Drug Administration (FDA) is also weighing a possible crackdown on menthol cigarettes, which fuel more than 80% of Lorillard's sales, after the agency banned all other cigarette flavors in 2009, said the report.
Following the release of the tobacco company statements confirming the talks, Nick Modi, analyst with RBC Capital Markets LLC, Toronto, said, "There have been many data points that have kept us on the side that a Reynolds-Lorillard deal was a high probability event, including Susan Cameron's placement on the 'Strategic Review Committee' before becoming [Reynolds] CEO, a disclosure by Reynolds in its 10Q that it is seeking to eliminate non-core brands and Reynolds not announcing an earnings release date yet when historically the company always announces within one to two days of Altria's announcement. While this may seem like 'reading tea leaves,' it only adds to our view that a Reynolds-Lorillard combo makes both financial and strategic sense. … Where there's smoke, there's fire."
He added that a deal "could fetch at the minimum $70 per share (and likely more) with ultimate synergies and cost savings reaching close to $900 million two to three years post deal closure."
Modi said he believes "the FTC hurdle is significantly lower than what most think, and the deal should receive little anti-trust scrutiny."
Herzog said, "We continue to anticipate Imperial-Commonwealth will acquire several of the smaller/non-priority brands in an attempt to pre-empt any potential FTC anti-trust issues."
But she also said, "We believe that with Imperial's reported interest in possibly acquiring more divested brands than we originally anticipated, a Reynolds-Lorillard transaction would have even fewer regulatory hurdles to clear, suggesting the likelihood of a deal being ultimately approved and closing continues to rise."
She concluded, "This transaction in our view will be very positive for the global tobacco industry and could be just the beginning of future transactions with e-cigs/vapor being the underlying catalyst."
A recently conducted CSP tobacco survey--released ahead of the July 11 statements confirming the merger talks--showed that retailers are divided in their support a Reynolds-Lorillard deal (with 48% for, 39% against) and whether a merger would be good for retailers (37% said it would be good for business, 33% bad for business, 15% predicted no effect and 15% were unsure).
Respondents were equally unsure about what a deal would mean for Lorillard's blu: a 43% majority of respondents believe a merger would have a "neutral" effect on sales of the e-cigarette brand, while 33% predict it would accelerate sales and 24% that it would slow sales.
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