90% Chance of Reynolds American (RAI)/ Lorillard (LO) Combination - Wells Fargo

Analyst Bonnie Herzog of Wells Fargo has increased conviction about a Reynolds American (NYSE: RAI)/ Lorillard (NYSE: LO) combination, and she thinks there is now a 90% likelihood of a deal. Lorillard may fetch up to $80 per share, based on her analysis. She also sees upside for Reynolds American, as investors may underappreciate the value of assets it can spin-off.

"Based on news reports that came out this afternoon (5/21/14) indicating that RAI (RAI, 1, $59.77) is in “active discussions” to buy LO (LO, 1, $62.63), we are reiterating our prior conviction that an RAI-LO combination remains highly likely – dare we say 90% probability? Given the current market environment where both targets and acquirers are being rewarded, we continue to believe this will be a value creating transaction for both RAI and LO shareholders. Therefore, we expect further upside potential in both stocks. Based on our interactive RAI-LO merger analysis published March 3, 2014, we continue to believe this deal will be accretive in year 1 up with RAI paying up to $80/sh a LO," she said.

"We think there's upside potential in RAI for 3 key reasons: (1) We continue to believe there's a high likelihood (now 90%) that RAI could acquire LO, paying up to $80/sh for the company, incorporating synergies of $400MM and BAT could either acquire or form a strategic partnership with the combined entity. We believe BAT will contribute capital to help finance the deal and maintain its existing 42% stake in RAI in the combined entity. Further, we believe the return of Susan Cameron as CEO is a positive catalyst for the stock as she leads the company into its next generation of growth; (2) We expect RAI's organic growth could accelerate and we have increased conviction in RAI's ability to operationalize innovation which we believe will be more crucial than ever with the rise of vapor; and (3) We believe RAI's Santa Fe asset, which we believe is worth $4.7B as a standalone business, is underappreciated and could be spun off/sold to create value for shareholders," added the analyst.

For an analyst ratings summary and ratings history on Reynolds American click here. For more ratings news on Reynolds American click here.

Shares of Reynolds American closed at $59.77 yesterday.

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