The tobacco industry went through a massive shakeup on Tuesday in the wake of Reynolds American’s (RAI) $27.4 billion purchase of Lorillard (LO) . Investors are scrambling to sort out the facts pertaining to the deal, including possible credit downgrades and regulatory scrutiny.
Lorillard will receive $68.88 per share, broken down into $50.50 in cash per share and the rest in Reynolds stock. Although the buyout values Lorillard’s shares at a premium and will provide Reynolds with an enormous share of the market, both stocks traded significantly lower on Tuesday for a number of reasons.
Moody’s has placed both companies on review for downgrade. “While there are strategic benefits to the acquisition of Lorillard, we expect that the size of the transaction will result in leverage higher than what is tolerable for the Baa2 rating category.”
Investors are also worried about regulatory approval. Once the deal is complete, Reynolds will control a massive 34 percent of the U.S. cigarette market. By comparison, Altria (MO) owns about 51% of the U.S. cigarette market.
Reynolds’ refusal to acquire Blu, Lorillard’s best-selling electronic cigarette producer, is somewhat befuddling. E-cigs are widely considered a hot area of growth in the tobacco industry, so it’s somewhat inexplicable why the company would decline to add a high-growth asset to its portfolio of tobacco brands. Value, rather than growth, appears to be their forte.
Blu will instead sold to Imperial, which is clearly the deal’s winner. The UK-based Imperial will also acquire Kool, Salem, Winston, and Maverick from Reynolds for around $7 billion. Reynolds likely conceded these brands to ease regulatory concerns, but their efforts may not be enough.
Investors were hoping for a straightforward deal with minimal risks and moving pieces, but the deal is fairly complex and surrounded by numerous question marks and headwinds.
Lorillard shares closed down 10.5% to $60.17 while Reynolds fell 6.9% to $58.84 at Tuesday’s closing bell.