Fitch Places Lorillard (LO) on Rating Watch Negative Following Reynolds American (RAI) Announcement

Fitch Ratings has placed Lorillard Inc.'s (NYSE: LO) 'BBB' Issuer Default Rating (IDR) on Rating Watch Negative. The rating action stems from Reynolds American Inc.'s (Reynolds) definitive agreement to acquire Lorillard for approximately $27.4 billion. The ratings apply to approximately $3.5 billion of Lorillard outstanding debt.

A complete list of ratings is provided at the end of this release.

KEY RATING DRIVERS
Reynolds' proposed offer of approximately $27.4 billion (12x EBITDA) comprises a cash component of $50.50 and an equity portion of 0.2909 shares of Reynolds' common stock per each share of Lorillard. The offer price represents $68.88 per share or a premium of around 40% from a closing price on Feb. 28, which was prior to media speculation surrounding a possible transaction. The companies expect the agreement to finalize in the first half of 2015.

Reynolds' purchase of Lorillard's will add the key cigarette franchise Newport to Reynolds' product portfolio, notably the mentholated varieties, an area presently underserved by the company's offerings. Obtaining the Newport brand franchise will make Lorillard the second largest cigarette manufacturer in the U.S. with an estimated cigarette market share around 32%., behind Altria Inc. that controls around one-half of the marketplace.

Upon completion of the transaction, Reynolds will divest remaining cigarette brands, including Kool, Salem, Winston, and Maverick, as well as the E-cigarette market leader blu to Imperial Tobacco Group p.l.c. (Imperial Tobacco, 'BBB'/Negative Outlook). Imperial Tobacco will also purchase certain Lorillard assets including manufacturing and research facilities in North Carolina for a total consideration of $7.1 billion (around $4.4 billion after-tax)(see 'Fitch Revises Outlook on Imperial Tobacco Group PLC to Negative; Affirms at 'BBB'' dated July 15, 2014).

Reynolds' leveraging acquisition of Lorillard will stress Lorillard's current credit profile and 'BBB' rating prompting the Negative Watch. Financial risk is partially mitigated as the cash cost of the acquisition may be moderated with divestiture proceeds from Imperial Tobacco, and additional investment from British American Tobacco p.l.c. (BAT, 'A-'/Stable Outlook) in order to maintain a 42% stake in the combined entity)(see 'Fitch Affirms British American Tobacco p.l.c. at 'A-'/'F2'; Outlook Stable' dated July 15, 2014). Fitch will resolve the Negative Watch as more detail of the transaction becomes clearer with the expectation the action will include a withdrawal of Lorillard's ratings.

RATING SENSITIVITIES
Negative pressure will arise from Reynolds' acquisition of Lorillard under the present terms of the offer. Fitch sees pro forma gross debt leverage of the combined entity at approximately 3.5x, a level more consistent with a low investment grade credit rating.

Fitch does not currently expect positive rating action given the leveraging acquisition offer from Reynolds. In addition, positive rating action is restrained by key factors in the mature industry, specifically secular volume declines, high litigation exposure, rising regulatory risks and an accommodative shareholder stance.

LORILLARD'S RATINGS
Fitch has placed the following ratings on Rating Watch Negative:

Lorillard Inc.
--Long-term IDR 'BBB';
--Short-term IDR 'F2'.

Lorillard Tobacco Co.
--Long-term IDR 'BBB';
--Senior unsecured bank credit facility 'BBB';
--Senior unsecured debt 'BBB';

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