E-cigarettes could sweeten potential Reynolds-Lorillard deal

NEW YORK Fri May 30, 2014 6:24am BST

An advertisement for the e-cigarette brand blu is seen on the window of a store in New York May 27, 2014. REUTERS/Shannon Stapleton

An advertisement for the e-cigarette brand blu is seen on the window of a store in New York May 27, 2014.

Credit: Reuters/Shannon Stapleton

Related Topics

NEW YORK (Reuters) - When Lorillard Inc bought the blu eCigs brand two years ago, the electronic cigarette had a 10 percent share of a tiny U.S. market, generating about $50 million in sales. It was available in only 12,000 retail outlets and over the Internet.

Today, the U.S. tobacco company’s marketing and distribution muscle, including its use of frequent TV commercials and concert sponsorships, has taken blu into 149,000 outlets and driven its U.S. market share to about 47 percent. Annual sales have quadrupled to more than $200 million.

The turbo-charged growth means that blu and Lorillard's British SKYCIG e-cigarette brand may be the assets with the sweetest potential for Reynolds American Inc as it holds talks over a deal to acquire its U.S. rival. Both brands would complement Reynolds' new Vuse e-cigarettes brand, due to go national this summer, and vault the combined company into an undisputed leadership position in the young market.

And the gains in e-cigarette sales may have only just begun. Some Wall Street analysts see e-cigarettes and other “vapor products” overtaking traditional tobacco sales within six years.

"Acquisition of Lorillard would give Reynolds a distinct advantage in the e-cig market," said Steve Marascia, Director of Research at Capitol Securities Management.

Reuters reported last week that the companies were in late- stage talks that would combine the second and third-largest U.S. tobacco companies, according to people familiar with the matter. A combination of Lorillard and Reynolds, which is 42 percent owned by British American Tobacco, would create a formidable rival to Altria Group Inc, which owns the Marlboro brand and controls about 50 percent of the traditional cigarette market in the U.S.

E-cigarettes are slim, reusable, metal tube devices containing nicotine-laced liquids that come in exotic flavors. When users puff, the nicotine is heated and released as a vapor containing no tar, unlike conventional cigarette smoke.

Taking the lead position in e-cigarettes is appealing but given the market’s nascent nature, it is not a sure bet.

New brands could easily grab market share, and there have been signs that other vaping products, including larger "tank"-based devices, may be gaining popularity. These products are typically less expensive to use, and can provide a stronger nicotine delivery.

"I think it's more of a hedge," said Morningstar analyst Philip Gorham in reference to the e-cigarettes part of any Lorillard acquisition. "But if e-cigs take off, it will be the future, and they'll be glad they invested."

MORE THAN MENTHOL

Lorillard's popular Newport menthol cigarette brand, whose sales have held steady even as cigarette smoking in the United States has declined, is likely to be the immediate driver of any deal. Newport accounts for 37 percent of the U.S. menthol market and 12.5 percent of overall cigarette sales.

U.S. sales of conventional cigarettes are forecast to drop to $15.3 billion in 2023 from $28.3 billion in 2013, according to a recent report from Wells Fargo Securities. In contrast, it sees revenue from e-cigarettes and other vapor devices growing to $24 billion by 2023 from $1.5 billion last year.

Altria is also getting into the game, though it only introduced its MarkTen brand in August 2013 in Indiana. It plans a nationwide rollout next month.

Lorillard bought blu two years ago from founder Jason Healy and his investors for $135 million. A year later, it paid $49 million for SKYCIG, now the leading e-cigarette in Britain.

The deals were part of a strategy by Lorillard CEO Murray Kessler to expand its offerings beyond conventional cigarettes. Formerly at Altria, he helped build that company's Skoal and Copenhagen into two of the best-selling smokeless, or chewing tobacco, brands.

Morningstar analyst Gorham estimates blu is currently worth $500 million to $1 billion, though it may account for a higher number in any deal for Lorillard, whose overall market value is currently about $22 billion. "Because Big Tobacco really wants a piece of the action, I could be low-balling it," he said.

Since the vapor market is still in its early stages, it is difficult to anticipate how it may evolve.

Regulatory changes could have a big impact. In April, the U.S. Food and Drug Administration issued proposed rules that would ban sale of e-cigarettes to anyone under 18 and require companies to list ingredients. But the rules so far would not restrict flavored products, online sales or advertising.

The big tobacco companies are expected to be in a much better position than their dozens of smaller rivals to handle any new oversight thanks to their long experience dealing with regulators and battling anti-tobacco lawsuits.

They may also have an upper hand in assuring quality control as the industry comes under stepped-up scrutiny after recent horror stories about the dangers of accidental poisoning from some ingredients on the market.

  "The big three tobacco guys will be the big three e-cigarette companies because of their resources, relationship with distributors and ability to comply with the FDA faster than competitors," RBC Capital Markets LLC analyst Nik Modi said, referring to the U.S. Food and Drug Administration.

(Reporting By Jilian Mincer; Editing by Martin Howell)

FILED UNDER: