On Monday, June 1 we sold Lorillard (LO)* in all accounts. We discussed our investment in Lorillard in the 6th edition of our dividend letter and one of the catalysts we highlighted was the potential merger with Reynolds American (RAI). The potential deal became an official announcement in July 2014 and has been under review by the Federal Trade Commission ever since. Then on May 26, 2015 the FTC approved the merger between Lorillard and Reynolds American. The merger is expected to close later this month.
The terms of the merger originally valued Lorillard at $68.88 per share. We sold Lorillard at an average price of $72.16 per share, a premium to the original deal price. This happened because Reynolds American’s offer is a mix of cash and stock. Each Lorillard shareholder will receive $50.50 per share in cash and 0.2909 shares in Reynolds American.
When the deal was first announced we intended to accept shares in the new Reynolds American and potentially add to it because of the large cost savings, the company’s potential for high profitability, and the high returns on capital that tobacco companies produce.
However, it has become clear that Reynolds American is now assuming Lorillard’s US. menthol cigarette legislation risk and it looks increasingly likely that some form of menthol legislation will come. We just don’t know when. Lorillard’s dominant position in menthol cigarettes is what made it an attractive takeover target. In our view, selling LO now allows us to remove the fat tail risk of increased menthol cigarette legislation from your portfolio at a premium price.
As always, if you would like to discuss this further please give us a call or send us an email.
Sincerely,
Your Portfolio Management Team
*We own Lorillard (LO) in many client accounts that employ our Dividend Income Strategy. However, we have not been significant buyers of LO since July 2014, so newer clients or clients that shifted to the dividend strategy after this time likely did not hold a position in LO.
