US: Filing Details Reynolds-Lorillard Negotiations

Source from:  Winston-Salem Journal  10/22/2014

A narrative of Reynolds American Inc.'s $27.4 billion offer for Lorillard Inc. reveals how Lorillard's board of directors broke talks off twice — most recently in March — before securing the $68 a share commitment that sealed the deal.

Reynolds' offer for its Greensboro manufacturing rival was announced July 15 - about 20 months after Reynolds' board of directors revived discussions about the often-speculated merger.

The Securities and Exchange Commission filing is required of companies engaged in a major consolidation proposal. It is aimed at giving shareholders more insight into key negotiations.

The filing also disclosed Murray Kessler, Lorillard's chairman, chief executive and president, would get golden parachute compensation of $44.7 million, including $10.7 million in lumpsum cash and $32.8 million in equity and stock performance awards. Kessler would join Reynolds' board.

The deal is being reviewed by the Federal Trade Commission. Both companies expect it to close in the first half of 2015.

"Generally the Securities and Exchange Commission responds to the companies within 30 days of filing of the preliminary proxy," Reynolds spokesman David Howard said Monday. "Once we have their response, the final proxy will be prepared, the dates of the shareholder vote and meeting established, etc."

The initial industry rumors about a Reynolds-Lorillard deal surfaced in early March with media reports that Reynolds was reported to be willing to pay between $18 billion and $22 billion for Lorillard.

The rumors struck a nerve locally because between 2, 000 and 2, 200 of Reynolds' 4, 800 employees are based in Forsyth County, while Lorillard has about 2, 900

employees, the majority of whom are based in Greensboro.

There was concern among civic and elected officials that hundreds of jobs could have been eliminated from overlapping operations.

Among new details in the narrative are:

• How early Imperial Tobacco Group Pic was brought into the negotiations: That occurred in December 2012, rather than seemingly emerging from nowhere as a key player in the four-way transaction on June 30, 2014;

• Reynolds considered another, unidentified manufacturer for divesting its Kool, Salem and Winston cigarette brands, but a deal-breaker proved to be the insistence on acquiring Camel.

• Lorillard's board determined it would be more lucrative to be bought by Reynolds than to be part of a merger of equals that would have given it up to a 37 percent ownership stake, but at a smaller purchase premium. Kessler was in consideration to run the combined company in the initial proposal.

• British American Tobacco Ltd.'s focus all along was on Reynolds buying Lorillard rather than attempting to raise its ownership stake in Reynolds from 42 percent to at least 50 percent.

• BAT initially balked at selling Lorillard's blu eCigs line to Imperial until Reynolds convinced BAT management of its confidence that Vuse would be a viable, if not superior, e-cig competitor.

Reynolds' board acknowledged in September 2012 when it renewed internal talks about the merger that the FTC would require significant brand divestitures by both companies to give its approval. The initial Reynolds plan was to sell its three cigarette brands and blu eCigs.

After Reynolds agreed to add Lorillard's Maverick cigarette brand, Imperial raised its offer to $7.1 billion for the brand portfolio, Lorillard's Greensboro manufacturing plant and research and development operations, and Lorillard's workforce of 2, 900 in Greensboro and Danville, Va.

Imperial's offer was pivotal to Reynolds being able to afford the overall $27.4 billion proposal. It also would serve to relieve much of the local concern about job cuts since Imperial would need the Lorillard operations and workforce to scale up U.S. operations of Commonwealth Brands of Reidsville.

Daniel Delen, Reynolds American's former president and CEO, and Kessler first met to discuss Reynolds' interest in a deal on Nov. 15, 2012.

Reynolds did not provide any deal parameters, which failed to whet Kessler's appetite for further discussion. At that time, Lorillard's share price was $38.43 a share.

Delen and Kessler met again Feb. 19, 2013. With Reynolds still not providing specific deal parameters, Kessler broke off talks, although he said "he and the board would remain open to considering any tangible developments that could enhance shareholder value."

Although the companies did not engage in specific talks again until December 2013, Reynolds, BAT and Imperial kept negotiating.

In May 2013, the three companies entered a confidentiality agreement.

Reynolds' initial non-binding offer to Lorillard consisted of a merger of equals, along with the Imperial brand portfolio purchase.

On Jan. 11, the Lorillard board decided the offer did not "provide sufficient value to Lorillard shareholders," but it remained interested in the merger of equals proposal.

Reynolds' board discussed in February an offer in which Lorillard would gain up to 40 percent ownership in the combined company.

That was on condition BAT approved shrinking its 42 percent ownership. Reynolds made an offer of 37.5 percent ownership stake in the combined company.

The offer intrigued Lorillard's board enough to agree on Feb. 24 to enter into mutual confidentiality agreements with Reynolds and BAT.

The agreements were amended to add Imperial on March 3.

Kessler said March 10 that Lorillard's board balked at Reynolds' offer because of not having enough clarity on how Imperial would take over Lorillard operations, the lack of top-level Lorillard officials within management of the combined company, and BAT would still hold the top corporate ownership stake. On March 13, Lorillard's board chose to end talks for nearly two months.

A key factor in jump-starting the talks was Susan Cameron being appointed as Reynolds' chief executive, effective May 1.

Cameron retired as Reynolds' chairwoman in December 2010 and as its chief executive and president in February 2011.

She returned to the Reynolds board in December 2013.

Having Cameron back at Reynolds' helm gave Kessler and the Lorillard more confidence in a potential deal.

Reynolds' board approved May 7 a $65 a share offer, with Lorillard owning 16 percent of Reynolds.

Kessler told Reynolds' chairman Thomas Wajnert that he would not consider a deal below $68 a share.

Reynolds made its formal offer May 27 and a draft merger deal was submitted June 11.

After about a month of negotiations, Reynolds offered $50.50 in cash and 0.2909 shares of its common stock per share of Lorillard common stock.

That represented an offer valued overall at $68.73 a share — a 40.1 percent premium to the Feb. 28 closing price and an 80 percent premium from November 2012.

Besides Kessler's $44 million golden parachute package, other top Lorillard management officials

— David Taylor, Randy Spell, Ronald Milstein and Charles Hennighausen

— would receive between $8.1 million and $13.3 million, including at least $3.74 million in cash.

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

However, the selling of blu eCigs and the four cigarette brands to Imperial 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.

Imperial's U.S. market share, through its Commonwealth Brands subsidiary in Reidsville, is projected to go from 3 percent to 4 percent to between 10 percent and 12 percent.

"Both Reynolds and Lorillard have declined since the deal was announced and the market is currently implying only a 30 percent probability of the deal being approved by the FTC," Wells Fargo Securities analyst Bonnie Herzog said Monday.

"We think the probability is much higher, over 70 percent, presenting a compelling buying opportunity in both stocks with limited downside risk even if FTC doesn't approve the deal." Enditem