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.