Houston, TX – (StockNewsDesk) – 07/17/2014 — Two of America’s largest cigarettes producing companies are expected to merge in order to provide stiffer competition to the market leader Altria Group, as was announced on Tuesday. Reynolds American is valued at $31.6 billion, while its merging company Lorillard’s market capitalization stands at $22.2 billion. Even after the merger, the new entity will only be second largest when compared to Altria Group, whose market capitalization stands at $83.3 billion. The move comes off the back of steady decline in cigarette consumption over the past years; growing awareness and deterrence measures have significantly hindered cigarette sales across the U.S. Smoking declined from 24.4% of the adult population in 2005 to 17.3% in 2012, the U.S. Centers for Disease Control estimates. Over the past year, cigarette consumption declined by a further 4%.
The two parties have been negotiating and working on finding a favorable outcome for the past 18 months. The talks have had a fair share of hiccups and hurdles in the process. The negotiations rekindled about three months ago, leading to Tuesday’s announcement. The total deal value is $27.4 billion and Lorillard shareholders will receive $50.50 per share in cash. Shareholders will also receive 29.09 shares of Reynolds America for every 100 Lorillard share they own. In the process of a merger, Reynolds’ premiere brands – Camel, Pall Mall and American Spirit — will become the new company’s portfolio, along with Lorillard’s portfolio of Newport menthol-flavored cigarettes and e-cigarettes. However, the move faces resistance from regulators as to why the second and third biggest tobacco producers should be allowed to team up. The anti-trust regulators’ primary concern lies with British American Tobacco, which will control 42% of the new combined company.
However, the economists and federal agencies would not be in a hurry to calculate the Hirfendahl-Hirshman Index due to the existence of a virtual cartel in the tobacco industry. The Master Settlement Agreement of 1998 deliberately allowed high cigarettes prices to discourage consumption and continue a consistent stream of tax revenue to the authorities. Hence, perhaps the move will be able to sail through the regulators’ watch. Another aspect which makes the merger seems more favorable is the fact that some of these Reynolds’ brands will be sold to Imperial Tobacco, which will re-align the tobacco market dynamics in the U.S. whilst allowing Reynolds to challenge the undisputed market leader Altria Group with its flagship Marlboro brand.
Reynolds and Lorillard have stated that they will each sell off some of their other brands to re-align the new company. Imperial Tobacco is the fourth-largest international tobacco company in the U.S. and it has agreed to purchase former Reynolds’ brands KOOL, Salem, Winston, Maverick and blu eCigs in a separate $7.1 billion transaction. Interestingly enough, the new company will hold onto the two separate brands of e-cigarettes produced by the two companies, i.e. Lorillard’s blu eCigs and Reynolds’ VUSE e-cigarette offering. The combined company would continue to run under the Reynolds American name. Besides taking on the Altria Group, another financial incentive for the merger exists under the belief that annual sales will be boosted to $11 billion and operating income will stand at $5 billion. The merger will allow the company to cut costs, improve profits and mount a competitive challenge to Altria’s throne.
Furthermore, the synergy is expected to increase spending on R&D and introduce innovation for new products. The merger will also mean that one unified company now has flagship brands, such as Camel and Pall Mall, while also boosting menthol exposure, such as Newport. Since a multitude of brands will also go to Imperial Tobacco, it will see its market share triple in the U.S. At a time when cigarette sales are declining in the U.S., it may seem startling to read news that British American Tobacco and other board members have approved this re-focusing act in the U.S. But the fact of the matter is that cigarette sales in Europe are declining much faster than in the U.S., hence it is a loss-minimizing strategy to refocus on the U.S. tobacco sales.