Could Imperial Play Role in Rumored Reynolds Deal?

Source from:  Winston-Salem (NC) Journal  07/18/2014

Analysts have identified a potential fourth party - one with a trans-Atlantic presence - that may be required for Reynolds American Inc. to pull off a rumored purchase of Lorillard Inc.

Talk of a mega Triad deal surfaced March 3, with Reynolds projected to spend between $18 billion and $29 billion to buy Greensboro-based Lorillard, thus acquiring Newport, the top menthol brand in the U.S.

Several American and European media outlets reported that the companies had hired advisory groups and launched negotiations.

Wells Fargo Securities analyst Bonnie Herzog has said there is a "90 percent probability" the deal will occur, particularly if Reynolds is willing to offer about $80 a share.

Overshadowing any possible deal is the 42 percent ownership stake British American Tobacco Ltd. has in Reynolds as part of Reynolds' 2004 purchase of former BAT subsidiary Brown & Williamson Tobacco Corp. for $4.4 billion. A 10-year moratorium on BAT buying more Reynolds stock expires July 30.

The latest potential connecting of the dots is Imperial Tobacco Group PLC's plans for an initial public offering for de Distribution Integral Logista Holdings unit of Madrid, Spain.

The New York Times reports the IPO could yield $2.53 billion. Imperial is projected to sell 30 percent of its Logista stake to institutional investors with an expected yield of $800 million.

The speculation is that those proceeds could be used to buy Reynolds' non-growth cigarette brands that include Kool, Winston, Salem, Doral, Misty and Capri. Those brands combined hold a 7.3 percent U.S. market share.

Reynolds' selling or divesting of that market share could be enough to persuade the Federal Trade Commission to approval a purchase of Lorillard.

Philip Morris USA, maker of top-selling Marlboro brand, is first at 50.7 percent.

With Reynolds holding 26.7 percent and Lorillard at 15.2 percent, their combined market share would approach 42 percent, including dominant menthol brands.

The combined market share of Newport, Camel and Pall Mall - the second through fourth-leading brands - is about 35 percent.

Although it would be a dominant No. 2 at that market share level, it is not significantly higher than the 77 percent that Philip Morris and Reynolds currently hold.

Herzog said there are some U.S. manufacturers that own between 2 percent and 4 percent market share, including Imperial, which operates as Commonwealth Brands in the United States with brands such as USA Gold and Sonoma.

Imperial has made no secret of its U.S. growth ambitions, which includes a recent expansion of Commonwealth' facility in Rockingham County.

Herzog estimates Kool, Winston and Salem's EBITDA (earnings before interest, taxes, depreciation and amortization) "could be $550 million and they could fetch a 7- to 11-times multiple," or nearly $5 billion.

Analysts have said BAT would not only have to give its blessing to Reynolds buying Lorillard, but also may provide some of the financing so as not to overburdened Reynolds financially.

Herzog suggested in June that Reynolds could sell its Santa Fe Natural Tobacco Co. subsidiary or spin it out as a publicly traded company.

Santa Fe makes Natural American Spirit cigarettes, which are marketed as being additive-free. Natural American has become a Top 10 U.S. brand with a 1.5 percent market share since Reynolds bought the company for $340 million in January 2002.

Herzog said Santa Fe could be worth as much as $6 billion, or about 166 percent more than what Reynolds paid for it. She said Santa Fe could be worth $11 a share compared with a current industry evaluation of $7 a share as a Reynolds subsidiary.

Merger speculation has captured the attention of the industry and the Triad since there would likely be a significant job impact if Reynolds were able to persuade Lorillard management, shareholders and regulators to sign off on the deal.

Between 2,000 and 2,200 of Reynolds' 4,800 employees are based in Forsyth County. Lorillard has about 2,800 employees, with the majority based in Greensboro.

Analysts say it is likely either Reynolds' plant in Tobaccoville or Lorillard's smaller plant in Greensboro eventually would be closed as demand for traditional cigarettes continues to shrink.

Reynolds is in the process of establishing production space in Tobaccoville for its electronic cigarette brand, Vuse.

As with most potential major corporate deals, there are four major negotiating areas: purchase price; who runs the combined company as chairman and chief executive; where it is based; and what is the surviving name or new name.

In this scenario, analysts said Reynolds likely would remain based in Winston-Salem and keep its name.

The carrot for Lorillard management could be for Murray Kessler, its president and chief executive, and other top executives to gain high-level positions within Reynolds. Enditem