Lorillard Shares Fizzle Out, But Is It Still a Buy?

Source: Thinkstock

Source: Thinkstock

On Monday July 14, we learned that Reynolds American (NYSE:RAI) intends to buy rival tobacco company Lorillard (NYSE:LO). The shares of both companies — and shares of Lorillard in particular — fell pretty dramatically on the news.

The fact that Lorillard shares fell (and they fell by 10 percent) might be puzzling to some. After all, the stock had been trading below the acquisition price of about $68/share. Specifically, owners of Lorillard will receive $50.50 in cash and 0.2909 shares of Reynolds American for each share. But the shares traded down to around $60/share and today they trade at just over $61/share. Even with the decline in Reynolds American shares the deal is still worth $67/share. Why, then, are the shares so weak?

I think there are at least three reasons for this. The first is that a lot of traders piled onto Lorillard in anticipation of this deal, and this pushed the price up so that the final deal price was only a couple percentage points higher than Lorillard’s closing price on the previous Friday. With the trade being over, several traders took their positions off the table, and this put downward pressure on the stock.

Second, Lorillard has been aggressively buying back shares of its own stock, and when the deal was announced, this stopped. This took a great deal of demand out from under the stock, and this is probably responsible for some fo the downside pressure.

Third, there is reason to believe that the deal may not go through. Some traders are concerned that the FTC may not approve of the deal due to anti-trust legislation. After all, if the deal goes through, there will only be 2 major tobacco players in the sector. Furthermore, many Lorillard shareholders are upset by the deal, and they either think that they should have gotten more or that the combined company isn’t as attractive as Lorillard as a stand-alone company. After all, Lorillard and rival tobacco company Altria Group (NYSE:MO) have been taking market share from Reynolds American. Furthermore, as part of the agreement the combined company will be selling some growth products to rival company Imperial Tobacco (ITYBY), and this makes the combined company even less attractive.