May 22, 2014 / 8:06 PM / 4 years ago

Lorillard-Reynolds cigarette deal would face regulatory risk: antitrust experts

WASHINGTON (Reuters) - An acquisition of U.S. cigarette-maker Lorillard Inc LO.N by Reynolds American Inc RAI.N could face a bumpy road with antitrust regulators, experts said, with some predicting the deal could be blocked outright and others saying it could only go through with significant divestitures.

Danny Herko, senior vice president of Research and Development of R.J. Reynolds Tobacco Company, demonstrates the use of a VUSE Digital Vapor Cigarette at a news conference in New York June 6, 2013. REUTERS/Zoran Milich

The combination, which would bring Reynolds’ Camel and Lorillard’s Newport brands under one corporate roof, would join companies controlling 27 percent and 15 percent of the U.S. cigarette market, respectively. Marlboro maker Altria Group Inc (MO.N) is the market leader with roughly 50 percent.

Reynolds is in active talks to buy Lorillard in a complicated three-way transaction in which British American Tobacco (BATS.L) could take a role, people familiar with the matter told Reuters on Wednesday.

Among six antitrust experts surveyed by Reuters, two predicted it would be blocked, and one said it should be stopped but might survive an antitrust review because the product was cigarettes. Three said regulatory agencies would likely allow it to go through with asset sales.

Beyond the market concentration in traditional cigarettes, the new company’s market share in electronic-cigarettes could draw scrutiny. Lorillard’s Blu currently controls about 50 percent of the market, but Reynolds plans to roll out its Vuse brand nationwide this summer. It remains unclear whether the merged company would keep both brands.

E-cigarettes are crucial to the three major U.S. tobacco companies, which have bought or developed their own brands in recent years. Sales of the electronic products in the United States are expected to outpace traditional cigarettes by 2020.

Still, traditional cigarettes now account for the vast majority of the industry’s sales and it was not immediately clear how much regulators would focus on the emerging technology.

“That’s a significant increase in concentration in an already highly concentrated market. I don’t see how that gets approved,” said David Smutny, a veteran of the Justice Department who is now at Orrick, Herrington & Sutcliffe LLP.

While the government is trying to discourage smoking, regulators may not ignore the possible impact of the deal on cigarette prices.

“Are the FTC or (Justice Department) going to let a merger go through that will result in higher prices because they think consumption of the product should be reduced?” said Bernard Nigro, an antitrust expert at law firm Fried, Frank, Harris, Shriver and Jacobson LLP. “I would be surprised if that were the outcome.”

Others said there would be little public outcry about the potential for higher cigarette prices. “There’s not a League of Addicted Smokers who are going to yell bloody murder about this,” said one Justice Department veteran, Peter Carstensen, now at the University of Wisconsin Law School.

He said that previously he would have expected a deal involving such large market shares to be shot down quickly, but that deals such as the settlement that allowed the American Airlines merger have made him think that a Lorillard-Reynolds deal might have a chance with regulators.

Analysts at Morningstar similarly argued that price would loom as less of a factor than in other industries.

Wells Fargo analyst Bonnie Herzog said the chances are high, 80 percent, that the deal would occur, but that it might require Reynolds to divest brands, including Kool, Winston and Salem, which it already could be “shopping”.

The 2004 merger of B.A.T’s U.S. business with R.J. Reynolds, flew through regulatory scrutiny relatively unscathed.

Beyond the health concerns associated with cigarettes in general, Lorillard has come under particular scrutiny because it now accounts for 65 percent of the U.S. menthol market, which could come under pressure from new regulations in the coming years.

Reporting by Diane Bartz; Editing by Peter Galloway

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