Reynolds to Buy Lorillard in $25 Billion Deal
Reynolds American Inc. agreed to acquire Lorillard Inc. in an ambitious and risky $25 billion deal that would reshape
the landscape of U.S. tobacco and make Newport menthols an even more formidable rival to Altria Group Inc.'s top-selling
The transaction would add Lorillard'sNewport, the No. 2 U.S. cigarette brand, to Reynolds's portfolio, which includes
Camel and Pall Mall cigarettes, giving Reynolds a commanding position in popular menthol smokes, which have been
stealing share from unflavored cigarettes.
Reynolds expects to have more than $11 billion in revenue and about $5 billion in operating income after the deal.
The deal--ultimately involving four different cigarette makers--is so complex that it isn't expected to close before
the first half of next year. It must win approval from antitrust authorities and shareholders not just of Reynolds and
Lorillard, both based in North Carolina, but also of Imperial Tobacco Group PLC of the U.K.
To clear antitrust hurdles, the transaction was structured to be "pro-competitive," executives said in a conference
call with investors Tuesday. Under the plan, certain operations will be divested to Imperial with the idea of turning
Imperial into a strong No. 3 in the U.S., behind the newly enlarged Reynolds.
Among those divestitures will be Lorillard's Blu electronic cigarette, the No. 1 e-cigarette in the U.S., with a
market share of more than 40% in convenience stores.
The deal requires Reynolds to make a couple of huge bets. First, it is taking a chance on menthol, even as the Food
and Drug Administration weighs possible restrictions on the minty smokes after banning all other cigarette flavors in
Currently, Reynolds is the No. 2 tobacco company in the U.S. and Lorillard is the No. 3, as measured by dollar sales.
In a preliminary assessment last year, the FDA said menthol cigarettes appeared to make it easier to start smoking and
harder to quit.
Newport's share of the U.S. cigarette market rose to 12.2% last year from 9.7% in 2008, trailing only Marlboro,
according to Euromonitor.The leading menthol brand also skews younger than most brands, giving Lorillard a 22.5% share
of consumers aged 18 to 25, RBC Capital Markets recently estimated.
Reynolds is also betting it can rise to the top of the small but fast-growing e-cigarette market without Blu. Reynolds
began rolling out its own brand, Vuse, nationally last month.
In a telephone interview, Reynolds CEO Susan Cameron said the Blu divestment was fueled in part by the need to shed
assets for antitrust reasons. But she said Reynolds also believes its Vuse e-cigarette technology is superior to that of
Blu, noting Vuse captured a retail share of more than 70% last year when it was launched in the test market of Colorado.
"We believe Vuse has game-changing technology," because it delivers a more consistent puff than other products on the
market, she added. Reynolds is rolling Vuse out across 15,000 stores in the first leg of its national launch.
Blu's sales have stalled in recent months as more powerful e-cigarettes known as "vaporizers" with larger, refillable
cartridges and bigger batteries become more popular.
The way the deal is structured, Reynolds would acquire Lorillard in a cash-and-stock transaction valued at $68.88 per
Lorillard share, or $25 billion. Including the assumption of debt, the value rises to $27.4 billion. Reynolds, based in
Winston-Salem, N.C., estimated the merger would create about $800 million in cost savings.
Lorillard's share price plunged 10.5% to $60.17, after many investors had placed bets in recent days that Reynolds
would offer a bigger premium for the company. Shares in Reynolds also tumbled, closing 6.9% lower at $58.84.
"Mostly I think it's just that there is not enough certainty on whether or not it gets regulatory approval," said
Michael Lavery, a tobacco analyst at CLSA.
Under the agreement, Imperial, the fourth-largest international tobacco company, would invest $7.1 billion to acquire
the Winston, Kool, Salem and Maverick cigarette brands along with Lorillard's Blu--a gem of the combined companies"
Imperial also would get Lorillard's manufacturing facilities and about 2,900 employees, including most of its sales
force. Lorillard is based in Greensboro, N.C. If the Reynolds deal is completed, Imperial would have a 10% share of the
$100 billion U.S. tobacco market, up from about 3%. The U.S. will account for 24% of Imperial's global sales, up from 7%
Making it a four-party transaction, British American Tobacco PLC, the No. 2 international cigarette company, has
agreed to pay $4.7 billion to maintain its existing 42% stake in Reynolds.
The deal is likely to draw intense antitrust scrutiny by creating a potential duopoly. Even with the divestments, the
new company would control roughly one-third of the U.S. cigarette market. Marlboro-maker Altria, based in Richmond, Va.,
already controls about half the market.
The two sides have been working on the deal for approximately 18 months and the talks have had a number of stops and
starts since then, according to a person familiar with the matter. They were active around the end of last year before
fizzling, for example. The negotiations rekindled about three months ago, leading to Tuesday's announcement.
A number of factors came together to enable the companies to finally strike the complicated four-way deal. They
include: an ample supply of cheap debt financing, even for tobacco companies, which have typically been constrained in
their ability to borrow by the decline of the industry as well as regulatory and litigation risk; and fewer concerns on
the part of the companies that the macroeconomic picture will darken dramatically--a factor that generally crimped deal
making for years in the wake of the financial crisis. Imperial Tobacco's willingness to participate was also crucial, as
antitrust concerns had been one of the factors that slowed the deal's progress in the past, this person said.
The merger between the two companies, which have a combined stock-market capitalization of more than $50 billion,
coincides with growing efforts by tobacco competitors to consolidate manufacturing and pare costs amid shrinking
cigarette consumption in the U.S.
Despite facing long-term declines in cigarette consumption--down about 4% last year, according to industry estimates--
the U.S. tobacco market is proving increasingly attractive for international tobacco companies. Sales of cigarettes are
declining even more sharply in Europe, and sales in several emerging market countries are slowing or contracting.
The U.S. offers a relatively benign regulatory environment compared with that in some European countries, as well as
the opportunity for cigarette makers to raise prices. Trade in illicit tobacco is also less of a problem in the U.S.
than in many developed markets.
"The U.S. is a key growth market for us," Imperial Chief Executive Alison Cooper said on a call with reporters. "We're
hugely excited about the opportunities that lie ahead." Ms. Cooper said Imperial would focus on expanding the Winston
brand, currently the No. 7 brand in the U.S.
Imperial said it would finance its purchase entirely through debt.
Imperial was founded in 1901 when a number of British tobacco companies combined to avoid being bought out by American
Tobacco Co., maker of Lucky Strike, which is now owned by BAT.
The Bristol, England, company also wants to dominate the fast-growing e-cigarette market, both in the U.S. and in
international markets where e-cigarettes have yet to make their mark. E-cigarettes are heating devices that use
batteries to turn nicotine-laced liquid into vapor.
Imperial already owns one e-cigarette brand, Puritane, but sells it only in the U.K. Ms. Cooper said Blu could be
built into an international brand, something that doesn't currently exist in the fragmented e-cigarette market.
"Clearly we've got a great international opportunity," Ms. Cooper said.
Lazard is lead financial adviser to Reynolds and J.P. Morgan Chase & Co. is also advising the company. Lorillard's
financial advisers are Centerview Partners and Barclays PLC.
Dana Cimilluca and Karishma Mehrotra contributed to this article.
Write to Mike Esterl at firstname.lastname@example.org and Peter Evans at email@example.com
Subscribe to WSJ: http://online.wsj.com?mod=djnwires
(END) Dow Jones Newswires
Copyright (c) 2014 Dow Jones & Company, Inc.