Tobacco M&A

Lorillard most likely deal partner

NEW YORK -- The future for Big Tobacco may be to get even bigger. Mergers and acquisitions in the tobacco sector have been all but snuffed out by the economic crisis and the restrictions in credit. But deal-making in the industry could resume once the financial markets bounce back, according to a report in the New York Times.

The tobacco industry has been in consolidation mode for quite some time. Since the beginning of 2007, there have been a number of deals, including Altria's purchase of UST last year for $11 billion, Japan Tobacco's acquisition of Gallaher, [image-nocss] and Imperial Tobacco's purchase of Altadis and Commonwealth Brands, just to name a few.

These mergers have been fueled by many factors, including product diversification and the desire to expand globally. But the main driver seems to be that the deals create real value. For example, the merger between R.J. Reynolds and Brown & Williamson in 2004 yielded $600 million in cost synergies and another $800 million in productivity improvements, according to investment firm UBS, New York.

Looking forward, UBS analysts took at look at three possible deal scenarios down the road and each one of them involved Lorillard, the maker of Newportthe best-selling menthol cigarette in the United States.

Lorillard is the smallest of the "Big Three" tobacco giants, which include Altria, maker of Marlboro, and Reynolds American, maker of Camel. It is also the only member of the Big Three that lacks a smokeless tobacco brand.

In a recent research note, UBS said it believes the most compelling deal scenario from both a financial and strategic perspective would be a merger between Reynolds American and Lorillard.

The merger would "substantially strengthen" Reynolds's cigarette portfolio through Lorillard's Newport brand and also improve its per-pack profitability, which currently includes a high percentage of discount brands, UBS analysts said in a note to investors.

UBS also saw substantial cost and even modest revenue synergies through the joining of both brands within the same retail trade contract.

The second most compelling possible deal would involve Lorillard being taken over by Imperial Tobacco of Britain, the maker of Davidoff and Gauloises Blondes, UBS said. Imperial has shown in the past that it is keen on expanding in the United States with recent acquisitions like Commonwealth, Altadis USA and Lignum 2. Adding Lorillard would give it a stronger base in which to build and market its brands in the lucrative American market.

Even less likely, but still in the realm of possibility, would be for Lorillard to acquire Swedish Match, UBS said. The deal would diversify Lorillard's product line from just cigarettes to other tobacco-related products, such as premium hand-rolled cigars, tobacco accessories and smokeless tobacco.