Background. On 7/15/2014, Reynolds (RAI) announced
that it plans to buy Lorillard (LO) for $50/share in cash and 0.2909 share of RAI stock. The
cash portion will be funded with debt raise, investment from BAT, as well as
selling off Blu eCig & other brands to Imperial. LO stock traded down to
$60/share. RAI traded down to ~$59.
o The
trade: Buy LO; short 0.2909 shares of
RAI. Pay $60 for LO, get ~$18 for
shorting RAI = Net cash outflow of ~42/share. This effectively locks in $50 of
cash for an 18% gain if deal closes.
·
I have not decided to enter this trade
- still taking notes and gathering some considerations here. Regardless, due to
the asymmetric risk and reward profile, this would not be a large position.
RAI-LO merger arbitrage considerations
o Deal
expected to close 1H 2015. Let's say June and we're looking at a little less
than a year, so IRR will be > 18%. Call
it 20%.
o Likelihood
of success?
·
Lots of approval needed. From shareholders of LO/RAI/Imperial, as well
as FTC. Should be no problem from RAI' end as it is 42% owned by British
Tobacco. But will LO shareholders
approve? LO shareholders might not like
that they'll be selling off Blu brand..
·
Does the deal make sense? I question the value of the deal without
Blu, and the fact that RAI just took on more menthol risk.
o Risk of
failed deal - partially protected/offset by RAI short.
·
Regulatory approval is an issue but in
that case RAI would get hurt as well.
·
Both Imperial Tobacco PLC and RAI will
be using debt financing so there's a capital market risk
o Risks
that are not protected by RAI short
·
If menthol regulation get worse then
that would hurt LO disproportionally. This risk has been around for at least 3
years and all parties are well aware of it.
·
Due diligence finds something wrong
with LO.
·
Management positions beyond CEO roles
are still being sorted out. Politics
could sink the deal.
·
LO has union employees who might oppose
this.
Risk & Reward:
o 18% gain
if deal closes.
o What kind
of losses am I looking at if deal fails?
If LO falls back to ~$48 (before media speculation started), then we're
looking at 20-40% loss depend on cost of closing out RAI short. I think losses
would be at the better end of that range since RAI stock also had benefited
from the potential merger.
o Correlation
between the stocks increases the chance that shorting RAI will be an effective
hedge
Notes on deal impact
- Combined
RAI/LO:
- Camel and Pall Mall, Natural
American Spirit, Grizzly and VUSE; + Newport
- Pro-forma: $10 billion in
revenue, ~32% market share
- Imperial
gets
- KOOL / Salem / Winston / Maverick / blu brand.
- In addition to the brands,
Imperial will acquire certain assets currently owned by Lorillard including
our headquarters, manufacturing and R&D facilities in Greensboro,
North Carolina, as well as LO's facility in Danville, Virginia and
approximately 2,900 employees, including its national sales force.
- Management
placement:
- RAI’s CEO, Susan Cameron, will
lead the combined RAI / Lorillard.
- Murray Kessler, Lorillard’s CEO,
will be joining the Board of Directors of RAI.
- Martin Orlowsky, former CEO of
Lorillard, will be joining as Executive Chairman Designate of Imperial’s
U.S. business
- The remaining management positions will be named at a later
time.
- $800 mm of cost saving on runrate
basis - I question how this works as RAI will have no job reductions and
LO will have minimum cuts...Can this really be just from selling to Imperial?
- LO
Retirees: "no effect on your
pension or benefits. All retiree benefits are fully-funded and you will
continue receiving all payments and benefits as you usually do."
- RAI side:
- RAI to its employees: "shut up its none of your business"
- Reynolds American will be raising $9 billion of new debt to finance the transaction. The company anticipates leverage of 3.6x debt/EBITDA at closing, moving to less than 3x within 24 months. They are confident the IG rating will be maintained
- R&D and technology-sharing initiative with BAT
No comments:
Post a Comment