The opinion
Reynolds Am. Inc. v. Third Motion Equities Master Fund Ltd., 2020 NCBC 35.
STATE OF NORTH CAROLINA IN THE GENERAL COURT OF JUSTICE
FORSYTH COUNTY SUPERIOR COURT DIVISION
17 CVS 7086
REYNOLDS AMERICAN INC., )
)
Plaintiff, )
)
v. )
)
THIRD MOTION EQUITIES MASTER )
FUND LTD., MAGNETAR CAPITAL )
MASTER FUND, LTD., SPECTRUM )
OPPORTUNITIES MASTER FUND LTD., )
MAGNETAR FUNDAMENTAL )
STRATEGIES MASTER FUNDS LTD., )
MAGNETAR MSW MASTER FUND LTD., )
MASON CAPITAL MASTER FUND, L.P., )
ANTON S. KAWALSKY, trustee for the )
benefit of Anton S. Kawalsky Trust UA )
9/17/2015, CANYON BLUE CREDIT )
INVESTMENT FUND L.P., THE ) FINDINGS OF FACT,
CANYON VALUE REALIZATION ) CONCLUSIONS OF LAW, AND
MASTER FUND, L.P., CANYON VALUE ) FINAL JUDGMENT
REALIZATION FUND, L.P., BLUE )
MOUNTAIN CREDIT ALTERNATIVES )
MASTER FUND L.P., BLUEMOUNTAIN )
FOINAVEN MASTER FUND L.P., )
BLUEMOUNTAIN GUADALUPE PEAK )
FUND L.P., BLUEMOUNTAIN SUMMIT )
TRADING L.P., BLUEMOUNTAIN )
MONTENVERS MASTER FUND SCA )
SICAV-SIF, AMUNDI ABSOLUTE )
RETURN CANYON FUND P.L.C., )
CANYON-SL VALUE FUND, L.P., )
PERMAL CANYON IO LTD., CANYON )
VALUE REALIZATION MAC 18 LTD., )
and BARRY W. BLANK TRUST, )
)
Defendants. )
)
1. THIS MATTER arises out of the assertion of appraisal rights by
Defendants, who are former shareholders of Plaintiff Reynolds American Inc. (“RAI”
or the “Company”), in connection with the merger of RAI with and into a wholly-
owned subsidiary of British American Tobacco plc (“BAT”) (the “Merger”). By statute,
the Court is charged with determining the fair value of Defendants’ shares at the
time of the transaction. N.C.G.S. § 55-13-30(a).
2. The Court has considered all relevant and admissible evidence of value
presented by the parties at trial, including the pre-Merger trading price of RAI stock;
the robustness of the negotiations between RAI and BAT and the resulting deal price;
the valuation work performed by Goldman Sachs Group, Inc. (“Goldman”), Lazard
(formerly known as Lazard Frères & Co.), and JPMorgan Chase and Co.
(“JPMorgan”) (collectively, the “Financial Advisors”) in connection with the Merger;
the pre-litigation valuations prepared by the parties; and other evidence from the
testimony of the fact witnesses, the testimony of the parties’ retained experts, and
the documents introduced by the parties as set forth herein.
3. After full consideration of the evidence presented at trial and the parties’
well-presented arguments in voluminous pre- and post-trial submissions and at an
all-day post-trial hearing, the Court, for the reasons set forth below, concludes that
the $59.64 per share that RAI has already paid Defendants equals or exceeds the fair
value of RAI shares as of the date of the Merger and that RAI is therefore entitled to
a judgment that no further payments to Defendants are required.
Cravath, Swaine & Moore LLP, by Gary A. Bornstein, Thomas G.
Rafferty, Samira Shah, Nicole D. Valente, and Brook E. Tay, and Smith,
Anderson, Blount, Dorsett, Mitchell & Jernigan, LLP, by Donald H.
Tucker, Jr., Christopher B. Capel, and Clifton L. Brinson, for Plaintiff
Reynolds American Inc.
Lowenstein Sandler LLP, by Lawrence M. Rolnick, Sheila A. Sadighi,
Thomas E. Redburn, Jr., Jennifer A. Randolph, and Jarrett Sena, and
Brooks, Pierce, McLendon, Humphrey & Leonard, LLP, by Jennifer K.
Van Zant and Jessica Thaller-Moran, for Defendants Mason Capital
Master Fund, L.P., The Canyon Value Realization Master Fund, L.P.,
Canyon Value Realization Fund, L.P., Canyon Blue Credit Investment
Fund L.P., Canyon-SL Value Fund, L.P., Permal Canyon IO Ltd.,
Canyon Value Realization MAC 18 Ltd., Amundi Absolute Return
Canyon Fund P.L.C., Anton Kawalsky, Blue Mountain Credit
Alternatives Master Fund L.P., BlueMountain Summit Trading L.P.,
BlueMountain Montenvers Master Fund SCA SICAV-SIF,
BlueMountain Foinaven Master Fund L.P., BlueMountain Guadalupe
Peak Fund L.P.
Abrams & Bayliss LLP, by J. Peter Shindel, Jr., Kevin G. Abrams, and
Matthew L. Miller, and the Sanderson Law Firm, PLLC, by George F.
Sanderson, III, for Defendants Magnetar Capital Master Fund, Ltd.,
Magnetar Fundamental Strategies Master Fund Ltd., Magnetar MSW
Master Fund Ltd., Third Motion Equities Master Fund Ltd., and
Spectrum Opportunities Master Fund Ltd.
Shanahan Law Group, PLLC, by Kieran J. Shanahan, Brandon S.
Neuman, and Christopher S. Battles, for Defendant Barry W. Blank
Trust.
Bledsoe, Chief Judge.
I.
PROCEDURAL BACKGROUND
4. RAI filed this judicial appraisal action on November 29, 2017, pursuant to
N.C.G.S. § 55-13-30. (ECF No. 4.) The case was designated as a mandatory complex
business case by Order of the Chief Justice of the Supreme Court of North Carolina
on November 30, 2017, (ECF No. 3), and assigned to the undersigned on December 1,
2017, (ECF No. 2).
5. This matter came on for trial before the undersigned and was tried to the
Court, sitting without a jury, on June 10–25, 2019. By consent of all parties, the trial
was held in Mecklenburg County. The trial was conducted by very experienced and
accomplished counsel and generated an extensive record. The Court admitted into
evidence 177 exhibits and received testimony both from witnesses appearing at trial
and from witnesses appearing by written deposition transcript and/or by videotape. 1
The parties have submitted post-trial briefs and proposed findings of fact and
conclusions of law, and the Court heard post-trial oral argument on October 2, 2019.
All issues and claims are now ripe for determination.
6. Having considered the relevant and admissible evidence 2 and the
submissions and arguments of the parties, the Court now makes the following
1 Four experts appeared and testified at trial. Plaintiff’s expert was Dr. Paul Gompers
(“Gompers”), the Eugene Holman Professor of Business Administration at Harvard Business
School. (Gompers Tr. 721:5–18; Parties’ Witness Summaries 3, ECF No. 189.) Defendants
introduced expert testimony from three experts: Dr. Fredrick Flyer (“Flyer”), the Executive
Vice President of Compass Lexecon, an economic consulting firm, (Flyer Tr. 1065:18–1066:11;
Parties’ Witness Summaries 2); Dr. Mark Zmijewski (“Zmijewski”), a Professor Emeritus of
financial accounting and corporate finance at The University of Chicago Booth School of
Business, (Zmijewski Tr. 1237:23–1238:5; Parties’ Witness Summaries 6); and Dr. Bilge
Yilmaz (“Yilmaz”), the Wharton Private Equity Professor and a Professor of Finance at the
Wharton School of the University of Pennsylvania, (Yilmaz Tr. 1863:23–1864:21; Parties’
Witness Summaries 6). Nine fact witnesses appeared and testified at trial. Deposition
testimony was introduced from an additional seven fact witnesses.
2 The parties lodged numerous objections to proffered exhibits and testimony during the trial.
The Court ruled on many of these objections at the time they were made. As to others,
however, the Court received the proffered exhibits and testimony subject to objection and
permitted post-trial briefing and argument on the objections. The Court’s rulings on the
parties’ remaining evidentiary objections are set forth in Appendix B attached hereto and
those rulings are incorporated herein.
findings of fact and conclusions of law pursuant to Rule 52(a) of the North Carolina
Rules of Civil Procedure (“Rule(s)”).
II.
FINDINGS OF FACT 3
7. Plaintiff RAI is a corporation incorporated under the laws of North Carolina,
with its principal place of business located in Winston-Salem, Forsyth County, North
Carolina. (JX0017.0003.)
8. Prior to July 25, 2017, RAI was a public company traded on the New York
Stock Exchange (“NYSE”), with over 1.4 billion shares of common stock outstanding.
(JX0017.0001, .0003.) Pursuant to an Agreement and Plan of Merger dated January
16, 2017 (the “Merger Agreement”), (JX0023.0572–.0647), a wholly-owned subsidiary
of BAT was merged with and into RAI on July 25, 2017 (the “Transaction Date”), with
RAI continuing as the surviving corporation and as an indirect and wholly-owned
subsidiary of BAT, (Corr. Stip’d Facts ¶¶ 17, 19; JX0017.0003).
9. Plaintiff seeks a judgment establishing the fair value of RAI common stock
at no more than $59.64 per share. (Bornstein Tr. 13:16–18.)
3 Any determination later stated as a Conclusion of Law that should have been stated as a
finding of fact is incorporated in these Findings of Fact. The Court incorporates herein and
adopts as findings of fact the Corrected Joint Statement of Stipulated Facts filed by the
parties on September 27, 2019. (Corrected Joint Statement Stipulated Facts [hereinafter
“Corr. Stip’d Facts”], ECF No. 233.) Citations to the record herein are not exhaustive and do
not necessarily reflect all evidence upon which corresponding findings of fact are based.
10. Defendants (or “Dissenters”) 4 are former shareholders of RAI who asserted
appraisal rights in connection with the Merger. Dissenters seek appraisal for
9,641,911 shares held on the date of the Merger. (Compl. Judicial Appraisal ¶¶ 3–
25, ECF No. 4; Appendix A.)
11. Dissenters contend that the $59.64 per share they received for their shares
does not reflect the shares’ fair value and instead seek a judgment establishing the
fair value of RAI common stock at $92.17 per share, plus interest, pursuant to
N.C.G.S. 55-13-30(e)(i). (Sadighi Tr. 30:5–8.) Dissenters also seek to recover their
costs and expenses, including their attorneys’ fees.
A. RAI’S Business
12. At the time of the Merger, RAI was a holding company whose wholly-owned
subsidiaries collectively had three major business lines: cigarettes, moist snuff, and
vapor and other “next generation products.” (Corr. Stip’d Facts ¶ 7.) RAI’s
subsidiaries operated predominantly in the United States, with domestic sales
accounting for over 97% of their collective revenue in 2016. (JX0017.0032, .0075,
.0154.) RAI’s wholly-owned subsidiary, R.J. Reynolds Tobacco Company (“RJRT”),
was the second largest tobacco company in the United States. At the time of the
Merger, RAI had a market capitalization of over $67 billion. (PX0115.0181; Gompers
Tr. 777:25–778:10.)
4 Each individual Dissenter, with the number of shares the Dissenter owned and the amount
RAI paid to the Dissenters for the Dissenters’ shares, is set forth in the chart attached hereto
as Appendix A. As shown on the chart, there are three groups of dissenters: the “Magnetar
Defendants,” the “Canyon, Mason, and BlueMountain Defendants,” and the “Barry Blank
Trust.”
13. RAI’s primary product was cigarettes, which it sold through its subsidiaries
RJRT and Santa Fe Natural Tobacco Company, Inc. (“SFNTC”). Cigarettes
accounted for approximately 90% of RAI’s revenue in mid-2017. (JX0017.0005, .0018;
Wajnert 5 Tr. 35:5–7; Fragnito6 Tr. 1670:3–5.) RAI’s primary cigarette brands were
Newport, the best-selling menthol cigarette in the United States; Camel; Pall Mall;
and Natural American Spirit. (Corr. Stip’d Facts ¶ 10; JX0017.0017.) These brands
accounted for approximately 93% of RAI’s cigarette units sold in 2016.
(JX0017.0038–.0041; PX0063.0044–.0045; Fragnito Tr. 1670:3–12.) RAI referred to
these brands as its “drive brands” and provided greater marketing and discounting
support behind them. (JX0017.0038; PX0063.0051–.0052; Gilchrist 7 Tr. 406:7–12.)
14. In addition to cigarettes, RAI sold moist snuff through its operating
company, American Snuff Company, LLC (“American Snuff”), which accounted for
roughly 7% of RAI’s revenue in 2016. (PX0009.0003.) At the time of the Merger,
American Snuff was the second largest smokeless tobacco products manufacturer in
the United States, (DX0321.0008), and its primary brands included Grizzly and
Kodiak, (Corr. Stip’d Facts ¶ 11; JX0017.0032). U.S. moist snuff retail volumes grew
2% to 3% annually from 2011 to 2016. (Flyer Tr. 1113:4–9; DX0321.0008.)
5Thomas Wajnert (“Wajnert”), the former Chair and Chief Executive Officer (“CEO”) of
AT&T Capital Corporation, was Chair of the RAI Board of Directors from 2010 until
December 31, 2016. (Wajnert Tr. 31:17–32:16, 34:11–12; Parties’ Witness Summaries 5.)
6 Joseph Fragnito (“Fragnito”) was President and Chief Commercial Officer of RJRT at the
time of the Merger. (Fragnito Tr. 1666:9–13; Parties’ Witness Summaries 3.)
7 Andrew Gilchrist (“Gilchrist”) was Chief Financial Officer (“CFO”) of RAI at the time of
the Merger. (Gilchrist Tr. 370:20–371:6; Parties’ Witness Summaries 3.)
15. RAI had another operating company, RAI Innovations Company (“RAI
Innovations”), that was responsible for its next generation products, including its
vapor products. RAI’s primary vapor product at the time of the Merger was Vuse.
(Corr. Stip’d Facts ¶ 12.) Prior to the Merger, RAI Innovations’ revenues were never
material enough to warrant separate public reporting. RAI Innovations accounted
for roughly $150 million in revenue in 2016, which was roughly 1.2% of RAI’s total
revenue that year. (Hanigan8 Tr. 1623:11–13, 1648:9–17; DX0061.0007–.0008;
DX0233.0016; JX0017.0069.) As of the Transaction Date, RAI Innovations had not
yet posted a profit on its vaping and other next generation products. (Hanigan Tr.
1651:13–17; Crew 9 Tr. 642:25–643:22; Flyer Tr. 1205:17–21; Fragnito Tr. 1683:21–
25.)
B. The Challenges Facing RAI and the U.S. Tobacco Industry
16. Although the parties agree that the tobacco industry is in decline, the
severity and rapidity of that decline and its impact on RAI’s future growth were hotly
contested issues at trial. Stated broadly, RAI tended to introduce evidence suggesting
that RAI’s future growth is imperiled by real and substantial risks that were not
quantified or measured through its ordinary course financial modeling and are
significant downward determinants in assessing RAI’s fair value. In contrast,
Dissenters tended to introduce evidence suggesting that RAI had enjoyed strong
8Carolyn Hanigan (“Hanigan”) was the President of RAI Innovations at the time of the
Merger. (Hanigan Tr. 1612:3–7; Parties’ Witness Summaries 3.)
9 Debra Crew (“Crew”) was President and Chief Operating Officer of RJRT before she became
RAI’s CEO and joined the RAI Board on January 1, 2017. She served as RAI’s CEO through
the Transaction Date. (Crew Tr. 631:17–22; Parties’ Witness Summaries 2.)
revenue and earnings growth in the years leading up to the Merger, its ordinary
course modeling forecasted continued strong growth for at least the next decade, and
RAI’s concerns over the future risks to its business were exaggerated.
17. Prior to the Merger, RAI had reasons for both optimism and serious concern
about its future. Through acquisitions and divestitures, cost-cutting, and sound
financial management, RAI had weathered the decline of the U.S. tobacco industry
reasonably well, and it had built a portfolio of strong brands. Indeed, RAI’s drive
brands accounted for well over 90% of RAI’s cigarette sales by mid-2017, (Fragnito
Tr. 1670:3–13), and three of those brands—Newport, Camel, and Pall Mall—
experienced volume growth during the ten years prior to the Merger, (Flyer Tr.
1110:4–11).
18. Nevertheless, RAI management and its Board of Directors appropriately
recognized that the Company was subject to certain key negative trends affecting the
U.S. tobacco industry at large. They also understood that the Company was limited
in its ability to grow in the ways it had in the recent past and was exposed to key
risks that, if they came to pass, would cause material harm to RAI’s business and
profitability and substantially limit the Company’s growth or even cause its business
to decline. (Wajnert Tr. 43:17–49:11; Gompers Tr. 730:10–731:5.)
a. Cigarette Volume Declines
19. The U.S. cigarette market at the time of the Merger was “[c]learly an
industry in structural decline.” (Crew Tr. 640:21–641:7; Wajnert Tr. 35:13–36:2;
Fragnito Tr. 1669:14–1697:8.) Overall demand for cigarettes had been declining
steadily at an average of 3% to 4% per year since 1981, and that trend was expected
to continue for the foreseeable future. (de Gennaro 10 Tr. 204:5–25; Wajnert Tr. 35:13–
36:2; Crew Tr. 640:21–641:10; Flyer Tr. 1092:20–1093:6; JX0017.0005.) As a point of
reference, the U.S. cigarette industry sold 624 billion cigarettes (“sticks”) in 1981. In
2016, the number was 258 billion, an amount roughly in line with sales during the
1940s when the U.S. population was less than half its total in July 2017:
(PX0009.0006.)
20. In addition to the total number of cigarettes sold, the number of consumers
and the individual levels of tobacco consumption by each consumer was also in long
term decline as of the Transaction Date. (JX0017.0018; Flyer Tr. 1188:17–1189:17.)
10 Maxence de Gennaro (“de Gennaro”) was a Managing Director at Lazard who provided
financial advice to RAI concerning the Merger as well as in connection with RAI’s purchase
of Lorillard Tobacco Company (“Lorillard”) in 2015. (de Gennaro Tr. 184:13–185:18, 186:21–
187:9; Parties’ Witness Summaries 2.)
The number of new smokers also was steadily decreasing, (Flyer Tr. 1189:8–17),
dropping from 20% of 20-year-olds to 10% over the prior 20-year period, (Flyer Tr.
1189:12–17, 1204:20–1205:13). The age at which smokers reached their peak
smoking consumption was also accelerating. (Flyer Tr. 1188:17–1189:7.)
21. The evidence showed that there are several factors contributing to the
tobacco industry’s decline, many of which are familiar: health concerns; price
increases; restrictions on advertising and promotions; governmental and private
restrictions on the locations where tobacco may be used; increases in federal, state,
and local regulation and excise taxes that have made tobacco more expensive for
consumers; a general decline in the social acceptability of smoking; and a migration
to smoke-free products. (JX0017.0018; de Gennaro Tr. 204:3–25.)
22. RAI was not immune to the industry-wide decline. Testimony from RAI’s
Fragnito confirmed that RAI’s sales volumes have declined at rates approaching the
rates of decline in the industry overall. (Fragnito Tr. 1669:10–1670:2.) Indeed,
Dissenters’ expert Flyer testified that it is possible RAI’s cigarette business will
decline such that by 2026, cigarettes “may be 15, 20 percent of the business[,]” as
opposed to nearly 90% of RAI’s business in 2017. (Flyer Tr. 1207:4–23.)
23. RAI had been able to partially offset declining volumes by growing its
market share for certain of its brands. (Fragnito Tr. 1678:4–9.) Increased market
share, however, does not directly correlate with increased profitability. As Fragnito
put it, gaining market share in cigarettes “essentially just means you’re gaining a
larger slice in a much smaller pie.” (Fragnito Tr. 1678:10–15.) There was no evidence
that RAI’s modest share gains would materially offset annual volume declines of 3%
to 4% in the future. In fact, RAI’s internal documents state otherwise. In materials
prepared for a February 2, 2017 meeting of RAI’s Board of Directors, in which RAI
management described 2016 as a “BIG year” with “Outstanding results[,]” RAI saw
an overall increase of 0.3% in its share of cigarette sales, but nonetheless experienced
a 2% decline in cigarette shipments and expected that “[l]ong term, [RAI would]
resume a 3% - 4% industry decline[.]” (DX0291.0121–.0124.)
b. Limited Sources of Potential Growth
24. Given the substantial declines in sales of cigarettes, which accounted for a
substantial majority of RAI’s profits, RAI historically employed a variety of operating
and non-operating mechanisms in order to meet its goal of annual earnings per share
(“EPS”) growth in the “high single-digit[s.]” 11 (Wajnert Tr. 110:14–18; Gilchrist Tr.
373:20–374:13.) RAI was able to achieve its EPS targets through a combination of
engaging in mergers and acquisitions, aggressively cutting costs, taking advantage
of low interest rates to refinance its debt, repurchasing its own stock, and—most
importantly—raising prices for its products. (Crew Tr. 642:7–24, 644:17–645:15,
646:4–25, 647:16–648:18; Peters 12 Dep. Tr. 93:05–94:01.) The evidence showed,
11 RAI’s EPS growth goal was in response to shareholder demands and expectations.
(Gilchrist Tr. 373:20–374:13 (“Q. And is there a reason that the company tracked EPS as its
primary metric? A. That was what the shareholders were primarily focused on. That’s what
our board had structured, you know, a lot of our goals and objectives around. So that was
our primary focus and that’s where our goals and objectives had been – you know, had been
focused from the board perspective.”).)
12 Mark Peters (“Peters”) was RJRT’s CFO at the time of the Merger. (Peters Dep. Tr. 17:14–
18:7.) Portions of Peters’s deposition were admitted into the trial record. (ECF No. 207.)
however, that, at the time of the Merger, the mechanisms RAI had previously
employed to increase profitability and meet its EPS targets were less likely to be
available in the future.
i. Fewer M&A Opportunities
25. Historically, consolidation had been a way for the tobacco industry to lower
costs and address declining consumer demand. While there had originally been a
group of seven leading U.S. tobacco companies, commonly referred to as the “Big
Seven,” over time consolidation in the industry had shrunk the number of competitors
from the Big Seven to the “Big Three.” (Crew Tr. 646:17–25; Fragnito Tr. 1674:13–
16.) The Big Three included (i) Altria Group, Inc. (“Altria”), the maker, through its
subsidiary Philip Morris USA Inc. (“Philip Morris”), of the leading Marlboro brand
cigarette and the market leader with a nearly 50% share of sales; (ii) RAI, with a
32.3% share of sales; and (iii) Imperial Tobacco Group, PLC (“ITG”), with a 9% share
of sales. Several smaller manufacturers of deep-discount brands competed for market
share against the Big Three. (Corr. Stip’d Facts ¶ 8; JX0017.0005–.0006;
JX0004.0024; PX0063.0047; Fragnito Tr. 1674:9–18.)
26. RAI had played a leading role in this consolidation trend. As Crew testified,
RAI had long served as a “consolidator in the industry[,]” with that history of
consolidation helping Reynolds “stay[ ] in business.” Crew testified that most of the
Big Seven U.S. tobacco companies “are now part of Reynolds American[,]” and
described how RAI had engaged in a series of acquisitions, culminating in the
acquisition of a large competitor, Lorillard, in 2015. (Crew Tr. 646:11–647:6;
JX0014.0001 (“Our 900% +return over the last 10 years ha[s] been largely driven by
deals[.]”).)
27. By the time of the Merger negotiations in October 2016, however, it
appeared that RAI would no longer be able to rely on meaningful future mergers and
acquisitions to overcome the effect of declining cigarette sales volumes and to increase
its profitability and EPS. As RAI’s CFO at that time, Gilchrist testified that
“consolidation had sort of run its course in terms of really material impact
consolidation.” (Gilchrist Tr. 433:13–20.) Wajnert similarly testified that, due to
antitrust concerns, there “were not major revenue [M&A] opportunities at all”
because “the industry had consolidated so much over the years[,]” leaving only three
major competitors. (Wajnert Tr. 40:18–41:2.) In addition, de Gennaro testified that,
after RAI acquired Lorillard, “it was inconceivable that the regulators” would have
allowed further consolidation in the tobacco industry to make it effectively a duopoly.
(de Gennaro Tr. 190:10–21.) In short, “there [were] no big deals remaining.”
(JX0014.0001; Crew Tr. 647:3–15; Flyer Tr. 1156:14–24; Peters Dep. Tr. 93:05–
94:01.) Thus, future consolidation was not a likely strategy for RAI to increase
profitability and EPS.
ii. Reduced Cost-Cutting Opportunities
28. Another important tool RAI had used to increase its profitability had been
cost-cutting. RAI historically had successfully implemented numerous cost-cutting
initiatives to improve productivity and efficiency. (Wajnert Tr. 39:8–23; Crew Tr.
642:16–19.) By the time of the Merger, however, RAI’s ability to further cut costs as
a standalone company had been nearly exhausted, particularly as synergies13 had
gotten “thin.” (Crew Tr. 648:19–649:5; Peters Dep. Tr. 93:05–94:01.) For example,
RAI identified $800 million in synergies attributable to the acquisition of Lorillard in
2015, but by July 2016, the vast majority of those synergies had been achieved. (Crew
Tr. 649:5–649:15; Wajnert Tr. 52:15–17; Gilchrist Tr. 490:1–10 (“I believe the
majority had been captured and we were just – the last piece of synergies had to do
with machinery and the move from the old Lorillard facility to Winston-Salem.”).)
iii. Debt Refinancing Completed
29. RAI also employed non-operating financial strategies affecting its finances
“below the line” to meet EPS targets, including liabilities management. (Crew Tr.
647:16–25.) Given RAI’s extensive mergers and acquisitions activity, RAI often had
substantial levels of debt. Accordingly, in 2016, one of the financial steps RAI took
to help meet its EPS goals was to capitalize on historically low interest rates to
refinance much of its debt. But this was a one-time event. Because there were few
opportunities for further debt refinancing, that once-effective strategy no longer
13 Synergies are gains that a buyer expects to achieve through the combination of its existing
business and the acquired one. See, e.g., Adam Barone, Synergy, Investopedia (March 10,
2020), https://www.investopedia.com/terms/s/synergy.asp (“Synergy is the concept that the
combined value and performance of two companies will be greater than the sum of the
separate individual parts.”); Synergy, Merriam-Webster’s Online Dictionary,
https://www.merriam-webster.com/dictionary/synergy (defining “synergy” as “a mutually
advantageous conjunction or compatibility of distinct business participants or elements
(such as resources or efforts)”).
presented RAI a significant path to increase its profitability moving forward. (Crew
Tr. 648:9–18; Price 14 Tr. 1044:20–25.)
iv. Limited Share Buyback Opportunities
30. RAI also sought to increase its EPS by repurchasing shares of its stock on
the open market in share buybacks. (Crew Tr. 647:16–25; Price Tr. 1022:16–22 (“So
the share repurchases are something that we had been doing for a number of years.
Something that the analysts liked seeing. And it was an efficient way to utilize the
cash when we didn’t have other uses for it.”).) Although RAI’s Board of Directors
approved a $2 billion share repurchase program in June 2016 due to certain unique
circumstances relating to RAI’s 1998 Master Settlement Agreement (the “MSA”)
payment obligations in 2017, (Gilchrist Tr. 412:4–413:11; Wajnert Tr. 146:2–5), as
with debt refinancing, share buybacks were not a viable, long-term solution to
overcome declining annual cigarette sales volumes to maintain or increase profits,
(Gilchrist Tr. 413:12–14).
v. Constrained Net Price Realization
31. Through the date of the Merger, the primary driver of profit growth for RAI
and its competitors in the U.S. tobacco industry had been the ability to increase
cigarette pricing above the rate of volume decline over many years due in no small
part to the largely inelastic demand for cigarettes resulting from nicotine addiction.
(JX0004.0006, .0028; Flyer Tr. 1095:17–21, 1096:12–21; Crew Tr. 642:7–15; de
14 Ronald Price (“Price”) was Vice President of Business Development of RJRT at the time of
the Merger. (Price Tr. 940:12–941:7; Parties’ Witness Summaries 5.)
Gennaro Tr. 204:3–16; Cameron 15 Dep. Tr. 25:08–16; Wajnert Tr. 37:18–38:4.) RAI
referred to this pricing power as “net price realization.” (DX0003.0094.) As Fragnito
explained, “[I]f volume is declining at 3 percent, we would have [to] price above the 3
percent in order to drive profit.” (Fragnito Tr. 1672:5–11.)
32. RAI recognized that its reliance on net price realization would increase as
volumes continued to decline and thus that achieving sufficient net price realization
was “a critical imperative” to meet its EPS goals. (Fragnito Tr. 1726:3–17;
PX0063.0044; JX0004.0006.) RAI anticipated that its future growth “would continue
through increased pricing on cigarettes as the volumes declined[,]” but RAI also
believed that the assumption that RAI could continue to raise prices indefinitely was
“tenuous at best[,]” (Wajnert Tr. 41:14–19), because “you get to a point where the
volume declines were so substantial that you would end up having to raise prices to
30, 40, $50 a pack of cigarettes, which obviously wouldn’t make sense[,]” (Wajnert Tr.
39:2–7). RAI’s Financial Advisors and RAI management, including Cameron, shared
these views, recognizing that pricing strategies cannot offset volume decline “[i]n
perpetuity” because to assume such would require “selling the last cigarette for 20
billion” dollars. (Cameron Dep. Tr. 93:13–25; de Gennaro Tr. 204:10–25; Crew Tr.
644:17–645:15; Fragnito Tr. 1672:20–1673:5; Gompers Tr. 746:11–17.)
15 Susan Cameron (“Cameron”) was RAI’s CEO from 2005 to 2010 and again from May 1,
2014 until December 31, 2016. She became the Chairman of the RAI Board on January 1,
2017 and held that position at the time of the Merger. (Cameron Dep. Tr. 10:18–11:8;
Fragnito Tr. 1669:5–9; Parties’ Witness Summaries 1.) Portions of Cameron’s deposition
were admitted into the trial record. (ECF No. 201.)
33. Additionally, Altria’s de facto control over pricing dynamics in the cigarette
industry was a significant source of uncertainty impacting RAI’s ability to continue
to increase prices to offset volume declines. For the two decades prior to the Merger,
cigarette pricing was led by Altria, which would raise prices for cigarettes twice per
year, amounting to about a 5% to 6% total price increase annually. The rest of the
U.S. tobacco industry, including RAI, tended to follow Altria’s pricing. (JX0004.0008–
.0013; PX0063.0100, .0107; Wajnert Tr. 37:1–8; Fragnito Tr. 1673:21–25.) Altria’s
subsidiary Philip Morris and its pricing practices are “the number one reason the
industry can or cannot take pricing.” (Jennette 16 Dep. Tr. 87:08–88:25.)
34. RAI could not raise its prices before Altria because “Altria had a substantial
market leverage, had much more volume. They had more control over the
marketplace.” (Wajnert Tr. 38:7–12.) For this reason, RAI believed that if Altria did
not raise prices, RAI could not profitably raise prices either, without accelerating
switching or “downtrading” from its consumers, (Crew Tr. 644:17–645:15; Fragnito
Tr. 1675:19–1676:21; PX0063.0107; JX0009.0001), which occurs “when a consumer
will choose a lower priced offering versus their usual brand that they would buy[,]”
(Fragnito Tr. 1680:5–22). In particular, RAI feared losing volume to Altria’s already
popular Marlboro cigarettes, “which would be a preferred brand” if priced lower.
(Wajnert Tr. 38:17–23.)
16 Winton Jennette (“Jennette”) was RJRT’s Senior Vice President of Strategy and Planning
at the time of the Merger. (Jennette Dep. Tr. 12:21–24; Parties’ Witness Summaries 4.)
Portions of Jennette’s deposition were admitted into the trial record. (ECF No. 205.)
35. RAI’s perception of the pricing environment is grounded in historical fact.
In 1993, Altria’s predecessor decided to dramatically drop the price of Marlboro
cigarettes on what is referred to in the industry as “Marlboro Friday.” As a result of
Marlboro Friday, “pricing in the U.S. came down significantly[.]” (Flyer Tr. 1090:8–
14; Peters Dep. Tr. 92:8–17 (“Marlboro Friday . . . reduced industry profits
dramatically.”).)
36. Further, Altria was a diversified company with sizeable interests in sectors
besides tobacco, including beer, wine, and cigars, among others. RAI was less
diversified and more reliant on cigarette pricing than Altria to grow its earnings.
(JX0004.0008–.0013; PX0063.0044, .0048–.0049; Fragnito Tr. 1677:1–17.) In 2016,
in connection with the merger of beer companies AB InBev and SABMiller, of which
Altria owned over 25%, Altria received a large cash payment and a roughly 10%
equity stake in the newly-formed company. There was significant concern within RAI
that Altria would have less pressure to raise cigarette prices as it had done in the
past because of the additional financial flexibility brought by the SABMiller deal.
(PX0063.0044, .0048–.0049, .0107; JX0004.0008–.0009; JX0009; Fragnito Tr.
1673:17–1674:8, 1677:18–1678:3 (“So [Altria has] other revenue and profit streams
that we don’t have at Reynolds that could potentially alleviate – if one of those other
profit streams did exceptionally well, it would reduce their need to drive a significant
amount of profit on their combustibles business via pricing.”).) As Wajnert explained,
If Altria had more alternatives to deliver earnings growth to their share
owners that wasn’t dependent on raising prices for their cigarette
portfolio, that would be a threat to Reynolds. Because if Altria didn’t
raise prices, Reynolds would not raise prices. In which case, the
reduction in cigarette volumes would have a significant impact on
Reynolds.
(Wajnert Tr. 44:25–45:6.)
37. RAI also perceived a risk that Altria and Philip Morris International, an
international tobacco company with no presence in the United States, would re-
combine and become a stronger, even more diversified company, again reducing
Altria’s need to raise prices and putting RAI’s ability to compete with the combined
company at risk. (JX0014.0001; Cameron Dep. Tr. 25:8–26:9; Wajnert Tr. 83:15–84:6
(“[T]hey had been together previously and had been separated – put those two
companies back together, the economic power and the brand power would be
tremendous. And, in fact, they were working together in terms of innovation products
as well, which was very threatening to Reynolds.”).)
38. RAI also had reason to believe that it would face increased pricing pressure
from deep-discount cigarette brand manufacturers. As pricing by the Big Three
continued to increase, these smaller manufacturers could become more competitive
by maintaining pricing levels, or increasing them only slightly, and creating greater
relative discounts to the brands of the Big Three. (Fragnito Tr. 1678:16–1679:15.) In
other words, the more the Big Three raised prices, the more attractive the deep-
discount brands would become to consumers and the more those brands could raise
their prices and increase their profits while still remaining lower-priced alternatives.
(Fragnito Tr. 1679:16–1680:4.)
39. RAI was particularly vulnerable to this threat due to its product mix. RAI’s
sales were concentrated in premium and super-premium brands, which accounted for
approximately 73% of RAI’s cigarette volume in 2016. (JX0017.0018; Flyer Tr.
1113:13–17.) This concentration made RAI more susceptible to downtrading: “as
consumers look for less expensive alternatives [to RAI products], there’s less products
within our portfolio that would meet that need from a price perspective. So they
ultimately move to products outside of our portfolio.” (Fragnito Tr. 1680:5–22;
JX0017.0018 (“RAI’s subsidiaries are more susceptible to consumer price
sensitivities[.]”).) In addition, smokers in the 50+ age category, who are the heaviest
smokers and account for approximately 50% of RAI’s revenue, are more sensitive to
increases in cigarette prices and are more likely to downtrade in the face of increasing
prices. 17 (Fragnito Tr. 1682:13–1683:8.)
40. Despite these serious long-term risks, RAI anticipated that, in the near term
(and barring a change in behavior by Altria or increased excise taxation), it would be
able to increase cigarette prices at historical levels and continue to profit. (Fragnito
Tr. 1672:2–1673:16.) Over time, however, RAI’s ability to maintain growth through
increased pricing would become more and more doubtful. (Fragnito Tr. 1672:20–
1673:3 (“[T]here would ultimately be a time where . . . the price of cigarettes would
have to be at a point where it would just accelerate the rate of decline.”).)
vi. Uncertain Growth and Profitability of Next Generation
Products
41. RAI expressed hope that its “next generation products,” including vapor
products, could someday be potentially “transformative” for RAI’s business and
17 This risk was somewhat mitigated by Newport’s appeal to younger smokers. (Flyer Tr.
1115:19–25.)
present “big opportunit[ies]” that could provide a possible avenue for overcoming
declining cigarette sales. (Crew Tr. 642:20–24; Hanigan Tr. 1613:14–17.) The
evidence shows, however, that RAI’s vapor products were not profitable at the time
of the Merger. (Flyer Tr. 1205:17–21; Wajnert Tr. 36:3–25; Crew Tr. 642:25–643:22;
Hanigan Tr. 1651:13–17.)
42. Indeed, despite RAI’s high hopes, it was unclear whether and when RAI’s
vapor products would achieve profitability or the degree to which those products
would impact RAI’s future revenues and profits. Prior to the Merger, RAI did not
“have a path to profitability based on a specific milestone” for its vapor products.
(Fragnito Tr. 1704:20–1705:2.) Vapor had not been profitable because
the cost of goods associated with an electronic cigarette are
exponentially higher than a combustible cigarette as you would imagine.
The electronics, the batteries, the fact that they’re manufactured in
China. And we don’t have the scale – the category is still relatively small
in the world of total tobacco. So without the econom[ies of] scale to offset
those higher costs. And because we’re still trying to educate, inform and
gain trial on consumers, there’s not a lot of pricing power in the
industry. . . . So relatively low price despite the high cost of goods, on
top of the significant amount of investment required from an R&D[ a]nd
then advertising and marketing perspective makes it difficult to make
money in that.
(Fragnito Tr. 1687:17–1688:7.)
43. Another challenge facing RAI in the vapor market was that, unlike
cigarettes, the vapor market was highly fragmented and rapidly evolving, with more
than a thousand competitors marketing their products through different “channels,”
including through convenience stores and gas stations (the “C-gas” channel, in which
RAI competed) and through vape shops and e-commerce (in which RAI did not
compete). (Hanigan Tr. 1639:8–1640:21; Fragnito Tr. 1684:18–1685:21.)
44. As of July 19, 2017, approximately 950,000 vapor products had been
registered with the FDA (including 900,000 e-liquids). (JX0019.0011.) RAI’s leading
vapor brand, Vuse, was sold only through the C-gas channel, in which RAI was able
to use its cigarette relationships to optimize shelf space and placement. While Vuse
was the industry leader in the C-gas channel with approximately 30% share of sales,
Vuse’s overall market share in all channels was estimated to be closer to 5%.
(PX0009.0025; Hanigan Tr. 1618:14–19, 1643:24–1644:13.)
45. Sales of vapor products impacted RAI’s profitability in other ways. Certain
consumers switched from cigarettes to vapor, resulting in greater sales of
unprofitable vapor products at the expense of profitable sales of cigarettes. (Crew Tr.
643:23–644:16; Fragnito Tr. 1688:8–1689:21.) Similarly, RAI found that in 2015,
42.7% of adult tobacco users under age 35 consisted of “poly-users”—consumers who
used vapor products in addition to other tobacco products. RAI’s profitability
decreased as vapor sales to those customers replaced cigarette sales. (PX0009.0004;
Fragnito Tr. 1688:8–1689:21.)
46. RAI’s efforts prior to the Merger to address its unprofitable vapor business
through mergers and acquisitions also failed. RAI Innovations considered acquiring
minority positions in three small vapor companies (Vape Forward, Cosmic Fog and
Five Pawns) but elected not to pursue transactions with any of them because none
passed RAI Innovations’ product integrity tests. In any event, none of these
companies had revenues that would have materially affected the profitability of RAI
Innovations’ vapor business. (Hanigan Tr. 1637:20–1639:1, 1650:16–1651:7.)
47. In addition to these hurdles, RAI identified “major obstacles to the consumer
adoption of vapor[,]” including, among other things, the “uncertainty and potential
difficulty of the vapor innovation approval pathway” and “a tough legislative and
regulatory environment.” (PX0063.0057.)
48. At the federal level, the U.S. Food and Drug Administration (“FDA”)
possesses broad authority under the 2009 Family Smoking Prevention and Tobacco
Control Act (the “Tobacco Control Act”), 21 U.S.C. § 387 et seq., over the manufacture,
sale, marketing, and packaging of tobacco products. In May 2016, the FDA issued a
regulation expanding the purview of the Tobacco Control Act to include vapor
products. Prior to this announcement, there had been no federal regulation, and very
little state or local regulation, of the vapor industry. Afterwards, vapor product
manufacturers were required to seek approval for existing vapor products on the
market by submitting Premarket Tobacco Product Applications (“PMTAs”). FDA
approval of a PMTA was also required before a manufacturer could lawfully release
a new tobacco product. (JX0017.0011; Hanigan Tr. 1620:9–17; Crew Tr. 642:25–
643:22; DX0230.0005.)
49. While RAI was better-positioned to comply with the FDA’s regulations than
some of its vapor competitors, RAI was not able to capitalize on that advantage
because the FDA delayed the deadline by which manufacturers were required to
submit a PMTA, allowing RAI’s competitors to sell vapor products in the market
longer without FDA approval. (Hanigan Tr. 1639:8–1640:9.) From 2009 until the
Transaction Date, the FDA authorized the introduction onto the market of only eight
new tobacco products, all of which were noncombustible cigarettes. (Flyer Tr. 1087:4–
1088:6.)
c. Substantial Regulatory, Taxation, and Litigation Risk
50. In addition to industry-wide cigarette volume declines and limited
opportunities for growth, extensive evidence was introduced showing that RAI faced
a number of other serious risks that had the potential to undermine the Company’s
future profitability or, depending on their nature and magnitude, have devastating
effects on RAI’s future business prospects. (Gompers Tr. 730:10–731:5; Gilchrist
387:25–391:9.)
i. Regulatory Risk
51. At the time of the Merger, the tobacco industry was highly regulated;
tobacco products were subject to a variety of federal, state, and local laws and
regulations, and regulation had an extensive impact on how the industry operated. 18
(JX0017.0011.) The evidence shows that the existing and future regulation of tobacco
products had the potential to substantially affect RAI’s ability to increase future
profits.
52. At the federal level, the Tobacco Control Act was a concern for the tobacco
industry. As Wajnert explained,
[H]aving the Tobacco Control Act put in place with the FDA having
supervision created perceived risks and I think have manifested
themselves in that the FDA has been working to reduce the harm within
18 At the same time, extensive regulation, including restrictions on marketing, distribution,
points of sales, and taxation, made it very difficult, expensive, and time-consuming to bring
new products from other countries into the United States, if at all. (Flyer Tr. 1086:6–1086:17,
1089:1–25.)
cigarettes, which could include changing formulations, could include
attractiveness of the product, and it could include banning certain
flavors, for example, as in menthol. All those were uncertain at the time
and I think still uncertain.
(Wajnert Tr. 46:7–20.)
53. In addition to federal regulations, many state, local, and municipal
governments and agencies had adopted laws or regulations restricting or prohibiting
the public use of tobacco products, including but not limited to age and location
restrictions, and bans or restrictions on the sale or use of e-cigarettes and other
tobacco products, including menthol cigarettes. (JX0017.0011; Crew Tr. 691:23–
692:9; Fragnito Tr. 1692:7–21, 1694:9–1695:6.) Indeed, regulation and legislation at
the local level were “becom[ing] the new frontier of tobacco control” and such efforts
were viewed by RAI as a significant threat, as there were “close to 700 pieces of anti-
tobacco legislation at the local level” that had the potential to impact RAI’s and the
industry’s growth prospects. 19 (Fragnito Tr. 1692:4–21.)
54. The parties presented conflicting evidence concerning the likelihood of
future regulation and its effects on RAI’s business. Much of this evidence related to
regulation of menthol cigarettes.
55. Menthol regulation was a primary concern for RAI because of the extent to
which RAI relied on menthol products for its revenue and profit, particularly in
comparison to other tobacco companies. At the time of the Merger, 60% of RJRT’s
19 Flyer testified that the purpose of much of this legislation was to reduce “second-hand
smoke essentially. And the health effects of . . . [e]nvironmental smoke levels . . . . So that’s
really my understanding is the impetus for – behind most of these laws in public places, you
don’t want to expose nonsmokers to smoke.” (Flyer Tr. 1183:6–16.)
revenue, and 50% of RAI’s overall revenue, was attributable to sales of menthol
cigarettes. RAI’s Newport brand was the number one menthol cigarette on the
market and was RAI’s best-selling product. (JX0017.0016; Fragnito Tr. 1670:17–
1671:5, 1671:20–1672:1; Flyer Tr. 1212:16–19.)
56. The RAI Board attributed “growing . . . importance” to sales of menthol
cigarettes to RAI’s adult smokers under 35 because RAI was realizing market share
growth to that demographic group, which implied that as “this segment aged, there
would be continued usage of the [menthol] product” due to nicotine addiction and
brand loyalty. (Wajnert Tr. 55:18–56:4; PX0009.0008.) As a result, heightened
regulation of menthol, such as a federal ban on sales of menthol cigarettes, was
viewed as “disastrous” and “devastating” for RAI, (Wajnert Tr. 119:21–120:5;
Fragnito Tr. 1690:14–20), and presented a credible, significant threat to RAI’s ability
to maintain or increase its profitability into the future.
57. Evidence was introduced that the FDA viewed a ban on menthol as a
potentially viable regulatory strategy. In 2013, the FDA announced its intention to
review the possible increased regulation of menthol cigarettes, including a potential
ban on menthol-flavored products. This announcement acted as an “overhang on the
[C]ompany and in the industry.” (Fragnito Tr. 1671:20–1672:1; JX0017.0016.) Crew
explained that after the FDA’s 2013 review of menthol, RAI believed that the FDA
had never stopped looking at it, despite the fact they couldn’t find any
increased toxicity or disease caused by menthol cigarettes, it was very
clear that the government was still intending to do something about
menthol. We weren’t sure what they were going to do, whether it was
just reduce the amount of menthol allowed or they could go all the way
to a ban. We weren’t sure exactly whether – but they – we knew they
felt like they could do that. So we were very concerned about that. It
was one of our largest profit contributors to the business.
(Crew Tr. 662:5–16.) That the FDA had, prior to the Merger, expressly considered
increasing regulation of menthol demonstrates that RAI’s fears of future regulation
were well-founded.
58. Flyer did not believe a federal menthol ban would have a meaningful impact
on the value of RAI. The Court finds this testimony unpersuasive. Flyer testified
that a menthol ban would simply push smokers to non-menthol products, but his own
research indicated that when adult smokers switched from Newport to another
brand, those smokers were much more likely to switch to Marlboro or another non-
RAI brand, thus reducing RAI revenues. (Flyer Tr. 1081:13–1082:20, 1215:1–1216:2
(“It makes sense it would be Marlboro because Marlboro’s four times the size or
maybe five times the size of Camel. So it would have to almost certainly be Marlboro
as being the closest substitute.”).)
59. Dissenters also offered statements by RAI reflecting RAI’s expectation that
it would be able to successfully manage regulatory risks associated with menthol.
(DX0009.0007 (“With new FDA chief, see potential for some easing of the more
onerous regulations.”); Price Tr. 1049:6–19.) The Court is again unpersuaded. While
RAI no doubt had plans to address any future menthol regulation and seek to mitigate
its impact, the record is clear that at the time of the Merger the threat of future
menthol regulation was a significant risk to RAI’s future profit growth and therefore
its fair value.
60. The Tobacco Control Act also established onerous requirements for a
manufacturer to launch a new tobacco product or modify an existing product, which
are known as “product standards” regulations. (JX0017.0016; JX0009.0001–.0002;
Flyer Tr. 1087:4–1088:6.) These regulations imposed restrictions on the composition
and use of RAI’s products and had the ability to significantly affect RAI’s revenues
and cash flows. (JX0017.0014–0017; Wajnert Tr. 119:21–120:5.)
61. Pursuant to FDA product standards regulations, manufacturers of tobacco
products introduced between February 15, 2007 and March 22, 2011 were required
to file a “substantial equivalence report” with the FDA’s Center for Tobacco Products
(the “CTP”). In the report, the manufacturer had to demonstrate that the new
product was “substantially equivalent” to a product already on the market. A product
subject to such a report is referred to as a “provisional product” because it was subject
to the CTP’s approval. If the CTP determined that a product was not “substantially
equivalent” to a product already in the market, the FDA could force the removal of
the provisional product from the market. (JX0017.0016.)
62. In September 2015, the CTP issued orders determining that four RAI
products, including RJRT’s Camel White and Camel Crush Bold brands, were not
substantially equivalent to a product already in the market. The CTP ordered RAI
to “stop all distribution, importation, sale, marketing and promotion” of those
products. (JX0017.0016; DX0069.0013; DX0291.0112; DX0392.0083.) Nearly all of
RAI’s products on the market as of the Transaction Date were provisional products
that were subject to a future FDA determination that could require RAI to remove
the product from the market. (JX0017.0014–.0017.)
63. In addition to product standards regulations on cigarettes, RAI’s moist snuff
business faced potentially catastrophic regulation. Prior to the Merger, the FDA
proposed regulations limiting the amount of a particular compound—
N-nitrosonornicotine, commonly known as “NNN”—that was found in RAI’s moist
snuff products. If such a regulation were put into effect, it could “basically ban” RAI’s
entire moist snuff portfolio. (Crew Tr. 663:16–664:7; JX0016.0004.)
64. Product standards regulations were not the only threat to RAI’s business
imposed by the FDA. In 2015, SFNTC received a “warning letter” from the FDA
concerning SFNTC’s use of descriptors including “natural” and “additive free” to
describe its Natural American Spirit cigarettes. (Crew Tr. 662:15–25.) The FDA
letter was cited in over a dozen private lawsuits that pose a threat to the future
growth and profits of RAI’s fastest-growing brand. (Crew Tr. 658:18–20.)
65. The FDA also publicly announced that it was considering requiring a
decrease in nicotine levels in cigarettes to a fraction of current levels. (Flyer Tr.
1199:16–1200:1.) As Fragnito testified, “the goal of the FDA with [lowering nicotine
levels] is essentially to terminate the existence of the industry” so that “ultimately
smoking would go away.” (Fragnito Tr. 1691:3–11.)
66. Restrictions on sales of flavored tobacco products generally, beyond menthol,
also represented a significant regulatory headwind for RAI. (DX0009.0007.) At the
time of the Merger, the FDA was actively considering proposals to limit the sale of
flavored vapor products. (Fragnito Tr. 1690:11–13, 1691:18–1692:3.) Certain
jurisdictions, including San Francisco and Beverly Hills, had already banned flavored
products altogether. (DX0009.0007; Fragnito Tr. 1692:13–16, 1695:3–6.)
67. Numerous state and local governments had also passed legislation and
ordinances limiting the places in which tobacco may be used. For example, smoking
had been prohibited on government property in Charlotte, and all forms of tobacco
use had been prohibited in public parks in Mecklenburg County. The express purpose
of these regulations is to “deglamorize and denormalize tobacco use helping it become
less acceptable.” (Flyer Tr. 1181:14–1183:21.)
ii. Taxation Risk
68. In addition to risks associated with heightened regulation, RAI faced the
prospect of significant excise tax increases. Cigarettes and other tobacco products
are subject to substantial taxation at the federal, state, and local levels. On average,
45–50% of the price of a pack of cigarettes is related to excise taxes. (JX0017.0019;
Fragnito Tr. 1695:7–1696:22.) Taxing authorities have increasingly imposed higher
excise taxes on tobacco products. As Price explained, “[A]s the governments become
more and more in need of money, tobacco is a very easy target for them to increase
taxes, whether it be at the state level or the federal level.” (Price Tr. 976:12–977:5.)
69. These increases in taxation posed significant risks to RAI’s business. While
an increase in the federal excise tax was viewed as the “most impactful” because it
would be applied on a national basis, (Gilchrist Tr. 384:12–17), state excise taxes also
significantly affected RAI’s profitability. RAI projected it would face an annual five-
cent-per-pack increase in net state excise taxes, an increase that, standing alone,
would cause RAI to lose sales of 300 million sticks and about $30 million in profit
every year. Fragnito explained that “at any given time of the 50 states, there were
usually a dozen or so proposals to increase” state excise taxes. RAI expected these
trends to continue, with each state proposing to increase its excise tax every two to
four years. (Fragnito Tr. 1700:10–1701:8, 1770:25–1772:5; JX0009.0001;
JX0010.0004; JX0017.0019.)
70. Increased excise taxes have resulted in declines in overall sales volume and
shifts by consumers to less expensive brands. Additional increases are likely to result
in future sales declines or downtrading to less expensive brands or both. Increased
taxes have also reduced RAI’s ability to increase pricing in areas with steep increases
in excise taxes. (JX0017.0019; Fragnito Tr. 1695:7–14; JX0009.0001.) As Wajnert
explained,
[W]hether federal or state excise taxes, if those were raised, that would
be passed through to the consumer which would raise the prices of
cigarettes which would have the effect of potentially reducing volumes,
because those pricing – the taxes are passed through.
(Wajnert Tr. 45:7–15.)
71. For example, in April 2017, California raised its excise taxes by $2 per pack,
which had an immediate effect on demand. Fragnito explained that the increase
essentially amounted to a 35 percent increase in prices. California’s
about 6 percent of industry volume. So it’s one of the largest states from
a volume perspective. And so that increase resulted in volumes
declining in the range of 25 to 30 percent in California . . . [, which] drove
an additional 80 basis points. So .8 of a percentage point decline in the
industry.
(Fragnito Tr. 1696:9–22.) At the time, RAI was also concerned that the California
excise tax increase would lead to a “snowball effect” and encourage other West Coast
states to increase their excise taxes to match California’s taxes. (Gilchrist Tr. 387:25–
388:15; JX0010.0006.)
iii. Litigation Risk
72. The potential for increased litigation and settlement costs posed another
meaningful risk to RAI’s future profitability. Already accounting for a large portion
of the tobacco industry’s costs, any increase in litigation and settlement costs would
have the potential to substantially affect RAI’s ability to increase profits.
(JX0017.0011, .0014–.0018.)
73. The risks associated with litigation had the potential to adversely affect
RAI’s growth potential. In the years leading up to the Merger, RAI had more than
50 active cases going to trial each year. There were thousands of active cases in
Florida alone against RAI and other tobacco manufacturers. (Crew Tr. 658:6–17;
Gilchrist Tr. 389:8–23.) Continued litigation arising out of the sale, distribution,
manufacture, development, advertising, marketing, and health effects of cigarettes
and other tobacco products was expected for the foreseeable future. (JX0017.0014–
.0018, .0096–.0138; PX0009.0002; Crew Tr. 658:6–17; Wajnert Tr. 46:21–47:2, 54:23–
55:3.)
74. In addition to litigation costs, the Big Three manufacturers all have
perpetual, multi-billion dollar annual payment obligations under the MSA, which
resulted from health-related lawsuits brought against tobacco companies by the
attorneys general of 46 states. (JX0017.0001, .0017–.0018; Gilchrist Tr. 390:1–12.)
Fragnito estimated the MSA payment at approximately $0.72 per pack. (Fragnito
Tr. 1702:13–1703:2, 1703:17–1704:14.) Because RAI’s annual MSA payment is
indexed to inflation, RAI’s payment obligations increase as inflation rises. The effect
of inflation has “a dramatic impact on [RAI’s] cost of goods sold[,]” and any increase
in inflation would increase the likelihood of an associated decrease in RAI’s
profitability. (Price Tr. 984:19–985:9; Gilchrist Tr. 389:24–390:12; JX0009.0001.)
C. RAI’s Transaction History
75. Prior to the Merger, RAI was involved in several significant corporate
transactions, several of which had features relevant to its competitive positioning and
relationship with BAT in the time leading up to the Merger.
a. Brown & Williamson Transaction
76. On July 30, 2004, R.J. Reynolds Tobacco Holdings, Inc. (“RJR”) and Brown
& Williamson Tobacco Corporation (“B&W”) completed a series of transactions that
resulted in the combination of RJR and the U.S. assets, liabilities, and operations of
B&W (the “B&W Transaction”). (Corr. Stip’d Facts ¶ 1; JX0017.0003, .0074;
JX0023.0042; Wajnert Tr. 60:5–9; Price Tr. 939:7–9.) As part of the B&W
Transaction, RAI was incorporated as a new publicly traded holding company to hold
the now combined businesses. (Corr. Stip’d Facts ¶ 2; JX0017.0003, .0074.)
77. Immediately prior to the B&W Transaction, RJR was publicly traded, and
B&W was an indirect wholly-owned subsidiary of BAT. (Corr. Stip’d Facts ¶ 3;
JX0017.0003, .0074.) As a result of the B&W Transaction, BAT owned approximately
42% of the stock of RAI. The remaining RAI shares were held by the former
stockholders of RJR and publicly traded on the NYSE. (JX0017.0003, .0155;
JX0023.0042; Wajnert Tr. 60:13–21.)
b. Lorillard Transaction
78. In June 2015, RAI acquired Lorillard, a competing tobacco company, for
consideration valued at $25.8 billion (the “Lorillard Transaction”). (Corr. Stip’d Facts
¶ 6.) Lorillard had been the third-largest cigarette company in the United States and
at the time its largest brand was Newport, which RAI acquired as part of the Lorillard
Transaction. (JX0017.0004, .0016.) To achieve antitrust approval for the Lorillard
Transaction, RAI divested certain cigarette and vapor products to ITG. 20 (Wajnert
Tr. 40:18–41:13; de Gennaro Tr. 243:19–23.)
c. RAI and BAT Governance Agreement
79. Contemporaneously with the B&W Transaction in 2004, RAI and BAT
negotiated a set of contractual restrictions designed, among other things, to maintain
RAI’s independence and strictly limit the influence BAT and its subsidiaries could
exert over RAI. This set of restrictions was known as the “Governance Agreement.”
(Corr. Stip’d Facts ¶ 5; JX0020; JX0023.0065; Wajnert Tr. 61:9–15; de Gennaro Tr.
185:23–186:20.) The Governance Agreement was put in place because the RJR Board
of Directors “did not want BAT to control the [RAI] business in any meaningful
way[.]” (Wajnert Tr. 61:2–8.) Nevertheless, RAI disclosed to investors that “BAT’s
20 The divested cigarette brands included Winston, Salem, Kool, and Maverick, four of RAI’s
weaker “tail brands.” (Flyer Tr. 1114:6–19.)
significant beneficial equity interest in RAI could be determinative in matters
submitted to a vote by RAI’s other shareholders, resulting in RAI taking actions that
RAI’s other shareholders do not support.” (DX0321.0024.)
80. Under the Governance Agreement, BAT had the ability to designate for
nomination five of RAI’s thirteen directors, 21 three of whom were required to be
independent of both RAI and BAT under applicable NYSE listing standards.
(JX0020.0006, at § 2.01(c)(ii); Wajnert Tr. 62:3–8.) For the remaining eight Board
seats, the Governance Agreement required BAT to vote its shares as directed by the
Board’s Corporate Governance and Nominating Committee. As a result, and as an
example, BAT would not have been allowed to vote Thomas Wajnert, an independent
director, off the Board. (JX0020.0006, at § 2.01(c)(iii); Wajnert Tr. 62:9–16.) BAT
thus contracted away its ability to direct its vote for those eight Board seats, thereby
foregoing any right to vote for or otherwise influence the composition of a clear
majority of the RAI Board. (JX0020.0006, at § 2.01(c)(iii).)
81. The five BAT-appointed directors had access to confidential, nonpublic
information shared at regular RAI Board meetings by virtue of their membership on
the RAI Board. (Wajnert Tr. 50:8–19, 146:15–149:15; Gompers Tr. 844:22–845:2;
Gilchrist Tr. 395:14–23, 405:2–19, 408:22–25; DX0024.)
82. Under the Governance Agreement, any material contract or transaction
between BAT and RAI required the approval of a majority of the seven independent
21 After the Lorillard Transaction in 2015, the Board of Directors was temporarily increased
to fourteen directors. BAT was still limited to nominating only five of those fourteen
directors. (JX0023.0065; DX0393.0045.)
directors not designated by BAT (known as the “Other Directors”). The Other
Directors did not depend on BAT’s support for their election. 22 (JX0020.0010, at
§ 2.07; Wajnert Tr. 62:17–24, 63:2–10.)
83. Under the Governance Agreement, BAT agreed not to increase its ownership
in RAI for ten years after the close of the B&W Transaction in July 2004. This
standstill provision expired as scheduled in July 2014. (JX0020.0020–.0021, at
§ 4.01; Wajnert Tr. 66:2–8.)
84. The protections under the Governance Agreement persisted even if BAT
became a majority shareholder of RAI. This device ensured that BAT could not
circumvent (or threaten to circumvent) these contractual restrictions by buying more
stock. Only if BAT acquired 100% of RAI’s stock would the Governance Agreement’s
protections fall away. (JX0020.0026, at § 6.11(a); Wajnert Tr. 63:11–17.)
85. BAT negotiated certain veto and contractual approval rights over certain
RAI corporate transactions. For example, subject to certain exceptions, approval of
the BAT-appointed directors was required for RAI to issue securities comprising 5%
or more of RAI’s voting power or to repurchase RAI’s common stock. (JX0020.0022,
at § 5.01(ii).) BAT’s approval as a shareholder was also required for the following
RAI activity: (i) the implementation of takeover defense measures, (ii) any
transaction that would “impose material limitations on the legal rights of” BAT or its
22The thirteenth director, who was neither a BAT designee nor an independent Other
Director, was RAI’s CEO. The fourteenth director, added after the Lorillard Transaction,
was the former CEO of Lorillard, who was also not an independent Other Director.
(DX0393.0045.)
subsidiaries, and (iii) the sale of intellectual property relating to international tobacco
brands that may be able to compete with BAT. (JX0020.0010, at § 2.04(b).)
86. BAT also held contractual protections that ensured its 42% ownership stake
would not be diluted. In November 2011, RAI and BAT agreed to amend the
Governance Agreement, whereby RAI would not be allowed to repurchase its shares
if the repurchase was implemented in such a way “that the number of outstanding
shares of RAI common stock would not increase, and the beneficial ownership interest
of BAT and its subsidiaries in RAI would not decrease.” (DX0323.0061.) BAT took
great effort to ensure its high ownership stake. For example, concurrently with the
completion of RAI’s acquisition of Lorillard, BAT invested approximately $5 billion in
order to maintain its approximate 42% beneficial ownership in RAI common stock.
(de Gennaro Tr. 192:13–18.)
87. Considering all of the facts, the Supreme Court of North Carolina concluded
that “[i]n several ways, the Governance Agreement placed ‘contractual handcuffs’ on
BAT that prevented it from controlling the Reynolds board.” Corwin v. British Am.
Tobacco PLC, 371 N.C. 605, 619, 821 S.E.2d 729, 739 (2018), reh’g denied, 822 S.E.2d
648 (N.C. 2019). As the Supreme Court explained, “the fact of BAT’s contractual
rights did not, on its own, give BAT the kind of coercive power over the Reynolds
board that could allow BAT to exercise actual control.” Id. at 620, 821 S.E.2d at 740.
“At best, the allegations that some terms in the transaction agreement were favorable
to BAT show only that BAT[ had] . . . the ability to secure some favorable terms from
the board. Those allegations do not show that BAT exercised control over the board—
that is, to make it take action.” Id. at 624, 821 S.E.2d at 742. Thus, BAT was not a
controlling shareholder of RAI, and notwithstanding BAT’s substantial holdings in
the Company, RAI had the freedom to make decisions independently from BAT.
(JX0023.0080; Wajnert Tr. 63:18–64:18.)
d. RAI Related Person Policy
88. RAI also instituted a related person transaction approval policy (the
“Related Person Policy”) to foster transparency and proper governance which
required various levels of review before RAI could enter into any transaction with
BAT. (PX0002.0001; Gilchrist Tr. 428:7–10.) In addition to the Governance
Agreement’s prohibition on material transactions between RAI and BAT without
approval of the Other Directors, the Related Person Policy established more granular
restrictions: any transaction between RAI and BAT involving an amount that would
be: (i) less than $1 million required the prior approval of RAI’s CEO, CFO or General
Counsel, (ii) equal to or greater than $1 million and less than $20 million required
the prior approval of RAI’s Audit Committee, and (iii) greater than $20 million
required the prior approval of the Other Directors. (PX0002.0003.) To implement
the Related Person Policy, RAI created a Related Party Transaction Committee,
which met monthly to review and approve all interactions between RAI and BAT in
the regular course of business. (Gilchrist Tr. 426:15–24.)
e. RAI’s Independence from BAT in Practice
89. RAI’s ability to act independently of BAT, and even in a manner contrary to
BAT’s wishes, was demonstrated in practice. Between July 2004 and the
consummation of the Merger in July 2017, RAI and BAT engaged in negotiations over
potential agreements on a variety of matters, some of which were protracted and
contentious, some of which did not result in agreement, and one of which led to
arbitration between the two companies. (Gilchrist Tr. 431:10–18; Crew Tr. 634:24–
635:20.)
90. As further evidence of RAI’s independence, in the fall of 2015, RAI invited
BAT to submit a bid to acquire the international rights to RAI’s Natural American
Spirit brand. (Wajnert Tr. 91:21–92:14; Constantino 23 Tr. 1812:7–20.) RAI wanted
to improve its balance sheet after the Lorillard Transaction by de-levering and
reducing its overall debt level through this sale. (Constantino Tr. 1804:12–18:06:18;
Gilchrist Tr. 412:16–413:11.) After BAT expressed its preference that RAI not sell
those international rights, BAT submitted an offer. BAT’s competitor, Japan
Tobacco, Inc. (“Japan Tobacco”) also submitted an offer and won the bid. Although
BAT preferred that the international rights not be sold at all, and expressed that
preference to RAI’s management, RAI proceeded with the sale to Japan Tobacco for
$5 billion in January 2016. (Wajnert Tr. 64:4–18, 65:9–16, 91:4–92:14.)
91. RAI and BAT engaged in other arm’s-length transactions in the years
preceding the Merger. In December 2015, after protracted negotiations with BAT,
the Other Directors ultimately approved a “vapor collaboration agreement” regarding
23 Daniela Constantino (“Constantino”) was a Partner and a Senior Member of the research
team of Mason Capital Management (“Mason Capital”), one of the Dissenters, at the time of
the Merger. (Constantino Tr. 1787:25–1788:6, 1789:17–1790:10; Parties’ Witness Summaries
1.)
certain next-generation technologies. (JX0023.0066; Hanigan Tr. 1617:10–12.) In
May 2016, a few months before the Merger negotiations began in October, RAI and
BAT negotiated a termination of the parties’ contract manufacturing agreement,
which was approved by the Other Directors. (Crew Tr. 634:24–635:20.) There is no
evidence that these interactions were not fairly negotiated.
D. Preparing for a Potential BAT Bid
92. Leading up to and after the expiration of the standstill provision in the
Governance Agreement in July 2014, RAI management met periodically with various
investment banks to discuss industry trends, RAI’s relationship with BAT, and
potential transactions involving RAI, including a potential transaction with BAT.
(Gilchrist Tr. 562:20–563:6, 568:21–569:11, 569:19–570:19, 572:8–25.)
93. Contrary to Dissenters’ suggestions, there was nothing sinister nor
nefarious concerning these meetings. Lazard had been advising RAI regarding its
relationship with BAT dating back to 2011. (de Gennaro Tr. 185:11–186:20.)
De Gennaro described his meetings with Gilchrist and others within RAI, including
Cameron, then the CEO of RAI, as a “banking exercise” and “banker positioning[,]”
and explained that “the nature of our business is that we try and stay involved with
our clients or potential clients constantly.” (de Gennaro Tr. 246:7–21.) In addition
to advising RAI on a potential offer from BAT, Lazard’s meetings with RAI during
these pre-Merger years addressed other topics, including the effects that a potential
transaction between BAT and ITG would have on RAI. (de Gennaro Tr. 244:4–23.)
Lazard’s evaluation of a potential offer from BAT was part of the “comprehensive
analysis” Lazard sought to offer its client. (de Gennaro Tr. 247:5–20.)
94. Goldman also periodically met with RAI management to discuss financial
industry trends, RAI’s business, and other topics. Around the time of the expiration
of the standstill in 2014, Goldman and RAI began discussing BAT’s ownership stake
and the potential for a future transaction, the terms an offer by BAT to purchase the
outstanding shares in RAI might include, and steps RAI could take to prepare for
such a potential offer. (Eckler 24 Dep. Tr. 14:8–15:16.)
95. JPMorgan met with RAI “on an ongoing basis in the ordinary course
coverage of the client” in the time leading up to the Merger. (Clark 25 Tr. 1462:14–
1463:4.) In August and September 2016, Gilchrist and Cameron met with
representatives from JPMorgan and discussed issues related to potential
transactions involving RAI and BAT, including premiums paid in transactions with
large shareholders, potential financing concerns for BAT in a transaction with RAI,
a potential mix of the offer between equity and cash, and the effects of Brexit on the
shareholder bases of RAI and BAT. (DX0063.0005; Clark Tr. 1462:14–1463:9,
1463:13–1469:18.)
96. There is no evidence anyone at RAI acted to further his or her own personal
interest ahead of the Company’s in the time period prior to the Merger and, in
particular, in RAI’s pre-Merger meetings with Lazard, Goldman, and JPMorgan.
24 Zachary Eckler (“Eckler”) was a Vice President (and later Managing Director) at Goldman
who advised the Transaction Committee concerning the Merger. (Price Tr. 1056:3–5; Eckler
Dep. Tr. 19:05–20:01; Parties’ Witness Summaries 2.) Portions of Eckler’s deposition were
admitted into the trial record. (ECF No. 199.)
25 John Clark (“Clark”) was a Managing Director at JPMorgan who advised RAI’s Board
regarding the Merger. (Clark Tr. 1425:6–21; Parties’ Witness Summaries 1.)
97. While Dissenters have tried to suggest that Gilchrist took actions to ensure
he would receive his “golden parachute” compensation, 26 (Gilchrist Tr. 555:6–556:18),
there is no evidentiary basis from which to draw such a conclusion. Gilchrist’s
compensation arose from his pre-existing employment contract and consisted of a
standard severance package of two years’ salary and bonus, vesting of restricted stock
options that he already owned, and a payout of his pension. (JX0023.0146, .0153;
Gilchrist Tr. 553:16–554:7.) None of his golden parachute compensation arose
specifically from the Merger; he would have received his compensation regardless of
the reason for his termination (other than firing for cause). (JX0023.0146, .0153;
Gilchrist Tr. 573:1–574:3.) In fact, he did not receive over 25% of his golden parachute
compensation because the conditions for its payment were not triggered. (Gilchrist
Tr. 555:25–556:4.)
98. Dissenters also suggest that Gilchrist sought the investment bankers’
perspectives on the amount BAT might be willing to pay in an acquisition of RAI to
manipulate a potential future valuation of RAI to a value within BAT’s perceived
price range. (DX0063.0013; de Gennaro Tr. 244:13–245:25; Gilchrist Tr. 580:18–
581:8, 585:22–586:4; Clark Tr. 1466:15–1469:9.) No credible evidence, however, was
offered to support this claim.
26 Dissenters appear to have backed away from this contention in their post-trial briefing,
asserting that the reason management did not provide the ten-year projections on which the
2016 “Strategy Day” presentation (explained in depth below) was based is “irrelevant.”
(Defs.’ Responsive Post-Trial Br. 12, ECF No. 231.) The Court addresses the contention
nonetheless.
99. As an initial matter, more people would have been needed to manipulate the
valuation, including Cameron, who received no personal benefit from the Merger,
(Cameron Dep. Tr. 223:11–18 (“I didn’t qualify for a penny, nothing. I was out,
December 31.”)), and Crew, who came to RAI with the goal of becoming CEO, (Crew
Tr. 634:9–23, 669:20–671:2 (“I literally had just been named sort of CEO elect and
then this unsolicited offer came in. So, you know, it’s just personally disappointing
. . . that I wasn’t going to get a chance to . . . lead the company . . . as an independent
entity.”)). There is no evidence either participated in this alleged scheme.
100. Moreover, the evidence shows that RAI management (including, but not
limited to, Gilchrist) made responsible efforts to understand the contours of a
potential offer from BAT in order to better understand the negotiating dynamics that
might accompany a potential transaction with BAT and to compare it to other
strategic alternatives available to the Company. (DX0063.0007–.0010; de Gennaro
Tr. 246:22–247:4; Clark Tr. 1468:8–1469:5; Gilchrist Tr. 580:22–581:8.)
101. Given BAT’s 42% ownership stake in RAI and BAT’s public representations
that it periodically considered the possibility of making an offer for RAI, RAI’s
separate pre-Merger meetings with Lazard, Goldman, and JPMorgan were a prudent
step taken by RAI management to be better prepared for a potential offer from BAT
and to be better positioned to advocate for a higher price if such an offer materialized.
Rather than evidence a conspiracy to facilitate acceptance of an artificially low price,
these meetings between the Financial Advisors and a variety of individuals from RAI
reflect prudent scenario planning on the part of RAI’s management and routine
business development efforts on the part of these investment banks.
E. The Merger
102. As set forth in more detail below, the deal price in this case was reached
through months of arm’s-length negotiations between sophisticated parties. On RAI’s
side, the deal was negotiated by a fully independent and well-informed transaction
committee, which showed a willingness to walk away from a deal entirely and
continue operating as an independent company if a fair price could not be obtained.
Three highly respected financial advisors separately concluded that the deal price
was fair to RAI’s shareholders. RAI’s non-BAT shareholders voted overwhelmingly
in favor of the Merger. For these and the other reasons set forth herein, the Court
finds that the deal price is entitled to substantial, if not determinative, weight in
determining the fair value of Dissenters’ shares of RAI.
a. BAT’s October 20, 2016 Offer
103. After the market closed on October 20, 2016, BAT made an unsolicited offer
to acquire the remaining shares of RAI that it did not already own through a letter
sent to Wajnert, as Chair of the RAI Board, and Cameron, as RAI’s CEO. BAT’s offer
letter proposed to purchase all of the outstanding shares of RAI for a mix of stock and
cash equal to $56.50 per share of RAI common stock (the “October 20 Offer”), a 19.8%
premium over the $47.17 closing price of RAI common stock that day (the “Unaffected
Stock Price”). (Corr. Stip’d Facts ¶¶ 13–14; JX0021.0002; JX0023.0068;
PX0115.0254, .0531, .0578; DX0095.0008; Cameron Dep. Tr. 20:9–21:25; Wajnert Tr.
65:17–22.)
104. The October 20 Offer exceeded RAI’s six-month average stock price prior to
BAT’s initial offer, which was $48.97, and its all-time high price of $54.48 per share
on July 5, 2016. (PX0115.0290, .0390.) The October 20 Offer implied a total equity
value for RAI of $80.56 billion. (PX0115.0128; JX0021.0002; JX0023.0068.)
105. Consistent with BAT’s obligations under U.S. securities laws, BAT publicly
announced its proposal the next day before the markets opened. In its
announcement, BAT stated that it expected to achieve approximately $400 million in
synergies from the transaction. (JX0021.0007; JX0023.0068.)
106. BAT’s letter acknowledged, consistent with the Governance Agreement,
that a proposed transaction between BAT and RAI would require the approval of a
majority of the Other Directors, BAT would not pursue the transaction without such
approval, and BAT expected that a merger would require the approval by a majority
of the votes cast by the non-BAT shareholders. (JX0021.0002; JX0023.0069.)
107. The RAI Board understood BAT’s representations to mean that BAT would
approach this transaction as a “friendly transaction” and that BAT “didn’t want to be
threatening in any way.” (Wajnert Tr. 68:8–69:17.) The Board found these
representations significant because, freed from a hostile takeover threat by BAT, the
Board would be able to “control the transaction” and ensure that whatever decision
it made about the October 20 Offer was fair to the other shareholders. (Wajnert Tr.
68:21–22.) Importantly, the requirement that the transaction be approved by the
non-BAT shareholders gave “the power to accept or reject the transaction” to the
non-BAT shareholders. (Wajnert Tr. 68:8–69:17.)
108. The October 20 Offer also stated that “BAT is interested only in acquiring
the shares of [RAI] not already owned by BAT[,] and . . . BAT has no interest in selling
any of the [RAI] shares it owns, nor would BAT support any alternative sale, merger
or similar transaction involving [RAI].” (JX0021.0003.) The Board did not consider
BAT’s representation to limit the Board “in terms of thinking through what the
alternatives might be for” the non-BAT shareholders; Wajnert explained that “at the
end of the day, anything would be negotiable. So while BAT was expressing an
interest in not participating in a transaction with someone else, the realities of the
world, people change their minds.” (Wajnert Tr. 69:18–70:19; Nowell 27 Dep.
Tr. 57:01–59:21 (“Q[.] . . . Did the board believe that [BAT’s statement] foreclosed the
possibility of selling to another third party? A[.] No.”).) Nevertheless, RAI disclosed
to investors that “BAT’s significant beneficial ownership interest in RAI[ ] and RAI’s
classified board of directors and other anti-takeover defenses could deter acquisition
proposals and make it difficult for a third party to acquire control of RAI without the
cooperation of BAT.” 28 (DX0317.0026.)
27 Lionel Nowell (“Nowell”) became Lead Director of RAI’s Board and Chair of the Transaction
Committee on January 1, 2017 and served in that capacity at the time of the Merger. (Nowell
Dep. Tr. 13:17–23; Crew Tr. 638:22–639:2; Parties’ Witness Summaries 4.) Portions of
Nowell’s deposition were admitted into the trial record. (ECF No. 202.)
28 For example, Goldman noted in its fairness opinion presentation that if “[BAT] is not
supportive [of a third-party sale of RAI], a merger requires approximately 88% approval from
all other shareholders.” (DX0277.0011.)
109. Contemporaneous research analyst commentary on the October 20 Offer
generally viewed the proposed transaction as a positive for RAI shareholders.
(PX0115.0129, .0289, .0459; Gompers Tr. 802:25–803:8; Zmijewski Tr. 1380:17–
1381:2.) In fact, some analysts perceived BAT to be overpaying or at least purchasing
at a time when RAI was trading at a relatively high multiple to its earnings.
(PDX0005.0025; Yilmaz Tr. 2004:16–19; PX0115.0623.)
b. Recusal and Formation of Transaction Committee
110. Between October 24, 2016 and October 28, 2016, the RAI Board and the RAI
Other Directors met multiple times and interviewed potential legal and financial
advisors. On October 24, 2016, Jerome Abelman and Ricardo Oberlander, the two
BAT employees on the RAI Board, voluntarily recused themselves from any RAI
board meetings at which any proposed transaction involving BAT or any potential
alternative strategic transaction would be discussed or considered. They also did not
participate in any discussion or consideration of a potential transaction with the BAT
Board or any BAT employees. (PX0031.0001, .0003; PX0033.0001; JX0023.0069;
Wajnert Tr. 76:3–6.)
111. On October 28, 2016, the RAI Board created a transaction committee
comprised solely of the Other Directors to consider and evaluate the proposed
transaction and any other strategic alternatives (the “Transaction Committee”).
(JX0007.0002–.0005; PX0033.0003–.0005; JX0023.0069–.0070.) RAI’s Board had
fourteen directors at that time, seven of whom were Other Directors. The seven Other
Directors were:
a. John A. Boehner, retired Speaker of the United States House of
Representatives;
b. Luc Jobin, President and CEO of Canadian National Railway Company;
c. Holly Keller Koeppel, former Managing Partner and Co-Head of Corsair
Infrastructure Management, L.P.;
d. Nana Mensah, Chairman and CEO of ‘XPORTS Inc.;
e. Lionel Nowell, retired Senior Vice President and Treasurer of PepsiCo;
f. Thomas Wajnert, former Chairman and CEO of AT&T Capital Corporation;
g. John Zillmer, retired President, CEO and Executive Chairman of Univar.
(JX0023.0069.)
112. Wajnert was selected to serve as the Chair of the Transaction Committee.
The remaining directors on the RAI Board in October 2016, none of whom served on
the Transaction Committee, were Cameron (CEO of RAI), Murray Kessler (former
CEO of Lorillard), and the five designees BAT added to the Board under the
Governance Agreement, two of whom were BAT executives. (JX0007.0001, .0003;
Wajnert Tr. 72:21–73:3, 146:6–14.)
113. The members of the Transaction Committee were fully independent of BAT
and able to consider the proposed transaction (and any alternatives) free of any
conflicts, focused only on the best interests of the RAI shareholders other than BAT.
(Wajnert Tr. 63:5–10, 72:21–73:3.) The Transaction Committee was “sophisticated”
and included a number of current and former CEOs, including “[a] lot of people with
financial backgrounds” and experience with mergers and acquisitions. All members,
except Speaker Boehner, had participated in the complex Lorillard Transaction. (de
Gennaro Tr. 214:9–215:14.)
114. The RAI Board delegated to the Transaction Committee the power and
authority to, among other things, evaluate, discuss and negotiate the terms and
conditions of, approve, recommend, and/or reject the October 20 Offer, any other
potential transaction with BAT, and any potential alternative strategic transaction.
The “Transaction Committee was empowered to analyze, accept, reject, full power to
make recommendations to the board, and then eventually to the shareowners. But it
had full power to move forward, one way or the other.” (Wajnert Tr. 71:21–25;
JX0007.0003–.0004; JX0023.0069–.0070.) The RAI Board resolved that if the
Transaction Committee rejected the October 20 Offer or any other offer, that rejection
would be final and binding on behalf of the full Board. (JX0007.0003–.0004;
JX0023.0069–.0070; Wajnert Tr. 74:8–24 (“[W]e had the final authority to accept or
reject and to move forward with another transaction.”).)
c. Retention of Financial Advisors
115. After interviewing several investment banks, the Transaction Committee
appointed Goldman as its financial advisor based on its reputation and experience
with large complex transactions, the tobacco industry, and with RAI and its business.
Another reason the Transaction Committee selected Goldman was because Goldman
had not been hired or compensated by BAT to provide any M&A financial advisory
services in the prior two years and had no other material relationships with BAT that
may have been expected to create a conflict of interest for Goldman. (Corr. Stip’d
Facts ¶ 16; JX0023.0070; PX0038.0005–.0006; Wajnert Tr. 74:25–75:8; Eckler Dep.
Tr. 15:17–16:20, 18:11–19:03.)
116. On October 25, 2016, the Other Directors hired Weil, Gotshal & Manges LLP
(“Weil”) and Moore & Van Allen as legal counsel. Both were fully independent of both
RAI and BAT. (Corr. Stip’d Facts ¶ 16; PX0035.0001–.0003; JX0023.0069; Wajnert
Tr. 71:13–20, 73:11–23.)
117. Jones Day served as legal counsel to the Board and RAI in connection with
the review of the October 20 Offer and any subsequent developments. The Board and
RAI also hired both Lazard and JPMorgan as their financial advisors. (Corr. Stip’d
Facts ¶ 16; JX0023.0070; de Gennaro Tr. 215:24–216:2; Gilchrist Tr. 437:5–10; Clark
Tr. 1561:13–1562:1.)
118. The Financial Advisors were highly sophisticated and respected investment
banks with extensive experience advising large companies in corporate transactions,
including in the tobacco sector. (DX0151.0015; DX0065.0008; de Gennaro Tr. 210:6–
19, 211:13–212:1; Clark Tr. 1427:10–25; Eckler Dep. Tr. 14:8–15:11.) The format of
the Financial Advisors’ compensation—each was to receive a percentage of any
completed deal (a “success fee”)—was typical in the industry and aligned the
Financial Advisors’ incentives with the Company’s to get the highest price. (Wajnert
Tr. 75:13–76:2, 77:8–12; de Gennaro Tr. 217:15–219:3, 257:22–258:8.) Investment
bankers understand that they may not receive a fee for their work on a proposed
transaction if the parties do not agree to a completed deal. (Clark Tr. 1428:23–1429:1;
de Gennaro Tr. 256:19–21.)
119. Although the Dissenters suggest that the Financial Advisors’ contingent fee
arrangements incentivized them to encourage the Transaction Committee and RAI
to agree to the Merger at a depressed price to ensure their compensation, there is no
credible evidence that any of the Financial Advisors took any action in connection
with the Merger to cause a transaction with BAT at less than fair value. To the
contrary, there was credible testimony that the Financial Advisors’ long-term
reputations were more important to each of them than the compensation to be earned
on the Merger and that attempting to depress the merger price would tarnish that
reputation. 29 (de Gennaro Tr. 257:2–18; Nowell Dep. Tr. 127:21–128:7.)
d. Information Provided to Financial Advisors
120. In the days following BAT’s initial offer, Gilchrist and Price spoke with
members of the teams at Goldman, Lazard, and JPMorgan about clearing any
conflicts of interest and determining what materials the Financial Advisors wanted
to review if they were selected as a financial advisor for the Merger. Gilchrist and
Price prepared the materials within days, allowing the Financial Advisors the ability
to get up to speed quickly. (JX0008.0001; DX0039.0001; DX0041.0001; Gilchrist Tr.
441:4–442:13; Price Tr. 945:19–946:11, 1051:19–1052:2.) The Financial Advisors
likewise prepared to receive the information they expected from RAI management so
that they would be able to run their analyses as quickly as possible if they were hired.
(de Gennaro Tr. 273:12–274:3, 283:14–285:6.)
29 The Financial Advisors eventually received deal fees of $46.3 million (Goldman), $41.1
million (JPMorgan), and $11.1 million (Lazard), nearly all of which was contingent upon the
completion of the Merger. (JX0023.0101, .0116, .0130.)
121. The parties’ dispute over RAI’s valuation in this action turns, in significant
part, on the reliability of the information RAI provided to the Financial Advisors to
inform their valuation analyses and whether RAI should have provided additional
information in the form of internal, nonpublic, ten-year financial projections that
underlaid RAI management’s presentation to the Board at RAI’s Strategy Day in July
2016 showing projections of 7% to 8% compound annual growth over the next ten
years. Dissenters contend that these ten-year projections, and, in particular, years
six through ten of those projections, were reliable and accurate, and when used in a
discounted cash flow (“DCF”) analysis to generate an adjusted blended terminal
growth rate, result in a far higher valuation for RAI than the deal price. (Defs.’
Opening Post-Trial Br. 31–43, ECF No. 221.) RAI argues that the out years of the
Company’s ten-year projections were never used or intended to value the Company
and are largely extrapolations of existing trends such that they are entirely unsuited
and unreliable for purposes of calculating RAI’s fair value. (RAI’s Post-Trial Br. 74–
77, ECF No. 219.)
i. RAI’s Financial Projections
122. RAI managed its business with a focus on attempting to provide regular
returns to its shareholders in the form of growing EPS by a stated target of growth
in the high-single digits. (Gilchrist Tr. 373:20–374:13; Wajnert Tr. 110:14–18.) EPS
was the single most important metric for the RAI Board in measuring RAI’s
performance. Management therefore focused its decision making and financial
presentations on maintaining target growth in RAI’s EPS year over year. (Gilchrist
Tr. 373:20–374:13 (“That was what the shareholders were primarily focused on.
That’s what our board had structured, you know, a lot of our goals and objectives
around.”).)
123. RAI maintained a financial projection process as part of its ordinary
operation of the business, which was designed to measure how well RAI was
performing relative to its annual EPS target. (Gilchrist Tr. 374:14–375:1.)
124. Before Gilchrist became CFO of RAI, he oversaw a project to overhaul RAI’s
forecasting process from what was once disjointed and focused on the short-term into
a more rigorous and disciplined process. (Gilchrist Tr. 452:22–455:6.) As part of this
overhaul process, RAI started taking a “forward-looking” perspective to the forecasts,
providing longer forecasts in the range of five to ten years, as opposed to focusing on
only one year, and began to update the forecasts every month as opposed to only four
times a year. (Gilchrist Tr. 454:22–455:15.)
125. The goal of the forecasting process was to stimulate more discussion and
transparency among business units so they would have a more cohesive view as to
what was happening at RAI as a whole. (Gilchrist Tr. 457:2–458:12.) To that end,
everyone involved in forecasting was working off one forecast for the entire company.
Gilchrist testified that “what we wanted to do was make sure that everybody – we
didn’t have people saying your forecast is wrong, our forecast is right. We had one
forecast, and everybody was working off the same forecast.” RAI developed a motto
for the forecasts: “one version of the truth.” (Gilchrist Tr. 458:20–459:11.)
126. As Gilchrist explained, RAI’s projections were “assumption-based,” in that
they incorporated
assumptions based on competitive activity, based on market dynamics.
It would be assumptions based on litigation, regulation, taxation. You
know, a lot of those things are unknown so we would obviously have to
make assumptions. And the way . . . we structured that was basically
to outline what those assumptions were so there was complete
transparency on the assumptions. Obviously, you know, everybody was
aware of what those assumptions would be and the – as those
assumptions changed, you would expect to see changes flow through the
[forecast].
(Gilchrist Tr. 378:6–18.)
127. The evidence shows that RAI’s financial projection process was not designed
to take into account the large looming risks to the industry, such as new or tightened
regulations, increased or new excise taxes, large litigation judgments or settlements,
or competitive changes like an alteration in Altria’s pricing behavior, because these
risks were difficult both to predict and to quantify and were largely beyond RAI’s
control. (Wajnert Tr. 58:2–59:9, 111:5–10, 119:5–120:5; Gilchrist Tr. 385:10–17,
391:4–9, 394:24–395:9.) As Jennette testified, “a company is not going to go forward
to [its] Board of Directors and say, [‘]Hey, you know, the industry is coming apart and
we don’t have any answers.[’] ” (Jennette Dep. Tr. 31:23–32:1; Holland 30 Dep. Tr.
40:5–25.)
30 Steven Holland (“Holland”) was Senior Director of Capital Markets of RAI Services Co., a
wholly-owned subsidiary of RAI, where he worked in the treasury group providing
information to financial advisors at the time of the Merger. (Gilchrist Tr. 598:3–16; DX0115;
Parties’ Witness Summaries 4.) Portions of Holland’s deposition were admitted into the trial
record. (ECF No. 206.)
128. Accordingly, RAI management and the Board discussed the existence of the
risks as downside sensitivities to the forecasts, which expressly assumed that the
risks would not occur during the projection period. (JX0009.0001–.0002;
PX0047.0002; JX0010.0006; PX0052.0004, .0006; Gilchrist Tr. 380:21–391:09.) If any
of those risks did occur, RAI would have to change its projections and, more
importantly, its business practices, in response to them. (JX0010.0006; JX0023.0134;
PX0052.0004, .0006; Wajnert Tr. 49:12–50:7; Gilchrist Tr. 378:22–379:15, 382:09–
391:09, 462:1–8; Fragnito Tr. 1774:3–11; Price Tr. 963:25–964:1.) As one example,
Gilchrist explained that while the imposition of onerous state excise taxes was a
large, looming risk to RAI’s business, RAI incorporated into its financial forecasts a
California ballot measure to raise its state excise tax in November 2016 only when it
passed and its effective date determined. (Gilchrist Tr. 462:18–463:12.)
129. In short, RAI’s projections “were intended to be the best estimate [of] the
future performance based on the assumptions that [the Company] had[,]” (Gilchrist
Tr. 377:23–378:5), but a proper consideration of those assumptions and sensitivities
was critical in determining whether the projections could be reasonably relied upon
for a particular purpose or use. Importantly, assumptions that “were unknown either
in timing, impact or scale, or implementation . . . [were] outlined as risks and
sensitivities” but not included in RAI’s management’s forecasts. (Gilchrist Tr.
378:22–379:15.)
ii. The Latest Estimates
130. In the ordinary course of business, RAI developed financial projections every
month except January. RAI’s financial planning process began with management’s
forecast of industry-wide volumes and pricing for the forecast period. (Gilchrist Tr.
457:12–23.) These volume and pricing forecasts were the “foundation” of RAI’s
financial projections, and were based on publicly-available, historical pricing, market
share and volume information, as well as publicly available information about
Altria’s financial results and stated EPS targets. (Gilchrist Tr. 529:12–25.) Once the
volume and pricing forecasts were developed, division finance leaders would add
projections for their specific businesses. From these, a single RAI forecast, called a
“Latest Estimate” or “LE,” was developed. (Gilchrist Tr. 376:19–377:12; Price Tr.
941:15–20.)
131. In the Latest Estimates from February through May every year, RAI
projected the current year plus two additional years, providing quarterly projections
for each of those years. (Gilchrist Tr. 375:2–24; DX0015, at tab “Consol Fcst.”) This
length of time was chosen because RAI’s Board and management were focused on
that short time horizon and because it was the most likely period of time to be
accurate due to the assumptions included in the projections. (Gilchrist Tr. 376:4–18;
Jennette Dep. Tr. 32:1–5.)
132. As Nowell testified,
[RAI] is a business . . . trying to get through the next six months, the
next quarter would have been, in some cases, long term because it’s a
declining industry based off of pricing and that. So getting out beyond
five years, . . . at that point in time, wasn’t value added because there
were too many variables that were outside of our control.
(Nowell Dep. Tr. 26:1–9.)
iii. The Operating Plan
133. Once per year, typically in October, RAI management created an “Operating
Plan” for the Board’s approval, which set out the Company’s financial targets and
budget for the upcoming year. Management based the financial portion of the
Operating Plan on the October LE, which contained five years of projections.
(JX0012.0017–.0019; JX0016.0005–.0007; Wajnert Tr. 41:25–42:13; Gilchrist Tr.
391:10–392:2.) The Operating Plan itself, as presented to the Board, contained high-
level financial projections for only the following two years, including “industry,
company and brand volume and market share; adjusted operating income; adjusted
operating margins and adjusted EPS growth.” (JX0012.0018; PX0063.0042; Gilchrist
Tr. 391:10–392:2.)
134. As Gilchrist explained, management used the additional years of financial
projections
to make sure that we had an understanding of the dynamics of the
business, to make sure that the strategies actually were working and
really for an opportunity to make sure that we had visibility on some of
the key milestones and/or gaps in the business so that we can identify
three years out[.]
(Gilchrist Tr. 392:10–15.) In contrast, the Board had no need for these additional
years of projections for purposes of evaluating and approving the Operating Plan,
which the Board used as a budget tool and to set financial performance and
marketplace objectives only for the upcoming year. (Gilchrist Tr. 392:7–394:23
(noting that projection years three through five were generally used “as a check to
make sure things are still on track”).)
135. The final Operating Plan prepared prior to the Merger was for 2017. On
several occasions, RAI management identified the key assumptions underlying the
2017 Operating Plan. At the September 2016 Board meeting, RAI management
presented those assumptions to the Board in preparation for the full plan review at
the next Board meeting. (DX0025.0011–.0012.) The key assumptions underlying the
2017 Operating Plan projections also were included in the Operating Plan executive
summary. (PX0063.0045–.0046.) Gilchrist discussed these same assumptions and
sensitivities at the December 1, 2016 Board meeting, which had been outlined in
PowerPoint slides shared with the Board prior to the meeting:
(PX0063.0100);
(PX0063.0106–.0107; see also JX0012.0018.)
iv. The Strategic Plan and Strategy Day
136. Once per year, typically in July, RAI held a Strategy Day Board meeting,
when
the board would gather with management to do – have deep thoughts
and think about where the company was going over the next five to ten
years, and discuss what the issues were that were obvious to everybody
at that particular point and what opportunities might be there as well.
(Wajnert Tr. 50:11–19.)
137. Nowell described Strategy Day in similar terms, as a time when
management would present
an overview of the company and how we thought we were going to
operate, say, going over the next two, three years. That would be then
overlaid with an R&D discussion about new products, new generation
products, other products we had in the pipeline, when we thought they
would be introduced. We would talk about the regulatory environment
in terms of what’s happening in DC in view of that political
environment, how that might impact us, what was going on in the
overall economy, and how that might impact us. And then rolling all
that together, kind of have a closer view on . . . all that being considered
along with . . . a lot of risk and other things that went through it, what
does that look like for us going forward.
(Nowell Dep. Tr. 24:19–26:09.)
138. In preparation for each year’s Strategy Day, members of RAI’s finance team
developed the June LE, which contained projections for the current year plus nine
years, providing quarterly projections for the current year and the next two years and
more generalized annual projections for the remaining years. (DX0140, at tab
“Consol Fcst.”) RAI management typically created a “Strategic Plan” for the Board’s
review at Strategy Day, the financial portion of which was based on the June LE.
(DX0011; Martin31 Dep. Tr. 34:21–37:08, 156:19–157:21). In preparing the June LE,
the finance team applied a “broad brush approach[,]” used a “much higher”
materiality threshold for forecasting years three through ten, and emphasized
“identifying significant gaps in achieving the desired earnings[.]” (DX0023.0002.)
RAI management used years six through ten of the June LE only in planning
manufacturing capacity and funding for capital expenditures. (Wajnert Tr. 116:21–
118:11; JX0004.0031).
139. Wajnert explained the purpose of the financial information presented at
Strategy Day as follows:
the discussion related to the future state of the tobacco industry and, of
course, Reynolds American. So you would have a discussion about three
years, five years, what could happen, discussing various scenarios. We
31 Stephen Thad Martin (“Martin”) was the Senior Director of Financial Planning of RAI
Services at the time of the Merger. (Gilchrist Tr. 465:19–21; Parties’ Witness Summaries 4.)
Portions of Martin’s deposition were admitted into the trial record. (ECF No. 204.)
wouldn’t be looking at approving financial projections for a long period
of time. That was not the purpose. The purpose was to frame the
conversation.
(Wajnert Tr. 57:7–15.)
140. RAI possessed “no material insight” about brand strength, trends or growth
in the industry in years six through ten that was not also available to individuals
outside the Company who were knowledgeable about the tobacco industry.
(DX0023.0002; Gilchrist Tr. 405:2–406:6, 528:24–530:6, 620:8–11 (“Q. And did RAI
have superior information over others in the tobacco industry to look at and analyze
that historical information and pull it forward? A. No. It was public information.”).)
RAI management and the Board considered the forecasts for years three through five
to be of ever-decreasing reliability and years six through ten to be extrapolations
intended to provide information about whether a continuation of existing trends
would allow the Company to meet its EPS targets. (Gilchrist Tr. 375:2–24, 404:9–
405:1, 501:9–16; Price Tr. 1017:13–20.)
141. Gilchrist testified that “the very foundational elements of the forecast,
industry volume, market share, pricing . . . were generally extrapolations” in years
six through ten. (Gilchrist Tr. 626:20–627:1.) The contemporaneous evidence
supports Gilchrist’s explanation of RAI’s forecasting process. For instance, the Yearly
Cigarette Volume tab of the June 2016 LE shows that RAI’s “Cigarettes – Share of
Shipments” projections are straight-line extrapolations derived directly from RAI’s
industry volume forecasts:
(DX0140, at tab “Yr – Cigt Vol,” rows 42–79; see also Gilchrist Tr. 617:21–620:15 (“If
you look at market share growth, for example, which is a key component, they would
just project out a certain market share growth which then would be translated down
to volume all the way through the process.”); Price Tr. 961:18–962:10.)
142. The fact that extrapolations provided the most fundamental inputs to years
six through ten of the ten-year projections was not contradicted. Although Dissenters
identified certain entries in the June 2016 LE, including the entries entitled
“discounting” in the RJRT Detail tab, that did not follow a straight-line pattern,
(DX0140, at tab “RJRT Detail,” row 940; Gilchrist Tr. 520:19–521:9), Gilchrist
credibly explained that “discounting” entries and many others were derived from the
volume, market share, and pricing elements, (Gilchrist Tr. 521:5–22). The results of
the interaction among those foundational elements would not necessarily reflect
straight-line patterns, despite the results having been based on entries that were
themselves extrapolated. (Gilchrist Tr. 617:21–620:15, 623:25–627:1.)
143. Many topics were covered by the Board during the July 2016 Strategy Day,
including competitive analysis, research and development, regulatory developments
and risks, new business opportunities, and, briefly, a discussion of the impacts of
RAI’s Strategic Plan on RAI’s financial projections. (PX0009.0010–.0013, .0021–
.0025; JX0003.0003–.0005; JX0004.0020–.00231.)
144. At the end of the July 2016 Strategy Day meeting, Peters presented to the
Board a short financial overview presentation, which showed summary and top-line
projected financials for the years 2016, 2017, 2018, 2021 and 2025. These projections,
presented in condensed fashion, reflected 7% to 8% compound annual growth over the
next ten years, (JX0004.0027; Gilchrist Tr. 526:22–25), and were based on certain
identified assumptions that there would be no significant changes from the status
quo, (JX0004.0020–.0035; Nowell Dep. Tr. 46:23–47:12; Wajnert Tr. 56:10–57:1,
117:19–118:4). As was the case with projections generally, the financial information
presented to the Board did not incorporate any of the large-scale risks facing RAI, in
part because many of the risks were effectively an “on/off switch” which could not
have been factored into the numbers accurately. (Wajnert Tr. 58:11–21;
JX0004.0021.) The Board did not receive the underlying ten-year projections from
the June LE, nor did the Board give feedback on the projections for management to
consider. (Wajnert Tr. 56:10–57:1, 58:7–21.)
v. The October 2016 Projections
145. On October 29, 2016, RAI sent each Financial Advisor a set of financial
projections (the “October 2016 Projections”). (JX0008.0001; PX0039.0001;
DX0043.0001.) The October 2016 Projections were based on the October 2016 LE,
the most recently completed LE available at the time of the October 20 Offer. The
projections used by the Financial Advisors for years one through five were based on
a three-tab spreadsheet containing an income statement, a balance sheet, and a cash
flow statement. (JX0008.0001, .0003–.0005; PX00039.0003–.0005; DX0043, at sheets
“Income Statement,” “Balance Sheet,” and “Cash Flow.”) The October 2016 LE also
served as the baseline for the 2017 Operating Plan that RAI’s financial management
was preparing prior to BAT’s October 20 Offer. (Gilchrist Tr. 441:8–442:13.)
146. Prior to sending the October 2016 LE to the Financial Advisors, RAI’s
financial team made a series of adjustments to account for updated information and
high-level financial decisions that had not yet been made public. These adjustments
were called “Top-Side Adjustments” or “Management Overlays.” The adjustments
added roughly $300 million in income before tax to each year of the October 2016 LE
projections, or approximately $1.4 billion in total. (DX0041, at tab “Top Side Adjs”;
Gilchrist Tr. 443:9–12, 443:15–444:18; Price Tr. 1053:18–1054:14, 105:23–1055:4;
Zmijewski Tr. 1246:5–12.) Some Top-Side Adjustments were based on public
information that had not yet been incorporated into the October 2016 LE, including
changes to state tax laws and effects from positive stock market performance. (Price
Tr. 957:22–958:6.) Other Top-Side Adjustments related to information that was not
widely known, such as a planned restructuring of RAI’s sales force that was projected
to increase RAI’s income. (Price Tr. 957:10–21.) Although these Management
Overlays were typically not included in the ordinary course forecasts, RAI added
them to provide the Financial Advisors with the most accurate and reliable
information it had concerning RAI’s business. (Price Tr. 983:3–985:14.)
147. Over the next few weeks, Gilchrist, Price, and others on RAI’s finance team
continued sending documents and information to the Financial Advisors, including
information about RAI’s projections, and participated in diligence calls with the
Financial Advisors to discuss the materials that were sent and any additional
questions or requested information. (Gilchrist Tr. 440:10–22, 445:17–20; Price Tr.
945:3–12; PX0047.0001–.0004; DX0046.0001–.0004.)
vi. The Ten-Year Projections
148. Dissenters have alleged that Gilchrist and Price intentionally withheld
certain information from the Financial Advisors, including RAI’s ten-year financial
projections developed in connection with the June 2016 Strategic Plan, in an attempt
to mislead the Financial Advisors about the prospects of the Company and deceive
the Board and Transaction Committee into accepting an offer from BAT below RAI’s
intrinsic value. (DX0067.0001; Clark Tr. 1518:1–21; Gilchrist Tr. 446:7–447:20,
628:13–629:5; Price Tr. 959:23–960:7, 1001:21–1003:2.) Dissenters’ allegation is
contrary to the evidence.
149. First, less than two weeks after the October 20 Offer, RAI management
provided each of the Financial Advisors with the financial information given to the
Board at the July 2016 Strategy Day, including projections of operating income and
growth rates for years six through ten of the June 2016 Strategic Plan.
(DX0069.0021; DX0169.0040; DX0234.0021.) The Financial Advisors were thus
aware of the forecasted compound annual growth rates of 7% to 8% for the out years
of those projections. A management team intent on hiding the ten-year projections
would not have provided the Strategy Day presentation with the ten-year operating
income and growth rates. At that point, the supposed conspiracy would have been
exposed because all three Financial Advisors knew the projected trajectory and could
have insisted on further detail if they believed it was necessary. That simply did not
happen here.
150. In addition, the June 2016 LE projections were several months old by
October 2016, and Clark testified that JPMorgan “can’t use [a] stale set of projections.
We have to use the most up-to-date set of projections.” (Clark Tr. 1519:7–11.) It is
undisputed that the five-year October 2016 Projections were the most up-to-date
projections available.
151. Further, years six through ten of the June 2016 LE projections were less
informative than the projections in the October 2016 Projections because the later
years, based in large part on extrapolations of existing trends, were developed with a
“broad brush approach[,]” and used a “much higher” materiality threshold.
(DX0023.0002; Gilchrist Tr. 375:2–24, 404:9–406:6 (“[I]t was the best view of what
the business would do based on the assumptions that we laid out.”), 501:9–16; Price
Tr. 1017:7–23.)
152. Next, the evidence does not indicate that the Financial Advisors needed
detailed ten-year projections to adequately perform their valuation analyses. Indeed,
representatives from Goldman, Lazard, and JPMorgan each testified that such
information was unnecessary. (Eckler Dep. Tr. 61:3–12; de Gennaro Tr. 352:8–13;
Clark Tr. 1432:23–1433:3.)
153. Contrary to Dissenters’ suggestion at trial, de Gennaro testified that there
is no “hard and fast rule” for the number of years of projections required for any of
the banks to do their work, although typically “five, five to ten years” are used.
(de Gennaro Tr. 205:24–206:11.) Although de Gennaro had an expectation that RAI
would provide ten-year projections just as they had in connection with the Lorillard
Transaction in 2015, (de Gennaro Tr. 273:18–23), he explained that
[t]here’s no magic to ten years, seven years, five years as long as it forms
a reasonable and best view and management tells us, this is what we
believe to be the case, we go through it, we get validation, that’s what
we use. And it’s perfectly adequate for our purposes. So I genuinely
have no recollection of being concerned that we might get ten years, five
years, other than we were going to use what we got, and we wanted to
be in a position to use what we got. There’s no issue with a five-year set
of numbers. There just wasn’t this pressing question, other than from a
procedural standpoint. We needed to know what numbers we were
going to get in order to be able to do analysis if and when the time came.
(de Gennaro Tr. 293:18–294:6, 352:8–13 (“[W]e were very comfortable working with
. . . a five-year forecast.”).)
154. Similarly, after reviewing and analyzing the information from RAI
management, Eckler determined that “the financial forecast was sufficient to make
all of the necessary judgments for the purposes of [Goldman’s] valuation analysis.”
(Eckler Dep. Tr. 61:3–12.) JPMorgan reached a similar conclusion. (Clark Tr.
1597:12–16.) Despite the preference of certain team members to work with ten-year
projections and initially asking whether RAI management could provide such
projections, JPMorgan ultimately determined that a detailed ten-year forecast was
“not necessary” to perform its valuation work. (Clark Tr. 1432:23–1433:3.)
155. Testimony from the Financial Advisors further indicates that it was typical
when performing valuation work to receive and use five-year projections from
management. (Clark Tr. 1432:3–8; Eckler Dep. Tr. 32:03–33:20, 34:01–14, 35:08–09,
35:11–19, 67:07–67:15; de Gennaro Tr. 205:24–206:11, 220:13–221:5, 222:19–223:5.)
Indeed, Dissenters’ own expert, Zmijewski, testified that he used ten-year projections
only to calculate RAI’s pension liabilities; he otherwise elected to perform his DCF
analysis for purposes of this case using five years of RAI management projections.
(Zmijewski Tr. 1247:1–1248:6.) And RAI itself, in preparing its share repurchase
ceiling (as discussed below), used five-year projections when it obviously knew that
ten-year projections existed. (DX00138; DX0622, at tab “Sheet1.”)
156. Dissenters’ suggestion that the Financial Advisors agreed, at RAI’s request,
to use five-year, rather than ten-year, projections to protect their compensation at the
expense of providing an accurate and reliable valuation, is not supported by the
evidence.
157. Price’s statements at his deposition that he prepared “ten-year projections”
for delivery to the Financial Advisors in late October 2016 does not change the Court’s
findings. At the time of trial, Price was no longer employed by RAI and had no
incentive to be untruthful. He offered a credible explanation at trial that he meant
to refer at his deposition to the five-year projections derived from the October 2016
Projections plus the Top-Side Adjustments and that he had not in fact prepared ten-
year projections in October 2016. (DX0039.0001; Price Tr. 946:18–952:5, 952:20–
953:22, 954:4–7.) Price’s trial testimony is corroborated by the fact that there is no
evidence that RAI prepared ten-year projections for any purpose other than the
Board’s Strategy Day in June of each year, (Gilchrist 375:13–376:3), and Dissenters
have not identified any evidence, documentary or otherwise, indicating the existence
of up-to-date, ten-year projections as of October 2016. The Court finds that Price
simply made an honest mistake at his deposition.
158. Similarly, Dissenters’ focus on alleged discrepancies between the testimony
of the Financial Advisors, Gilchrist, and Price does not diminish the credibility of the
latter two. While the evidence shows that JPMorgan asked RAI for ten-year
projections, (Clark Tr. 1433:4–17), and that Lazard had received ten-year projections
from RAI in the Lorillard Transaction, (de Gennaro Tr. 260:20–24, 262:23–263:11,
312:24–313:7, 364:8–365:4; DX0148.0009–.0013), that evidence does not contradict
Gilchrist’s and Price’s testimony that they did not recall Clark’s requests, (Gilchrist
Tr. 589:23–590:11; Price Tr. 1016:23–1017:6). Clark testified that Gilchrist and Price
told him that RAI did not have “an up-to-date set of ten-year financial forecasts[,]”
(Clark Tr. 1433:4–17), and that the ones that it did have were “stale[,]” (Clark Tr.
1518:12–21), which is consistent with all the credible evidence introduced at trial.
159. Considering all of the evidence, including the credibility of the relevant
witnesses, the Court cannot conclude that RAI’s decision to provide the Financial
Advisors with the five-year October 2016 Projections rather than the ten-year
projections from the June 2016 LE was calculated to deprive the Financial Advisors
of important information to drive down their valuations of RAI to a range affordable
to BAT. All credible evidence is to the contrary. Ultimately, the record is clear that
the Financial Advisors received all the information they believed they needed for
their valuation work, (de Gennaro Tr. 352:8–13; Eckler Dep. Tr. 61:3–12), and no
credible evidence was offered at trial supporting any effort by RAI management to
hide information to depress the resulting valuation of the Company. 32
e. Share Repurchase Plan
160. In the summer of 2016, the RAI Board approved a share repurchase program
in response to unique circumstances related to RAI’s MSA payment obligations in
2017 that gave rise to a $250 million increase in RAI’s costs. RAI referred to this
increase as the “NPM cliff”:
[I]n 2013 a settlement was reached with 22 states and jurisdictions on
disputed 2003-2012 NPM [non-participating manufacturer] credits, plus
two more states in 2014, for credits to be paid over five years.
Additionally, a settlement was reached with the State of New York
related to payment years 2004-2014 for credits to be paid over a four-
year period. The NPM credits account for a total financial benefit of
approximately $1.2 billion through 2019. Some transition credits
expire[d] after 2014, with most of the remaining credits expiring after
2016, creating a one-time $250 million drop in 2017 and $100 million in
2019 – the “NPM cliff.” The removal of these credits will increase Cost
of Goods Sold for RJRT in 2017, causing year over year profit to be flat.
(PX0063.0046.)
161. RAI management expected to mitigate the 2017 NPM cliff “through actions
that will not impact the commercial business[;] these mitigation activities will appear
32 As will be discussed infra, the evidence actually shows that RAI management advocated to
the Financial Advisors for a higher valuation, in order to obtain the best possible purchase
price for the Company. (Price Tr. 1054:23–1055:14.)
below operating income.” (PX0063.0046, .0100.) Management recommended to the
Board a share repurchase plan in the summer of 2016 using RAI’s excess cash to help
boost EPS, describing the share repurchase program as a “cliff mitigation element to
help overcome the impact of the loss of those credits.” (Gilchrist Tr. 412:16–413:14.)
162. A share repurchase plan involves a company’s “go[ing] on the open market
and repurchas[ing] its shares to reduce its overall share count.” (Gilchrist Tr. 412:7–
12.) By reducing a company’s share count, the share repurchases reduce the
denominator in the EPS calculation and therefore increase EPS. (Gilchrist Tr.
413:15–21.)
163. To proceed with the share repurchase plan, RAI management requested and
obtained Board approval for the time frame of purchases (two-and-a-half years), the
amount of capital to be used ($2 billion), and the authorization ceiling at which
management would be permitted to repurchase shares without further Board
approval ($65 per share). (Gilchrist Tr. 413:22–414:14.)
164. The share repurchase authorization ceiling was an internal corporate grant
of authority from the Board to management, allowing management to purchase
shares on the open market up to the ceiling price if management believed it was in
the best interest of the Company to do so. (Gilchrist Tr. 415:2–5, 416:10–417:13,
417:20–418:1, 418:11–15.) Consistent with standard practices of publicly traded
companies, RAI’s share repurchase authorization ceiling was an internal matter and
was not disclosed to the market. (Wajnert Tr. 166:5–21; Crew Tr. 714:15–25.)
165. RAI arrived at the $65 share repurchase authorization ceiling after
performing a rough discounted cash flow calculation using “conservative
assumptions” over the two-and-a-half year length of the proposed program.
(DX0284.0003–.0004; Holland 30(b)(6) 33 Dep. Tr. 37:16–40:18 (“We would
purposefully kind of weight it on the higher end.”), 43:5–44:8; Gilchrist Tr. 418:2–10,
548:15–549:2.) The share repurchase DCF was not intended to value the Company,
but rather to derive a reasonable request for RAI management to make to the Board
as a ceiling price for management’s authority to repurchase shares. It was not
management’s intention to set the share repurchase authorization ceiling at the
“intrinsic value” of RAI’s shares; rather, RAI management sought to
get authorization from the board to purchase shares up to a certain point
if the market took the stock to that point. So we were intending to
obviously reduce our share count over a period of time to help overcome
that NPM cliff. That’s really what we were trying to accomplish.
(Gilchrist Tr. 414:19–415:1.)
166. Once the ceiling price was set, RAI management retained discretion to make
a judgment in each quarter as to whether buying shares at the then-prevailing
market price was an appropriate use of the Company’s resources. It was not required
to proceed with the purchases, even if the shares were trading below $65. (Gilchrist
Tr. 412:7–15, 417:14–21; Wajnert Tr. 149:16–23 (noting that in a share repurchase a
33 Holland was designated pursuant to N.C. R. Civ. P. 30(b)(6) to testify regarding certain
topics on behalf of RAI. (Parties’ Witness Summaries 4.) Portions of Holland’s 30(b)(6)
deposition were admitted into the trial record. (ECF No. 210.)
company will not pay shareholders “more than what the company believes the stock
is worth”).)
167. Indeed, the status of the share repurchase program and management’s
intended purchases were subject to regular review by the Board’s Audit and Finance
Committee. (Gilchrist Tr. 413:22–414:14, 419:12–420:2; DX0284.0003–.0006;
DX0622.0003.) Gilchrist testified that even though he had requested authority from
the Board to buy shares at a price up to $65 per share, he intended to discuss the
matter with the Board again if the stock traded higher and he determined the price
was not attractive. (Gilchrist Tr. 417:22–418:15.) RAI ended up purchasing only a
“very small amount” of shares pursuant to the plan because RAI suspended the plan
once BAT made its first offer. (Gilchrist Tr. 416:23–417:13.)
168. The inputs used in the share repurchase DCF included a very wide range of
terminal growth rates from 1% to 4% and a very wide range of weighted average costs
of capital from 7% to 9.5%. (DX0622, at tab “Sheet1”; DX0138, at tab “Sheet1”;
Holland 30(b)(6) Dep. Tr. 58:16–59:7.) The DCF analysis RAI created for the share
repurchase program ultimately used a 7.5% weighted average cost of capital
(“WACC”) and a 3.0% perpetuity growth rate (“PGR”) for RAI. (Gilchrist Tr. 543:20–
24; DX0284.0003.) The analysis was “based on the 2016 Strat[egy] Plan as of June
2016 for a five-year period” and did not include the projected compound annual
growth of 7% to 8% in years six through ten referenced in the 2016 Strategic Plan.
(Gilchrist Tr. 545:7–12, 547:3–13; DX00138.)
169. These inputs are not a reliable basis for valuing RAI. The range of weighted
average costs of capital is much higher than is supported by any of the other evidence
in the case, including from both sides’ experts and all three Financial Advisors.
Indeed, in the context of a valuation, there are significant methodological flaws with
RAI’s selection of the weighted average cost of capital. (Gompers Tr. 759:7–762:10,
762:15–19.) These problems undermine the utility of both the weighted average cost
of capital and the perpetual growth rate in the share repurchase DCF because the
two are linked, and RAI management considered them together in making its
selection as to the authorization ceiling to request from the Board. (DX0622, at tab
“Sheet1”; DX0138, at tab “Sheet1”; Gilchrist Tr. 421:12–20; Gompers Tr. 760:3–13;
Flyer Tr. 1226:23–1228:18 (“So the higher the WACC, the actually higher my implied
PGR would be, because I’m weighing the beginning period more. The lower the
WACC, the lower the PGR would be, because I’m weighing the later periods more.”).)
f. Further Deliberations and Negotiations
170. On November 6, 2016, RAI sent each Financial Advisor a planned
presentation for Board and Transaction Committee meetings on November 8 that
outlined the assumptions and sensitivities to the October 2016 LE Projections as well
as some of the high-level figures. (PX0052.0001, .0004, .0006; JX0010.0001, .0004,
.0006; Gilchrist Tr. 380:21–381:8.)
171. On November 8, 2016, the RAI Board met and reviewed the October 2016
Projections. During the meeting, Gilchrist gave a presentation to the Board in which
he explained that the financial forecasts incorporated significant assumptions about
the industry dynamics, including ”[c]ontinuation of recent pricing environment – no
significant disruption[,]” “cigarette industry volume down ~3 - 4 percent[,]” “moist
and vapor industry volume up ~2 percent[,]” “3 percent inflation[,]” “[state excise
taxes] $.05 per pack annually, moist snuff $.01 per can annually[,]” “Share
repurchase beyond 2018 at $1 billion per year[,]” and “Capital expenditures continue
at $150 - 200 million per year[.]” (PX0052.0004; JX0010.0004.)
172. Gilchrist also identified upside and downside sensitivities to the financial
projections, including “Accelerated growth from new revenue streams –
Vapor/Transformation” as an upside and the greater risk of adverse FDA regulations
as a downside. (JX0010.0006.) After his presentation, Gilchrist and Crew spoke with
the Board about “potential upside and downside to the business based on their
current thinking[,]” (PX0054.0002–.0003), and specifically advised the Board that
“the upside sensitivities and the downside sensitivities are not all created equal[.]”
(Gilchrist Tr. 389:1–3; JX0010.0003, .0006; PX0115.0127, .0377; JX0023.0070–
.0071.)
173. On November 11, 2016, RAI rejected BAT’s October 20 Offer.
(JX0023.0071–.0072). On December 5, 2016, BAT made a revised offer to acquire
RAI, which RAI also rejected. On neither occasion did RAI make a counterproposal.
As shown on the following chart, BAT ultimately raised its offers four times before a
final deal was reached on January 17, 2017:
Date BAT Cash Value Per Total Value on
Shares Share on Date Offer Date 34
Oct. 20, 2016 0.5502 $24.13 $56.50 $80.56 billion
Dec. 5, 2016 0.4923 $29.44 $56.60 $80.70 billion
Dec. 20, 2016 0.5105 $29.44 $58.30 $83.12 billion
Jan. 10, 2017 0.5250 $29.44 $59.15 $84.34 billion
Jan. 10, 2017 0.5260 $29.44 $59.20 $84.41 billion
Jan. 17, 2017 0.5260 $29.44 $59.64 $85.04 billion
(Corr. Stip’d Facts ¶ 17; JX0023.0068–.0078.)
174. The Transaction Committee never demanded that BAT support an
alternative transaction to allow for an auction process, (Wajnert Tr. 70:7–11, 90:7–
9), although there was no evidence at trial that BAT would have agreed to withdraw
its announced opposition had it been pressed. Nor did the Transaction Committee
authorize the Financial Advisors to solicit any expressions of interest from other
parties concerning the sale of the Company or an alternative transaction,
(JX0023.0650, .0652, .0655; DX0272), but, similarly, there was no admissible
evidence at trial from any source that any third party was interested in purchasing
RAI with or without BAT’s support.
175. Indeed, given the nature of the tobacco industry, regulatory requirements,
RAI’s large size, and antitrust concerns, there were few (if any) companies in the
world—in the tobacco industry or adjacent industries—that could have made an offer
for RAI, regardless of BAT’s stock ownership. (JX0023.0070; PX0115.0469; Eckler
Dep. Tr. 51:08–52:08.) Significantly, although BAT’s offer was widely publicized, no
34 Offer value is calculated based on the trading price of BAT stock and the British pound/U.S.
dollar exchange rate as of the closing price on the date of the offer. (JX0023.0068–.0070.)
Total value is the implied market capitalization, i.e., RAI’s total shares outstanding on the
offer date multiplied by the value per share of the offer. (JX0023.0084–.0085.)
third party ever contacted the Transaction Committee, RAI management, or any of
RAI’s Financial Advisors about the possibility of engaging in diligence or making a
competing bid. (Wajnert Tr. 90:3–6; Clark Tr. 1429:16–18.)
176. Goldman reviewed alternatives to negotiating a merger with BAT with the
Transaction Committee. (Eckler Dep. Tr. 50:13–50:25.) The Transaction Committee
considered whether Japan Tobacco could be a serious potential alternative buyer but
concluded that it was not. This conclusion was based on RAI’s previous dealings with
Japan Tobacco in which Japan Tobacco was quick to respond to RAI’s offers but
maintained a difficult internal process to move forward. Past conversations with
Japan Tobacco also led the Transaction Committee to reasonably believe that Japan
Tobacco would not be interested in dealing with the U.S. regulatory regime. The
Transaction Committee also reasonably believed that, given their positive
relationship with Japan Tobacco and Japan Tobacco’s 2016 purchase of the
international rights to RAI’s Natural American Spirit brand, if there had been any
real interest in purchasing RAI, Japan Tobacco would have reached out to RAI
directly. (Wajnert Tr. 91:1–3, 99:17–100:1, 171:19–172:12 (“[W]e were not optimistic
at all about Japan Tobacco being a potential bidder. And we knew them well enough
individually, had visited together and the like, that if there had been an interest, a
real interest, they would have called.”).)
177. While BAT indicated that it was not interested in selling its shares to an
alternative buyer, that did not mean RAI had to sell the Company to BAT, nor did it
mean that the members of the RAI Transaction Committee and Board were willing
to—or had any reason to—sell the Company for less than its fair value.
(JX0021.0003; Wajnert Tr. 73:24–74:24.) Multiple witnesses testified that RAI
seriously considered strategic alternatives, including remaining independent from
BAT. (Nowell Dep. Tr. 150:13–24; Cameron Dep. Tr. 106:16–107:11; Crew Tr.
665:16–666:15.) Indeed, the Transaction Committee twice rejected BAT’s merger
offers without making a counterproposal—showing the Transaction Committee
thoroughly explored the viability of RAI’s remaining independent as an alternative
to executing a transaction with BAT. (JX0023.0067–.0073.)
178. It was not until after the Transaction Committee successfully negotiated
four price increases, securing an additional $4.5 billion in value for shareholders by
the time of signing, that the Transaction Committee concluded that a merger with
BAT was more attractive than other alternatives. (JX0023.0065–.0078.) In fact,
JPMorgan advised RAI on various alternatives to BAT’s offers, including
continuing to operate as a stand-alone entity, looking at other M&A
transactions where Reynolds would not – not be the seller but be a
potential acquirer of assets . . . [,] alternatives related to the company’s
capital structure, whether or not a leveraged recapitalization could
make sense, alternatives as it relates to its use of free cash flow in the
context of repurchases or dividends. A variety of alternatives.
(Clark Tr. 1429:2–12.)
179. The Transaction Committee and its advisors ran a thorough deal process
from October 28, 2016 to the signing of the Merger Agreement on January 16, 2017.
All negotiations with BAT were conducted by the Transaction Committee or its
representatives. Wajnert, as Transaction Committee Chair (and after his retirement
on December 31, 2016, his replacement, Nowell), negotiated directly with BAT CEO,
Nicandro Durante. (Wajnert Tr. 79:13–81:9; Nowell Dep. Tr. 169:11–170:6, 170:13–
171:4, 171:12–173:9, 174:21–176:25; JX0023.0072–.0076.)
180. Likewise, Goldman negotiated directly with BAT’s bankers at Centerview
and Deutsche Bank. The Transaction Committee repeatedly rejected BAT’s offers
and did not make a counterproposal until after BAT made its third offer, on December
20, 2016, which BAT had said was its final proposal. (Wajnert Tr. 79:13–81:5;
JX0023.0073–.0074.) The Transaction Committee regularly met and spoke with
Goldman about the offers and investor reactions. (JX0023.0070–.0078.) Goldman
and JPMorgan made many presentations of their valuation analyses to the
Transaction Committee and to the Board during the negotiation process.
(JX0023.0070–.0078.)
181. As a result of the Transaction Committee’s efforts, BAT increased its offer
to purchase RAI’s common stock four times from a per-share value of $56.50 in the
October 20 Offer to a per-share value of $59.64 when the transaction was announced
on January 17, 2017, amounting to an additional $4.5 billion in deal value for RAI’s
shareholders and a 26.4% premium over the Unaffected Stock Price. (Wajnert Tr.
80:19–22; Nowell Dep. Tr. 173:25–176:25; JX0023.0068–.0076, .0088.)
g. Financial Advisors’ Fairness Opinions and Shareholder Vote
182. Corporate boards contemplating a sale of a company often seek fairness
opinions from their financial advisors before agreeing to recommend the transaction
to stockholders. In order to arrive at a fairness opinion, a financial advisor performs
a financial analysis of the company typically using a variety of techniques. (de
Gennaro Tr. 192:24–194:3.)
183. To prepare their fairness opinions in connection with the Merger, Goldman,
Lazard, and JPMorgan each separately evaluated the final BAT offer from
January 10, 2017 and determined that it was fair from a financial point of view to the
RAI shareholders other than BAT. Each of the Financial Advisors presented a draft
fairness opinion to its fairness committee prior to giving the bank’s final fairness
opinion to the Board or the Transaction Committee or both on January 16, 2017.
184. Each Financial Advisor conducted several types of valuations of RAI,
including analyses of comparable companies’ market multiples, precedent
transaction multiples, and DCFs, based on their knowledge of RAI, the tobacco
industry, and the market. These valuation analyses were meant to be examined
together. (JX0023.0077–.0078; PX0115.0252–.0282, .0526–.0570, .0572–.0635; de
Gennaro Tr. 227:19–229:14, 232:19–235:20; Clark Tr. 1448:24–1449:8, 1435:14–
1436:5, 1448:24–1449:8; Eckler Dep. Tr. 49:4–15, 201:7–22.)
185. RAI management represented to the Financial Advisors that the five-year
projections provided earlier were management’s best estimates of its future cash
flows, and the Financial Advisors relied on that representation, stating in their
fairness opinions (also published in SEC filings in connection with the Merger):
“[T]he unaudited financial forecasts were prepared on a reasonable basis and
reflected the best then-currently available estimates and judgments of RAI’s
management.” (JX0023.0133, .0649; Martin Dep. Tr. 113:05–113:10 (“Q. . . . [D]o you
recall anyone at Reynolds commenting that the projections that were going to go into
the proxy statement were unrealistic? A. No.”); Price Tr. 710:15–19 (“Q. [Y]ou would
never give the financial advisors projections that were – that you thought were
unreliable . . . . A. Well, no. We’re going to be very transparent with everything we
can. We disclose all of this.”).)
186. In preparing their valuations, the Financial Advisors had access to whatever
information they requested from RAI for their analyses. (Gilchrist Tr. 445:17–20,
446:7–447:20, 481:1–13, 481:19–482:12 (“I am certain they had everything that they
requested and that they needed.”), 587:8–12; Price Tr. 1017:5–6; de Gennaro
Tr. 222:12–18.) As illustrated by the “football field” slides reproduced below from
each of the Financial Advisors’ January 16, 2017 presentations to the RAI
Transaction Committee and/or Board, the $59.64 per-share deal price was well within
the calculated ranges of equity value per share:
(PX0115.0539);
(PX0115.0258);
(PX0115.0582).
187. The deal price that RAI negotiated with BAT, as described by Lazard’s de
Gennaro, was a “very full price” and a “landmark price.” (de Gennaro Tr. 236:6–16.)
JPMorgan’s Clark described it as a “homerun transaction for [RAI,]” (Clark Tr.
1443:24–1444:5); he further testified that he had no concerns about issuing a fairness
opinion for the Merger, stating that “it was a fantastic transaction[,]” and that he
wished he “had the ability to get transactions like this for all of [JPMorgan’s]
clients[,]” (Clark Tr. 1451:7–12). A number of analysts even expressed concern that
BAT was overpaying. After the announcement of the Merger, research analysts did
not comment that BAT was receiving a bargain or that RAI was undervalued in the
deal. (Gompers Tr. 802:25–803:8; Yilmaz Tr. 2003:4–22.)
188. From BAT’s October 20 Offer until the Transaction Date in July 2017, the
S&P 500, a broad measure of large U.S. companies, rose 17.15%. Altria, the only
other major U.S. tobacco company, rose 20.44% over that same period. (Gompers Tr.,
792:2–11.)
189. At the shareholder vote on the Merger, RAI’s shareholders overwhelmingly
approved the deal, by both a majority (83%) of the outstanding shares and by a
majority (71%) of the non-BAT-owned outstanding shares. Nearly 72% of the non-
BAT-owned shares were voted in the Merger, and 99% of those shares were voted in
favor of the Merger. (Corr. Stip’d Facts ¶ 18; DX0277.0011; DX0324.0002;
JX0023.0044; Crew Tr. 671:23–672:10.)
190. Roughly 80% of RAI’s public shareholders were sophisticated, institutional
investors. (PX0115.0618.) Among those voting in favor of the Merger were RAI’s
directors and officers, who had the best information about the value of the Company.
RAI witnesses testified that they voted in favor of the deal, including Price, who lost
his job as a result of the Merger. (Wajnert Tr. 85:13–24; Price Tr. 1061:1–1062:2.)
None testified that they voted against it.
191. On July 25, 2017, the Merger became effective, and an indirect, wholly-
owned subsidiary of BAT was merged with and into RAI, with RAI continuing as an
indirect and wholly-owned subsidiary of BAT. (Corr. Stip’d Facts ¶ 19; PX0109.0002,
.0085–.0086; DX0325.0003.) The merger consideration on that date had a cash value
of $65.87. The increase in the value of the merger consideration from January 16,
2017 to the Effective Date of the Merger was due to the increase in the BAT share
price and favorable changes to the British pound/U.S. dollar exchange rate.
(DX0325.0003–.0004; Zmijewski Tr. 1241:24–1242:10.)
192. In September 2017, RAI sent payment to Dissenters for RAI’s $59.64 per-
share estimate of the fair value of the shares held by Dissenters, plus interest
calculated pursuant to N.C.G.S. § 55-13-01(6). (Corr. Stip’d Facts ¶¶ 20–25;
Appendix A.)
F. Evidence of Value
193. At trial, RAI introduced evidence of value using various valuation concepts
and techniques that, when cross-checked against one another, show that the price
paid by BAT reflected the fair value of RAI. Additionally, RAI presented testimony
from its executives, Board members, and Financial Advisors regarding the
contemporaneous analyses and assessments they performed based on their
knowledge of the Company and the industry—most of which supported the conclusion
that RAI shareholders received fair value in the transaction.
194. The conclusion that the deal price reflected fair value was further
corroborated by the testimony of RAI’s valuation expert, Gompers, who testified about
his own valuation analyses and those of the Financial Advisors. Based on that
evidence, and for the reasons set forth below, the fair value of RAI at the Merger
closing on July 25, 2017 was no more than the deal price of $59.64.
195. Dissenters sought to explain why all of the valuation evidence presented by
RAI should be ignored, and that the value of RAI should be determined based solely
on the DCF model developed by their experts, Zmijewski and Flyer. Relying entirely
on this made-for-litigation analysis, Dissenters request that the Court find that RAI’s
fair value as of July 25, 2017 was $92.17—an amount that far exceeds any other
evidence of value in the record and suggests that RAI’s management, RAI’s Board,
RAI’s Financial Advisors, RAI’s shareholders, stock market analysts, and the market
itself mispriced RAI by as much as $50 billion. 35
a. Market-Based Valuations
196. Extensive evidence was offered showing that RAI’s fair value was in line
with the value that the market ascribed to RAI. In the circumstances presented here,
the market’s view of the value of RAI is persuasive evidence of underlying fair value.
As Gompers testified, “[I]f the market is efficient and there’s no material, non-public
information, then the market price will be the best estimate of a firm’s . . . intrinsic
or fundamental value.” (Gompers Tr. 784:1–6.)
i. RAI’s Stock Price
197. On October 20, 2016, RAI’s common stock closed at $47.17 per share (the
“Unaffected Stock Price”). (Corr. Stip’d Facts ¶ 13.) The evidence shows that this
price did not represent a substantial deviation from the price at which RAI’s stock
was previously trading. RAI’s 52-week trading average prior to BAT’s initial offer
was approximately $49.00. (PX0115.0258.) RAI’s common stock hit its all-time high
of $54.48 per share on July 5, 2016. (PX0115.0390.) In fact, RAI’s share price had
35 Zmijewski also testified at trial about a series of late-made calculations that were disclosed
to RAI the morning prior to his testimony. He acknowledged, however, that “[he] did one
valuation. . . . And that value is $92.17.” (Zmijewski Tr. 1325:3–13, 1325:21-23 (“Q. So is it
fair to say that the rest of these just illustrate the math if I asked you ‘what would it be if?’
A. Yes.”).)
realized significant gains in the years leading up to BAT’s initial offer.
(PX0063.0039.)
198. RAI’s stock was trading “at a peak multiple in the marketplace” prior to
BAT’s October 20 offer. (Gilchrist Tr. 560:22–561:11.) Although RAI’s share price
had dropped at that time from its all-time high three months before, from the time
the Lorillard Transaction closed in June 2015 until October 20, 2016, the volume
weighted average price of RAI stock was $46.26—slightly below the Unaffected Stock
Price. And trading data shows that the deal price was substantially above prior price
levels:
(PX0115.0071.)
199. Yilmaz testified that there are certain circumstances where the presence of
large blockholders that have access to nonpublic information can lead to an increase,
rather than a decrease, in a company’s value. (Yilmaz Tr. 1967:18–1968:13 (“Q. . . .
[I]f the large blockholder does a good job . . . monitoring management’s performance,
that could lead to an increase in value . . . ? A. Yes. Q. And if the large blockholder
has expertise in the industry . . . it can provide to management, that too can increase
the company’s value . . . ? A. It is possible. Yes.”).) While Zmijewski suggested that
BAT’s ownership stake in RAI could have depressed RAI’s market price to some
degree, (Zmijewski Tr. 1384:25–1387:1), he presented no evidence to support his
suggestion or the magnitude of any hypothetical depressive effect of BAT’s stake.
Contrary to his suggestion, numerous analysts indicated that, prior to BAT’s October
20 Offer, RAI’s unaffected stock price incorporated some value attributable to a
possible acquisition by BAT. (Cameron Dep. Tr. 80:14–81:2; Nowell Dep. Tr. 107:11–
19; PX0115.0091.)
200. A detailed analysis of market efficiency requires an answer to three
questions: (i) “[d]id the . . . stock trade in [an] efficient market?”; (ii) were “there
market frictions that would cause a disconnect between the company’s publicly traded
stock price and its fair value?”; and (iii) “was there value-relevant, non-public
information?” (Zmijewski Tr. 1317:19–1318:8.)
201. RAI possessed many attributes that courts have found to suggest that a
stock trades in an efficient market. Experts for both sides testified that they had
identified no “trading frictions” or other evidence suggesting that RAI’s stock was not
trading efficiently. (Yilmaz Tr. 1966:18–1967:6; Gompers Tr. 785:9–11, 785:24–
786:8.)
202. Experts for both sides also agreed that the market for most publicly traded
stocks on most days is close to semi-strong form efficient, particularly stock for large
companies like RAI. 36 (Yilmaz Tr. 1967:7–13; Gompers Tr. 785:3–8.) Although both
sides’ experts agreed that the fact a company is widely traded on a national exchange
does not mean it automatically trades in a semi-strong efficient market at any given
point, (Gompers Tr. 833:23–834:6; Zmijewski Tr. 1320:17–1321:2), given the evidence
introduced by RAI, which was not disputed by Dissenters, there is a sufficient factual
record 37 for the Court to determine that the market for RAI’s stock was semi-strong
form efficient:
a. Until the Merger, RAI was publicly traded in high volumes and with high
liquidity on the NYSE, the largest stock exchange by market capitalization
and monthly trading volume in the world. (JX0017.0003.)
b. RAI was a very large company with a market capitalization of
approximately $67.3 billion on October 20, 2016. (Gompers Tr. 777:25–
778:10; PX0115.0181.)
36 A market that is semi-strong form efficient quickly incorporates into the price of a security
the release of all new publicly available information. (Gompers Tr. 833:11–15; Yilmaz Tr.
1874:18–21.)
37 RAI did not offer expert testimony to establish that the market for RAI’s stock was semi-
strong form efficient, an alleged failure of proof Dissenters suggest precludes the Court from
finding market efficiency. (Defs.’ Resp. Post-Trial Br. 19, ECF No. 231.) The Court disagrees
and concludes that expert testimony on market efficiency is not necessary to the Court’s
determination in light of the undisputed evidence of record establishing that the market for
RAI’s shares was semi-strong efficient at the time of the Merger. (See Appendix B at § E.)
c. Information about RAI was both widely available and readily disseminated
to the market. (de Gennaro Tr. 215:15–23 (“No indication that the market
wasn’t absorbing news on a regular basis.”).) For most public companies,
“most of the relevant information is disclosed.” (Wajnert Tr. 124:4–7.)
d. RAI’s historical stock price increased and decreased in relation to the
release of new Company-specific information and market-wide trends.
(Wajnert Tr. 59:10–60:4; de Gennaro Tr. 215:15–23.)
e. RAI’s stock was followed by 16 equity analysts, who frequently published
research about the Company. (PX0063.0010, .0025; de Gennaro Tr. 187:18–
188:8 (RAI was “a well-covered company . . . . A lot of analysts issued
regular reports.”).) These analysts were well-informed about RAI’s business
and the U.S. tobacco industry. (PX0063.0010, .0025; de Gennaro Tr.
187:18–188:8, 199:2–19.)
f. RAI did not have a controlling shareholder at any time prior to the Merger.
(JX0023.0080; Wajnert Tr. 63:18–64:18.)
203. Dissenters also sought to prove at trial that RAI’s stock price was not a
reliable indicator of fair value because of the existence of certain material nonpublic
information that was not reflected in the stock price: (i) the Top-Side Adjustments to
the October 2016 Projections provided to the Financial Advisors, (ii) the projected
growth rates for years six through ten in the June 2016 LE, and (iii) the $65 share
repurchase authorization ceiling. (See Defs.’ Resp. Post-Trial Br. 22–24.) None of
this nonpublic information warrants disregarding RAI’s Unaffected Stock Price as
evidence of value. Indeed, Dissenters’ expert, Yilmaz, admitted that he did not have
an opinion “one way or the other on whether the private information at the company,
on balance, was more negative or more positive[.]” (Yilmaz Tr. 1959:1–12 (“Given
that I have not done the work, I [can] not opine on that.”).)
204. First, the Top-Side Adjustments amounted to an additional $1.4 billion in
RAI’s income before taxes, or roughly $300 million added to each year of the five-year
projections. (DX240, at tab “top side adj,” row 14; Price Tr. 989:18–990:16.) As of the
record date of June 12, 2017, RAI had approximately 1.426 billion shares of common
stock outstanding. (JX0023.0029.) Given RAI’s immense size, public disclosure of
this additional projected income would not likely have affected the stock price in a
meaningful way, and it does not undermine the relevance of the Unaffected Stock
Price as evidence of value. There is certainly no basis to find that this information
could justify the massive premiums to RAI’s Unaffected Stock Price for which
Dissenters advocate. Further, some of the Top-Side Adjustments were based on
public information that had not yet been incorporated into the October 2016 LE, such
as changes to state tax laws and effects from positive stock market performance.
(Price Tr. 957:22–958:6.)
205. Next, as discussed previously, the growth rates in years six through ten of
the June 2016 LE were based largely on extrapolations of current volume and pricing
trends in the industry, which were publicly available and therefore already likely to
be reflected in RAI’s stock price. (Gilchrist Tr. 375:2–24, 404:9–406:6, 529:12–25.)
206. Moreover, and also as previously discussed, RAI management credibly
testified—and the documents relating to the ten-year projections confirmed—that the
projections for these later years did not account for any of the various serious risks
facing the Company. (DX0023.0002; Gilchrist Tr. 410:8–412:2.) In particular, they
were not intended to be used to value RAI’s shares but only in connection with certain
limited planning objectives. The projected growth rates were not based on any
underlying material, value-relevant information about specific business plans or
other developments. They did not constitute the kind of information that, if disclosed,
would have meaningfully affected the stock price, and they do not provide any reason
to believe that the fair value of RAI materially deviated from the Unaffected Stock
Price. Dissenters do not contest that RAI was not required to have disclosed these
projections. (Yilmaz Tr. 1959:15–25.)
207. Finally, the authorization ceiling for the share repurchase approved by the
Board is not material, value-relevant information because it was not a valuation of
RAI. Rather, as discussed above, it was an internal corporate authorization for a
purchasing program, which was intentionally set at a price that was higher than
what RAI management ever expected it would need to spend. (Gilchrist Tr. 414:19–
415:1.) Indeed, Zmijewski pointedly declined to testify that the authorization ceiling
was value-relevant information even when prompted by counsel. (Zmijewski Tr.
1316:10–1317:3.)
ii. Adjusted Unaffected Stock Price
208. RAI’s July 24, 2017 stock price is not a relevant proxy for fair value on the
Transaction Date because after BAT’s announcement of its October 20 Offer, RAI’s
stock price would have reflected the expected deal price, including expected synergies
created by the Merger, and the market’s view of the likelihood of the deal closing.
(Gompers Tr. 790:1–11.)
209. In addition, in the time between the October 20 Offer and the Transaction
Date, events took place that may have affected RAI’s standalone value and been
reflected in RAI’s stock price had BAT not made its October 20 Offer. (Gompers Tr.
790:12–791:12.) In particular, Donald Trump had been elected President of the
United States, and the Republican Party held a majority in both the Senate and the
House of Representatives. Both President Trump and Republican congressional
candidates had campaigned on a lowered corporate tax rate. While no formal tax
plan had been proposed or implemented prior to the Transaction Date, there was
speculation that the Republican-led Congress would pass a tax bill that would lower
the corporate tax rate and that there would be a more benign regulatory climate for
the U.S. tobacco industry. (PX0115.0185, .0446, .0456; Eckler Dep. Tr. 101:07–102:3.)
210. To estimate the effect that these and other market industry developments
would likely have had on RAI’s stock price between BAT’s October 20 Offer and the
closing of the Merger on July 25, 2017, 38 Gompers calculated an “Adjusted Unaffected
Stock Price” that indexed RAI’s Unaffected Stock Price to the performance of its
closest competitor, Altria, and to the performance of the S&P 500 generally from
October 20, 2016 through July 24, 2017. Based on the performance of the S&P 500
38 At trial, no evidence was offered of a material, value-relev
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