US: Feds Reviewing Reynolds'' Deal to Buy Lorillard

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

The Federal Trade Commission is requesting additional information from Reynolds American Inc. and Lorillard Inc. about Reynolds' proposed $27.4 billion purchase of its tobacco-manufacturer rival.

The companies said Friday the separate requests also concern their plan to sell to Imperial Tobacco Group Pic four traditional cigarette brands (Kool, Salem and Winston from Reynolds and Maverick from Lorillard), as well as Lorillard's blu eCigs electronic cigarette brand.

The request is part of the FTC's antitrust review that began shortly after the companies announced their proposed transaction July 15. The companies said the request "is a normal part of the regulatory review process."

The request serves to extend the waiting period of the antitrust review until 30 days after the companies have complied. The waiting period can be further extended by the companies or can be terminated by the FTC before 30 days is up.

The companies said the request should not hamper their bid to close the deal by June 30. The deal also requires shareholder approval.

Some analysts stress that any deal faces long　odds of receiving FTC approval.

However, the selling of blu eCigs and the four cigarette brands may be enough to ease regulatory concerns about Philip Morris USA (50.7 percent) and Reynolds (33 percent) having combined about 84 percent market share.

The deal is one of the largest Triad corporate transactions in history and the latest tobacco industry-shaking merger.

Although Reynolds is buying Newport, the top-selling U.S. menthol brand and No. 2 overall, it is not taking with it blu eCigs, the top-selling U.S. electronic cigarette.

Imperial would pay Reynolds $7.1 billion for the five tobacco brands, as well as Lorillard's Greensboro manufacturing plant and research-and-development operations. Lorillard has a workforce of 2,900 in Greensboro and Danville, Va.

British American Tobacco would retain its 42 percent ownership in Reynolds through a new, $4.7 billion investment in Reynolds stock.

Imperial also secured from Reynolds indemnity from historic product liabilities with the cigarette brands.

The odds of federal regulators approving Reynolds' purchase could come down to how consistent regulators are at reviewing antitrust concerns surrounding the last deal.

That deal involved Reynolds buying Brown & Williamson Tobacco Corp. for $4.4 billion, a deal announced in October 2003. It closed in July 2004 after an intensive review and a 4-0 vote by the Federal Trade Commission.

By gaining Newport, Reynolds would have in its portfolio the No. 2, No. 3 (Camel) and No. 4 (Pall Mall) brands and a 32 percent market share. Philip Morris USA, maker of No.

1 Marlboro, has a 50.7 percent market share.

There is one pivotal parallel between the 2004 deal and the one Reynolds, Lorillard and Imperial are attempting.

In each case, the No.

2 and No. 3 manufacturers wanted permission to merge, and the No. 4 manufacturer stood to surge to a double-digit market share. Lorillard had an 8.4 percent market share in 2004.

Behind the strength of Newport, and Reynolds' de-emphasizing of menthol brands Kool and Salem, Lorillard nearly doubled its market share to 15 percent.

Imperial's U.S. subsidiary, Commonwealth Brands, has between a

3 percent and 4 percent market share. By gaining Reynolds' Kool, Salem and Winston brands, as well as Lorillard's Maverick brand, it could jump to 10 percent (its estimate) or 12 percent (analysts' forecasts).

Susan Cameron, Reynolds' chief executive and president, said the three companies took the approach of trying to help the FTC "get comfortable" with the deals by anticipating its divestiture requests. That's one reason why Reynolds agreed to sell Lorillard's blu eCigs brand — the top-selling U.S. electronic cigarette — to Imperial.

Cameron also stressed Reynolds' view of the superiority of Vuse over any other e-cig product. The companies said Imperial buying blu eCigs and the four cigarette brands should position it for significant growth in the U.S. market, particularly if analyst predictions are accurate that e-cig and vapor product sales could eclipse traditional cigarette sales as early as 2021.

"It was very important that shareholders in all four companies have confidence in the divestiture strategy," Cameron said.

Despite that potential level of dominance by Philip Morris and Reynolds at the top of the U.S. market, several analysts said they believe the FTC will approve the acquisitions.

"Lorillard may be somewhat range-bound for a while (with its share price) given investors' concerns over whether FTC will approve the deal, though we firmly believe the deal will be approved within a year," Wells Fargo Securities analyst Bonnie Herzog said.

Carol Levenson, research director for research firm Gimme Credit, expressed concern in recent days that Reynolds may be taking on too much debt to pay for the acquisition.

"The premium being paid is a bit less than we had conjectured in our Monday report, but the cash portion is significantly higher — about $4 billion more in cash — thus worsening the credit profile impact," Levenson said.

"With an expected close in the first half of 2015 and the need for regulatory and shareholder approval, plus the necessary participation of two other companies - BAT and Imperial Tobacco - there is considerable execution risk. "We will have more in an upcoming report but we reiterate our 'underperform.'"

Reynolds said it expects to achieve $800 million in cost savings, primarily from reducing corporate expenses and the assumption of the Lorillard operations by Imperial. Lorillard shareholders would own 15 percent of Reynolds stock.

The purchase price represents a 40.4 percent premium on Lorillard's share price of Feb. 28 — the last trading day before rumors of a Reynolds-Lorillard deal surfaced March 3.

Alison Cooper, Imperial's chief executive, said the deal "is a great opportunity to transform our U.S. business."

"We plan to build a U.S. brand portfolio through national distribution and create a stronger, more competitive business." Its market share is projected to go from 3 percent to 4 percent to between 10 percent and 12 percent. Enditem