WILLIAMSBURG, Va. — The past few months have raised more questions than answers in the tobacco category. Will Reynolds American Inc. (RAI) and Lorillard Inc. get the OK to merge? Will e-vapor products be the game changer many industry insiders are banking on? What will the Food and Drug Administration (FDA) do with menthol?
While no one has a crystal ball, leading tobacco analysts gathered at the Tobacco Merchants Association (TMA) Centennial Annual Meeting & Conference Wednesday to bring some insights to these questions. The panelists were Bonnie Herzog, managing director of beverage, tobacco and convenience store research for Wells Fargo Securities LLC; Michael Lavery, director and senior analyst at CLSA; and Vivien Azer, director and senior research analyst at Cowen & Co.
RAI and Lorillard announced in July their plans to merge in a $27.4-billion deal, which also calls for Imperial Tobacco to pay $7.1 billion to acquire the Winston, Kool and Salem brands from RAI and the Maverick and blu eCig brands from Lorillard. As the players approach the 11-month mark, the analysts expressed surprise the deal hasn't received final approval from the Federal Trade Commission (FTC) yet, though they expect it any day.
In fact, Herzog and Lavery jokingly said they expect the final nod to come when they are on a plane or on vacation.
"I am a little surprised it is taking longer than expected," Herzog said, noting she expected an announcement in March or April.
"The fact that it is taking so long is a little curious and unexpected," Lavery agreed.
While all three believe the FTC will give the deal the green light, Herzog is the most bullish by giving it a 90-percent probability rating. Lavery puts the chances lower, at between 65 percent and 70 percent.
According to Lavery, the potential deal raises some issues the FTC may be addressing: it gives RAI a significant concentration in menthol, and there are questions over Imperial's long-term potential as a third player in the U.S. tobacco space.
These concerns could be what is holding up the deal at this point. Herzog said there may be some changes to the proposed transaction, but "nothing dramatic."
Imperial "has a chance" as a No. 3 player in the United States if it puts some money behind the Winston brand, she explained. However, Lavery cautioned if Winston succeeds on price promotion, it could take away from Imperial's other value brands.
As for other potential mergers in the tobacco industry, the analysts agree the next moves could be in the international arena, as well as in the e-vapor space — more consolidation like the recent Japan Tobacco and Logic Technology Development deal.
Speaking of the e-vapor space, Azer pointed out she is not as bullish on the segment as some of her colleagues. "The problem is there is very good trial, but very little repeat," she said. "If you don't have adoption, does it point to a disruptive [product]?"
That being said, she doesn't see electronic cigarettes going away. Convenience stores need to start balancing their portfolios with next-generation products, according to Azer.
Herzog agreed, pointing out that retailers are beginning to shift their vapor sets. "I adamantly believe the technology is going to have to continue to improve across the board because we're simply not there yet," she said.
Still, she believes e-vapor consumption will surpass combustible cigarette consumption in the next decade — with 2017-2018 emerging as the tipping year.
Lavery explained that the e-cigarette segment represents a different competitive landscape from traditional cigarettes. Traditional cigarettes have high brand equity, high brand loyalty and high pricing, while on the e-cigarette side, there are unknown players, unknown brands and lower price points.
"In time, with branding and technology, consumers will be willing to pay for a better product," Herzog said.
The segment is battling another problem: consumer perception. Herzog admitted she has become more cautious on e-vapor products because the safety perception has become clouded. "Increasingly, people are not believing they are less harmful," she said.
However, Azer pointed out flattening in the segment dates back further than the negative publicity. "The category started rolling over almost two years ago, but the headlines are more recent," she said.
The Question of Menthol
Another big question mark in the tobacco industry is the future of menthol.
The FDA has been reviewing a possible ban on menthol since 2011, with the agency's Tobacco Products Scientific Advisory Committee (TPSAC) issuing a report that came down on the side of a ban. The report, though, hit a stumbling block in July when U.S. District Court Judge Richard Leon barred the agency from using the report because of biases on the part of TPSAC members.
"I think the FDA has the intention or the desire to ban menthol," Lavery said. "Absent the TPSAC decision last summer, we may have already seen a ban on menthol. It's still on the horizon, from my standpoint. We just don't know when."
Azer expects to see some headlines around the issue in mid-2016. "It will be a research-based decision; [FDA's Center for Tobacco Products Director Mitch Zeller] has been clear on that. So until we start seeing the research, we won't have a ban."