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?