What the Reynolds American Deal Means for Altria Group

By Markets Fool.com

Tobacco giant Altria Group (NYSE: MO) leads the U.S. market, with its Marlboro cigarettes, Copenhagen snuff, and Ste. Michelle wines presenting a formidable diversified portfolio of popular brands. Yet Reynolds American (NYSE: RAI) has been increasingly feisty in the No. 2 spot in the domestic tobacco market, and the decision from partner British American Tobacco (NYSEMKT: BTI) to buy out the portion of Reynolds American that it doesn't already own has many investors wondering if another merger in tobacco has the potential to hurt its own business. Let's look more closely at the Reynolds deal to see what's at stake, and how it will affect Altria.

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Image source: Reynolds American.

The Reynolds deal in a nutshell

Under the proposed combination, British American Tobacco agreed to pay Reynolds American shareholders roughly $56.50 per share, with a combination of cash and stock as consideration for the deal. Reynolds shareholders would receive $24.13 in cash along with stock in British American worth $32.37, or 0.5502 shares for every Reynolds share owned. British American noted that the offer represented a 20% premium to the closing price for Reynolds shares immediately prior to the announcement.

British American was optimistic about the positive effects of the merger. Currently, brands like Newport, Kent, and Pall Mall have their ownership rights split across the two companies, with Reynolds having domestic sales and marketing privileges, while British American takes care of international distribution and sales of those brands. Combining the two companies unites ownership in a single entity, simplifying some of the inter-corporate transactions that are required under the current structure.

Moreover, British American celebrated the idea of creating a global powerhouse in tobacco. Reynolds would provide the leadership position in the key U.S. market, while British American pointed to high-growth emerging markets across South America, Africa, the Middle East, and Asia as a key asset that it's bringing to the table.

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Most investors believe that the British American deal will make it through regulatory scrutiny. As the companies themselves note, there's relatively little geographical overlap between the two companies, presenting a much different situation than what Reynolds American faced when it sought to merge with tobacco peer Lorillard in 2014.

Why Altria shareholders shouldn't panic

It's that last point that should provide some reassurance to Altria investors. At least for now, it's not evident that British American would seek to make any moves to expand its presence in the U.S. as part of a merger with Reynolds American. Instead, things are likely to remain similar to the status quo for the domestic tobacco market, with Reynolds continuing to look for ways to outduel Altria.

However, that doesn't mean that Altria can afford to ignore the deal's implications entirely. One of the key planks that British American and Reynolds American can point to as a long-term growth strategy is integrating their next-generation products (NGP) divisions, bringing together research and development teams to look more closely at the higher-growth arena within smoking. British American said in its description of the merger that part of its goal from the combination was "to deliver a world class pipeline of vapour and tobacco heating products across all the fastest-growing NGP markets globally."

Some have argued that a combination of Reynolds and British American could spur Altria to look at reuniting with its spun-off Philip Morris International. Altria is actually the smaller company, and so it would be likely that any merger proposal would be made by Altria's former subsidiary. Given the reputation Altria has as an industry leader, it wouldn't necessarily want to be overshadowed by a combined British American that boasted the highest sales and operating profit in the business.

Reynolds American hasn't formally accepted British American's offer yet, so speculating on what Altria would do in response is a bit premature. Nevertheless, given the likelihood of a Reynolds merger going through, Altria needs to look long and hard at how it can respond to the move going forward.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.