NEW YORK -- The landmark merger between Reynolds American Inc. (RAI) and Lorillard Tobacco Co. (LO) was a central issue of Wells Fargo’s annual “Tobacco Talk” retailer survey this quarter, with 97% of the questioned tobacco retailer and wholesalers predicting that the Federal Trade Commission (FTC) would ultimately approve the deal.
“Our retailer contacts overwhelmingly believe the RAI-LO deal will be approved, albeit with some modifications or additional brand divestitures,” Wells Fargo analyst Bonnie Herzog wrote in a research note. “The skepticism seems to be Imperial won’t be a ‘strong enough’ No. 3 player.”
Herzog added that several of Wells Fargo’s retail contacts had been contacted by the FTC, answering questions on issues such as brands, pricing, positions on fixtures, interaction between Camel and Newport, menthol, if the manufacturers discount menthol more consistently than non-menthol, and more.
“There may need to be some more divestitures of brands to Imperial,” wrote one respondent. “I suspect the FTC would rather see a strong No. 3 rather than a weak No. 3.”
“I believe there may be more restrictions,” another retailer added. “It will be interesting to see how Imperial will invest and gain shelf space or if the FTC makes this part of the deal.”
For her part, Herzog predicts the deal will gain FTC approval and close sometime in early 2015.
Less certain than when and how the merger will go through is what effect it will have on retail contracts with both Reynolds and Altria. One retailer reported Altria was revamping its 2015 Retail Leaders contracts, “designed to only reward retailers that are all in with Philip Morris,” as opposed to today’s program that allows retailers to opt into the pricing program on a store-by-store basis.
“I am seeing this as an emerging battle over new market situation with Lorillard-Reynolds merger,” the retailer concluded.
Herzog agrees this strategy “makes a lot of sense,” adding that “if the past is any indication, the manufacturers will seek to separate retailers with various programs that will provide more funding for lower retails but this will come at a cost to retailers.”
Based on information from retail, wholesale and manufacturer contacts, Herzog predicted these retail cigarette contracts will indeed change in 2015 as both Altria and Reynolds adjust to the new competitive landscape--ultimately causing additional squeezed margins for retailers.
“The concern for retailers is that if you participate in the Altria MPO program and the RJR EDLP program these programs continue to drive down retails and margins for retailers on all brands,” acknowledged one retailer.
This isn’t to say retailers aren’t at least intrigued by what the merger will ultimately mean for the tobacco landscape: when asked about their biggest excitements and predictions for the tobacco category, many retailers had the Reynolds-Lorillard-Imperial/Commonwealth deal at the top of their list.
“I’m excited to see how merger shakes out,” wrote one such respondent. “Will Imperial be a major or bit player? What will happen with RAI-LO support and programs?”
“Commonwealth is fixing to change the market,” another retailer said. “It is going to be fun to watch.”
In fact, one retailer predicted the deal will cause a huge shakeup in the cigarette market, suggesting the combined Reynolds and Lorillard “will place them in the No. 1 position in cigarettes and smokeless by end of 2018.”
Only time will tell.
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