NEW YORK (The Deal) -- Reynolds American (RAI) and Lorillard (LO) said on Tuesday they expect to close their $27.4 billion merger by the end of June after agreeing to antitrust conditions required by the Federal Trade Commission.
The FTC announced late Tuesday that the companies must divest four cigarette brands to Imperial Tobacco Group (ITYBY). The divestiture terms are largely along the lines of those the companies proposed when they announced their merger plans in July 2014. The brands to be divested are Reynolds' Winston, Kool and Salem, and Lorillard's Maverick.
The conditions address FTC charges that the proposed merger would likely be anticompetitive. The FTC noted that Reynolds markets two of the best-selling cigarettes in the country, Camel and Pall Mall, as well as Winston, Kool, and Salem. Lorillard's flagship brand, Newport, is the best-selling menthol cigarette.
Reynolds and Lorillard are the second- and third-largest U.S. cigarette makers, behind industry leader Altria Group (MO - Get Report), which sells Marlboro cigarettes. Those three producers account for roughly 90% of all cigarette sales, according to the FTC. Imperial and Liggett Group (VGR - Get Report) , another small producer, have only 3% market shares each. All other producers have market shares of 1% or less.
According to the FTC complaint, without the divestiture to Imperial, the proposed merger would likely eliminate current and emergent head-to-head competition between Reynolds and Lorillard in the U.S. market for "traditional combustible cigarettes." It also increases the likelihood that the merged firm would unilaterally raise prices, and that Reynolds and Altria, as the remaining two large competitors in an already concentrated industry, would engage in coordinated interaction.
Imperial is an British multinational tobacco manufacturer with a competitive presence in about 70 countries, but a relatively small presence in the U.S. By acquiring the designated assets, Imperial would become a more substantial competitor here, the FTC said.
In addition to the designated brands, the FTC is requiring Reynolds to sell Imperial the Lorillard manufacturing facilities in Greensboro, N.C., and to provide Imperial with the opportunity to hire most of the existing Lorillard management, staff, and sales team. It also requires the newly merged Reynolds and Lorillard to provide Imperial with retail shelf space for five months after the spinoff and to provide other operational support during the transition.
Reynolds must complete the divestiture on the same day it acquires Lorillard.
The FTC order is subject to a 30-comment period that runs through June 25, after which the commission will review the submissions and decide whether to make the proposed consent order final.
The settlement largely matches the companies' proposed settlement, which called for the spinoff of Winston, Kool and Salem, as well as Lorillard's discount Maverick brand. The merger agreement also required Reynolds to include its Doral brand in the divestiture package if the FTC demanded it, but the commission didn't include that in the package.
Although the companies also proposed to shed Lorillard's blu e-cigarette line, the settlement does not address e-cigarettes.
The brands to be divested have a combined share of approximately 7% of the total U.S. cigarette market. The FTC said the designated divestiture package, including the nationally recognized Winston and Kool brands, "provides Imperial an opportunity to rapidly increase its competitive significance in the U.S. market."
The FTC said, "Imperial will shift immediately from being a small regional producer with limited competitive influence on the larger firms to become a national competitor with the third-largest cigarette business in the market."
The commission was split 3-2 on the settlement, with commissioners Julie Brill and Joshua Wright dissenting.
The commission majority acknowledged that the targeted brands have lost market share but said it has confidence Imperial is capable and has the incentive to revive them. "Imperial has successfully executed similar turnarounds with brands in other international markets," they said.
Imperial, they argued, will have greater opportunity and incentive to promote and increase sales of the divested brands. Reynolds had no incentive to support them, they said, because incremental sales of these brands were likely to "cannibalize" sales from its other brands.
"Imperial's incentive to reduce the price of the divestiture brands, in order to grow their market share, is a procompetitive offset to the reduction in competition that will result from the consolidation of Reynolds and Lorillard," they said. "Ultimately, the divestiture package provides Imperial with a robust opportunity to undertake procompetitive actions to grow its market share in the U.S. cigarette market, and address the competitive concerns raised by the merger."
In her dissenting statement, Democratic Commissioner Brill said Imperial's 10% market share post-transaction will be too small to offset the combined 83% market share that Altria and the combined Reynolds/Lorillard will hold. Currently, the top three makers hold, 49%, 41% and 15% market shares, respectively, for Altria, Reynolds and Lorillard.
Aside from the resulting increased concentration, she questioned whether Imperial is capable of maintaining or restoring competition in the market with the divested brands. "I have reason to believe Imperial will not be up to the job," she said.
The post-divestiture market shares may overstate the competitive significance of the designated brands, she said. She noted that Reynolds will obtain the second-largest brand in the country, Newport, and keep the third-largest brand, Camel. By contrast, Imperial will "have no strong brands in its portfolio. Winston, Kool, and Salem are "declining and unsuccessful," she said. "Their combined market share has gone from approximately 14% in 2010 to 8% in 2013, and they are still losing share."
She said: "It is no surprise that Reynolds would want to unload these weak brands, and refuse to provide a meaningful divestiture package that would replace the competition lost through its merger with Lorillard. I have reason to believe that Winston, Kool, and Salem, as well as Maverick, will languish even further outside the hands of Reynolds and Lorillard."
Republican Commissioner Wright opposed the settlement on procedural grounds, arguing that because the spinoffs to Imperial were agreed to by the parties upfront, there is no need for the FTC to issue a formal order requiring the divestitures.
"When the commission is presented with a three (or more) way transaction, an order is unnecessary if the transaction -- taken as a whole -- does not give reason to believe competition will be substantially lessened," he said. In this case, the fact that the Reynolds-Lorillard portion "when analyzed in isolation" is likely to be anticompetitive, does not imply that the whole transaction is also likely to harm competition when the spinoff to Imperial is taken into account, he said. Only if the FTC had reason to believe that the sales to Imperial would not be completed would the FTC have grounds to issue an order or otherwise challenge this transaction, he said.