Cigar Weekly

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Los Angeles –(First Reported by Cigar Weekly on January 15, 2010, ed.) Scandinavian Tobacco Group chief executive Anders Colding Friis made no secret of his ambitions. In an interview with the European Cigar-Cult Journal, last summer, he noted "We’re already very close on the heels of Swedish Match. Soon, we’ll be disputing their current position as the second-largest cigar company in the world."

There won’t be a dispute, but rather a combination of forces as Swedish Match and STG signed a letter of intent in mid-January to create a joint-venture company that would create the largest cigar-centric company in the world:

=> Swedish Match will, according to its announcement, offer "the premium and machine-made cigar businesses of Swedish Match (with the exception of the U.S. mass market cigar business)" and include the "pipe tobacco and accessories businesses . . . as well as distribution of lights products in relevant markets."

That most obviously includes General Cigar, the premium-cigar sales leader in the United States, retailer Cigars International, perhaps the second-largest seller of premium cigars in the U.S. and the company’s smaller European operations, plus multiple large cigar-making factories in the Dominican Republic and Honduras.

=> STG will provide its tobacco businesses, which include a massive international presence for the Henri Wintermans and Nobel line of small cigars, the C.A.O. premium-cigar company based in Nashville and cigar factories operated by the Torano family in Honduras and Nicaragua, plus their pipe-tobacco interests, which account for 25% of all pipe-tobacco sales worldwide. It will also pay Swedish Match 40 million Euro (about $57.5 million U.S.) to even up the valuations according to the new ownership shares.

It’s certain that Britain’s Imperial Tobacco’s cigar interests will still be larger, but it is primarily a cigarette company, where the new SM-STG venture will clearly be focused on cigars.

The joint venture concept – which is still subject to what could be a difficult regulatory review by the European Union and by Swedish regulatory agencies – would be 51% owned by STG and 49% by Swedish Match and would have Colding Friis as the chief executive. Based on full-year 2008 results, the new venture would have sales of 670 million Euro (about $962 million) and operating profits of 125 million Euro (about $179.5 million) on turnover of about 2.5 billion cigars annually. More than half of the combined cigar sales total – about 1.7 billion – will be of STG’s small-cigar brands.

The Swedish Match announcement noted at the end, "The completion of this transaction is subject to due diligence by both parties and final transaction agreements, as well as bondholder and regulatory approvals. Signing is expected to take place during the first half of 2010 with completion as soon as possible thereafter. Please note that there can be no assurance as to whether the transaction will be completed."

On the assumption that it will be completed, analysts were generally positive about the concept:

=> A note from Citi analyst Adam Spielman commenting on the impact to Swedish Match stated "We think the new structure helps financially and strategically – Back of the envelope calculation suggests mid-single-digit [earnings per share] accretion after synergies. Furthermore, the greater focus on the growing smokeless market can only help."

Spielman also noted that Swedish will contribute "about 20% of its business into this JV; its remaining fully-consolidated businesses will be just the smokeless business (plus the U.S. mass market cigars, which are sold through the same channels), and its small lights and Scandinavian distribution businesses." He sees this as a positive, with the possibility for better cigar sales in Europe, where STG is strong and Swedish is weak.

=> Comments from an unidentified analyst to the Swedish newswire Nyhetsbryan Direkt were positive, with the wire story noting "Via the move, Swedish Match has made another step towards becoming a pure-play (moist) snuff company, according to the analyst, who estimates that the synergies from the joint venture are not to be neglected.

"It is also considered positive that the company will retain its flourishing U.S. [mass market] cigar business, while transferring the less profitable European operations to the joint venture." So what will the impact be?

=> The new company will have serious production capabilities in all three major cigar-producing countries: Dominican Republic (General Cigar Dominicana and the newer factory for La Gloria Cubana), Honduras (both Swedish Match’s former UST factory and STG’s Latin Cigars factory operated by the Toranos) and Nicaragua (Torano factory owned by STG).

=> The new company will have an enormous brand portfolio that includes General’s industry-standard brands such as Excalibur, Hoyo de Monterrey, Macanudo, Partagas, Punch and many more as well as C.A.O.’s younger lines, plus distribution of the Dunhill and Torano brands.

=> C.A.O.’s small and highly-efficient headquarters team and sales force will be integrated with the powerful General team, although whether in Richmond or Nashville is still to be decided.

=> The joint venture will have a direct retail channel in the energetic Cigars International, thought to be the second-largest seller of premium cigars in the U.S., which will take STG out of the position of possibly buying one of the remaining independent operations in the U.S.

=> An even greater concentration of power in the U.S. cigar trade will take place, with one of the mid-level players combined with the market leader, leaving Altadis U.S.A., the new joint Swedish-STG venture, Davidoff of Geneva and Arturo Fuente/J.C. Newman as the top companies, with Rocky Patel Premium Cigars the next largest. Shelf space in U.S. retail shops will become harder and harder to find for new brands.

Those are the immediate impacts. Looking into the future, the Nyhetsbryan Direkt report noted analyst comments that "‘The question is what Swedish Match will do [later] and I will think it will consequently sell its stake,’ said the analyst, who is certain that STG had wanted full ownership from the beginning but Swedish Match had preferred to make the move in two steps."

That would leave Swedish Match clearly-focused smokeless tobacco company and highly attractive to be acquired itself; Citi’s Spielman think Imperial Tobacco could be a possibility and U.S. anti-trust issues would be avoided if General Cigar were not part of the deal. And Colding Friis would get what he wants for STG: to be the worldwide no. 2 in cigars with a chance to focus on being no. 1.

>> A long struggle over outdoor smoking that presaged an even larger battle ended after an 18-month tug-of-war between competing interests in Los Angeles with the passage of an ordinance extending smoking bans to outdoor dining areas of restaurants.

The decidedly-liberal City Council passed the measure (08-1544), which was originally requested by Council member Greig Smith to "prohibit smoking in outdoor dining areas" back in June of 2008. After complaints from cigar smokers, who engaged the anti-smoking lobby at committee hearings and lobbied furiously with funding assistance from Cigar Rights of America, the final version of the ordinance was written in a close-cropped manner:

=> Specifically exempted from the ordinance were bars; in fact, the final language reads "an outdoor dining area shall not include an area that is continuous to . . . A bar, or a nightclub that requires that its patrons be eighteen or older," and

=> An exemption was also added for outdoor dining areas of "A restaurant, business or non-commercial building that is completely closed to the public for a private event."

These are important in that, as regards restaurants, some smoking-friendly establishments convert to bar status – with only age-18 or older admitted – during late-night hours, and smoking could be allowed at those times, and the exemption for private events held in outdoor dining areas of restaurants or other facilities preserves the ability to hold cigar dinners or other charitable events and have smoking permitted.

While the new ordinance is another unwelcome encroachment on the freedom to smoke outdoors – where there is no health risk from so-called "secondhand smoke" – the exemptions that were won demonstrated again how civic involvement and participation makes a difference. Council member Tom LaBonge, who personally refereed the arguments between the anti-smoking and cigar-smoking groups, said at the initial committee meeting on the Smith motion that the anti-smoking groups "would have success on this," but recognized that the public’s tolerance for limits on smoking was reaching its limits.

Further, a long discussion about signage requirements under the new ordinance was resolved to no one’s complete satisfaction. There will be a one-year grace period, during which a sign must be "clearly visible and readable to a majority" of restaurant customers that a smoking ban in that area will take effect in January 2011 and then a permanent sign is required which must only be "clearly visible and readable to most diners in the outdoor dining area." That’s quite a bit less onerous than other smoking-ban signage required in the Los Angeles Municipal Code and signals a very modest signage requirement that businesses must undertake.

In addition, the new ordinance specifies no enforcement mechanism or primary agency, which means that complaints will almost certainly be made to the Los Angeles Police Department, which will just as certainly place a low priority on such calls.

The fight by cigar smokers against the easy passage of this ordinance was successful in that the exemptions carved out of what could have been – and would have been – a blanket ban on outdoor dining areas of all types. The compromise can be seen to stand for the proposition that – at least outdoors – smoking is to be allowed in venues for which minors are not admitted. That’s important. (The City of Los Angeles does not control indoor smoking laws because of preemptive California-wide statutes.)

Just as crucial is that the enormous effort expended by cigar smokers against this proposal has left a much more dangerous motion by City Council member Bernard Parks essentially stillborn. His proposal, submitted on August 8, 2008 (08-2123), was to create ordinances which banned smoking in all places in which people might or could congregate, which would essentially ban smoking everywhere in the City except possibly in private homes. That proposal, likely submitted by Parks as an election-year idea in 2008 in his losing campaign to win an open seat as a Los Angeles County Supervisor, was cheered by anti-smoking advocates, but has gone nowhere in the 18 months since he submitted it. It could still be considered, but is most likely to simply expire on August 11 of this year. That’s good.