Reynolds American Inc., the producer of Camel and Pall Mall cigarettes, has agreed to buy rival Lorillard Inc. for $27.4 billion including debt in a deal that reduces the 400-year-old U.S. tobacco industry to two major competitors.
Reynolds will pay a mixture of cash and stock valuing each Lorillard share at $68.88, according to a statement. British American Tobacco PLC of the will fund $4.7 billion of the transaction to maintain its 42 percent stake in Reynolds. BAT's British rival Imperial Tobacco Group PLC will acquire brands including Kool and blu eCigs for $7.1 billion.
After decades of anti-tobacco health campaigns, slumping demand has put pressure on the industry to consolidate. U.S. cigarette shipments fell by a median of 2.9 percent in the first quarter among the nation's top tobacco companies, according to data compiled by Bloomberg Industries. Merging Reynolds and Lorillard would help the companies cope with the slowdown and create a more potent competitor to market leader Altria Inc.
"It's transformative because it creates a duopoly in the U.S. and will help them to manage the volume declines," Philip Gorham, an analyst at Morningstar Inc. in Amsterdam, said before the transaction was announced. "They are still getting younger smokers in developed markets, but not at the rate as the old ones are dying off."
Excluding debt, the purchase is about $25 billion based on shares outstanding. The enlarged company will have annual revenue of more than $11 billion and operating income of about $5 billion, Reynolds said in the statement.
The deal -- which followed months of on-again, off-again talks -- will have to pass antitrust hurdles. To help meet those, Imperial Tobacco will acquire brands that also include Salem, Winston and Maverick. The U.K. company said separately that it will fund the transaction entirely through debt.
"The most surprising element is that Imperial is taking the e-cigarette business from Lorillard," Gorham said Tuesday. "It was probably the sweetener that convinced them to buy what is essentially a selection of third-tier brands."
Lorillard was down 7.3 percent at $62.30 in early trading Tuesday. Reynolds was off 4 percent at $60.65. Reynolds said it expects cost savings of about $800 million and for the deal to be accretive to earnings in the first year.
Susan Cameron will continue as chief executive of Reynolds after the acquisition, and the company will remain headquartered in Winston-Salem, North Carolina. Murray Kessler, chairman, president and CEO of Greensboro, North Carolina-based Lorillard, will join Reynolds's board.
Lorillard's biggest product, Newport, will give Reynolds fresh ammunition against Altria, whose brands account for more than half of the U.S. retail cigarette industry. Altria's Marlboro by itself has market share in the United States of about 44 percent, according to the company's website.
Reynolds, Lorillard and London-based BAT have been in talks since last fall to reach an agreement that would satisfy all three parties, people familiar with the matter have said. They made a tentative deadline of July to reach a deal because of a standstill agreement by BAT not to raise its stake in Reynolds without the approval of Reynolds's board until this month. BAT's agreement keeping it from increasing its stake in Reynolds dates back to the merger of R.J. Reynolds Tobacco Holdings Inc. with Brown & Williamson Tobacco.
REGULATORS TO TAKE HARD LOOK
The Federal Trade Commission is likely to take a hard look at the latest proposed transaction, said David Balto, a Washington attorney and former policy director for the FTC who litigated BAT's merger with Reynolds in 2004.
The FTC allowed that deal to go through because Brown & Williamson was losing market share and Lorillard was still around as a viable competitor, according to a brief released by the FTC. The market is more consolidated now, and this deal will face serious scrutiny, Balto said.
"The FTC will be very concerned about competition in this market," he said in a phone interview. "The FTC will want to make sure some level of competition is restored." There is a chance that just selling off the minor brands to Imperial won't be enough, he said.
"There is a difference between these brands being in the hands of a powerful company like Lorillard and being owned by an upstart like Imperial," Balto said.