LO is up nearly 3% intraday after closing up 4% yesterday (and hitting all-time highs) – we believe rumors that RAI is interested in acquiring LO are responsible for the move, however we think a hypothetical deal (especially an imminent one) is challenged:
- Our main flag is that a combined RAI + LO would own ~ 67% of U.S. menthol market, which we believe should trigger anti-trust flags.
- Big tobacco is already a highly concentrated industry in the U.S. across the big three – MO has a leading ~51% of market share; a combined RAI + LO would equate to ~ 42% share.
RAI could look to divest such menthol brands as Kool, Winston and Salem (~5% total market share), which could serve to change the consideration of the FTC/DOJ.
We’re not surprised to hear rumors that LO is a take-out target. Underling our Best Idea Long Call on Lorillard in early March 4th was the strength of its portfolio:
- Leading share and profitability of its core menthol business,
- Our belief in the limited menthol regulatory risk over the longer term (substantiated by a Washington, D.C. tobacco expert), and
- Upside growth in its blu e-cigarette business that commands leading share in the U.S.
As part of the Best Idea’s thesis we did not consider a RAI + LO deal. We think the recent announcement that Susan Cameron will replace Daan Delen on May 1 could also be fueling speculation that she wants to come out of the box “strong” – which is drumming up rumors about this deal.
There’s been no comment from either LO or RAI. Even without consideration of a deal with RAI, we’ve outlined a scenario in which LO’s business propels the stock to $80/share over the longer term. That would be ~ 36% higher than today’s price.