NEW YORK -- “It's not a matter of if but when” for Federal Trade Commission (FTC) approval of the combination of Reynolds American Inc. and Lorillard Inc., “which we continue to expect any day,” Bonnie Herzog, managing director of beverage, tobacco and convenience store research for Wells Fargo Securities Inc., said in brand-level analysis of the impending tobacco deal.
The $25-billion deal will combine the second- and third-largest cigarette makers, respectively, behind Altria Group Inc., Richmond, Va. Regulatory approval will clear the way for a three-way transaction that will reshape the tobacco industry. Winston-Salem, N.C.-based Reynolds and Greensboro, N.C.-based Lorillard also agreed to sell five brands to U.K.-based Imperial Tobacco Group PLC for $7 billion.
After the analysis, Herzog said Wells Fargo has “even more conviction in the power created by [Reynolds’] acquisition” of Lorillard’s Newport menthol cigarette band.
They expect:
- RJ Reynolds Tobacco Co. (RJR) should take an incremental 140 basis points (bps) of cigarette shipment share, to 32.2% by 2017.
- Newport share gains under Reynolds American ownership will accelerate to 14% by 2017, 50 bps higher than if there were no deal.
- Camel and Pall Mall should benefit from a post-deal "halo effect" driven by better shelf space and synergies, taking slight incremental share.
- RJR's controllable cigarette costs/pack should decrease to 60 cents per pack by 2017, 14% lower than if there were no deal, driving incremental margin expansion of 410 bps to 48.9%
“Minor tweaks” to the deal could include:
- The extension by a few months to the already agreed-upon shelf-space provisions for Imperial/
- Changes to Reynolds American’s every day low price (EDL) retailer program. Reynolds American “could agree to exclude Newport for a certain number of months to give Imperial a ‘fighting chance’,” said Herzog.
- Divestiture of “non-growth” brand Doral to Reynolds American or other very small brands. As laid out in the merger agreement, if the shipment share from wholesale to retail for Winston, KOOL and Salem in the three months prior to the deal closing month is less than 4.9%, then Doral will be divested to Imperial.
“We learned from our retailer contacts that [Reynolds American] increased promos on Winston and Kool in select markets in May, possibly to ensure the divested brands' market share does not fall below the 4.9% threshold,” she said. “Bottom line—we believe any modifications would be minor and an approved deal would result in high-single-digit earnings accretion in FY16 and double-digit accretion by 2017.”
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