Wells Fargo Puts RAI-LO Combination at 90% Likelihood

“Given the current market environment where both targets and acquirers are being rewarded, we continue to believe this will be a value creating transaction for both RAI and LO shareholders,” says Wells Fargo analyst.

Based on news reports that came out the afternoon of May 21, noting that Reynolds American, Inc. (RAI) is in “active discussions” to buy Lorillard (LO), Wells Fargo Securities LLC reiterated its prior conviction that an RAI-LO combination remains highly likely.

“Dare we say 90% probability?” noted Bonnie Herzog, managing director, beverage, tobacco & convenience store research for Wells Fargo Securities LLC.

“Given the current market environment where both targets and acquirers are being rewarded, we continue to believe this will be a value creating transaction for both RAI and LO shareholders. Therefore, we expect further upside potential in both stocks. Based on our interactive RAI-LO merger analysis published March 3, 2014, we continue to believe this deal will be accretive in year one with RAI paying up to $80 a share for LO,” Herzog added.

Wells Fargo attributes the upside potential in RAI for three reasons: “(1) We continue to believe there’s a high likelihood (now 90%) that RAI could acquire LO, paying up to $80/share for the company, incorporating synergies of $400MM, and British American Tobacco (BAT) could either acquire or form a strategic partnership with the combined entity. We believe BAT will contribute capital to help finance the deal and maintain its existing 42% stake in RAI in the combined entity. Further, we believe the return of Susan Cameron as CEO is a positive catalyst for the stock as she leads the company into its next generation of growth;

“(2) We expect RAI’s organic growth could accelerate and we have increased conviction in RAI’s ability to operationalize innovation which we believe will be more crucial than ever with the rise of vapor; and

“(3) We believe RAI’s Santa Fe asset, which we believe is worth $4.7B as a standalone business, is underappreciated and could be spun off/sold to create value for shareholders,” according to Herzog.

Wells Fargo also believes the timing is right for a combination of the companies, because of “limited menthol overhang for LO and (2) We believe Susan Cameron was enticed out of retirement to take RAI to its next level of growth and not just maintain the company’s existing strategic direction. Further, since Cameron has given a 2-3 year commitment to running RAI, we think this could suggest a deal needs to happen sooner rather than later.”

 

 

 

 

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