Sin Taxes?

Big Tobacco's Big Taxes Could Help Clear the Lorillard Merger


When any industry attempts to create a true duopoly—two companies that would control 90 percent of a market—it should be safe to assume that regulators will find plenty of antitrust red flags. The merger of Lorillard (LO) and Reynolds American (RAI) would create just such a two-member cartel. The combined companies would control about 34 percent of the tobacco market, second only to Altria’s (MO) 47 percent share.

Yet approval of the $25 billion merger would also create a behemoth in a collapsing industry still seen as Public Health Enemy No. 1 in the U.S. Over the past 50 years, the U.S. has made enormous strides in marginalizing smoking and decreasing sales in the $90 billion market. “It’s a duopoly. That said, the market is shrinking,” says Bloomberg Industries analyst Kenneth Shea. “So is that going to be taken into consideration? Maybe.”

About 18.1 percent of American adults smoke cigarettes, down from more than 20 percent in 1995 and 43 percent in 1965, according to U.S. statistics. Given such long-term decline—and states’ continued health efforts to combat the harmful effects of smoking—the tobacco industry’s financial health could potentially be a factor in reviews made by the Federal Trade Commission and the Justice Department.

For one thing, the industry pays an estimated $30 billion each year in local, state, and federal taxes, Shea says, providing crucial financial underpinning for municipal bond issues. About half the tax take flows to the U.S. government, according to Bloomberg data.

Sure, many people—including government regulators—would like to see cigarettes disappear. But there’s a fiscal interest “to keep the industry viable for awhile,” Shea says.

The deal between Lorillard and Reynolds is likely to face review for at least the rest of this year and possibly into 2015. But allowing Big Tobacco to consolidate—and benefit from the improved pricing power likely to result—is one way to keep a shrinking industry stable for a time.

Bachman is an associate editor for Businessweek.com.

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