Holders of tobacco settlement bonds were rewarded with good news on two fronts this week by R.J. Reynolds – one business related and one legal.
Business wise, tobacco bondholders may benefit from the stability that is likely to occur following the recently announced merger between the tobacco units of R.J. Reynolds and British American Tobacco’s (BAT) Brown & Williamson (B&W).
Under a definitive agreement reached by both tobacco makers early this week, a new company, Reynolds American, Inc., will comprise the domestic cigarette businesses of both RJR and Brown & Williamson.
By combining the second and third largest tobacco producers, Reynolds American will have an estimated 32% market share, trailing only Altria’s Philip Morris USA unit, which controls almost 50% of the domestic tobacco market.
BAT will own 42% of Reynolds American, with the remaining 58% owned by current RJR shareholders. The merger, expected to close in mid-2004, will result in a company generating annual revenues of $10 billion and a domestic cigarette volume of 136 billion units.
Under the merger agreement, B&W will transfer to RJR all of its Master Settlement Agreement liabilities and approximately $750 million to cover previously accrued payment obligations. As outlined in the MSA, this transfer will be automatic and should have no effect on payments to bondholders.
Positive effect on MSA
Other aspects of the merger should have positive effects on the ability of the surviving entity, Reynolds American, to meet its MSA payment obligations. Although both RJR and B&W have struggled in recent years, their combination is expected to bring $500 million in operational savings each year and allow the new company to better rationalize its product lineup in the face of continuing competition from low-cost brands.
Assuming the merged entity is able to achieve its goals, Reynolds American should emerge as a strong and more profitable competitor in the domestic tobacco industry. In this case, Reynolds American will be a more stable producer in an increasingly fractious market.
On the legal front, RJR benefited from an emergency stay, granted on October 24 by a justice on the Illinois Supreme Court, in the Turner “lights” case. This class-action suit against RJR was brought in Madison County, Ill., the same venue as the earlier Price case against Philip Morris USA.
Since the Supreme Court has decided to hear the Price case this fall, skipping the intermediate appellate court, it is notable that Illinois’ highest court has decided to consider whether the similar Turner case should be stayed pending its ruling in Price.
Through both actions, the Supreme Court may be indicating that it is tired of seeing lower courts in Illinois (and Madison County in particular) being used for unnecessary class-action suits. Forthcoming rulings on both Price and Turner will indicate if this reading is correct. In any case, the court has moved to remove both cases from the public spectacle in which they had become engulfed.
Ultimately, we believe that the court will most likely rule in favor of PM USA and RJR, and we continue to follow both cases closely.
