Altria Could Be the Big Winner in This FTC Move

Source from:  investopedia.com 04/17/2015

The tobacco industry has been relatively stable for decades, so Reynolds American's (NYSE: RAI) announcement that it would merge with Lorillard (NYSE: LO) was a groundbreaking event. In particular, the joining of the No. 2 and No. 3 players in the U.S. tobacco market had huge implications for Altria Group (NYSE: MO), as it would make the post-merger Reynolds a much more powerful competitive force for its rival. Yet when the Federal Trade Commission chose not to hold a scheduled vote to approve the merger late last month, it raised concerns among Reynolds and Lorillard investors that the deal might not go through as planned. As bad as that would be for the two companies involved, Altria could be a big beneficiary if the FTC blocks the deal or requires the companies to make more concessions to finalize the merger.

Dealing with antitrust issues

All along, Reynolds and Lorillard knew they would have to clear significant antitrust hurdles to combine the two companies. It took well over a year for the companies to reach a final agreement after initiating merger talks, in large part because the two parties knew they would have to figure out ways to sell off at least some of their respective business units in order to satisfy the FTC and other regulatory bodies.

In the proposed deal, Reynolds and Lorillard agreed to what appeared to be fairly considerable concessions. As part of the merger, the two companies said they would sell off Lorillard's then-leading e-cigarette concept blu, as well as Reynolds' cigarette brands Kool, Salem, Winston, and Maverick, to Britain's Imperial Tobacco Group. That transaction involved about $7 billion in assets, making up a considerable part of the overall $27 billion deal, and both companies hoped it would satisfy antitrust regulators that the merger wouldn't hurt competition.

After nearly nine months of study, though, the FTC still hadn't made a decision on the merger, and reports that certain FTC staff members had recommended against the deal in advance of the commission's scheduled vote increased investors' worries. Analysts speculated that various parts of the FTC didn't agree about whether the deal should go through, as some staff members focus more on the economic impact of a proposed merger while others consider more qualitative impacts on competition.

One concern is that the Imperial portion of the deal might not boost competition. Right now, Altria has a commanding U.S. market share of about 47%, with Reynolds and Lorillard possessing about 24% and 14%, respectively. If the merger goes through, Altria and Reynolds would collectively control a huge portion of the overall U.S. tobacco market, leaving Imperial with about 10% market share and facing a much stiffer challenge than Reynolds and Lorillard currently do against Altria.

Will Altria get another chance to dominate?

Obviously, if the FTC blocks the Reynolds-Lorillard deal entirely, it would be a big win for Altria. Without a competitor approaching its overall size, Altria would retain all its present advantages from economies of scale. Moreover, an abrupt about-face in overall strategy would leave both Reynolds and Lorillard reeling as they tried to return to their former courses as independent companies.

Few people believe the FTC will kill the deal entirely. Yet even if the merger is approved, the FTC might impose additional restrictions, such as requiring Reynolds and Lorillard to make further asset sales or take other measures to ensure competitive balance in the industry. Any move that disrupts the strategic vision for the post-merger Reynolds would be a step in the right direction for Altria, as it would allow Altria to make further progress in developing new products such as its MarkTen and Green Smoke e-cigarettes. Altria would also presumably be better able to preserve its margins if Reynolds and Lorillard couldn't gain the full efficiencies they hoped to capture from a merger.

With a potential agreement possible at any time, Altria shareholders should keep looking closely at what the FTC says about Lorillard and Reynolds American. Even if the long-awaited merger goes through, Altria might end up the winner if FTC approval comes with further strings attached.

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