Reynolds American, Lorillard discussing merger; would create formidable No. 2

BUSINESS

Cigarettes consolidation: Reynolds American, Lorillard discussing merger

Michael Felberbaum The Associated Press
Published Friday, July 11, 2014 10:43AM EDT Last Updated Friday, July 11, 2014 1:31PM EDT

This Oct. 21, 2009 file photo shows Camel cigarettes, a Reynolds American brand, in Philadelphia. (Matt Rourke)

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RICHMOND, Va. -- Cigarette makers Reynolds American Inc. and Lorillard Inc. on Friday said they are in talks of a possible merger that would combine two of the nation's oldest and biggest tobacco companies.

The announcement follows media reports over the past few months about the possible combination that would create a formidable No. 2 to rival Altria Group Inc., owner of Philip Morris USA, and could spur a wave of consolidation in the tobacco business.

In separate statements, the companies said no agreement has been reached and there's no assurance that one will be.

The merger discussions come as demand for traditional cigarettes declines in the face of tax increases, smoking bans, health concerns and social stigma. U.S. cigarette sales fell about 2.6 per cent last year to 285 billion cigarettes, according to market researcher Euromonitor International.

Most tobacco companies have been raising prices and cutting costs to keep profits up and are focusing on cigarette alternatives -- such as electronic cigarettes, cigars and smokeless tobacco -- for future sales growth.

Reynolds markets Camel, Pall Mall and Natural American Spirit cigarettes, as well as Grizzly and Kodiak smokeless tobacco brands. Its has about 27 per cent of the U.S. retail cigarette market. Reynolds, which is based in Winston-Salem, North Carolina, also expanded its Vuse brand electronic cigarette nationally last month.

Reynolds' profit rose 35 per cent to $1.72 billion last year on revenue of $8.24 billion, excluding excise taxes.

Lorillard, which was founded before the Revolutionary War and is the oldest continuously operating U.S. tobacco company, was spun off from Loews Corp. in 2008. The Greensboro, North Carolina-based company has about 15 per cent of the retail market, bolstered by its flagship Newport cigarette brand, which commands 37.5 per cent of the menthol cigarette market.

Lorillard because the first major tobacco company to jump into the e-cigarette market when it acquired the Blu e-cigarette brand in 2012. Blu now accounts for almost half of all e-cigarettes sold. Lorillard's profit rose 8.5 per cent to $1.19 billion last year on revenue of $4.97 billion, excluding excise taxes.

The move would likely mean a consolidation of the companies' operations and staff. Reynolds has about 5,200 full-time employees and produces its cigarettes at its 2 million-square-foot Tobaccoville, North Carolina, plant. Lorillard has about 2,900 full-time employees and produces cigarettes in Greensboro, about 40 miles southwest of Reynolds' plant.

The combined company would challenge Richmond, Virginia-based Altria, which holds about half of the retail cigarette market, led by its top-selling Marlboro brand. It also sells Black & Mild cigars, Copenhagen and Skoal smokeless tobacco and is expanding MarkTen e-cigarette brand nationally.

In a note to investors late Thursday, Wells Fargo Securities analyst Bonnie Herzog wrote that the merger would be "very positive for the global tobacco industry and could be just the beginning of future transactions."

Any deal would include involvement from British American Tobacco PLC, which makes Kent and Dunhill cigarettes overseas. British American Tobacco owns a 42 per cent stake in Reynolds and a 10-year moratorium on the company increasing that stake expires at the end of July. Reynolds said Friday that British American Tobacco is involved in the merger discussions and expects to support the deal and maintain its existing stake in the company.

Also on Friday, Imperial Tobacco Group PLC said it was in talks to buy some Reynolds and Lorillard brands should a merger occur. The combined company would likely keep most of its top-selling brands.

The U.S. "remains one of the world's largest and most profitable cigarette markets," noted Imperial, which owns Bowling Green, Kentucky-based Commonwealth Brands Inc., maker of USA Gold cigarettes. Altria, Reynolds American and Lorillard all sell cigarettes only in the U.S. Other companies sell their brands overseas.

Herzog also noted that Imperial's involvement in the potential deal could help to stem any potential Federal Trade Commission anti-trust concerns by buying up several of the companies' smaller brands.