Reynolds, BAT Finalize Vapor Tech Sharing Agreement

Source from:  Winston-Salem Journal 12/02/2015

R.J. Reynolds Tobacco Co. said Tuesday it has signed a definitive vapor technology sharing and licensing agreement with a subsidiary of British American Tobacco Ltd., effective immediately.

The agreement with Nicoventures Holdings Ltd. is considered a key part of not only Reynolds' relationship with its largest minority stakeholder - BAT owns 42 percent of Reynolds.

It also played a role in BAT's decision to provide Reynolds with $4.7 billion to keep the ownership stake at 42 percent following the completion of Reynolds' $29.25 billion megadeal for Lorillard Inc. Legacy Lorillard shareholders have owned 15 percent of Reynolds since June 12.

The companies signed a term sheet in September that provided the framework for the tech-sharing agreement, which runs through Dec. 31, 2022.

The agreement allows Reynolds and Nicoventures to collaborate to develop next-generation vapor products, such as joint research and development activities, and cooperation on regulatory, scientific and manufacturing issues related to vapor products.

"This is a great opportunity for the companies to continue to seek innovation in the vapor category, giving adult tobacco consumers more smoke-free options to consider," Debra Crew, R.J. Reynolds' president and chief operating officer, said in a statement.

BAT did not release a statement about the tech-sharing agreement, and officials could not be reached for immediate comment.

Kingsley Wheaton, BAT's managing director of next generation products, said in September he considered the tech-sharing agreement as a "milestone to enhance our next generation product business globally, further enabling us to meet the demands of today's consumer."

Reynolds spokesman David Howard said Tuesday that although the focus will be on developing vapor technologies going forward, the companies will share technologies on current products, such as Reynolds' top-selling electronic cigarette, Vuse, and four Vuse product extension unveiled recently to investors - Port, Pro, Connect and Fob.

"It will be build on new technologies that already exists," Howard said. "It's more about moving forward on innovations and providing a great opportunity to take vapor innovation to a global level."

Port may be the most intriguing of the four Vuse product extensions given it features a "dock and lock" closed format that allows for refillable vapor liquid products to be inserted into a Vuse cartridge. Reynolds has described it "as the vapor tank system re-imagined."

Howard said those five Vuse products would be considered as "current generation" products.

BAT was scheduled to roll out this week a hybrid tobacco product that combines electronic cigarette technology with tobacco, according to multiple media reports.

The hybrid cigarette, called iFuse, incorporates elements of its Kent cigarette brand. The iFuse product, like most e-cigs, heats nicotine-laced liquid into an inhalable vapor.

In this instance, the vapor passes through a bit of tobacco near the tip that imparts flavor, Wheaton, told Reuters.

BAT formed Nicoventures in April 2011 as its format for developing and commercializing innovative regulatory-approved nicotine products.

Vuse is made by R.J. Reynolds Vapor at its Tobaccoville plant.

Howard said he could not speculate on whether the agreement could lead to BAT distributing Vuse globally, as many analysts have projected. Such an arrangement could save Reynolds the immense expense of re-establishing a major global distribution chain.

Susan Cameron, Reynolds' chief executive, said when announcing the Lorillard deal in July 2014 that she is "very bullish about the combination of the research and development resources of both entities and the geographic and revenue-generating opportunities of that initiative."

Nicandro Durante, BAT's chief executive, said in July 2014 that "this strategic partnership will combine the experience and expertise of both companies to produce a world-class pipeline of next-generation products with global reach, better suited to meeting the emerging requirements of today's smokers, "

Susan Cameron, Reynolds' chief executive, said when announcing the Lorillard deal in July 2014 that she is "very bullish about the combination of the research and development resources of both entities and the geographic and revenue-generating opportunities of that initiative."

Nicandro Durante, BAT's chief executive, said in July 2014 that "this strategic partnership will combine the experience and expertise of both companies to produce a world-class pipeline of next-generation products with global reach, better suited to meeting the emerging requirements of today's smokers."

Wells Fargo Securities analyst Bonnie Herzog said that "by joining forces and leveraging each other's strengths, BAT and Reynolds will likely accelerate the pace of e-cig/vapor/reduced risk products' growth on a global basis. Importantly, they will be able to more successfully engage with regulators, both in the U.S. and internationally."

"Reynolds will likely leverage BAT's extensive international sales force. Given the large size of the global combustible cigarette market, the long-term upside potential for reduced-risk products is substantial."

As to continued speculation that BAT may acquire a majority ownership in Reynolds, Herzog said "the strategic partnership the companies are pursuing is the best of both worlds, and there is value created for shareholders whether or not Reynolds and BAT eventually combine."

Herzog predicts that e-cigs ($1.5 billion) and vaporizers ($2 billion) combined will exceed $3.5 billion in sales in 2015, and overtake traditional cigarette sales within the next 10 years.

"It is the right licensing deal at the right time," said Stephen Pope, managing partner with Spotlight Ideas on London.

"The takeaway is that such an arrangement will be identified as a driver to both the top and bottom line," Pope said. "There can be no doubt that over time the tobacco companies will report quarterly earnings that will show slow, but steady, shift in the sales breakdown away from rolled tobacco products in a combustible tube in favor of a 'less harmful, ' 'less socially undesirable' electronic alternative."

Herzog said Reynolds and BAT are following the vapor technology-sharing path of Philip Morris USA and Philip Morris International.

However, MarkTen, the e-cig product of Philip Morris USA subsidiary NuMark, has struggled to gain traction in the U.S. with a fourth-place market share.

The BAT-Reynolds vapor-technology sharing agreement has been the subject of a Reynolds shareholder lawsuit, which was dismissed by a N.C. Business Court judge on Aug. 4, but the dismissal is being appealed.

The essence of the lawsuit is that legacy Reynolds shareholders would be shortchanged from a Reynolds revenue standpoint if BAT gained access to Vuse and other next-generation vapor technology without paying an additional price. Enditem