RICHMOND, Va. -- Cigarette-maker Reynolds American (RAI) is planning to buy rival Lorillard (LO) for about $25 billion in a deal to combine two of the nation's oldest and biggest tobacco companies.
The deal announced Tuesday would create a formidable No. 2 to rival Altria Group (MO), owner of Philip Morris USA, and will likely face scrutiny from regulators. It also could spur a wave of consolidation in the tobacco business, shrink factories and workforces, and push prices for cigarettes higher even as smokers buy fewer of them. The companies value the deal, which is expected to close in the first half of 2015, at about $27 billion including debt.
The companies said they will sell the Kool, Salem, Winston, Maverick and Blu eCigs brands to Imperial Tobacco Group for $7.1 billion to ease regulatory concerns about competition, tripling that company's share of the U.S. cigarette market. Imperial also will acquire Lorillard's manufacturing and research and development facilities in Greensboro, North Carolina, and about 2,900 employees. Imperial owns Fort Lauderdale, Florida-based Commonwealth-Altadis, maker of USA Gold cigarettes.
The move allows Reynolds to keep its Camel, Pall Mall and Natural American Spirit brands and acquire Lorillard's flagship Newport brand, giving it a 34 percent share of the U.S. retail market. It also will give it a dominant place in the still-growing menthol cigarette segment, led by Newport's 37 percent retail share.
"We're very confident that this portfolio of strong, iconic brands lives together very well," Reynolds CEO Susan Cameron said in a conference call with investors.
Lorillard shareholders would receive $50.50 in cash for each share and 0.2909 of a share in Reynolds stock at closing, a deal that's valued by the companies at $68.88 per share.
The deal comes as demand for traditional cigarettes declines in the face of tax increases, smoking bans, health concerns and social stigma. U.S. cigarette sales fell about 2.6 percent last year to 285 billion cigarettes, according to market researcher Euromonitor International.
But raising prices and cutting business costs has kept the industry handsomely and reliably profitable. The companies also have cut costs to keep profits up, and the larger scale of a combined company could make future cost-cutting easier. Reynolds expects to save about $800 million a year in costs.
The next step for tobacco companies is an increased focus on cigarette alternatives -- such as electronic cigarettes, cigars and smokeless tobacco -- for sales growth.
In addition to its cigarette brands, Reynolds, based in Winston-Salem, North Carolina, markets Grizzly and Kodiak smokeless tobacco brands and also expanded its Vuse brand e-cigarette nationally last month. It has about 5,200 full-time employees and produces its cigarettes at its 2 million-square-foot Tobaccoville, North Carolina, plant. Reynolds' profit rose 35 percent to $1.72 billion last year on revenue of $8.24 billion, excluding excise taxes.
Lorillard, which was founded before the Revolutionary War and is the oldest continuously operating U.S. tobacco company, was spun off from Loews Corp. (L) in 2008. It became the first major tobacco company to jump into the e-cigarette market when it acquired the Blu e-cigarette brand in 2012. Blu now accounts for almost half of all e-cigarettes sold. Lorillard's profit rose 8.5 percent to $1.19 billion last year on revenue of $4.97 billion, excluding excise taxes.
The combined company would challenge Richmond, Virginia-based Altria, which holds about half of the retail cigarette market, led by its top-selling Marlboro brand. It also sells Black & Mild cigars, Copenhagen and Skoal smokeless tobacco and is expanding MarkTen e-cigarette brand nationally.
Altria, Reynolds American and Lorillard all sell cigarettes only in the U.S. Other companies sell their brands overseas.
The companies said British American Tobacco, which makes Kent and Dunhill cigarettes overseas will maintain its 42 percent stake in Reynolds, and Lorillard shareholders will hold a 15 percent stake. Reynolds and British American Tobacco also agreed to share technology related to the development and commercialization of next-generation tobacco products, including heat-not-burn cigarettes and other nicotine-delivery products.
Lorillard's stock fell $3.62 to $63.60 in premarket trading. Reynolds' stock fell $1.58 to $61.60.