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Reynolds, Lorillard to reshape Big Tobacco with merger

Reynolds American and Lorillard are in the final stages of agreeing a complex merger that will reshape Big Tobacco by bringing together the two biggest US operators with a combined market capitalisation of $56bn.

The deal will have a knock-on effect on the two big UK rivals, British American Tobacco – which holds 42 per cent in Reynolds – and Imperial Tobacco, which has confirmed it will buy assets from the merged group.

Read MoreTobacco majors Lorillard and Reynolds American near merger

Chris Goodney | Bloomberg | Getty Images

Reynolds, Lorillard and BAT have agreed key elements of the deal, including price, and are finalising details such as which cigarette brands and production facilities to dispose of in order to assuage antitrust concerns.

Negotiations between the three companies, which have gone on since early this year, have intensified in recent days and the parties hope to announce a deal as soon as next week, according to people familiar with the matter. No deal is certain, however, and the talks could still fall apart, these people said.

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The FT first reported in March that Reynolds and Lorillard, the second and third largest tobacco producers in the US, respectively, were working on the proposed merger. But concerns about the response from competition regulators and the complexity of BAT owning a significant portion of Reynolds had stymied efforts to agree a deal.

Reynolds brands include Camel and Pall Mall. Lorillard brands include Maverick, Old Gold and Kent. However, more than 80 per cent of Lorillard's sales come from the Newport brand of menthol cigarettes, which have bucked a long-term decline in US smoking rates.

In terms of market share, Reynolds and Lorillard lie behind Altria, which accounts for more than half of the US cigarette market. The company's Marlboro cigarettes alone have a market share of about 44 per cent.

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Bonnie Herzog, analyst at Wells Fargo, said Imperial could be in the market for several Reynolds brands, including Winston, Salem, and the Kool menthol brand.

"Bottom line, this transaction in our view will be very positive for the global tobacco industry and could be just the beginning of future transactions with e-cigs/vapour being the underlying catalyst," she said.

The transaction also raises questions for Japan Tobacco, which has made a big push into Europe but looks set to be effectively "shut out" from the US, said Chris Wickham, analyst at Oriel Securities.

"In the US you will have Altria, Reynolds-Lorillard, followed by Imperial. I don't see Japan Tobacco among those names," he said.

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The wider US cigarette market, with annual sales of $90bn, has been shrinking at a rate of 3 per cent a year.

Founded in New York in 1760, Lorillard controlled 11.7 per cent of the North American tobacco market in 2012, according to Euromonitor, compared to Reynolds' 25 per cent and Altria's 41.5 per cent.

Reynolds and Lorillard did not immediately return requests for comment.

Imperial's shares were up 3.5 per cent at £27.51 in early Friday trading. It said on Friday: "Imperial confirms it is in discussions with Reynolds and Lorillard to evaluate a possible acquisition of certain assets and brands owned by Reynolds and Lorillard."

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The move echoes the fallout from the 1999 merger of BAT with Rothmans International, when Imperial picked up 16 per cent market share in Australia as part of moves to satisfy regulators in the country.

BAT shares rose 1.4 per cent to £35.70 in early trading.

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