FTC Sets Face-to-Face Discussion With Reynolds & Lorillard

WASHINGTON, D.C. — The proposed merger between two major U.S. tobacco companies is entering the homestretch.

The Federal Trade Commission (FTC) asked to meet with executives from Reynolds American Inc. (RAI) and Lorillard Inc. to discuss the $27.4-billion deal that has been on the table since July. A final vote by the commission could come as soon as this week, people familiar with the review told the Wall Street Journal. A majority of the five-member panel has to agree on a course of action.

Under the terms of the pending agreement, Winston-Salem, N.C.-based RAI will buy Greensboro, N.C.-based Lorillard and keep the Newport, True and Old Gold brands. United Kingdom-based British American Tobacco, RAI's largest shareholder, will maintain its 42-percent ownership in RAI through an investment of approximately $4.7 billion.

Once that transaction closes, Imperial Tobacco will pay $7.1 billion for the Winston, Kool and Salem brands from RAI and the Maverick and blu eCig brands from Lorillard.

The face-to-face meeting will give the FTC a chance to directly question RAI and Lorillard executives. Commission members have already spoken with competitors, retailers and wholesalers about how the consolidation would affect cigarette pricing and competition, according to the news report.

Some retailers expressed concern about a reduction in competition, which could result in slimmer margins, said Dave Woodley, executive vice president of sales and marketing with Altoona, Pa.-based Sheetz Inc. 

"Less competition is typically not good," Woodley told the WSJ.

Others believe the effect will be minimal. "We don't think it will change much, if any, of the way we'll do business," said Mike Thornbrugh, spokesman for Tulsa, Okla.-based QuikTrip Corp.

The FTC's sit-down with RAI and Lorillard is coming just two weeks after the commission took a closer look at Imperial's role in the merger and its ability to compete in the U.S. tobacco scene, as CSNews Online previously reported.

Cowen and Co. gives the deal as proposed a 65-percent probability of approval and a 70-percent probability if amended.

"We continue to question [Imperial's] ability to compete as a viable No. 3 in the industry over time, as the proposed portfolio would have a 10-percent share that meaningfully under-indexes with adult smokers under 30. While price discounting can serve to stabilize/grow market share, given the discount/ legacy positioning of these brands, we believe that pricing action would most resonate with older smokers, thus not bringing the much needed young adult smoker into the portfolio," according to a report issued by Vivien Azer, director and senior research analyst at Cowen and Co.

"While [Imperial] also has the opportunity to revitalize packaging and shelf placement, product innovation (e.g., menthol for Winston) requires FDA approval. And, to the extent that precedent from the last industry consolidation is a factor, the FTC will see that the industry has become increasingly consolidated over the last decade, while pricing has been consistently robust," Azer added.

As for any changes to the proposed deal, Cowen & Co. believes RAI's Doral brand could be added to the divestiture package to Imperial, as has already been agreed upon.

Wells Fargo Securities LLC puts the probability of the FTC approving the merger higher, at more than 90 percent. Bonnie Herzog, managing director of beverage, tobacco and convenience store research at Wells Fargo Securities, pointed out that stocks have reacted negatively to the news of a meeting between the tobacco companies and the FTC, but the reaction may not be warranted.

"We believe the market's negative reaction to these meetings is unjustified based on our industry sources that are telling us these meetings are completely normal and should be viewed as positive," she said.

In addition, Wells Fargo Securities' industry sources have maintained that "no part of the FTC review has been hostile."