Altria Lights Up Cigars
Published in CSP Daily News
PM USA parent acquires John Middleton in "strategically compelling and financially attractive" deal
NEW YORK -- Altria Group Inc. said that it has entered into an agreement to acquire John Middleton Inc., a major manufacturer of machine-made large cigars, from privately held Bradford Holdings for $2.9 billion in cash. The deal represents a major move into cigars for the parent of Philip Morris USA.
This acquisition, which takes place on the eve of Altria Group Inc.'s intended restructuring, is being undertaken to enhance our long-term growth momentum in the U.S. market and create shareholder value, said Michael E. Szymanczyk, chairman and CEO of PM [image-nocss] USA, Richmond, Va. The acquisition is both strategically compelling and financially attractive. It fits squarely with our announced strategy to grow our U.S. tobacco business beyond cigarettes and complements our recent initiatives in the smokeless category.
As reported in a CSP Daily News Flash yesterday, the net cost of the acquisition, after deducting approximately $700 million in present value tax benefits arising from the terms of the transaction, is $2.2 billion.
John Middleton's operating revenues are projected to reach $360 million in 2007, generating operating income of $182 million. Over the 2003 to 2007 period, operating revenues and operating income are estimated to have grown at compound annual rates of approximately 10% and 13%, respectively, driven by the strength of the Black & Mild cigar brand franchise. In 2007, total company cigar volume is expected to reach 1.2 billion units.
Subject to necessary regulatory approvals, Altria anticipates that the transaction will be completed by yearend 2007. The acquisition, which will be financed with existing cash, is expected to be modestly accretive to Altria's 2008 earnings and generate an attractive double-digit economic return.
While there may be some cost savings, captured predominantly through procurement synergies and the elimination of duplicative expenses, the real appeal of this acquisition is to capitalize on PM USA's sales, distribution and marketing infrastructure and expertise, Szymanczyk said. Further, PM USA will contribute its strong capabilities, resources and focus on corporate responsibility, including youth smoking prevention.
He added, The plan is to accelerate the Black & Mild brand's market share growth momentum in the years ahead by leveraging the expertise and capabilities of both John Middleton Inc. and PM USA.
Black & Mild, a cigar made with a proprietary blend of pipe tobacco, enjoys strong brand equity, high brand awareness and solid volume and share growth momentum, Altria said. The brand is the second-largest selling machine-made large cigar in the United States, it added, with a retail market share of approximately 23%, and the Black & Mild five-cigar pack is the best-selling large machine-made cigar package in the United States, said Altria, citing data through June 2007 from Information Resources Inc. (IRI). It is particularly strong in the U.S. South and Southeast, which together account for approximately 55% of segment volume.
John Middleton was founded in 1856. It operates two manufacturing facilities in King of Prussia and Limerick, Pa. Upon closing, it will continue to operate from its current facilities. Orrin Ridington Jr., the current president, will continue to lead the company's operations from Limerick, and will work closely with the PM USA management team. Clinton Price Sr., the current CEO, will retire as previously planned, and has agreed to stay on in an advisory capacity during a transition period.
In a research note, Bonnie Herzog, an analyst with New York City-based Citi Investment Research, told CSP Daily News that the acquisition is very positive for PM USA, given the potential of the growing cigar category and brand equity of Black & Mild, which has 23% share in its category. The deal confirms her belief that PM USA will become a full tobacco company in its own right once the spinoff of the overseas Philip Morris International group from Altria occurs, she said.
Beyond the new cigar stake, Herzog also said she believes PM USA has considered leveraging the Black & Mild brand equity in inner cities by extending it into a menthol cigarette.
Furthermore, according to one of our industry contacts, distribution of Black & Mild within the retail outlets is very high already, which is certainly positive, said Herzog in a research note. However, given PM USA's vast distribution network, sales force and strong relationships, it seems logical that the company could expand the distribution of Black & Mild by increasing its shelf-space allotment and the overall awareness of the cigar category.
Herzog also said she sees the acquisition as a way for PM USA to generate additional sales and volume internationally, once separated from competing directly with Philip Morris International. She doesn't, however, anticipate that the acquisition impacting the eventual spinoff of Philip Morris International. We continue to anticipate that the Beast will be Unleashed', she wrote.
And Credit Suisse analyst Filippe Goossens said in a research note, We view the transaction as positive as it allows PM USA to get an immediate footprint (as compared to the current organic initiatives in the smokeless category, at least for now) in the growing domestic cigar market. We believe that the transaction makes sense [because] it represents the first full step toward diversifying into other tobacco products; the cigar business, in addition to smokeless, remains a growth category; Middleton provides an attractive margin structure and distribution opportunities; provides an opportunity to start using some of PM USA's financial flexibility; and could provide international expansion opportunities in the future.
He added, however, that it exposes PM USA to the risk of above average FET [federal excise tax] increases on cigars, and the transaction appears fully priced.
To learn more on how the deal will affect retailers, click here to register for the CSPNetwork CyberConference Tobacco Update with Bonnie Herzog.