Reynolds American, Lorillard in Advanced Talks to Combine, Source Says -- Update

By Dana Mattioli and Mike Esterl 

Reynolds American Inc. and Lorillard Inc. are in advanced talks to combine in a deal that would dramatically reshape the U.S. tobacco landscape, creating a powerful No. 2 to industry leader Altria Group Inc., according to a person familiar with the matter.

The potential takeover would combine leading Reynolds cigarette brands such as Camel and Pall Mall with Lorillard's Newport, the top-selling menthol cigarette, at a time when the $100 billion U.S. tobacco industry is wrestling with flagging cigarette sales.

It would also give Winston Salem, N.C.-based Reynolds a commanding position in the fast-developing market for electronic cigarettes, the battery-powered heating devices that turn nicotine-laced liquid into vapor, and represent a growing alternative to traditional smokes.

Lorillard's blu e-cigarette has nearly a 50% market share in U.S. gasoline and convenience stores. Reynolds has been slower to dive into e-cigarettes, which could top $2 billion in U.S. sales this year. Reynolds plans to begin a national rollout of its Vuse e-cigarette next month, after launching the product in Colorado and Utah in recent months.

A tie-up would also create international ripples. U.K.-based British American Tobacco PLC, maker of Kent and Dunhill cigarettes, owns a 42% stake in Reynolds and would likely have a major say in any deal. A 10-year standstill agreement between British American and Reynolds expires in July, when it can make an unsolicited offer for the Reynolds shares it doesn't currently own.

Talk of potential deals involving the three companies has coursed through financial markets and periodically surfaced in media reports for months.

Reuters reported earlier Wednesday that Reynolds was in active discussions to buy Lorillard in a three-way transaction in which British American could take a major role.

Reynolds, Lorillard and BAT declined to comment on any potential talks.

Reynolds's share price rose 4.4% to $59.77 Wednesday, bringing its stock market capitalization to $32 billion. Lorillard's shares closed 10% higher at $62.63, pushing its stock market capitalization above $22 billion.

Any deal would likely carry a heavy dose of risk.

The U.S. Food and Drug Administration is considering curbs on menthol cigarettes after it banned all other cigarette flavors in 2009. That poses a significant regulatory threat for Lorillard--which derives more than 80% of its revenue from menthol--or anybody that acquires it. A final ruling from the FDA could be months or years away.

It also would likely face antitrust scrutiny, placing about 90% of the U.S. tobacco industry in the hands of two companies. Reynolds has a roughly 25% share and Greensboro, N.C- based Lorillard has a roughly 15% market share. Altria, maker of Marlboro cigarettes, controls about 50% of the market.

Senior Lorillard executives were called into an urgent meeting Wednesday on short notice, according to a person outside the company.

Speculation of a potential deal was heightened when Reynolds announced unexpectedly last month that Daniel Delen would retire as chief executive at the end of April. Mr. Delen was replaced by Susan Cameron, who had retired as CEO in 2011 but rejoined Reynolds's board last December.

Ms. Cameron ran Reynolds for seven years, overseeing the company's integration of rival Brown & Williamson after the two U.S. companies combined in a $3 billion deal in 2004. Brown & Williamson had been BAT's U.S. subsidiary.

Reynolds and Lorillard last year had net sales of $8.24 billion and $4.97 billion, respectively, excluding excise taxes.

Write to Dana Mattioli at [e-mail] and Mike Esterl at [e-mail]

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