The cost of combining Reynolds American Inc. and Lorillard Inc. could include the closing of a manufacturing plant, whether in Tobaccoville or Greensboro, and the elimination of hundreds of Triad jobs, an industry analyst said today.
Investor interest has not cooled today in the possibility that Reynolds, the nation’s No. 2 tobacco manufacturer, could buy No. 3 Lorillard in a deal that could cost as much as $30 billion.
Their share prices are up again as of 1 p.m. today – Reynolds by 2.9 percent to $54.89 and Lorillard by 1.2 percent to $54.76. Reynolds’ share price rose Monday 4.8 percent, while Lorillard’s was up 9.3 percent.
Reynolds spokesman Bryan Hatchell said “per company policy, we do not comment on rumors or speculation.” Lorillard could not be reached for comment.
Wells Fargo Securities analyst Bonnie Herzog said she believes it may take an $80 a share offer by Reynolds to persuade Lorillard management and shareholders to sell. Analysts projected Monday an offer price of $60 to $62 a share.
Getting that high of an offer would require significant cost savings from the deal, Herzog said.
“Incorporating synergies and cost savings of around $400 million, or 8 percent of Lorillard’s revenue, would include manufacturing, potentially closing either Lorillard’s or Reynolds’ plant, which makes sense given we expect cigarette volume declines to accelerate as e-cigs continue to displace volume,” Herzog said.
She cited potential reductions in the combined company’s sales force and “other headcount reductions.”
Herzog said a potential Reynolds offer could involve paying $750 million in cash – about half of its cash balance – and issuing 260 million new shares of Reynolds stock, equal to 40 percent of the deal.
Herzog said it is possible the deal could begin providing a boost to earnings as early as fiscal 2015.
“Bottom line: a potential Lorillard-Reynolds could result in increased scale, enhanced competitive position, greater retail leverage and could help to maintain a rational competitive environment in the cigarette industry,” Herzog said.
Reynolds opened its 2-million-square-foot Tobaccoville plant in 1986, which has undergone frequent equipment upgrade. Lorillard has an 854,300-square-foot Greensboro plant that likely is newer than the Tobaccoville plant. The Lorillard plant also has 187,300 square feet of space for warehouse, shipping and receiving operations.
Both companies have become tight-lipped about their manufacturing workforces.
It is likely Reynolds has between 1,100 and 1,200 manufacturing employees of its overall 2,000 to 2,200 workforce in Forsyth County. It had 1,355 production jobs as recently as March 2012 before it announced it would cut 540 job positions in its latest consolidation effort. Some jobs were re-created through hiring workers back at a lower salary or by outsourcing some work.
According to the latest Reynolds annual regulatory report, as of Dec. 31 it had 3,700 R.J. Reynolds Tobacco employees, 550 with its American Snuff Co. LLC subsidiary and 350 with its Santa Fe Natural Tobacco Co. subsidiary. Altogether, it has 5,200 full-time and 90 part-time employees.
According to the latest Lorillard annual regulatory report, as of Dec. 31 it had 2,900 employees, the bulk of whom are based in Greensboro, although it has a major warehouse facility in Danville, Va. About 1,110 of its employees are represented by one of two unions, which could signify a production workforce of 900 to 950.
As with most potential major corporate deals, there are four major negotiating areas: purchase price; who would run the combined company as chairman and chief executive; where it is based; and what is the surviving name or new name.
In this scenario, analysts said Reynolds likely would remain based in Winston-Salem and keep its name. The carrot for Lorillard management could be for Murray Kessler, its president and chief executive, and other top executives gaining high-level positions within Reynolds.
Citigroup analyst Vivien Azer said she believes investors are positive about a Reynolds-Lorillard combination because they believe it could be a precursor to getting British American Tobacco PLC (BAT) interested in gaining a majority ownership stake in Reynolds after July 30.
“We believe (investor interest) reflects the already-building interest in a possible event-driven catalyst for the stock; namely a potential acquisition of Reynolds by BAT,” Azer said.
Reynolds spent $4.4 billion in July 2004 to buy Brown & Williamson Tobacco Co. from BAT, essentially eliminating the industry’s No. 3 competitor from the marketplace and securing a stronger No. 2 position behind industry leader Philip Morris USA.
As part of the deal, BAT acquired a 42.04 percent ownership stake in Reynolds, or 226.2 million shares. BAT also gained five Reynolds board seats. The companies agreed to a 10-year moratorium on BAT buying additional Reynolds shares, a period that ends July 30.
With such a major ownership stake already, BAT would have to give its blessing to a Reynolds bid for Lorillard.
Herzog said a combined Lorillard and Reynolds “would be an attractive strategic partner for BAT, and could be a win/win for all parties to market/sell e-cigs globally.”
Azer said investors have projected for years that Lorillard “would represent an attractive acquisition candidate” even with uncertainty about how the Food and Drug Administration could regulate menthol cigarettes. Lorillard’s Newport brand is the top-selling menthol cigarette at 37 percent market share.
“We believe that menthol regulation is still a key factor for Lorillard and will likely remain a limiting factor in terms of the premium that any acquirer would likely be willing to pay,” Azer said. About 80 percent of Lorillard’s revenue comes from menthol sales.
Herzog said that while gaining Federal Trade Commission approval will be challenging, “we believe the FTC would ultimately approve a combination taking cues from the beer industry, though it is likely brands would need to be divested.”
That could mean that in order for a combined company to have Camel, Newport and Pall Mall as its growth brands, it may have to sell some brands, such as Doral, Kool, Salem and Winston, which are receiving less or no marketing support.
Jefferies & Co. said in an analyst report that the FTC may balk at allowing Philip Morris USA and a combined Reynolds-Lorillard to control 91 percent of the U.S. market share.
Spinning off the non-growth brands into a separate entity “might potentially make the anti-trust clearance a little easier but it would beg the question of what Reynolds actually gained from such a transaction given the high margins and cash flow that these brands generate.”
Jefferies said having the FDA menthol regulatory uncertainty makes “it unlikely that Reynolds would be willing to enter such a risk at the moment.”