Five Reasons Why Cigar Companies Will Acquire More Retailers

Following the news that Imperial Brands, plc—the same company that owns Altadis U.S.A., JR Cigar and the Casa de Montecristo retail chain—purchased Serious Cigars, a Houston, Texas-based cigar store with four physical locations and a website, we received the following question from reader Steve.

Morning Guys. My question is is there an advantage for manufacturers to buy retail stores or chains in regards to the FDA governing rules?

It’s an interesting question, particularly as many cigar companies—notably the aforementioned Imperial, Oettinger Davidoff AG and Rocky Patel Premium Cigars—have made a bigger push into retail stores over the last two years.

In short, I don’t think there’s anything in the text of the rules that I would describe as incredibly compelling in regard to a cigar company buying a retail store. However, there certainly are some circumstantial advantages, or at least potential advantages, which might explain why you could see more of these maneuvers over the next few years.

Every topic or question in the cigar business after May 5—the day the regulations were announced—can in one way or another be related to FDA regulations. The trend of cigar companies expanding in the retail channel was one that certainly existed before May 5,[ref]Davidoff’s expansion in the U.S. market last year, Imperial acquiring Cigar Inn, Davidoff hiring a director of omnichannel retail, etc. all happened before May 5 of this year.[/ref] but FDA regulations have definitely made it a more pressing issue.

As with many Ask halfwheel answers before it, this is a lengthy article—and one that dives deeper than most into the backend of selling cigars. I’ve included a brief glossary of the three main players mentioned below.

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Imperial Brands, plc

A publicly-traded British company with a current market capitalization around $46 billion dollars.

• Cigars: The company owns Altadis U.S.A., which sells H. Upmann, Montecristo, Romeo y Julieta and others in the U.S. Imperial also owns a 50 percent stake in Habanos S.A., the company that sells and distributes Cuban cigars worldwide.
• Retail: Imperial owns JR Cigar, best known for its catalog and internet business but which also has physical stores in North Carolina (two), New Jersey (two), Detroit, St. Louis and Washington D.C. Additionally, Imperial has a separate chain of stores known as Casa de Montecristo, which operates stores in New York City (two), Boynton Beach, Fla. (franchise), Chicago (franchise), Dallas, Las Vegas (franchise) and Miami (franchise). Imperial recently acquired Serious Cigars, which operates four brick and mortar locations in Houston as well as an online storefront. Imperial also has a strong presence in the French and Spanish retail/distribution markets.
• Other: Cigarettes are Imperial’s primary business. It sells a laundry list of cigarette brands throughout the world including the Kool, Maverick and Winston brands in the U.S. through its subsidiary ITG. Imperial is also the company behind blu e-cigarettes, as well as Backwoods and Dutch Masters brands of little cigars. The company has numerous lines of smokeless tobacco, cut tobacco and other tobacco products, and sells Davidoff cigarettes through a licensing agreement.

Oettinger Davidoff AG

A privately-held Swiss company.

• Cigars: The company makes the AVO, Camacho, Cusano, Davidoff Griffin’s and Zino brands. Davidoff has licensing deals with Room101 and others.
• Retail: There are over 50 Davidoff-branded stores worldwide, some of which are owned by Davidoff, many other the Davidoff of Geneva – since 1911 name, and others which are operated as franchises. In the U.S., this includes three corporate stores in New York City and single locations in Atlanta and Houston, as well as franchise locations in Las Vegas and Tampa. The company also has a partnership with Blend Bar based in Indianapolis, Ind. and has additional locations in Nashville, Tenn. and Pittsburgh, Pa. with plans for more. Davidoff also has a website where it sells its own products in the U.S.
• Other: Davidoff is the U.S. distributor for S.T.Dupont, which produces cigar accessories such as lighters and cutters as well as writing instruments and leather goods. It also has a European distribution company that sells candies and other products. The Davidoff name is used on cigarettes and fragrances through licensing agreements.

Scandinavian Tobacco Group (STG)

A publicly-traded company based in Denmark with a market cap of around $1.74 billion.

• Cigars: STG owns CAO, Foundry Macanudo and Toraño. In the U.S. it sells Cohiba, Hoyo de Monterrey, Partagas and others.
• Retail: STG owns Cigars International, which has a catalog, online storefront and brick and mortar stores in Pennsylvania. It also operates CigarBid.com and Cigar.com online, as well as a few other brick and mortar stores like Club Macanudo in the U.S. and a new Macanudo store in Copenhagen.
• Other: STG sells little cigars, snus and pipe tobacco.

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1. FDA UNCERTAINTY MIGHT PUSH RETAILERS TO SELLING

First and foremost, there is uncertainty everywhere.

I would argue the level of knowledge people have about FDA is quite below what it should be, particularly on the manufacturing and retail level. As parts of the regulation become closer to going into effect, there are signs that manufacturers are learning more and more, but quite honestly I’m not seeing the same sort of development on the retail side.

Even the most educated in the industry are still quite clear on the fact that much of the rules, particularly how strict they will be interpreted, are unknown at this time. As such, there’s uncertainty about the overall financial impact.

For many retailers, this is only going to increase their interest in selling a business.

I’m not sure whether or not this is the case with Serious Cigars, but any family-owned retailer that operates an online cigar business should be concerned. The advertising restrictions are one of the least resolved facets of the rules and if FDA leans towards a stricter interpretation it could become so expensive in regards to compliance that retailers like Serious simply cannot justify the costs.[ref]In my mind, the issue is not actually e-verify; rather whether FDA considers an online storefront to be a form of advertising. If so, it could be subject to advertising warning plans which would be very costly in time and money to comply with.[/ref]

2. ACCESS TO CONSUMERS IS GOING TO BE MORE RESTRICTED & EXPENSIVE

On that same note, the ban on free samples and new restrictions on advertising mean that access to consumers is going to be more challenging, particularly non-face-to-face interactions.

Imperial, Oettinger Davidoff and STG—i.e. the big three premium cigar companies—all want (increased) omnichannel retailing.

Omnichannel refers to a retail business that has multiple avenues for consumers to buy products and more importantly, ways for the companies to follow up with consumers to encourage more sales. While there are some tax implications to omnichannel retailing,[ref]The businesses have to worry about nexus issues, i.e. because most online/catalog retailers do not pay state tobacco taxes, they need to be careful from having businesses that have physical stores with the same name as the online/catalog business in each state. To comply with this, companies will simply set up a separate business to handle the brick and mortar sales and another business entity handles the online/catalog sales. The brick and mortar business adheres to whatever the local tax laws are whereas the online/catalog business adheres to its local tobacco tax laws, which in the states of Florida and Pennsylvania are zero tobacco tax on cigars.[/ref] the companies want to be able to track a particular customer if they make a purchase in a retail store, a catalog, online storefront, etc. They will then use this data to better market to that customer directly, gather information about what products to stock in specific cities, etc.

Omnichannel is becoming more and more important in all businesses, but new FDA rules only increase its importance because the data gathered by the retailers can then be shared with the cigar companies themselves, something that is much easier and more profitable than trying to gather the data through third-party affiliates. For example—and this is entirely hypothetical—by acquiring Serious Cigars, Imperial might learn that consumers in Texas purchase belicosos more in the month of May than any other time of the year. They could than use this data to help promote Montecristo and Romeo y Julieta belicosos throughout the state in the month of May.

While the example above is rather rudimentary, it sheds light on just how much data can be acquired by acquiring an larger, established retailer in a key market. Data that will be significantly harder to acquire under FDA rules as the communication between consumer and manufacturer gets more restrictive.

3. THE RETAIL LANDSCAPE IS STILL UNDERDEVELOPED

The cigar business prides itself on being a very traditional—err, old—business. People love to talk about the simplicity of handshake deals and good ole’ fashioned _____. 

While there certainly is a lot of romance to that, the other side of the coin is that much of the retail business is very underdeveloped. Some of the smartest people I’ve met in the cigar business are those who are working for the large catalog and internet retailers. In many ways, it reminds me of the sabermetrics revolution in baseball, where people like Theo Epstein—who has now been the architect of World Series wins for the Boston Red Sox and Chicago Cubs,[ref]Yay, #flythew tie-in.[/ref] came to a very old school game and combined advanced statistics with the traditional approaches to baseball scouting and managing.

These are not simply numbers geeks with their Excel spreadsheets, they are people that understand both the numbers and the unmeasurables—relationships, good staff and good service. Most importantly, they are able to balance the two approaches to make more informed strategies than either one could individually. These people are becoming more and more valued at the larger companies with the epitome coming last year when Craig Reynolds, the head of Cigars International, was promoted to become the head of STG’s premium cigar division, i.e. the boss of the new boss of General Cigar Co.

People like Reynolds and Rob Norris, the head of JR Cigar, were becoming more and more important even before FDA, but as the cost of marketing cigars becomes more expensive, their skills and leadership are even more valuable, and as such, their influence within larger companies is growing.

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I think many cigar companies believe the retail markets in many cities can drastically improve. How true that is remains to be seen, I’ve yet to hear anyone describing the new stores from Davidoff or Imperial as immense successes sales-wise, but it’s still quite early.

If you were to look at the U.S. retail markets like a game of Monopoly, the board is quickly filling up with people acquiring properties right next to each other.

• Houston — Davidoff (one store); Imperial (four stores)
• Las Vegas — Davidoff (franchise store); Imperial (franchise store)
• New York City — Davidoff (three stores); Imperial (two stores); STG (Club Macanudo)
• Pittsburgh — Davidoff (affiliated Blend Bar by Davidoff); Rocky Patel (planned Burn location)

There will be more cities where multiple companies open up stores or franchises and it’s going to happen at a quicker and quicker pace, somewhat due to FDA, but more because of point number four.

4. THIS IS A REACTIONARY BUSINESS

Shortly after publishing the news about Serious Cigars, a thought popped into my head: what is going through the heads of the people at Davidoff and STG?

The cigar business is very reactionary and because of the Monopoly-like aspect, nowhere is it more reactionary than in this particular genre of the industry.

Two years ago when Davidoff was announcing a host of new stores in the U.S., it certainly accelerated the plans for what Imperial had in mind for its own retail expansion. While people at both companies might argue that Casa de Montecristo and Davidoff of Geneva since 1911 don’t compete with each other—they do, and they know it.

There’s good locations and bad locations to put a store. There’s timing. And there’s also market size.

Davidoff, Imperial and STG probably cannot all open or acquires stores in Omaha, Neb. within a one-year period. The market—as I understand it—is probably not big enough for all three, it may not even big enough for one. There are only so many cities where these larger companies can see retail profits that justify the investment in build-out, the potential cannibalization of products from existing stores and the negative reactions from indepedently-owned stores who don’t like the idea of competing against a supplier.

And the list of retailers that are probably worth acquiring is substantially smaller than the number of cities that are profitable.

Imperial has now acquired two chains, both unique in many regards and both anchors in major cities. Just like in Monopoly when the stack of unclaimed properties begins to dwindle lower and lower, people become more aggressive and I expect we see a similar situation play out in a very real game.

5. BRICK & MORTAR STORES MIGHT HELP CIGAR COMPANIES SELL THEMSELVES

On May 5, the phone calls came. People were angry, confused, scared and plenty of other emotions. There also was a lot of talk—including publicly—about companies being for sale.

The talk then was about smaller cigar companies being acquired by larger companies, but now, largely unrelated to FDA,[ref]The regulation of e-cigarettes by FDA certainly is playing a part in the talks between larger tobacco companies.[/ref] there are talks about the largest tobacco companies being for sale. Two weeks ago news broke that British American Tobacco had made an offer to buy Reynolds American. While the deal had about zero direct cigar implications, British American Tobacco does own the Dunhill brand, it would create the largest publicly traded tobacco company in the world.

This past Monday, Japan Tobacco International (JTI) publicly stated it was interested in acquiring companies and there is already speculation that Imperial could be its main target.

While many thought FDA would lead to large companies like Davidoff, Imperial, STG and others acquiring smaller cigar companies—something that could happen—there’s also a very real possibility that one of the large cigar companies, or its parent, could also be acquired.

Making investments into buying existing retailers or opening up new brick and mortar stores would be logical if a company were to be acquired as the retail stores would be valued at their potential earning capabilities for tomorrow, not whatever the register says today.

The big three are all in very different places. Oettinger Davidoff AG is a family run company, STG became a public company this past year and Imperial is a gigantic corporation where the cigar business is not a very large piece of the pie.

That being said, when a company like JTI—a $76 billion company—says it is looking to acquire, anything is possible.

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