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Cigar Industry

Tabacalera's American Gambit

A Madrid-based cigar giant buys a foothold in the U.S. market.
| By Michael Kaplan | From Sylvester Stallone, Mar/Apr 98
Tabacalera's American Gambit

Tradition says that big business deals transpire in smoke-filled conference rooms. You know the drill: attorneys and businessmen sit nose to nose, spending caffeine-fueled days hammering out details, negotiating profit points, splitting the fine hairs of ownership percentages. If this fabled scenario held even remotely true when a landmark deal was recently hammered out amid the historic tobacco houses and cigar-rolling factories of Tampa, Florida, then whatever tension that existed was surely cut by the air's richly alluring scent.

On one side of the table sat Madrid-based Tabacalera, the world's largest importer of tobacco and cigars from Cuba, which aimed to enter America's premium cigar market; on the other side was Havatampa, America's second largest manufacturer of machine-made cigars, such as Phillies and Havatampa Jewels. Surely, when both parties convened, the air turned blue with the fragrant aromas of Tabacalera's fresh-from-the-farm Cohibas, Punches and Montecristos. While Antonio Vázquez, director of cigar operations for Tabacalera S.A. and one of the key players in the series of meetings driving this particular deal, diplomatically insists that Havatampa's smokes were consumed as well--he alludes to the need to be polite in business dealings--it is hard to imagine primo Cubans remained unflamed while Philly Blunt curls filled the air. Whatever the case, when the smoke cleared in early December, Tabacalera--for a price of $275 million--bought a 25 percent share of America's $1.6-billion machine-made and hand-rolled cigar market. "Of course cigars are being smoked," Vázquez said at the time. "Is there any other way to negotiate?" Considering the results, there may not be another that is more effective.

Combining the refined leaf sensibility of Tabacalera with the business savvy that is already built into the infrastructure of Havatampa, the freshly muscled company has the potential to pump itself up into a cigar powerhouse. "When we come out with our brands, they will be very high-class, premium cigars," vows Benjamin Menendez, Tabacalera's director of Central American and Caribbean operations. Hired away from General Cigar for the express purpose of overseeing Tabacalera's burgeoning premium-cigar business for the American market, Menendez has a lifetime of industry experience. He began his tobacco education with an adolescence spent in his family's factory, where cigars were hand-rolled for Montecristo and H. Upmann in pre-Castro Cuba.

One of the world's authorities on cigar blending, Menendez is now creating blends of Dominican, Costa Rican, Nicaraguan and Mexican tobaccos, among others. The cigars are slated for release later this year and will retail in the $5 to $7 range. "We are looking to make an excellent cigar with a darkish wrapper," says Menendez. "It will be a strong but smooth cigar, very round."

Another key personality in Tabacalera's American invasion is Peter Strauss, the recently appointed director of U.S. operations and a fourth-generation cigar professional who served as the matchmaker between Spain's tobacco giant and Havatampa. In his 50 years in the cigar business, Strauss has heard a lot of industry rumors, and one of the things he heard was that the owners of Havatampa, Thomas D. Arthur and W. Tommy Morgan III, were toying with the idea of selling their company to the right suitor. "They did not want to sell to a purely financial buyer or to somebody who would use their company as another factory and take over their brands," recounts Strauss, sitting in the study of his Westchester County, New York, home, which doubles as his office. "They wanted to see the organization remain intact; they wanted to sell to a buyer who would keep the company running as it was running."

Tabacalera was amenable to the request. As Spain's largest tobacco company--and until 1996 its only one--it had been looking to expand its cigar-producing capacity; until now, 90 percent of its business has been in cigarettes and a good chunk of the rest has been in the production of machine-made cigars. The acquisition of Havatampa, as well as two cigar companies in Honduras and Nicaragua, Tabacalera hopes, will allow it to establish a base for building up a premium cigar presence in the States. Since Havatampa's mass-produced business is so good, Tabacalera expresses no interest in tinkering with that end of the operation. This came as welcome news to Havatampa's Arthur and Morgan. Early last year, Strauss arranged for the companies' representatives to become acquainted. Significant degrees of chemistry and dovetailing goals became immediately apparent.

For Tabacalera, the strategic appeal of purchasing Havatampa was instantly clear. "It will give us critical mass in this country," says Strauss, a serious, gray-haired man. "Already it's gotten everyone's attention; it's put us in the game. Plus, Havatampa has an impressive top and middle management, so we want to maintain those people in terms of their place and what they are doing." Does it conflict with Tabacalera's game plan for the premium cigar market? "Distributing premium cigars is the primary focus, but we are in the cigar business. Period. We want to be involved with everything from the little cigars on up to the superpremiums."

While in Tampa shepherding the deal, Strauss learned from the investment banking firm Goldman Sachs that Max Rohr Importers Inc. was up for sale. Not a huge company, but a prestigious niche marketer that specializes in premium cigars and also provides smokers' supplies and gifts ranging from humidors to walking sticks, Rohr was especially alluring for a reason that went beyond the ancillary market.

"They own [the American rights to] some significantly well-known [Cuban] brand names like Romeo y Julieta, Saint Louis Rey and Gispert," says Strauss. Though Rohr's non-Cuban Romeo y Julietas have been in short supply (only one million were released in 1997), Strauss adds, "They have a sales force that is well regarded in the tobacco industry. That gives us entrée to the retailers of high-end cigars. The accessories and gift business is less interesting to us, but when you are servicing the high-grade tobacco industry, you have to be in that end of things in order to be important to the retailer."

Strauss and his colleagues at Tabacalera began negotiating with Max Rohr in May 1997, after outbidding Lew Rothman, the chief executive of 800-JR-CIGAR Inc., and other cigarmakers for the company with a bid of $53 million. The final negotiation "is still not closed yet," says Strauss. "We have some problems with tax issues that need to be resolved." The deal was scheduled to be closed in January.

Once they are sewn up, however, Tabacalera will have invested at least $355 million in the U.S. market without having distributed a single cigar there. In addition to the two acquisitions, that price also includes its purchase of factories in Nicaragua and Honduras (at a total cost of $27 million), both earmarked for the production of high-end cigars under the watchful eyes of Benjamin Menendez. When all is said and done, Tabacalera plans to make its way into America's premium cigar arena with new brands, new blends and a less ghostly presence for Romeo y Julieta. "We will not replace the manufacturer," Antonio Vázquez emphasizes when talking about the non-Cuban Romeo y Julieta's future. "But we will increase its distribution."

Now that Tabacalera has purchased Havatampa and is negotiating to buy Max Rohr, the pressure is mounting on Menendez. Based in the Dominican Republic, he spends much of his time jetting around Central America and the Caribbean, checking with suppliers and gearing up the premium cigar-making operation that will soon be in full swing. A bit like a gourmet chef who's fine-tuning recipes in preparation for the opening of a highly touted restaurant, Menendez is dabbling with various tobacco configurations. Fresh from a trip to Honduras, he has just smoked the latest incarnation of what will eventually hit the market. "It's pretty good," he cautiously says. "But by the middle of [1998] it should be really good."

The creation of a new cigar is an artful process, comprising hit-and-miss experimentation that takes place within tight parameters. "The first thing you do is start smoking the tobacco from different sources," Menendez explains. "Then you start blending and see how it develops. Once it's close to where you want it to be, you start passing the cigars around. You let people taste them. You get their opinions and keep working at it. I have the basic blend right now, but I cannot say what it is." Adding that he is not yet sufficiently satisfied to solicit opinions on his latest creation, he lends the impression that there is little in this industry that matches the passionate rush of giving birth to a new cigar. "I've always loved to play with tobacco and blend different varieties."

By coming out with three variations of his new cigar, Menendez hopes to capture the allegiance of a broad market. "We're going at this in a very serious way and intend to hit all the segments," he says. "But taste is subjective, and we only hope this will be a pleasant smoke. We will give the choice of mild, medium and heavy variations. Then it is up to the public to smoke what it wants."

Saying that Tabacalera predates the cigar boom is to make one of the world's great understatements. The company has been involved with tobacco since its founding in 1636, and today ranks as one of Spain's major corporations. The government-controlled company (in 1998, Spain is expected to sell its 52 percent stake in Tabacalera) has long had a monopoly on the country's cigarette and cigar trade. Before the expansion of the 1990s, the international cigar business didn't hold particular allure for Tabacalera, but with an expanding market and the possibility that the U.S. trade embargo against Cuba would be dropped, the cigar business in the United States looked increasingly appealing. In 1995, the company made an attempt to acquire controlling interest of General Cigar, which would have given it American rights to many of the Cuban brand names it already commands worldwide.

Prior to the arrival of chairman of the board Cesar Alierta in 1996, the company was being run by what Strauss characterizes as "government bureaucrats." Alierta is the polar opposite: well acquainted with free enterprise--prior to joining Tabacalera, he sold his private merchant banking business--the new boss, who graduated from Columbia University with a master's degree in business, entered the firm with his sights set on international expansion.

Spanish investors have responded favorably to this strategy; over the course of Alierta's one-year tenure, Tabacalera's price on the Madrid stock exchange has more than doubled. "Tabacalera's big market," says Strauss, "is cigarettes. But why should anyone beat his head against the wall, competing against giant companies like Philip Morris and Reynolds?"

The international cigar trade must have seemed a lot more penetrable. "Around the world the cigar business is extremely segmented," continues Strauss. "There are a lot of players, but no dominating players. It seemed like a good way to go. Then they realized that if they were going to grow in the cigar business, they should tap the largest available market: the United States, where it is very dynamic."

This realization is not exactly a new one, as borne out by Tabacalera's attempt to purchase a 51 percent controlling interest in General Cigar, one of the three largest premium cigar companies in the United States. The deal (estimated at more than $100 million) fell apart when the two sides could not agree on controlof General, which Vázquez attributes to the difficulty of trying to purchase a controlling interest rather than an entire company. "In the end, General got seller's remorse," adds Strauss. "Also, it's difficult to negotiate from a foreign country with nobody but a lawyer representing you here. Today we would not be talking to these companies and closing these deals if we did not have somebody in this country working away at it--and I am not talking only about myself, I am talking about anyone."

Even with its corporate purchases, Tabacalera will not necessarily have an easy time cracking the American nut. Benjamin Menendez is a master producer of cigars, and he clearly is aiming to create a product that will be palatable to a large number of American smokers. In spite of that, Strauss has been around the business long enough to recognize the challenge of succeeding in the current environment. "We are not coming in at the most opportune moment as far as the premium market is concerned," he says. "It's flattened out and will peak pretty quickly."

He hesitates for a beat and allows that to sink in before continuing. "But we still think there is a lot of opportunity. During the recent period of growth, many newcomers put less-than-high-quality cigars on the market. And there is not enough premium tobacco in the world right now. So people are using tobacco that they have rather than the tobacco that they want. They're forcing blends, they are not aging properly. In the last few years, it was enough just to make cigars. Now that will change."

He's saying, of course, that the American smoker has become more educated about cigars and, as a result, more discriminating. What he has not yet said, though, is how a newcomer like Tabacalera will find its foot-hold with this increasingly discerning consumer base. "Tabacalera has been buying tobacco for a long time, so some of the premium stocks are available to us," Strauss responds. "But even though we're fortunate to have gotten access to a grower in Central America, we are facing the blue mold problems in Connecticut and Ecuador [where wrapper is grown]. It hasn't stopped raining in Ecuador since the beginning of [1997]--and only now are we getting into the rainy season."

There is, however, an up side to all of this. "The interesting aspect of the premium business," Strauss says, "is that the very large ring gauge sizes are the most popular; and the larger the ring gauge, the less influence the wrapper has on the taste. It still influences the appearance and the way it burns, but there are a lot of satisfactory wrappers around the world."

When the Tabacalera people talk about what we can expect from them during the first half of 1998, there is a certain amount of vagueness. They talk about releasing top-end cigars, but don't go into details on what the cigars will be composed of. There are discussions about making the non-Cuban Romeo y Julieta cigar widely available in America, but then nobody seems sure of when we can expect them or how many might be produced. When it comes to brand names and marketing gambits, everyone is mum. All they will say is that their new line--with its mild, medium and heavy varieties--will be highly competitive with similarly priced products that are already in the shops.

While there is quite a bit of optimism about the impact that Tabacalera will have on America's cigar universe, there is also a high degree of uncertainty. "We have significant stocks of premium tobacco right now," allows Strauss, the tone of his voice emphasizing that this is a very exciting time for him and his colleagues. "But what could prevent us from rolling out in a very large way is that the workmanship has to be there. We are not aiming sheerly for numbers. We are producing cigars to produce quality and we will not put them out until they are ready."

Stepping back for a moment and becoming slightly cynical, it is easy to wonder why Tabacalera is getting into the premium cigar business in the first place. Seemingly, it would be an easier and more natural progression for the company, now that it's purchased Havatampa, to instantly become huge in the mass-produced world. Clearly, the infrastructure for that is in place. When you consider that Tabacalera already has a thriving economy cigar business in Spain, it begins to seem like a bit of a no-brainer.

Strauss drives the point home even further, saying "That you can't make a good cigar with a machine is a myth. You can even make a premium cigar with a machine." So why doesn't anyone do it? "Well, the fact is that a good handmade cigar is still better than a good machine-made cigar," he concedes. "But there is a market in the category of the sub-premium cigar--those that range from 80 cents to $1.50. We will continue distributing the ones that are currently being produced for Max Rohr and we will produce some brands that do not yet exist. I can tell you that they will be among the best [of that type] in the trade."

Of course, this further begs the question of why Tabacalera will enter a crowded, unpredictable, financially risky battle for the loyalties of upscale smokers. Strauss smiles and says, "The profit margins for premium cigars are significant. Premium cigar earnings are what allowed Consolidated and General to put issues on the stock market." Then he looks determined as he adds, "Beyond the money, though, there is an element of pride. To produce a handmade cigar and successfully market it, that gives people a bigger kick than producing a mass-merchandised cigar."

For Tabacalera, another big kick will surely come when the United States finally lifts its embargo on Cuban imports. Asked to guess when sanctions will be done away with, Strauss offers an optimistic opinion: "I think the embargo on Cuban cigars will be lifted sooner rather than later. I have a philosophy that if the Pope makes his visit to Cuba in 1998, that will begin the process for the embargo being lifted. It's totally the antithesis of this country's philosophy for dealing with totalitarian regimes; normally we engage them in a way that may lead to democratization. China, with its favored nation status, is an example of that. If you let them be pariahs, like Cuba and North Korea, then there is no opportunity to force change. The reason we do this regarding Cuba is because of our domestic politics. The Cuban émigrés are a potent force and they are understandably opposed--as we all are--to Castro. But all [the embargo] does is make things worse for the people of Cuba, not better. Now that Clinton doesn't have to be reelected, I think we will see something happen by the end of his term."

At that point Tabacalera will be in an extremely enviable position. Its solid relationship with Cuban tobacco growers, combined with the ownership of classic Cuban brand names, will leave it poised to capitalize on Cuban smokes in the United States. Strauss agrees with this before offering an interesting caveat. "Cuban cigars will not take over this country," he contends. "First of all, they will not have the production to do that. Second, the Cuban cigar is not to the American taste. Cuban cigars are very strong, very heavy, and the old adage was that nobody ever finished a Cuban cigar. The taste in this country is cultivated by Honduran, Dominican, Nicaraguan and Mexican tobaccos--all of which are much lighter than Cuban tobacco."

This is not to say that Strauss fails to see Cuban tobacco enhancing the enjoyment of cigar smoking--and, particularly, Tabacalera cigar smoking. While musing on the subject, Strauss fondly recalls the old Robert Burns panetela, with its 70-30 mix of Cuban and Puerto Rican tobaccos. "Once the embargo lifts, I believe one of the preferred blends will be a combination of Cuban and other high-quality tobaccos," he says. "The opening of trade will benefit the blends of cigars, but it will not leave us smoking pure Havana blends only."

And, no doubt, Strauss sees Tabacalera, with its blends by Menendez and brand names courtesy of the pre-Castro past, potentially at the forefront if the United States does reopen its doors to Cuban products. If he is right that the embargo will be lifted by the completion of Clinton's term, Tabacalera will have had a leisurely shot at establishing itself in America. That kind of conservative time frame plays into Peter Strauss's aversion to rushing or forcing things. While hoping that there will be enough early hype "to get us rolling and to generate interest, I don't expect to build Rome in a day," he says. Strauss's game plan contrasts with what has been the popular (and often fatal) wisdom for newcomers during cigar smoking's recent boom years: "I see success in this business as being gradual. If I have a splash to begin with and can't produce the product, then I ruin everything. The right advertising and marketing campaigns are needed, but it's quality merchandise that is really important. That will win out in the end."

Michael Kaplan is a freelance writer based in New York City.

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