DealBook: Reynolds in Talks to Acquire Lorillard in Merger of Tobacco Rivals

Photo Reynolds American is the parent company of R.J. Reynolds, the maker of Pall Mall and Camel cigarettes.Credit Keith Srakocic/Associated Press

Updated, 12:18 p.m. |

Two of the biggest American tobacco companies said on Friday that they were in talks to merge and create a $56 billion colossus in cigarettes — a move to cut costs and shore up profits as the number of smokers shrinks.

A deal between the second-biggest tobacco company in the United States, Reynolds American, and No. 3 Lorillard would unite the maker of the brands Camel and Newport and would create a formidable rival to the industry leader the Altria Group, home of Marlboro.

The merger discussions represent the industry's boldest response yet to a declining, if still profitable, market. Declining smoking rates generally and aggressive public health campaigns aimed at curbing smoking have cut into sales in the United States.

About 42 million people in the United States, or about 18.1 percent of the adult population, smoke cigarettes, according to the Centers for Disease Control and Prevention. That compares with about 20.9 percent of the adult population nearly a decade ago and 42.9 percent of the adult population in 1965, according to the centers.

Lately, the industry has seen opportunity in the new business of e-cigarettes. While e-cigarette sales are a tiny fraction of tobacco sales, both Reynolds and Lorillard have recently made big pushes into e-cigarettes. A merger could give the companies sufficient scale for the technology and the promotion need to make what is now a small niche a bigger market.

"This transaction in our view will be very positive for the global tobacco industry and could be the just the beginning of future transactions with e-cigs/vapor being the underlying catalyst," Wells Fargo analysts wrote in a note.

A merger would also have ripple effects in the global market. Imperial Tobacco of Britain, owner of Gauloises cigarettes and Montecristo mini cigars, is considering the acquisition of some assets and brands from the two American companies. And British American Tobacco, is Reynolds' largest shareholder with a 42 percent stake, is backing a merger. Reynolds said that British American Tobacco would seek to maintain a 42 percent stake in the combined company.

The announcements on Friday came after Imperial Tobacco said it was in discussions on potential purchases.

"The discussions are consistent with RAI's strategy of considering a variety of options to enhance shareholder value," Reynolds said in a statement.

In midday trading, shares of Reynolds were down 2 percent, while Lorillard shares were up 3.5 percent.

Media reports emerged earlier this year that Reynolds and Lorillard were discussing a potential tie-up.

The companies on Friday did not disclose financial terms for the potential merger. Lorillard has a total enterprise value of $24.6 billion, according to Standard & Poor's Capital IQ.

Given the influence on the market that a combined Lorillard-Reynolds could potentially exert, the companies will probably have to sell brands or some assets to win approval from antitrust regulators. The combined company would have 42 percent of the tobacco market in the United States, according to Credit Suisse research, leaving it a duopoly with Altria.

Still, Reynolds, in its regulatory filings, has described the United States as "a mature market in which overall consumer demand has declined since 1981, and is expected to continue to decline."

In response to changing attitudes about smoking, Lorillard agreed to acquire the maker of Blu, an electronic cigarette, two years ago. It purchased Skycig, a British e-cigarette company, in 2013 and introduced the Blu brand to the British market this year.

Reynolds is the maker of Vuse, a competing e-cigarette.

In the first quarter, Lorillard had net sales of $57 million from its e-cigarette business, where it accounts for about 45 percent of all sales in the United States. Lorillard had net sales of $1.59 billion in the first quarter and net sales of $6.7 billion in 2013.

Founded in 1760, Lorillard, based in Greensboro, N.C., is the oldest continuously operating tobacco company in the United States. Its brands include Newport, Kent, True, Maverick and Old Gold.

Reynolds, based in Winston-Salem, N.C., is the parent company of R.J. Reynolds, the maker of Pall Mall and Camel cigarettes; Santa Fe Natural Tobacco Company, the maker of American Spirit cigarettes; and American Snuff Company, the maker of Kodiak smokeless tobacco. Reynolds posted net sales of $8.3 billion in 2013.

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