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Analyzing Reynolds American’s Strategy Behind the Lorillard Acquisition

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The Lorillard acquisition overview

On June 12, 2015, Reynolds American (RAI) completed its acquisition of Lorillard and related divestitures. As a result of this acquisition, Lorillard is now a wholly-owned subsidiary of Reynolds American. In this transaction, former Lorillard shareholders received $50.50 in cash and were given ~0.2909 part of a share in the parent company for each share held in Lorillard. Shareholders of the former Lorillard now own ~15% of Reynolds American’s common stock.

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Brands after acquisition

Reynolds American’s operating companies have key brands across major industry categories. Newport, Camel, Pall Mall, and Natural American Spirit are its brands in combustible cigarettes, while the company has Grizzly and Vuse brands in the smokeless tobacco and in the vapor market, respectively. In the divestitures related to the transaction, however, subsidiaries of Reynolds American sold the Kool, Salem, Winston, Maverick, and blu eCigs brands to ITG Brands, a subsidiary of the Imperial Tobacco Group (ITYBY), for ~$7.1 billion in cash.

Additionally, British American Tobacco (BTI) maintained its ~42% ownership in Reynolds American through an equity investment of ~$4.7 billion.

Acquisition by peers

In 2014, Altria Group’s (MO) Nu Mark acquired the e-vapor business of Green Smoke and affiliates for $0.1 billion. Philip Morris International (PM), a former subsidiary of Altria, is exclusively licensed to commercialize Nu Mark’s e-cigarette MarkTen internationally. To learn more about Philip Morris’ spin-off from the Altria Group, please read “Philip Morris’s Spin-off from Altria, with New Collaborations.”

Other companies like British American Tobacco (BTI) and Vector Group (VGR) also produce innovative e-cigarettes to meet consumer expectations. Vype (BTI) and Zoom (VGR) are the e-cigarettes produced by these companies.

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Benefits of the acquisition

With the transaction, Reynolds American aims to become more susceptible to consumer price sensitivities. Adverse economic conditions could increase the number of consumers switching to a lower-priced brand. The company believes in time-to-time investments in M&A (mergers and acquisitions) and in looking at divestiture opportunities. On September 29, 2015, it announced the sale of the international businesses of its Natural American Spirit brands to Japan Tobacco for $5 billion. To learn more about this deal, please read “Japan Tobacco Buys Natural American Spirit’s International Assets.”

With the acquisition of Lorillard, Reynolds American’s brands are together better equipped to deal with the market leader Marlboro, which is by far the most dominant brand in the US market, with 43.8% of the total US retail (XRT) share. Reynolds American’s 5-year retail market share went up by three points from 31% to 34% after this transaction. While this does not change Marlboro’s market leadership, it does improve the company’s market positioning.

Reynolds American has exposure in the iShare Core S&P 500 ETF (IVV), with 0.2% of the portfolio’s total weight as of September 23, 2015.

In the next part of this series, we’ll look more at the Lorillard acquisition and its related divestitures.

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