New Analysis Illustrates Power of RAI-Lorillard Deal

WINSTON-SALEM and GREENSBORO, N.C. — The pending Reynolds American Inc. (RAI) and Lorillard Inc. merger will provide several strategic advantages for the combined company, according to a new analysis performed by Wells Fargo Securities LLC.

The report authored by Bonnie Herzog, managing director of beverage, tobacco and convenience store research for Wells Fargo, states that the RAI-Lorillard merger — if approved by the U.S. Federal Trade Commission (FTC) — will provide four primary benefits for the combined company. They are:

1. RAI's R.J. Reynolds division (RJR) should take an incremental 140 basis points of cigarette shipment share, to 32.2 percent by 2017;
2. Newport share gains under RAI ownership will accelerate to 14 percent by 2017, 50 basis points higher than if there were no deal;
3. Camel and Pall Mall should benefit from a post-deal "halo effect" driven by better shelf space and synergies, taking slight incremental share; and
4. RJR's controllable cigarette costs per pack should decrease to 60 cents per pack by 2017, 14 percent lower than if there were no deal, driving incremental margin expansion of 410 basis points to 48.9 percent.

Although the FTC continues to review the merger, Herzog believes it's not a "matter of if, but when" the transaction receives regulatory approval.

She said she's 90-percent certain the FTC will approve the transaction, but "minor tweaks" may be deemed necessary. These changes — which Herzog referred to as "no big deal" — could include:

• Extension by a few months to the already agreed-upon shelf space provisions for Imperial;
• Tweaks to RAI's EDLP (every day low price) retailer program; and
• Divestiture of Doral, which would likely be sold to Imperial Tobacco Group plc.