U.S. Tobacco Firms Confirm Merger Talks

Updated July 11, 2014 2:06 p.m. ET


Reynolds American Inc.



RAI -0.82%



Reynolds American Inc.


U.S.: NYSE


$61.75


-0.51
-0.82%



July 11, 2014 4:02 pm

Volume (Delayed 15m)
:
3.88M



AFTER HOURS



$61.97


+0.22
+0.36%


July 11, 2014 7:56 pm

Volume (Delayed 15m):
23,359




P/E Ratio
21.29

Market Cap
$33.10 Billion


Dividend Yield
4.34%

Rev. per Employee
$1,566,730









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is nearing a deal to acquire


Lorillard Inc.



LO +4.63%



Lorillard Inc.


U.S.: NYSE


$66.01


+2.92
+4.63%



July 11, 2014 4:01 pm

Volume (Delayed 15m)
:
13.01M



AFTER HOURS



$66.36


+0.35
+0.53%


July 11, 2014 7:41 pm

Volume (Delayed 15m):
17,874




P/E Ratio
21.74

Market Cap
$23.93 Billion


Dividend Yield
3.73%

Rev. per Employee
$1,723,100









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that, if successful, would transform the U.S. tobacco industry and put additional corporate muscle behind the already hot electronic-cigarette market.

The companies on Friday confirmed talks about a deal that would combine Reynolds’ Camel and Pall Mall cigarettes with Lorillard’s popular Newport menthol brand to create a more powerful No. 2 to U.S. industry leader


Altria Inc.,



MO +1.12%



Altria Group Inc.


U.S.: NYSE


$43.43


+0.48
+1.12%



July 11, 2014 4:02 pm

Volume (Delayed 15m)
:
9.87M



AFTER HOURS



$43.59


+0.16
+0.37%


July 11, 2014 7:51 pm

Volume (Delayed 15m):
45,388




P/E Ratio
20.11

Market Cap
$86.27 Billion


Dividend Yield
4.42%

Rev. per Employee
$1,966,440









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maker of Marlboro. Reynolds and Lorillard have a combined stock-market capitalization of more than $50 billion.

The potential tie-up faces significant risks, including tough antitrust scrutiny. The U.S. Food and Drug Administration is also weighing a possible crackdown on menthol cigarettes, which fuel more than 80% of Lorillard’s sales, after the agency banned all other cigarette flavors in 2009.

The companies confirmed they are in talks to sell certain brands to


Imperial Tobacco Group



IMT.LN +3.05%



Imperial Tobacco Group PLC


U.K.: London


GBp2740.00


+81.00
+3.05%



July 11, 2014 4:35 pm

Volume (Delayed 15m)
:
4.18M




P/E Ratio
0.39

Market Cap
GBp26.22 Billion


Dividend Yield
2.83%

Rev. per Employee
GBp406,232









07/11/14 Tobacco Mergers: What’s in the…
07/11/14 Reynolds American, Lorillard C…
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PLC, a move that would likely ease regulatory concerns.

A deal would give Reynolds a jump on Altria in electronic cigarettes, the small but fast-growing alternative to traditional smokes. Both companies had been slow to enter that market, only beginning to roll out their brands nationally this summer. As part of a merger, Reynolds would get Lorillard’s Blu e-cigarette brand, which has more than a 40% market share in U.S. convenience stores.

The potential combination comes as tobacco majors try to increase scale and cut costs amid a yearslong decline in U.S. cigarette consumption, including an estimated 4% contraction last year, even as profits remain robust. Two rare pockets of growth in the $100 billion U.S. tobacco market are e-cigarettes and menthol cigarettes. Lorillard is the market leader in both.

The companies face many hurdles to closing a deal. For starters, the acquisition would result in much greater consolidation in the U.S. tobacco industry. Altria has roughly 50% of the U.S. cigarette market. Reynolds and Lorillard have roughly 25% and 15% U.S. market shares, respectively. Without divestments, 90% of the U.S. market would be in the hands of two companies.

“In almost every industry, three-to-two mergers are a bright line,” said John Briggs, an antitrust lawyer with Axinn, Veltrop & Harkrider LLP, referring to industry dominance by two companies versus three.

Altria declined to comment.

Any tie-up—and its potential to lead to higher prices—could bring out different views from various corners of the federal government.

Public-health officials have urged people to quit smoking, and studies have shown that higher prices lower consumption. Yet competition authorities focus on protecting customers from deals that raise prices or limit choices. The Justice Department and Federal Trade Commission declined to comment.

Adding another layer of complexity are the number of players involved.


British American Tobacco



BATS.LN +0.20%



British American Tobacco PLC


U.K.: London


GBp3528.00


+7.00
+0.20%



July 11, 2014 4:35 pm

Volume (Delayed 15m)
:
2.69M




P/E Ratio
0.17

Market Cap
GBp65.85 Billion


Dividend Yield
N/A

Rev. per Employee
GBp169,895









07/11/14 Reynolds American, Lorillard C…
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PLC and Imperial Tobacco, two U.K. cigarette giants, are participating in the talks.

British American, or BAT, which owns a 42% stake in Reynolds, said Friday it expects to support the acquisition of Lorillard if it proceeds. BAT, the second-largest international cigarette company, with brands including Kent and Dunhill, said it would invest to keep its stake in Reynolds at 42%.

Imperial Tobacco, which has around a 3% share of U.S. cigarette sales, largely behind its USA Gold discount brand, is being enlisted to allay antitrust concerns and help finance the deal. It said Friday it is in talks to buy assets from Reynolds and Lorillard. Those would likely be smaller brands like Reynolds’ Kool and Salem or Lorillard’s Maverick.

An agreement could be announced as early as Monday, according to a person familiar with the discussions, but the companies cautioned there was no assurance a deal would come together. Shares of Lorillard rose 4.7% to $66.01 on Friday while Reynolds fell 0.8% to $61.75.

A deal would also thrust menthol—about a third of U.S. cigarette sales—further into the regulatory spotlight.

Lorillard’s crown jewel is Newport, whose share of the U.S. cigarette market rose from 9.7% in 2008 to 12.2% last year, trailing only Marlboro, according to Euromonitor. The leading menthol brand also skews younger than most brands, giving Lorillard a 22.5% share of consumers aged 18 to 25, RBC Capital Markets recently estimated.

The FDA, which began regulating tobacco products in 2009, said last year that the mint-flavored smokes likely make it easier for teenagers to start smoking and harder for smokers to quit.

That has set the stage for potential restrictions on their sale, including the possibility of a ban. Any proposed FDA curbs are still likely months if not years away, and companies could challenge a menthol ban in court.

The FDA is also considering curbs on e-cigarettes, the battery-powered devices that turn nicotine-laced liquid into vapor. Such regulations, though, could be years away as authorities try to determine if e-cigarettes help wean smokers off more-harmful combustible cigarettes or act as a gateway to more smoking.

E-cigarette sales more than doubled last year and are expected to top $2 billion in 2014. Reynolds and Altria are scrambling to catch up after Lorillard jumped to an early lead by acquiring Blu in 2012 and quickly ramping up distribution across tens of thousands of U.S. stores. Reynolds only began rolling out its Vuse e-cigarette brand nationally last month. Altria is also starting a national rollout of its MarkTen brand this summer.

BAT and Imperial Tobacco have signaled their appetite for more exposure to the U.S. market. Sales in Europe and some emerging markets are shrinking or slowing, as authorities crack down on smoking.

Cigarette volumes in the European Union fell an estimated 7.5% last year, nearly twice the rate of the U.S. decline, according to Citi Research. While smoking has been under siege in the U.S. for decades, the business is still very profitable despite a lingering threat of expensive U.S. lawsuits for tobacco companies.

In April, an Illinois court reinstated a $10.1 billion verdict against Altria for marketing its “light” cigarettes as less harmful. Altria is appealing the ruling, but the class action, which began more than a decade ago, highlights U.S. lawsuits aren’t going away even after tobacco companies agreed in the late 1990s to pay tens of billions of dollars in compensation to states.

When BAT sold U.S. subsidiary Brown & Williamson to Reynolds in 2004, Reynolds assumed the British company’s litigation liabilities in the U.S. Lawsuit risks in the U.S. also factored heavily into Altria’s spinning off its international operations in 2008.

Imperial Tobacco has identified the U.S. as a “key growth market,” along with others including Cambodia, Vietnam and Greece. Analysts estimate Imperial could increase its share of the U.S. tobacco industry to around 10% by acquiring brands cast off by Reynolds and Lorillard—especially Reynolds’s Kool brand, the No. 2 menthol cigarette in the U.S.

But some observers have questioned Imperial’s wisdom in attempting to buy relatively low-profile brands in a market where cigarette sales are in long-term decline. “The assets likely to be on offer don’t feel hugely attractive,” said

Martin Deboo,

an analyst at Jefferies, in a research note published Friday.

—Liz Hoffman and Shayndi Raice contributed to this article.

Write to Mike Esterl at mike.esterl@wsj.com and Peter Evans at peter.evans@wsj.com

  Click to listen highlighted text! Updated July 11, 2014 2:06 p.m. ET Reynolds American Inc. RAI -0.82% Reynolds American Inc. U.S.: NYSE $61.75 -0.51 -0.82% July 11, 2014 4:02 pm Volume (Delayed 15m) : 3.88M AFTER HOURS $61.97 +0.22 +0.36% July 11, 2014 7:56 pm Volume (Delayed 15m): 23,359 P/E Ratio 21.29 Market Cap $33.10 Billion Dividend Yield 4.34% Rev. per Employee $1,566,730 07/11/14 U.S. Stocks Close Higher 07/11/14 Tobacco Mergers: What’s in the… 07/11/14 Reynolds American, Lorillard C… More quote details and news » is nearing a deal to acquire Lorillard Inc. LO +4.63% Lorillard Inc. U.S.: NYSE $66.01 +2.92 +4.63% July 11, 2014 4:01 pm Volume (Delayed 15m) : 13.01M AFTER HOURS $66.36 +0.35 +0.53% July 11, 2014 7:41 pm Volume (Delayed 15m): 17,874 P/E Ratio 21.74 Market Cap $23.93 Billion Dividend Yield 3.73% Rev. per Employee $1,723,100 07/11/14 U.S. Stocks Close Higher 07/11/14 Reynolds American, Lorillard C… 07/11/14 Stocks to Watch: Lorillard, We… More quote details and news » that, if successful, would transform the U.S. tobacco industry and put additional corporate muscle behind the already hot electronic-cigarette market. The companies on Friday confirmed talks about a deal that would combine Reynolds’ Camel and Pall Mall cigarettes with Lorillard’s popular Newport menthol brand to create a more powerful No. 2 to U.S. industry leader Altria Inc., MO +1.12% Altria Group Inc. U.S.: NYSE $43.43 +0.48 +1.12% July 11, 2014 4:02 pm Volume (Delayed 15m) : 9.87M AFTER HOURS $43.59 +0.16 +0.37% July 11, 2014 7:51 pm Volume (Delayed 15m): 45,388 P/E Ratio 20.11 Market Cap $86.27 Billion Dividend Yield 4.42% Rev. per Employee $1,966,440 07/11/14 Tobacco Mergers: What’s in the… 07/11/14 Reynolds American, Lorillard C… 07/11/14 Stocks to Watch: Lorillard, We… More quote details and news » maker of Marlboro. Reynolds and Lorillard have a combined stock-market capitalization of more than $50 billion. The potential tie-up faces significant risks, including tough antitrust scrutiny. The U.S. Food and Drug Administration is also weighing a possible crackdown on menthol cigarettes, which fuel more than 80% of Lorillard’s sales, after the agency banned all other cigarette flavors in 2009. The companies confirmed they are in talks to sell certain brands to Imperial Tobacco Group IMT.LN +3.05% Imperial Tobacco Group PLC U.K.: London GBp2740.00 +81.00 +3.05% July 11, 2014 4:35 pm Volume (Delayed 15m) : 4.18M P/E Ratio 0.39 Market Cap GBp26.22 Billion Dividend Yield 2.83% Rev. per Employee GBp406,232 07/11/14 Tobacco Mergers: What’s in the… 07/11/14 Reynolds American, Lorillard C… 06/26/14 Imperial Tobacco Sets Price Ra… More quote details and news » PLC, a move that would likely ease regulatory concerns. A deal would give Reynolds a jump on Altria in electronic cigarettes, the small but fast-growing alternative to traditional smokes. Both companies had been slow to enter that market, only beginning to roll out their brands nationally this summer. As part of a merger, Reynolds would get Lorillard’s Blu e-cigarette brand, which has more than a 40% market share in U.S. convenience stores. The potential combination comes as tobacco majors try to increase scale and cut costs amid a yearslong decline in U.S. cigarette consumption, including an estimated 4% contraction last year, even as profits remain robust. Two rare pockets of growth in the $100 billion U.S. tobacco market are e-cigarettes and menthol cigarettes. Lorillard is the market leader in both. The companies face many hurdles to closing a deal. For starters, the acquisition would result in much greater consolidation in the U.S. tobacco industry. Altria has roughly 50% of the U.S. cigarette market. Reynolds and Lorillard have roughly 25% and 15% U.S. market shares, respectively. Without divestments, 90% of the U.S. market would be in the hands of two companies. “In almost every industry, three-to-two mergers are a bright line,” said John Briggs, an antitrust lawyer with Axinn, Veltrop & Harkrider LLP, referring to industry dominance by two companies versus three. Altria declined to comment. Any tie-up—and its potential to lead to higher prices—could bring out different views from various corners of the federal government. Public-health officials have urged people to quit smoking, and studies have shown that higher prices lower consumption. Yet competition authorities focus on protecting customers from deals that raise prices or limit choices. The Justice Department and Federal Trade Commission declined to comment. Adding another layer of complexity are the number of players involved. British American Tobacco BATS.LN +0.20% British American Tobacco PLC U.K.: London GBp3528.00 +7.00 +0.20% July 11, 2014 4:35 pm Volume (Delayed 15m) : 2.69M P/E Ratio 0.17 Market Cap GBp65.85 Billion Dividend Yield N/A Rev. per Employee GBp169,895 07/11/14 Reynolds American, Lorillard C… 06/26/14 Philip Morris Strikes U.K. E-C… 05/30/14 Russian Cigarette Consumption … More quote details and news » PLC and Imperial Tobacco, two U.K. cigarette giants, are participating in the talks. British American, or BAT, which owns a 42% stake in Reynolds, said Friday it expects to support the acquisition of Lorillard if it proceeds. BAT, the second-largest international cigarette company, with brands including Kent and Dunhill, said it would invest to keep its stake in Reynolds at 42%. Imperial Tobacco, which has around a 3% share of U.S. cigarette sales, largely behind its USA Gold discount brand, is being enlisted to allay antitrust concerns and help finance the deal. It said Friday it is in talks to buy assets from Reynolds and Lorillard. Those would likely be smaller brands like Reynolds’ Kool and Salem or Lorillard’s Maverick. An agreement could be announced as early as Monday, according to a person familiar with the discussions, but the companies cautioned there was no assurance a deal would come together. Shares of Lorillard rose 4.7% to $66.01 on Friday while Reynolds fell 0.8% to $61.75. A deal would also thrust menthol—about a third of U.S. cigarette sales—further into the regulatory spotlight. Lorillard’s crown jewel is Newport, whose share of the U.S. cigarette market rose from 9.7% in 2008 to 12.2% last year, trailing only Marlboro, according to Euromonitor. The leading menthol brand also skews younger than most brands, giving Lorillard a 22.5% share of consumers aged 18 to 25, RBC Capital Markets recently estimated. The FDA, which began regulating tobacco products in 2009, said last year that the mint-flavored smokes likely make it easier for teenagers to start smoking and harder for smokers to quit. That has set the stage for potential restrictions on their sale, including the possibility of a ban. Any proposed FDA curbs are still likely months if not years away, and companies could challenge a menthol ban in court. The FDA is also considering curbs on e-cigarettes, the battery-powered devices that turn nicotine-laced liquid into vapor. Such regulations, though, could be years away as authorities try to determine if e-cigarettes help wean smokers off more-harmful combustible cigarettes or act as a gateway to more smoking. E-cigarette sales more than doubled last year and are expected to top $2 billion in 2014. Reynolds and Altria are scrambling to catch up after Lorillard jumped to an early lead by acquiring Blu in 2012 and quickly ramping up distribution across tens of thousands of U.S. stores. Reynolds only began rolling out its Vuse e-cigarette brand nationally last month. Altria is also starting a national rollout of its MarkTen brand this summer. BAT and Imperial Tobacco have signaled their appetite for more exposure to the U.S. market. Sales in Europe and some emerging markets are shrinking or slowing, as authorities crack down on smoking. Cigarette volumes in the European Union fell an estimated 7.5% last year, nearly twice the rate of the U.S. decline, according to Citi Research. While smoking has been under siege in the U.S. for decades, the business is still very profitable despite a lingering threat of expensive U.S. lawsuits for tobacco companies. In April, an Illinois court reinstated a $10.1 billion verdict against Altria for marketing its “light” cigarettes as less harmful. Altria is appealing the ruling, but the class action, which began more than a decade ago, highlights U.S. lawsuits aren’t going away even after tobacco companies agreed in the late 1990s to pay tens of billions of dollars in compensation to states. When BAT sold U.S. subsidiary Brown & Williamson to Reynolds in 2004, Reynolds assumed the British company’s litigation liabilities in the U.S. Lawsuit risks in the U.S. also factored heavily into Altria’s spinning off its international operations in 2008. Imperial Tobacco has identified the U.S. as a “key growth market,” along with others including Cambodia, Vietnam and Greece. Analysts estimate Imperial could increase its share of the U.S. tobacco industry to around 10% by acquiring brands cast off by Reynolds and Lorillard—especially Reynolds’s Kool brand, the No. 2 menthol cigarette in the U.S. But some observers have questioned Imperial’s wisdom in attempting to buy relatively low-profile brands in a market where cigarette sales are in long-term decline. “The assets likely to be on offer don’t feel hugely attractive,” said Martin Deboo, an analyst at Jefferies, in a research note published Friday. —Liz Hoffman and Shayndi Raice contributed to this article. Write to Mike Esterl at mike.esterl@wsj.com and Peter Evans at peter.evans@wsj.com Powered By GSpeech