|
|
Get Four
|  | APRIL 27, 2006
By Nanette Byrnes Reynolds Takes a Bite of ChewThe cigarette company's purchase of smokeless business Conwood for a surprising sum has analysts looking twice at Skoal parent USTThe announcement that Reynolds American (RAI ) will pay $3.5 billion for the Conwood smokeless tobacco and cigar business has left some people gasping with surprise. The deal, disclosed Apr. 25, awarded a multiple nearly eight times Conwood's roughly $450 million 2005 sales, and 14 times its $250 million in earnings. That's a rich premium for a company that's a distant No. 2 to smokeless-tobacco giant UST (UST ). Conwood, a private company owned by the Pritzker family of Chicago, has less than 25% of the U.S. moist smokeless market, to UST's 63.3%. Only a few weeks ago, Citigroup (C ) analyst Bonnie Herzog estimated Conwood would fetch about half the price Reynolds is willing to pony up. So what's so great about chew? Well for starters, its popularity is growing in the U.S., while cigarette smoking is down. The market for chewing tobacco is small compared to cigarettes -- between 5 million and 6 million consumers, compared to 45 million plus smokers -- but consumption has been increasing. While the officially tallies of cigarette consumption show an annual drop of 2.3% a year since 1997, smokeless tobacco sales are rising 4% to 6% a year. CHEAPER HABIT. Chew has some unpleasant characteristics, starting with the need to spit out the secretions, but it's got advantages too, most clearly the fact that it doesn't create smoke, making it a way to satisfy the nicotine craving without violating the increasingly common bans on public smoking. New Jersey is the most recent state to restrict smoking in public places, and the list will keep growing. Some argue that consumers will increasingly shift to smokeless tobacco to satisfy their cravings in a less regulated way. It's cheaper too. None of the smokeless-tobacco companies except UST signed the industry's version of the Master Settlement Agreement with the states' attorney generals. The agreement the cigarette companies signed contains the same restrictions on advertising, but the payouts are far larger. Cigarette smokers are paying roughly $10 billion a year to the states because of high payouts due to the MSA. In high tax districts, the MSA costs plus rising excise taxes have combined to make cigarettes a luxury. In New York City, for example, a pack of premium cigarettes can cost $7 to $8. Of that, $1.50 is state excise tax, $1.50 is city tax, and 39 cents goes to federal excise tax. Premium chew costs between $4 and $6 a can, with discount brands like Conwood's Grizzly brand at half that. Taxes are lower too, only pennies per can in federal taxes. State taxes vary, but some don't tax chew at all. SLOWER KICK. According to David Bishop, a director at Willard Bishop, a Barrington (Ill.)-based retail marketing consulting firm that counts Altria (MO ) and UST among its clients, the higher cigarette taxes go, the more common chew becomes. In Europe, he says, per capita consumption of smokeless tobacco is actually higher than it is here in the U.S. He thinks that's because there, taxes are even higher, often as much as 80% of the price of a pack, compared to 50% to 60% here. But health-care experts, including Gregory Connolly, a professor at the Harvard School of Public Health, argue that chew still remains largely a habit of the South, and that there's little evidence of widespread switching from cigarettes to smokeless tobacco. On the contrary, Connelly notes, many chew users end up trading up to cigarettes for the far faster delivery of nicotine to the brain that smoking provides. "It's an introductory product," says Connelly, "it's like training wheels for nicotine addiction." Chew does have its own health issues, including mouth cancers, but the mortality rates are lower than they are for smokers. LESS LITIGATION. Manufacturers of chewing tobacco certainly have been trying to broaden its appeal. UST's apple and peach flavored versions of its Skoal brand have done well, as has the new pouch packaging that has replaced some of the canned product. In an Apr. 25 report, Merrill Lynch (MER ) analyst Christine Farkas, who rates UST "neutral," notes that in the first quarter, such new products represented 11.3% of the company's total volume. Bishop says the company is testing a product that you could swallow instead of spit, something that might be more appealing to women than the prospect of carrying around a spittoon. For cigarette makers, there's one more draw: The smokeless manufacturers don't face anything like the legal issues cigarette makers do. Richard Daynard, president of the Tobacco Control Resource Center and a professor of law at Northeastern University, says there's little pending litigation against chew companies. "There's clearly a continued risk of litigation, but probably not of the potentially bankrupting litigation there is in cigarettes," says Daynard. "We're simply not talking about the death rate we have with cigarettes." Some analysts wondered after the announcement whether it might also make UST a more attractive acquisition target. The stock hit a month high of $44.92 the day Reynolds announced the Conwood deal. Cigarette companies are strong cash generators, and the most likely purchaser would seem to be Philip Morris, a unit of Altria and the maker of the dominant Marlboro cigarette brand. Both companies declined to comment, but after the price Conwood just pulled down, it would certainly be a costly target.  Byrnes is a senior writer for BusinessWeek in New York Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | |
 Copyright 2006, Bloomberg L.P.Terms of Use | Privacy Notice |
Printer-Friendly Version
