Two of the biggest American tobacco companies said Friday they were in talks to merge -- 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 complex transaction -- involving not only the two companies, but also British American Tobacco and the Imperial Tobacco Group -- could be announced as soon as early next week, according to people briefed on the matter.
Under the proposed terms of the deal, Reynolds American would buy Lorillard to create a company with a combined market value of more than $56 billion. It would then sell several billion dollars' worth of brands and other assets to Imperial, raising the smaller British rival to the No. 3 position in the United States and potentially assuaging antitrust concerns.
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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. E-cigarettes already have about $2.5 billion in annual sales. Though that is a tiny fraction of the overall tobacco market, e-cigarettes sales are expected to grow quickly in the coming years. 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 needed 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 U.S. companies. And British American Tobacco, 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 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.
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 Co., the maker of American Spirit cigarettes; and American Snuff Co., the maker of Kodiak smokeless tobacco. Reynolds posted net sales of $8.3 billion in 2013.