Why Reynolds American Is Buying Rival Lorillard

Why are two of the world's largest cigarette markers are merging in a $25 billion deal?

Jul 18, 2014 at 10:00AM

America's second-largest tobacco company, Reynolds American (NYSE:RAI), has announced that it plans to buy the third-largest tobacco company, Lorillard (NYSE:LO), for roughly $27.4 billion, in a deal that is one of the largest ever seen in the tobacco industry. If regulators agree to the acquisition, the deal will likely reshape America's tobacco industry. Clearly, both companies think bigger is better when competing against Altria Group, currently the largest tobacco company in America. But why exactly is Reynolds acquiring Lorillard?


Source: Reynolds American.

The deal
As the deal is extremely complex, it may take several quarters to complete the acquisition process. Lorillard shareholders are expected to get $50.50 in cash and 0.2909 Reynolds American shares per Lorillard share. This represents $68.88 per Lorillard share, which is equivalent to a total enterprise value of $27.4 billion. 

After the acquisition is done, Lorillard shareholders will own approximately 15% of the new entity. British American Tobacco, which currently owns 42% of Lorillard, will invest $4.7 billion to fund the transaction, which will allow this competitor to keep its 42% ownership in Lorillard.

Dealing with regulators
Needless to say, this massive deal will likely face scrutiny from regulators. To persuade antitrust regulators to approve the merger, Reynolds plans to sell some of its brands to competitor Imperial. The brands to be divested include KOOL, Salem, Winston, and Maverick. 

The purpose
As Brian Solomon from Forbes notes, the deal will finally create a credible second-place challenger to Altria. Note that Altria is the owner of Marlboro, the largest selling brand of cigarettes in the world. It has a huge marketing budget, economies of scale, and a well-known portfolio of tobacco brands, making it difficult for single players to compete.

By merging with Lorillard, Reynolds will be able to improve its product mix. For example, it will own the Newport menthol line, which is quite popular in urban areas. The new entity is also expected to have greater geographic diversity, as Reynolds has been traditionally strong in the west, while Lorillard has been stronger in the east.

The deal could also help the new entity to have more pricing power, although the probability of seeing a rise in tobacco prices is low, as that could be objected by the government.

At any rate, the merger will create a huge entity with annual revenue of more than $11 billion, or roughly two-thirds the yearly sales volume of market leader Altria -- and which is likely going to have better economies of scale than Reynolds or Lorillard.

Goodbye E-cigs?
Perhaps the most shocking part of the deal is that it includes the sell-off of Lorillard's blu, which is America's leading e-cigarette brand.

By selling blu to Imperial, Reynolds will lose a huge opportunity to gain extra exposure to one of the fastest-growing segments in the tobacco industry.

However, this may not be a completely negative factor, as e-cigarettes usually have lower profit margins than traditional cigarettes. More important, it should be noted that Reynolds has its own e-cig brand, Vuse, which is currently in the process of a national rollout.

Final Foolish takeaway
The largest deal in the tobacco place will create a huge company with more than $11 billion of annual revenue. Reynolds will likely see product mix improvement, and it is also expected to gain geographic diversity, because Reynolds has been traditionally strong in the west, while Lorillard has been stronger in the east. However, it should be noted that the deal is not only a huge opportunity for Reynolds to win market share, it is also full of risks regarding changing regulations.

Tobacco companies aren't the only great dividend picks out there
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That’s beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor’s portfolio. To see our free report on these stocks, just click here now.

Victoria Zhang has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.


Compare Brokers