Is The Lorillard-Reynolds Deal Likely To Go Ahead?

When it was announced that Reynolds American (NYSE: RAI  ) was putting together an offer for smaller peer Lorillard  (NYSE: LO.DL  ) , the market celebrated. Now that the party's died down, though, some have started to ask if the deal will actually go ahead.

Taken by surprise
Without a doubt, Reynolds' rumored swoop on Lorillard was a surprise for many. You see, Lorillard's best-selling cigarette brand is the Newport brand of menthol cigarettes, which continue to report rising sales year after year and have bucked the general long-term decline in U.S. smoking rates. However, there is still uncertainty over the FDA's stance on menthol cigarettes and the FDA could move to ban regulate menthols; such a move would decimate Lorillard. It is widely expected that a decision on the menthol matter will be released by the FDA soon, although it appears Reynolds does not want to wait.

Lorillard was also a first mover in the U.S. e-cig market, which has allowed the company to grab a near 50% share of the country's still juvenile market. Reynolds could be attracted by this. The deal would lead to billions of dollars of synergies for Reynolds, allowing it to compete more effectively with industry behemoth Altria.

Not Reynolds' decision
Unfortunately, the final decision on this deal could be out of Reynolds' hands as Reynolds is 42% owned by Anglo-American company British American Tobacco (NYSEMKT: BTI  ) . As a majority shareholder, British American would have to give the go-ahead on a deal as large as this.

Fortunately, British American has a reputation for good management. It is unlikely that they will give the green light on a Reynolds-Lorillard deal unit the menthol issue is sorted. What's more, it's possible that Reynolds would have to ask British American for help funding the deal. Based on year-end 2013 numbers, it is questionable if Reynolds can afford to make the deal itself. This makes a request for funding or a cash call likely. Reynolds had $1.5 billion of cash at the end of the year, long-term debt of $5.1 billion, and a debt-to-equity ratio of 100%. Even if Reynolds were to stump up 50% of the estimated $20 billion needed to acquire Lorillard, the company's balance sheet would be put under immense strain.

More deals could follow
Of course, this deal chatter could be just the beginning of further consolidation within the tobacco industry.

As the volume of cigarettes sold around the world continues to decline, British American Tobacco is searching for growth. For this reason, it is likely that the company will make a move to acquire the part of Reynolds that it does not already own. At present, though, British American is not allowed to increase its ownership of Reynolds as there is a standstill agreement still in place from when the initial stake was acquired ten years ago. The agreement prevents British American from boosting its share in Reynolds until expiration. The agreement is scheduled to expire during July of this year.

Unlike Reynolds, British American has a relatively clean balance sheet and the company would be easily able to find the cash to acquire Reynolds without having to ask anyone's permission. This means that a deal between these two companies is looking increasingly likely.

Is Uncle Sam About to Claim 40% of Your Hard-Earned Assets? 
Thanks to a 2013 law called the "American Taxpayer Relief Act (ATRA)," he can... and WILL... if you aren't properly prepared.

Fortunately, The Motley Fool recently uncovered an arsenal of little-known loopholes to protect yourself from "ATRA"... and help keep the taxman at bay when he inevitably comes calling. We reveal them all in a brand-new special report. Simply click the link below for instant, 100% FREE access.

Protect my hard-earned wealth from Uncle Sam

Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2878914, ~/Articles/ArticleHandler.aspx, 8/30/2015 10:33:40 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Rupert Hargreaves

Rupert has been writing for the Motley Fool since December 2012. He primarily covers tobacco and resource companies with a passion for value-oriented investments. .

Today's Market

updated 2 days ago Sponsored by:
DOW 16,643.01 -11.76 -0.07%
S&P 500 1,988.87 1.21 0.06%
NASD 4,828.33 15.62 0.32%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

8/28/2015 4:01 PM
BTI $107.22 Up +0.15 +0.14%
British American T… CAPS Rating: *****
LO.DL $0.00 Down +0.00 +0.00%
Lorillard, Inc. CAPS Rating: ****
RAI $84.67 Up +0.19 +0.22%
Reynolds American,… CAPS Rating: ****