NEW YORK -- Philip Morris USA's recent acquisition of cigar company John Middleton has led Citi Investment Research analyst Bonnie Herzog to speculate about other potential acquisitions in the cigar category. "We believe that a Reynolds-Swisher combination is the next most likely consolidation move in the U.S. tobacco sector," she said in a research note. "We believe there is a 75% chance that Reynolds acquires Swisher within the next 6-12 months."
An acquisition of Swisher International Inc., a private tobacco company and a market leader in machine-made [image-nocss] cigars, would offer several benefits to Reynolds American Inc. including a quick market share grab of the growing cigar industry, substantial cost savings and synergies with its Conwood and Lane subsidiaries, an opportunity to truly become a "total" tobacco company and to become a bigger player in the growing U.S. cigar category than PM USA, said Herzog.
She added that such a transaction's price tag could be between $4.2 billion and $6.4 billion, depending on tax breaks.
Reynolds would gain an approximately 27% share of the large machine-made cigar category and a 32% share of the small machine-made cigar category. Overall, the machine-made cigar category has grown at roughly 1-3% over the past decade according to Swedish Match, with the large machine-made cigar category having grown at 4% per year since 2003 according to PM USA. "As a result of our proprietary survey results, we anticipate the machine-made cigar category in the U.S. could grow at a rate of roughly 3-5% annually in the future," she said. "By acquiring Swisher, Reynolds would be catapulted into the growing U.S. cigar market as a solid No. 1 player in machine-made cigars, by units sold, in the U.S. cigar market."
Reynolds would now have products with national distribution within the large machine-made cigar category, and would also be able to use Conwood and Lane's the distribution networks to help boost sales of newly acquired Swisher smokeless and cigar brands, respectively, Herzog said.
By purchasing a leading producer of machine-made cigars, Reynolds could have the ability to control the pricing of the segment, which could give it the upper hand, much like PM USA currently possesses in the premium cigarette category with its Marlboro brand, she added.
"We believe it is very likely that Reynolds would see an acquisition of Swisher as a way to cement itself as the No. 1 player in the machine-made cigar category in the U.S," she wrote.
An acquisition of Swisher would give Reynolds the opportunity to become the second-largest domestic cigarette manufacturer, the second-largest smokeless manufacturer and the largest machine-made cigar manufacturer, she added. With U.S. cigarette volumes consistently declining, and Reynolds inability to take its famous cigarette brands outside the United States given the sale of these trademarks, "we believe an acquisition of Swisher provides Reynolds with a growth opportunity within the domestic tobacco sector, much like Conwood, considering cigar volumes have been growing, even despite limited promotion of the segment."
While Herzog said she anticipated that Reynolds would be the main bidder for Swisher, she did not completely discount the possibility of Lorillard or UST making an attempt to acquire it. "But we do not believe the potential acquisition target would fit into either company's strategic growth plans," she said. "UST currently has its hands full with trying to grow its premium volumes in the smokeless category, which is growing at an impressive 6-7% annual clip and, therefore, is not in need of a secondary product in hopes of entering an arena where volumes are not on the decline."
Herzog discounted Lorillard, which she said "might appear to be a solid candidate to buy Swisher at first glance since it is strictly a domestic cigarette manufacturer, and not exposed to the smokeless segment," because it is owned by Loews Corp. Loews Corp, and because Lorillard's main brand, Newport, continues to produce strong revenue growth and sustained volumes.
But yesterday's announcement by Loews, which said that it will, in fact, spin off Lorillard in 2008, could change that dynamic (see related news story in this issue of CSP Daily News).
"We feel Reynolds' strong distribution network and solid relationships with the trade, as well as its position as a 'total' tobacco company, make Reynolds the most likely buyer of Swisher," she said. "We believe Reynolds will be extremely eager to make sure PM USA does not have any significant advantage in the cigar category following its purchase of John Middleton."
She also speculated that Reynolds could extend the Swisher Sweets brand into a cigarette or possibly, a smokeless tobacco product.
Darien, Conn.-based Swisher offers machine-made cigars including Swisher Sweets, King Edward, Blackstone, Santa Fe, Optimo and Keep Moving; premium cigars including Dominican Hallmark, Casino Gold, Macbeth, Tiburon and Sabrosa; dry snuff including Railroad Mills, Three Thistle and Tops; moist snuff including Kayak, Redwood, Silver Creek and Swisher Sweets; and chew including Mail Pouch, Lancaster, Starr and Chattanooga.
Reynolds American, headquartered in Winston-Salem, N.C., is the parent of R.J. Reynolds Tobacco Co.; Conwood Co. LLC.; Santa Fe Natural Tobacco Co. Inc.; Lane Ltd.; and R.J. Reynolds Global Products Inc.
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