Tobacco’s New Big 3


A lot of questions surround the planned merger of Reynolds American Inc. (RAI) and Lorillard Inc. and the expansion of Imperial Tobacco Group plc to a larger portion of the U.S. tobacco business. As of press time, the industry was still waiting to see if the deal gets final federal approval, but what convenience store retailers really want to know now is what’s in it for them.

Questions about the fallout of the deal began popping up almost as soon as the merger was announced this past summer. On July 15, RAI and Lorillard revealed — after months of industry speculation — that the two companies would become one. The pending merger is not so cut and dried, though. In fact, four companies play key roles in the agreement: Lorillard, RAI, Imperial Tobacco Group and British American Tobacco (BAT).

Under the proposed deal structure, Winston-Salem, N.C.-based RAI will buy Greensboro, N.C.-based Lorillard for $27.4 billion and keep the Newport brand, which represents 90 percent of Lorillard’s existing sales and profitability, as well as the True and Old Gold brands. United Kingdom-based BAT, 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. These acquisitions will build on Imperial’s existing U.S. portfolio at Commonwealth-Altadis, which currently accounts for a 3-percent share of the U.S. market, principally through the USA Gold brand.

In addition, United Kingdom-based Imperial will acquire Lorillard’s infrastructure, which includes the company’s manufacturing facility, headquarters offices, research and development facility, and approximately 2,900 employees. Hereafter, Imperial’s new U.S. subsidiary will be known as ITG Brands LLC and be based in Greensboro.

In terms of the merger’s status, RAI and Lorillard certified substantial compliance with the Federal Trade Commission’s request for additional information on Dec. 31 and entered into a timing agreement with the FTC to extend the normal 30-day waiting period for a “limited period of time” before consummating the deal, according to Bonnie Herzog, managing director of tobacco, beverage and convenience store research at Wells Fargo Securities LLC.

“We think this should be viewed as positive and could suggest the parties are cooperating nicely and negotiations are progressing toward ultimate FTC approval with very minor modifications, if any,” Herzog explained in early March.

The companies continue to expect the deal to close in the first half of 2015. If regulatory issues remain outstanding as of July 15, the “end date” of the merger would be automatically extended by six months, she added.


Upon completion, the top U.S. tobacco companies, commonly referred to as the “Big Three,” will see some big changes — notably a new player and a shift in power. Up to this point, the order has been Richmond, Va.-based Altria Group Distribution Co., followed by RAI and then Lorillard.

If all goes according to plan, post-merger ITG Brands will be a broader No. 3 player in the tobacco business compared to what Lorillard ever was, according to David Bishop, managing partner of Balvor LLC, a sales and marketing firm based in Barrington, Ill. For the most part, he explained, Lorillard was a cigarette manufacturer that eventually moved into electronic cigarettes with its April 2012 acquisition of blu, but kept that separate.

ITG Brands will be a different story. Post-merger, it will have a much broader and deeper bench. It picks up an e-cigarette in the United States with an established brand. The company already has a market share presence in cigars. And while it is not in smokeless tobacco today, its parent company does have products internationally that ITG could possibly introduce into the U.S. market, very similar to what Swedish Match did with General snus.

“I see [ITG Brands] really stepping into that third position more broadly. That is, not just in cigarettes, but in tobacco primarily because of its existing portfolio and presence in cigars and cigarettes,” said Bishop, whose firm provides analytic, consulting, research and sales support services to retailers and product suppliers.

As for RAI, the acquisition of Newport will be an extremely beneficial addition to its portfolio. “Newport is the No. 2 cigarette brand. It is a brand that has continued to grow market share for the last several years. It is a brand that really has, for the most part, gone against the industry trend for year-over-year decline in pack sales,” he said. “It does complement what Reynolds does offer already in the menthol space, and [Reynolds] can benefit by helping accelerate distribution and national availability of Newport with its own sales force.”

The industry saw that effect when Reynolds rolled out VUSE, its digital vapor cigarette. “VUSE really benefited from the sales and distribution muscle Reynolds had on the street, which is no different from what Lorillard had. The key is: this gives Reynolds — besides the No. 2 brand — more clout at the table,” Bishop explained.


The most substantial shift from the new Big Three is expected to occur in the cigarettes category.

ITG will have a bifurcated brand architecture now with the acquired brands. Commonwealth-Altadis has been primarily a price value branded company. With the acquisition of the Reynolds brands — Winston, Kool and Salem — ITG is moving up to branded discount and premium, depending on how the company positions those brands.

“What’s clear from what I can see with [ITG Brands is that] it is going to leverage the strength of the Winston brand to go national,” Bishop pointed out. “Before that, it was really more regionalized in a couple pockets of the country. Beyond leveraging the Winston brand nationally, it is obviously going to leverage the national scope that blu has.”

ITG’s investment will primarily be behind those two core brands, Bishop believes.

Increased support behind Winston could give ITG Brands a “fighting chance,” Herzog said. Wells Fargo Securities had previously learned from its retailer contacts that Reynolds performed a test on Winston in 2012, giving the brand greater marketing and promotional support, which resulted in a “small surge” in the brand, she explained.

“We believe Reynolds performed this test on Winston in an effort to ‘prove’ that it has brand equity and can therefore show some signs of life and take share if given a ‘little love,’” said Herzog, adding that Wells Fargo Securities believes this “evidence” has been provided to the Federal Trade Commission to show that ITG Brands has the ability to maintain and possibly grow its share as it focuses on and increases support behind Winston.

Adding Maverick to its brand portfolio will also bode well for ITG Brands. The move gives the company the No. 1 discount brand and puts it in an interesting position as it can now appeal to the very price conscious and more brand conscious consumer in that space, Bishop said.

“The old adage in cigarettes was if you owned the bottom, you could manage the top. It’s kind of an interesting dynamic,” he remarked.

The dust will need to settle on the integration post-merger, but what will make the transition easier is the fact that ITG Brands has an established sales force in Lorillard that is going to come onboard, especially given that two of the four major brands it is acquiring were already in the sales force and the other two have very strong equity that were just under-invested in because they were not the focus or core brands of their predecessors, Bishop cited.


With all the moving parts, it wouldn’t be surprising if people get lost in the details. However, what matters most to convenience store retailers is the impact on their tobacco business.

An exclusive tobacco retailer study conducted by Convenience Store News found that almost half of respondents think the RAI-Lorillard merger will have no effect on their tobacco business. Another 25 percent think it is too soon to tell what the impact will be.

“We are in discussions with [R.J. Reynolds Tobacco Co.] about it,” one retailer said. “Philip Morris is still the big elephant in the room. I honestly don’t think it will have any effect on us.”

In addition, 58 percent of the c-store retailers surveyed said the emergence of ITG Brands as the new No. 3 player will have no effect on their tobacco business. Some retailers did point out, though, that they expect to see more support behind acquired brands like Winston, Salem and Kool.

“I’m looking forward to it because they are getting a couple of brands with potential: Winston and Kool,” one retailer commented. “This will mitigate the loss of competition from the Reynolds-Lorillard merger.” (For more of the study findings, see page 36.)

As Bishop pointed out, ITG Brands will throw a lot of support behind Winston and blu in the marketplace. This will most likely come in the form of price promotion for Winston, which will be a net benefit for the retailer. As for blu, support will probably be in building a broader awareness and adoption off the good base Lorillard has already established.

With brands changing hands, retailers should expect to be faced with a tougher choice between retailer programs: Altria’s Marlboro Leadership Price (MLP) program vs. Reynolds’ Every Day Low Price (EDLP) program. The decision has usually hinged on what the retailer’s market share is with one manufacturer vs. the other, according to Bishop.

“Typically — not always, but typically — what happened was retailers would elect to go with Altria primarily because it had a larger share and there was more financial benefits from doing so. That made it very challenging for Reynolds to expand its EDLP program when wholesalers and retailers were looking at the alternatives and saying it just doesn’t make sense to give up control of my space for what I’m getting,” he said.

Post-merger, Reynolds should improve its presence at retail through its EDLP program and that’s a positive for retailers because it will cause Altria to be more competitive in those situations. Ultimately, the retailer benefits from tougher competition between No. 1 and No. 2.

“While Altria is still No. 1, you now have a faster, stronger No. 2. To that end, that is better for the retailer because now they have more viable options to consider. Because of that, the market power begins to shift; though it doesn’t flip, it starts to shift. That is a net positive for the retailer,” the Balvor executive explained.

In turn, Bishop expects ITG Brands will likely assume the position Lorillard played in the No. 3 spot, which was to have more accommodating and retail-friendly programs, be more flexible and be more willing to work with the retailers.

“I don’t know if, in fact, that is going to be the case. But just looking at history and knowing where they’re going to be with this relative position in terms of market share, I would assume ITG Brands would take advantage of existing opportunities and lessons learned from how Lorillard built its business in the No. 3 position,” he said.

According to a Wells Fargo Securities Tobacco Talk survey released on March 9, retailers are positive overall on the leadership news that Lorillard’s Chief Financial Officer David Taylor will lead the newly formed ITG Brands. Taylor’s prior experience with premium brands is expected to help ITG Brands grow, although some retailers believe a finance chief at the helm could be detrimental to running a business, Herzog stated.


From the perspective of the retailer, increased competition in the tobacco supplier community is good. It will make their pricing that much more competitive, helping draw more consumers from the respective markets into their stores because of that promotional activity, Bishop said.

“Those retailers who comply or participate in those programs are likely to win a little more share within their respective marketplaces,” he said. “If that does play out that way, the retailers will end up in those respective pools, if you will, making more gross profit dollars on cigarettes and most likely on other products given the basket that goes along with cigarettes.”

While Bishop thinks it has been instrumental and imperative that there is a strong No. 3, he believes it is more important that there’s a stronger No. 2 now. The strong No. 3 is key for maybe competitive purposes from a government regulatory environment component. But at a minimum, retailers know they always have to have two, he pointed out.

“You can look at packaged beverages: Coke vs. Pepsi. You can look at beer: it was Anheuser-Busch vs. Miller. There always has to be a real two in the fight. The third, not that they are inconsequential, but they generally are the thought leader, the more adaptive player, the more flexible one,” he said, citing that the industry sees this with Dr Pepper Snapple Group. The same thing holds true in other categories, such as candy.

“The No. 3 wins share based on thought leadership, based on retailer collaboration, based on things other than simply market power. I think that’s the role Imperial/ITG Brands will continue to fill, which was really dominated by Lorillard up this point,” he said.

“The key point is Reynolds becomes stronger compared to Altria, and that’s a net benefit to the retailer and a net benefit to the consumer. I don’t discount a No. 3, but more importantly the market needs a strong No. 2.”

“We think this [FTC extension for consummating their merger agreement] should be viewed as positive and could suggest the parties [RAI and Lorillard] are cooperating nicely and negotiations are progressing toward ultimate FTC approval with very minor modifications, if any.”

“While Altria is still No. 1, you now have a faster, stronger No. 2. To that end, that is better for the retailer because now they have more viable options to consider. Because of that, the market power begins to shift; though it doesn’t flip, it starts to shift. That is a net positive for the retailer.”

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