Thursday, October 30, 2003

Proposed tobacco merger Tobacco giants R. J. Reynolds (RJR) and British American Tobacco (BAT) - through its Brown & Williamson subsidiary - have decided to merge their US retail operations into a new company. The new spin-off, if allowed by regulators, will be called Reynolds American. It would combine the #2 and #3 US tobacco companies with a combined 36% market share. (Altria/Philip Morris is, and will remain, #1 with almost a 50% share.) RJR would be the controlling interest, with 58% of the shares/. The new company would be the residual holder of all US tobacco-related liabilities for the companies. That’s a good deal for BAT, which clearly wants to restrict its exposure in the US. Some such move was widely anticipated, as RJR had recently announced drastic job cuts, amount to 40% of its employees. It is also dropped sponsorship of the Winston Cup NASCAR auto racing series. In addition, both companies reported poor financial results in the last quarter. The brands of both companies have been in decline over the last decade. R.J. Reynolds sells cigarette brands including Camel, Winston, Salem and Doral, while Brown & Williamson sells Kool, Lucky Strike, GPC and Capri brands RJR has already announced that it will try to push Camel and Salem, which have better sales. One of the problems the new company will have is whether to push the Salem (RJR) or Kool (BAT) brand of menthol cigarettes. According to a Wall Street Journal article ("RJR and BAT to Join Forces", 10/28/03), this is a reaction of changes in the market. "All these big players have faced growing competition from manufacturers of deep-discount cigarettes, which has cut into their profits and forced them to lower prices and step up costly promotions. The new company hopes to achieve cost savings of $500 million a year to better compete with Philip Morris, whose deep pockets have made it easier to weather the storm."  The company may face serious antitrust concern, according to the WSJ. "This is almost a merger to duopoly, and the FTC has been very tough in such cases recently," said David Balto, a former FTC antitrust enforcer involved in the 1994 merger challenge. "This will get intense scrutiny by the FTC. There are very few significant tobacco producers left in the U.S. today." William Baer, another former senior FTC official, said that the antitrust review would be carried out in a "neutral" way and that any effort to discourage consumption as a matter of public policy "is a separate question from allowing a cartel or monopoly." Our take – this exemplifies several principles. The market is essentializing, and the #3 player is eager to sell out. A variety of social and market changes has put the industry on the defensive, and this merger is a hunkering itself-protection position for both companies. Given the dominance of Altria, it will be hard for antitrust regulators to deny the creation of a far smaller competitor. 4:39:43 PM

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