Reynolds American to buy Lorillard in $27bn deal

September 2014 | DEALFRONT | MERGERS & ACQUISITIONS

Financier Worldwide Magazine

Reynolds American Inc announced in mid-July that it had agreed to acquire rival cigarette manufacturer Lorillard Inc in a deal worth approximately $27.4bn, including the absorption of debt.

According to the terms of the transaction, Reynolds will pay $68.88 in cash and stock per Lorillard share. The agreed purchase price represents a premium of 40.4 percent on the company’s stock price on 28 February, the last day of trading prior to the appearance of media speculation about a possible merger between the firms.

Both companies expect the deal to be completed in the first half of 2015, subject to customary closing conditions, including approval by the shareholders of both companies, as well as

regulatory approvals. Once the deal has been completed, Lorillard’s existing shareholders will own approximately 15 percent of the new Reynolds. Reynolds chief executive Susan Cameron, who only assumed the role in May, will retain her post in the new company.

The deal will undoubtedly have a transformative effect on the American tobacco industry. Reynolds, the second biggest tobacco producer in the US thanks primarily to its Camel and Pall Mall brands, will significantly strengthen its standing in the American tobacco sector by acquiring Lorillard, the US’ number three manufacturer. However, in order to allay any potential regulatory concerns, the companies will be required to divest a number of their prominent brands, including Kool, Salem, Winston and Maverick. The Blu e-cigarette brand will also be sold off to British firm Imperial Tobacco, as will Lorillard’s former headquarters, manufacturing plant and research facility in North Carolina; in total roughly 2900 Reynolds employees will also be transferred to Imperial as per the terms of that transaction. The deal for these assets is believed to be worth $7.1bn; however the sale of the Reynolds brands to Imperial is dependent on the closing of the Reynolds/Lorillard transaction.

Further complicating the deal, British American Tobacco, which owns around 42 percent of Reynolds, will inject $4.7bn into the newly combined company in order to maintain the size of its stake, and to help finance the transaction. The combined Reynolds-Lorillard will, however, maintain its ownership of the leading US menthol cigarette brand, Newport, as well as both the Camel and Vuse brands.

The number of smokers in America has fallen dramatically over the last 50 years, according to the latest government statistics. Today around 18 percent of adult Americans smoke cigarettes, down markedly from 43 percent in 1965. Although the industry is still worth approximately $90bn annually, it is attempting to arrest the decline in smoking numbers by introducing a variety of tobacco replacements. The Vuse brand is Reynolds’ entrant in the burgeoning e-cigarette market, and the firm has announced its intention to heavily promote Vuse, believing it to be a superior product to the Blu e-cigarette. As a result Reynolds will work with British American Tobacco to develop new brands in the e-cigarette/vapour market. “We have such confidence in Vuse’s superior technology, that it is a game-changing product,” said Ms Cameron. “And we believe that Vuse will be very successful, and is showing great signs as we have embarked on our national rollout.” The wider e-cigarette market accounted for sales of around $7bn in 2013 and could be worth up to $50bn by 2030.

Once the merger has been completed the new Reynolds is projected to have revenues in excess of $11bn as well as operating income of roughly $5bn. The company expects that the total transaction will see cost savings of $800m, mainly through cutting corporate costs and the divestitures to Imperial.

The deal will also result in just two firms controlling the bulk of the tobacco industry in the US. The newly merged Reynolds and rival firm Altria, whose Marlboro brand accounts for nearly half of all American cigarette sales on its own, will dominate the American market. Reynolds will own a 40 percent share. In order to assuage antitrust concerns Reynolds insists that the firm’s divestitures will help to establish Imperial as a solid and viable third place manufacturer; Imperial’s US market share will rise to around 10 percent.

In trading immediately following the merger announcement, shares in Reynolds fell 6.9 percent to $58.84. Imperial Tobacco declined 3.7 percent, British American Tobacco fell 1.8 percent and Altria dropped 3.7 percent.

Richard Summerfield