Reynolds American acquisition of Lorillard will change the tobacco market in the USA dramatically. Regardless of the limits set by regulators, this transaction shows the power of brand in tobacco marketing.
Reynolds American, the second tobacco player in the USA, had a strong portfolio of “growth brands” even before the transaction. While nothing comparable in terms of sales to Altria’s Marlboro, it was really strong.
Reynolds American Growth Brands
- Natural American Spirit
- Pall Mall
Natural American Spirit is the leader in Super Premium segment, with 1.4 % market share (2.7bn sales volume in 2013). With margin over 50%, this brand has been growing in terms of volume, earnings and share basing on “additive-free” and “organic” image.
Introduced in 1913, Camel is a premium brand with 8.9 % market share and 14.9 % of the premium segment . It is growing in menthol and prides the strong demographic profile of its user base.
Introduced in 1899, Pall Mall brand is a legendary brand, it was the first to introduce king-size (85mm) and 100s (100mm) cigarettes. Since 2001, with the “new filtered” it is positioned in value segment. It has achieved leadership there with 8.9 % market share. It is also one of the fastest growing brands with its menthol variations that account for a quarter of its current volume.
Grizzly is a smokeless tobacco (moist snuff) brand, leader in its category with 30.4% market share. As it grows with its category, it also brings high margin of more than 55%.
VUSE is a premium e-cigarette brand with market leadership in Colorado. Planned national expansion this year.
Lorillard, on the other hand, kept his third position in the market mostly because of one brand. Newport.
Lorillard growth brands
Newport is a premium cigarette brand, the second largest selling cigarette brand overall in the United States in volume, and is the top selling menthol cigarette brand . The Newport brand accounted for approximately 88 percent of Lorillard sales revenue for the 2013.
Maverick®, the other important brand of the company is a leading discount cigarette brand, that offers adult smokers the smooth taste of a premium priced cigarette at an everyday low price. It has 2% market share.
Imperial Tobacco in the USA
The third party of the transaction, Imperial Tobacco has long struggled to get hold on the US market. Its whole portfolio market share in the US is only 3%. Its flagship brand, USA Gold – is a leader in the discount segment with 1.2% market share.
This will all dramatically change, if the transaction is approved in the presented shape. Imperial for $7.1 bn will gain:
- Cigarette brands in the US currently owned by Reynolds, comprising Winston, Kool and Salem.
- A cigarette brand in the US currently owned by Lorillard, Maverick.
- The e-cigarette business currently owned by Lorillard, consisting of blu in the US and UK.
- The infrastructure and factory currently owned by Lorillard at Greensboro, North Carolina, USA.
This will make it an important player in the discount segment and, what is more interesting, in e-cigarettes.
Giving away blu brand to Imperial Tobacco, Reynolds left out an important asset – domination in the US and global plans for expansion of this leading e-cigarette brand. Its in-house e-cigs, Vuse, are so far tested only in Colorado and Utah. In Colorado Vuse has won the market, but nationally, blu is much stronger.
Imperial Tobacco will also increase its footprint in discount category, adding Maverick to USA Gold to achieve combined 3.2 % of the market from this segment only. Combined, new brand portfolio of Imperial Tobacco should get around 10% of the U.S. market. Former Lorillard’s Chairman, President and CEO, Martin Orlovsky joins Imperial Tobacco to ensure that integration of the new business runs smoothly.
Alison Cooper, Chief Executive of Imperial Tobacco, said in the press release:
“This is a great opportunity to transform our US business and secure a significant presence in the world’s largest accessible profit pool. We plan to build a US brand portfolio through national distribution and create a stronger, more competitive business. We intend to internationalise blu, the US leader in e-cigarettes and enhance its growth opportunity with our know-how. We expect opportunities for cost optimisation through integration. The acquisition of these assets, without historic product liabilities for the cigarette brands, on reasonable terms means that it is expected to offer a return of over 10%, well in excess of our cost of capital in its first full year and is expected to be significantly earnings enhancing in the first full year post completion. The value this will create for shareholders and the strategic transformation of our position in a key growth market, makes this an outstanding opportunity.”
Indeed, it seems that Imperial Tobacco may be one of the winners in this transaction. Another one, and a leading party is obviously Reynolds American.
Reynolds American benefits from the acquisition of Lorillard brands
Reynolds brand portfolio expanded with Newport brand enters new geography and demographic profile. Newport is particularly popular within black smokers. It is important, as Camel, the strongest menthol brand of Reynolds so far, is the brand of choice of white smokers. Both Camel and Newport are strong in the younger population, but while Reynolds American is strong in the Western U.S. and Lorillard’s complementary strong presence on the East Coast.
Regulatory Risks for Reynolds American and Lorillard transaction
Nothing is perfect though. From regulatory perspective Reynolds American faces two challenges. First, it will need to convince regulators, that it did not gain monopolistic position. It will be hard to do even taking into account Altria’s volmes made with Marlboro. Regardless of letting go KOOL and Salem brands to Imperial Tobacco, Camel and Newport together dominate menthol segment completely.
Another issue is with the menthol segment itself. First, a note to non-U.S. readers. In the U.S. market menthol cigarettes are growing in volume, but are associated with low socio-economic profile, so the margin is not as high as in European markets. Additionally, as flavoured cigarettes tend to be perceived as softer and somehow healthier or at least more acceptable, they are being regulated. If FDA follows the path of Brazilian and European legislators, the core of the deal may be worthless. Menthol cigarettes are already banned in Brazil, and EU follows with the ban to be imposed in 2022. It means, that the menthol deal may not pay itself back before the whole segment is banned.
In the short term it seems this deal is won by British companies. Imperial gains a footprint in the U.S. and it is an obvious win. The less visible, but more important from the global perspective is position of British American Tobacco. This main stakeholder of Reynolds American and a sponsor of the deal gains here position against its archrival – Philip Morris International. If the merge succeeds, Reynolds American will be able to challenge Altria’s leadership in the U.S. market.