Wednesday, April 26, 2006

RJ Reynold buys Conwood LP. Are Altria and UST next?

RJ Reynolds (RAI) has made it's big move into smokeless tobacco by purchasing Conwood LP for $3.5 made $300 million in cash and $3.2 billion in new debt. The deal valued Conwood at 7.8 times sales. That would imply a private value of UST is worth $12 billion to $14 billion, compared with its market capitalization current market capitalization of around $7.24 billion.

RJ Reynolds was forced to finance this acquisition with debt, as a result of the companies current policy of maintaining a 75% Payout ratio. Issuing new shares to finance the deal would have been impossible because it would jeopardize the current $5 a share dividend. RAI claims that the deal will be accretive to earnings. The heavy leverage means that if RAI succeeds at growing the conwood business, it will be very profitable.

This acquisition is very strategic for RJ Reynolds, given that cigarette's are a dying market. Conwood has been taking market share from UST for quite a while, and have several obvious growth opportunities. RJR's research and development department have historically been top notch, and Conwood has excellent R&D as well even though it hasn't been shown in their existing products in an obvious way. Logical brand extensions include introducing Camel and Winston branded snuffs. I would venture that Winston is the most likely brand for recasting, since it is the "manliest".

Conwood's core premium Kodiak brand currently only comes in wintergreen, straight, and ice flavors. Logical expansion would be to copy UST's recent introductions of kid friendly flavors of Skoal such as apple, vanilla, and peach, RJR has been very successful at introducing seasonal line extensions for Camel, and that could obviously be done with snuff as well.

Most importantly, this implies that Altria (MO) might consider buying UST (UST) or Swisher. Historically the major cigarette companies did not have any smokeless tobacco business (this dates back to the break up of the American Tobacco Trust in 1912, and American Snuff Company in 1907), because historically the snuff industry was so different and so much smaller than the cigarette industry. As cigarette sales have shrunk and snuff sales have grown, having a significant chunk of the smokeless market would be meaningful to the major tobacco companies.


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