Coverage: Tobacco firms plan to merge

In a complicated deal, Reynolds American will buy Lorillard. It’s hard to believe that a merger would be good, but with stagnant growth, tobacco powerhouses have to find some way to try to grow.

The New York Times story by Michael J. de la Merced and Chad Bray outlined how the transaction would work:

Reynolds American agreed on Tuesday to buy its smaller rival, Lorillard, for $27.4 billion, uniting two of the country’s largest tobacco producers in a bet that bigger is safer in a declining industry.

Under the terms of the deal, Reynolds will pay $68.88 in cash and stock for every Lorillard share and assume its debt.

Two other companies are also involved in the complicated transaction. The Imperial Tobacco Group will pay $7.1 billion for several brands — including Kool, Salem and Winston cigarettes and Blu e-cigarettes — and acquire a former Lorillard manufacturing plant that employs about 2,900 people in Greensboro, N.C.

And British American Tobacco, which already owns 42 percent of Reynolds, will spend about $4.7 billion to buy additional shares to maintain that level of ownership in the combined company and help finance the deal.

The long-awaited combination, over a year in the making, will reshape America’s tobacco industry as companies grapple with a decades-long drop-off in smoking. Buying Lorillard will make Reynolds a stronger competitor to the Altria Group, whose Marlboro brand alone accounts for nearly half of all cigarette sales in the United States.

The Washington Post reported in a story by Fred Barbash that the move would generate competition for Altria:

The deal gives the No. 1 tobacco company, Altria — owner of Philip Morris — a much more formidable competitor. It could also reduce the workforces of the companies and raise cigarette prices.

Bloomberg offered this context in a story by Duane D. Stanford, David Welch and Gabi Thesing:

Decades of anti-tobacco health campaigns have hurt demand and put pressure on the industry to consolidate. Acquiring Lorillard, the U.S. industry’s third-largest competitor, would help Reynolds cope with the slowdown and give it the Newport menthol line, which is popular in urban areas. Still, the deal faces challenges, and investors signaled that they’re uncertain it will close in its current form. Lorillard shares slid as low as $61.42 in New York, 11 percent less than the purchase price.

“There’s a lot of risk,” said Owen Bennett, an analyst at Nomura Holdings Inc. in London. “There are a lot of factors involved.”

Including debt, the purchase is valued at $27.4 billion. The new company will have annual revenue of more than $11 billion — almost two-thirds the yearly sales of U.S. market leader Altria (MO)Group Inc. — and operating income of about $5 billion.

Reynolds shares also fell after the acquisition was announced, dropping as much as 5.5 percent to $59.72. Imperial Tobacco declined 3.7 percent to 2,638 pence in London, while BAT fell 1.8 percent to 3,532 pence. Altria dropped 2.8 percent to $42.12.

Reynolds said the combined company will account for almost 33 percent of the U.S. industry. That leaves the U.S. with two competitors — Reynolds and Altria — selling nine out of every 10 cigarettes. Imperial said its market share will more than triple to 9.5 percent from 2.5 percent.

Shayndi Raice of The Wall Street Journal pointed out that the deal wouldn’t do much to alter the global market:

While the Reynolds-Lorillard deal shakes up the lucrative but slowing U.S. market, it doesn’t alter the global picture dramatically. That makes it unlikely Philip Morris, the global leader in cigarette sales excluding China, or Japan Tobacco, would feel the need to swoop in and try to muddle the deal with any counteroffer, industry watchers said.

“There aren’t that many players around,” said Andrew Monro, a partner at KPMG. And smaller players won’t be able to finance big deals, he said.

“You can never say never,” one banker said on the likelihood of another big tobacco pact. “It’s not unthinkable, but it would be very bold and ambitious and a little bit too big of a bite at this point.”

Big tobacco acquisitions have triggered knock-on deals in the past. When Japan Tobacco said it would buy Britain’s Gallaher Group in 2006, Imperial reacted by buying rival Altadis.

“I don’t see that replicating here,” one banker said. “It’s constrained to one market, which is the U.S., and this is the last move in the U.S.”

Some watchers said they think tobacco companies could turn to smaller deals for emerging-markets firms in Indonesia, India or Thailand. But because some of those assets are family-owned, it could be tough to find deals.

It’s hard to be concerned about growth for companies that sell a product like cigarettes, but there could be a loss of jobs as the companies combine. But it seems that this might be the last of the mergers in the space, particularly in the U.S. market. I guess next companies will be fighting for control in global markets, particularly as e-cigarettes spread.