The Federal Trade Commission (FTC), yesterday evening, May 26, “voted to accept a proposed consent agreement” by a 3-2 vote, paving the way for Reynolds American Inc. (RAI) to proceed with its Lorillard (LO) acquisition, broadly in line with certain already agreed-upon conditions relating to brand divestitures, but no further behavioral modifications, Wells Fargo Securities LLC reported.
Next, a court must issue an order relating to a 1999 lawsuit confirming that Imperial Tobacco Group (ITG) Brands intends to/is capable of complying with the court’s “remedial order” related to ITG’s soon-to-be-acquired brands, Wells Fargo pointed out. This motion is unopposed per a court hearing with all parties held on May 19, 2015.
The implied price for LO based on the deal is $72.44 (per share), which is +.15% above its closing price of $72.12 on May 26. The deal is still expected to close by the end of June.
“As the deal is unlikely to close by June 1, we believe LO will likely be on the hook for its roughly $240 million dividend payment. We reiterate our $89-91 valuation range for RAI and pro forma EPS (earnings per share) estimates of $4.46/$5.04 for fiscal year (FY) 2016/FY2017, based on our brand analysis,” said Bonnie Herzog, managing partner, beverage, tobacco and convenience research for Wells Fargo Securities.
“We have long believed the RAI-LO transaction would get approved by the FTC and that it’s a value creating transaction for RAI and LO shareholders. We reiterate our ‘Outperform’ rating on RAI and our ‘Overweight’ tobacco sector rating given the strong industry fundamentals and even stronger industry pricing potential now that the deal is moving forward. We expect U.S. tobacco stocks to trade up sharply (on May 27) on this news.
Terms of Agreement
Wells Fargo noted that as part of the approval, the FTC is requiring RAI to:
(1) divest four brands with a combined market share of 7%: Winston, Kool, Salem and Maverick (and not Doral) – consistent with Wells Fargo expectations;
(2) sell LO’s manufacturing facility and headquarters to Imperial;
(3) give Imperial employment rights for most of LO’s current staff/salesforce;
(4) guarantee Imperial visible retail shelf-space for five months following deal close; (5) provide transition services.
“We believe these are reasonable and in line with expectations, and expect a combined RAI-LO to reap the benefits of the merger while Imperial should be well positioned as a formidable No. 3 industry player,” Herzog said.
Deal Creates Value for RAI
(1) Newport is now poised for even faster growth, which should generate incremental profitability—especially given Camel and Newport have complementary geographic strengths;
(2) Synergies of $800 million should drive double-digit accretion in the mid-teens by 2017 (2nd full year after completion), generating incremental value for shareholders;
(3) RAI will have 90% of its revenue derived from growth brands;
(4) Minimal cultural/integration risk given RAI essentially “only” acquired the Newport brand, while the bulk of LO’s other assets are being divested to Imperial.