(USA Today) -- As the U.S. cigarette market dips, the nation's second-largest tobacco company Reynolds American announced Tuesday that it plans to buy the third-largest one Lorillard for about $27.4 billion, creating a rival for market leader and maker of Marlboros Altria Group.
Reynolds, maker of Camel and Pall Mall, will acquire Lorillard, maker of Newport, for cash and stock valued at $68.88 per Lorillard share. The deal is one of the largest ever in the tobacco industry and will likely face scrutiny from regulators.
To allay regulators' concern, the companies said they would sell some of their smaller brands to Imperial Tobacco for $7.1 billion, making Imperial the third U.S. largest tobacco company with a 10% market share. Reynolds will sell Winston, Kool and Salem, which account for a combined 5% of the cigarette market, and Lorillard will sell its e-cigarette brand blu eCigs, which dominates the expanding market for electronic cigarettes.
The news may surprise some industry analysts who expected Reynolds was partly interested in Lorillard for its blu eCigs brand, which it acquired in 2012.
Yet Reynolds' president and CEO Susan Cameron, in announcing the deal, made clear that the company plans to take on the e-cigarette market with its own new VUSE product, recently rolled out nationally. She said VUSE offers "superior technology" and told investors Tuesday that Reynolds is ramping up the brand's production. "We're selling it very quickly," she said.
Reynolds stock dipped nearly 3% in pre-market trading Tuesday while Lorillard's shares fell 5% to $63.80 per share. Both companies' shares closed slightly higher Monday.
The consolidation could boost the ability of Winston Salem, N.C.-based Reynolds to take on Altria Group Inc., owner of Philip Morris USA, which alone commands 46% of the U.S. cigarette market, according to Euromonitor International. Reynolds currently has 25% of the market mostly because of Paul Mall and Camel, which each comprise 8%. Lorillard has 12% due almost entirely to Newport.
The market for conventional cigarettes has steadily fallen, shrinking nearly a fifth between 2008 and 2013, as the share of U.S. adults who smoke them has fallen from 42% in 1965 to 33% in 1980, 25% in 1995 and 18% in 2012, according to data from the Centers for Disease Control and Prevention.
In contrast, sales of other types of tobacco that have not faced the same degree of federal regulation and taxation - -- notably smokeless, hookahs and e-cigarettes -- have fared better so cigarette makers have been diversifying their product lines.
"This is a win-win," Cameron told investors in a morning conference call. In the company's announcement, she said the Reynolds and Lorillard have "complementary core strengths and the addition of Newport to our operating companies' existing key brand portfolios – including flagship brands Camel, Pall Mall, Natural American Spirit and Grizzly – will enhance our ability to compete in the combustible cigarette and smokeless categories."
British American Tobacco will maintain its 42% ownership of Reynolds, and Lorillard shareholders will hold 15% of newly expanded Reynodls' shares. Cameron said the acquisition will give Reynolds "additional resources to invest in innovation, R&D and its operating companies' brands."
That worries public health advocates. "There's serious concern that a merged company with increased resources poses a real threat to increased tobacco marketing to America's kids," says Matthew Myers, president of the Campaign for Tobacco-Free Kids.
"This is a marriage of Joe Camel and Newport -- two brands that have played a major role in youth tobacco use," Myers said.
Michael Lavery, tobacco analyst at New York-based CLSA Americas, said the deal will enable Reynolds to consolidation production, sales and overhead. "There's real savings there," he said.
Lavery also questioned the deal because of uncertainty about federal regulation of menthol cigarettes, which comprise 85% of Lorillard's total sales. The U.S. Food and Drug Administration has banned other flavors in cigarettes and issued a report last year that said menthol cigarettes contribute to youth tobacco addiction. The FDA, which has proposed rules for e-cigarettes, has not said whether it will regulate or ban menthol.
"It's a lot of money to spend without knowing that," Lavery said.