LO and RAI Off To The Races, Again Takeout Rumors

The tobacco rumor mill stirred up late yesterday with the London Times reporting that BAT could buy its remaining share of RAI (58%) and/or that RAI is looking to buy LO.  The Times mentioned that BAT sought out Deutsche Bank as an advisor for a possible deal; we’ll note here that these are not “new” rumors as BAT has been exploring potential deals since last year, and since mid-March of this year the rumor mill on a RAI-LO deal swirled heavily. 

Two weeks ago this same rumor “excitement” contributed to a +8.5% w/w move in LO’s stock price, however last week was apparently “rumor off” week and the stock was basically flat.

We maintain that this rumor flow continues to be a great tailwind for our Best Idea Long Call Lorillard that we presented on March 4 of this year, with a longer term price target of $80/share.

We maintain that a hypothetical deal (especially an imminent one) between RAI and LO 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. Underlining our Best Idea Long Call on Lorillard in early March 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 also think the recent announcement that Susan Cameron will replace Daan Delen on May 1 could also be fueling some speculation that she wants to come out of the box “strong” – which is drumming up rumors about this deal. 

Below we’ve outlined our TREND duration over the intermediate term (3 month); appreciation to our $80/share target would be +35% higher than today’s price.

LO and RAI Off To The Races, Again Takeout Rumors - lo lo new

Howard Penney

Managing Director

Matt Hedrick

Associate

Fred Masotta

Analyst