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Japan Tobacco to Acquire Natural American Spirit Outside US

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October 1st, 2015

Reynolds American Inc. has announced that the international rights to the Natural American Spirit brand name and associated trademarks, along with the international companies that distribute and market the brand outside the US, will be sold to the Japan Tobacco Group of companies (JT Group) in an all cash transaction with a value of approximately US$5 bn.  The purchase does not include the rights to the Natural American Spirit brand name and associated trademarks in the US. The deal includes the trademarks and all outstanding shares in RAI’s nine subsidiaries in Belgium, France, Germany, Italy, Japan, the Netherlands, Spain, Switzerland and the UK. The purchase agreement contains a non-compete clause which restricts RAI and JT from producing, selling, distributing and developing natural, organic and additive-free combustible tobacco cigarettes and RYO products in each other’s territories of business, for a period of up to five years from the close of the transaction.

This is the Japanese company’s most expensive acquisition since Gallaher, UK cigarette market leader, for US$11.4bn in 2007.  The acquisition is in keeping with the announcement by Japan Tobacco President Mitsuomi Koizumi in February 2015 that 2015 would be the company’s ‘year of investments’ including increased stakes in other types of tobacco products such as e-cigarettes. To clear the decks for greater concentration on the tobacco business, Japan Tobacco recently pulled out of the soft-drink business. Japan Tobacco was privatized in 1994 and became a global tobacco business with the acquisition of the non-U.S. tobacco business of RJR Nabisco in 1999 for US$7.8bn followed by Gallaher Group for US$11.4bn in 2007. Like BAT, the ambition of Japan Tobacco is to be world number one which means overtaking PMI, owner of the international rights to the mighty Marlboro.

Additive free appeal

The appeal of the Natural American Spirit is stated as its ‘additive-free tobacco’. The brand had a share of some 1.5% in the US in 2014 according to Euromonitor International and is sold at a ‘super premium’ price. According to reports, the brand is popular among younger smokers and has acquired a following in Japan.  JT plans to position Natural American Spirit as one of its primary flagship brands behind Mevius, Winston and Camel. Clearly JT believes in the international potential of Natural American Spirit with its ‘natural’ and ‘additive free’ appeal placing it, at least in the minds of some smokers, in the reduced risk category.

Most concentrated

The global tobacco industry (excluding China) is probably the world’s most concentrated in terms of the proportion of a global FMCG business controlled by a small cadre of international companies with a history of acquisition.  In 2014 PMI, BAT, Japan Tobacco and Imperial accounted for some 71% of the global cigarette market, according to Euromonitor International. China is one of a few countries in the world where the tobacco market leaders are not one of a combination of PMI, BAT and JT. The main exceptions are India, South Korea, Egypt, Vietnam and Thailand. Another exception is the world’s third’s largest market by volume and second largest by value – the US.  However the situation here is not like China where a state controlled company (CNTC) with its own brands is dominant: the US cigarette market is dominated by the same flagship brands found almost everywhere else in the world – Marlboro, Camel, Winston and Pall Mall. The difference is that the brand owners are different – Altria rather than PMI owning Marlboro, Reynolds owning Camel and Pall Mall respectively rather than Japan Tobacco and BAT in the rest of the world.

Market changing event

Further changes of ownership might have been expected in the US in the aftermath of the US$27 billion Lorillard acquisition, which transferred ownership of the second largest brand – Newport, to the second largest company – Reynolds. The other significant aspect of this market changing event was the US$7.1bn sale of the US brands Winston, Maverick, Kool and Salem (plus the e-cigarette blu) to Imperial, already an important player in the US market through its USA Gold and Sonoma price value brands.

This appears a very good deal for RAI: the US$5 bn plus the value of the disposals to Imperial will mean approaching half the cost of the Lorillard acquisition had been recouped. How well the deal turns out for Japan Tobacco will depend on how successful it is at internationalising a US success story. The appeal is one of quality and implied reduced risk. Japan Tobacco will obviously be aware that the US FDA recently sent a letter to RAI calling on the company to prove that cigarettes they have labelled  as ‘natural’ and ‘additive-free’ are less harmful than ordinary cigarettes in order to continue to market the cigarettes by using the implication of lower health risk.  Proving any tobacco product less harmful than any other tobacco product to the satisfaction of any health agency is not an easy task, although some styles of Natural American Spirit are made, according to reports,  with USDA-certified organic tobacco.

Japan Tobacco’s next move

JT’s willingness to spend US$5 bn on internationalising a US brand is a bold move and begs the question – what next in the year of investment?  Imperial Tobacco has long been regarded as a potential takeover target for one of the three larger international companies or even CNTC, should the giant Chinese state owned company choose to accelerate its international ambitions. The acquisition of Imperial by JT would enable the company to overtake BAT in terms of cigarette volumes sold as well as becoming global leader in cigars and smoking tobacco.

However, seasoned tobacco takeover speculators do not tend to link Imperial with Japan Tobacco, the two companies being a less comfortable fit, than, for example, BAT and Imperial or, though to a less extent,  PMI and Imperial. Japan Tobacco and Imperial, account between them for some 72% of the UK cigarette market which would certainly be viewed as anti-competitive.  BAT, like Imperial a UK based company, would make a more logical fit: the combined company, though leading the UK market, would account for less than 50% of the market and the same would apply in Spain. Meanwhile, in France, the combined shares of PMI and Imperial of over 60% would certainly cause regulatory issues.  However, as witness the RAI acquisition of Lorillard in the US, which necessitated the disposal of more brands than were acquired, where there is a will there is a way and accommodations are always possible.  And there remain other possibilities (excluding state owned tobacco companies): Gudang Garam and Djarum in Indonesia between them have sales of approaching 100bn sticks.  KT&G in South Korea has sales of some 66bn sticks while Donskoy in the huge Russian market had sales of over 20 bn sticks in 2014.

US Strategy

According to CEO Susan M Cameron, ‘once the transaction is complete, the international rights to all of RAI’s operating companies’ cigarette trademarks will be owned by international tobacco companies, allowing the RAI companies to focus on brand growth in the US market. The international companies being sold employ about 280 people, primarily in Europe and Japan. According to RAI, those companies distribute and market Natural American Spirit additive free and organic styles of cigarettes and roll your own tobacco primarily in European and Asian markets, the brand’s largest markets being Japan, Germany and Switzerland. Natural American Spirit sells at a premium price in each of the markets in which it competes, just as it does in the US market. According to RAI ‘Natural American Spirit has achieved excellent international growth over the past several years’. The transactions must be approved by regulatory authorities in a number of countries and approvals are expected by early 2016.

The deal makes RAI’s strategic positioning as a purely US company crystal clear despite obviously flirting with the idea of using Natural American Spirit as a vehicle for its own international growth.  Presumably there was extensive discussion with RAI’s 42% shareholder BAT which might have done exactly what Japan Tobacco intends to do with Natural American Spirit.  Presumably the decision was reached that US5bn for an internationally unproven brand was too good to miss.

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