Tuesday, July 15, 2014

Reynold's American (RAI) to buy Lorillard (LO)

This morning it was announced that Reynold's American (RAI) would buy methol cigarette maker Lorillard (LO) in a deal valued at $68.88 per share.  If the acquisition is approved then LO shareholders will receive $50.50 in cash for each share of LO and 0.2909 shares of RAI at closing which is projected to take place in 2015.  I was quite surprised to see that shares of both LO and RAI sold off pretty hard on the news with RAI losing 6.9% on the day and shares of LO losing about 10.5%.  Pretty surprising considering that when talks of a potential merger/acquisition surfaced shares of LO had increased strongly on the rumor.

The deal could definitely face some headwinds due to regulatory and anti-trust concerns and could therefore fall through.  If the merger is given the green light then the new company will be divesting some of the smaller brands to the British tobacco company Imperial Tobacco.  What was really surprising to me is that one of the brands that will be sold off is the Blu e-cigarette that Lorillard currently owns.  Blu is the leader in the e-cigarette market and I don't understand why you would want to get rid of that even if RAI is coming out with their own e-cig called Vuse.  This is the most baffling piece of information about the merger, at least to me.

Besides the anti-trust issues there's still the potential for regulation overhang from the FDA regarding LO's main product of menthol cigarettes.  If the FDA does levy stricter requirements or even an outright ban on menthol cigarettes this would essentially nullify the deal in terms of adding to RAI's bottom line.  Especially since the Blu divestiture is already taking away one of the few "tobacco" markets that is actually seeing growth.

RAI expects to see $800 million per year in cost savings in the combined company which will help out the overall declining cigarette market.  Gains over the last decade or so have been made through cutting costs, higher operational efficiency, and increasing prices and not through overall volume gains.  Lorillard has a 7 year dividend growth streak whereas Reynold's has a 10 year streak of its' own.  The combined company should be able to continue paying an increasing dividends for years to come.

I'm not a big fan of the merger the way it's currently set up mainly because of the Blu divestiture.  It'll be interesting to watch this unfold and see whether the merger is allowed to take place.  Personally I think it should especially given the brand divestiture but the regulators have the final say and I doubt they'll ask me.  If there's room for one tobacco company that commands 50%+ of the market there should be room for the 2nd and 3rd largest brands to merge if they think that's best for them in the long run.

What do you think about the merger announcement?  Any preliminary plans on what you'll do if the merger goes through?  What if the merger fails?


  1. I was a little surprised at the offer. I had figured they would need to offer more in order to get the shareholders to agree to merge. Last time I counted 4 law firms have declared they are about to do their investigation of the boards for breach of shareholder fiduciary duty. Some of this happens always, but I haven't seen that many law firms jump so quickly on a merger.

    I am also perplexed by them selling the e cig business, it seems like they are letting some good assets go and keeping the ones that could have the higher regulatory hurdle (menthol being outlawed).

    I am not sure which group of shareholders are being fully rewarded to be honest.

    I am leaning towards selling my LO stake if the merger goes through. Once more details emerge, I will make my decision. Of course, I could just wait and get a few shares of RAI, assuming regulators approve.

  2. JC,

    I'm mixed on it. I think near $69/share makes sense, and I think there's a solid premium there. I have no problem with the price, even though some were expecting near $80(!). And I'm personally not opposed to getting the cash which will further reduce my stake in tobacco. That's something I've been interested in anyhow. And getting a small piece of a more diversified tobacco company, with less overall exposure to menthol, is attractive.

    However, the divestiture of blu, in my opinion, is a big mistake. That's a fantastic brand, and one of the big reasons I was so heavy in Lorillard from the get go. But RAI is pretty bullish on their Vuse product.

    We'll see. I already halved my position in LO after a big run, and with 50 shares now it won't really matter to me much either way. I'll be left with cash to invest elsewhere, which I wouldn't mind, and a small position in RAI which I may keep or not.

    Best wishes!

  3. I read about this the other day and have been thinking about what I want to do since. I own both LO and RAI so merging the two companies works for me. I am not excited about selling Blu e-cig. It doesn't make sense to me if it is the industry leader in the e-cig market to sell off that brand. My thoughts are the big reason RAI wants to acquire LO is the menthol cig brand Newport. RAI must feel confident that menthol cigs won't be banned. Otherwise this acquisition doesn't make much sense in my opinion.

    I'll be waiting and watching what happens. If LO's price gets back up near $68, I may consider selling and moving on at the time so I don't have to worry about the merger. Not really sure yet on my plans.