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Reynolds, Lorillard to Combine Forces in $27B Deal

NEW YORK (The Deal) -- Camel maker Reynolds American (RAI - Get Report) said Tuesday it had agreed to buy Newport producer Lorillard (LO) for $27.4 billion, including assumed debt, in a deal that hands a supporting role to the U.K.'s two leading tobacco companies.

The two North Carolina tobacco groups said they had forged a firm agreement for Reynolds to pay $68.88 per Lorillard share, breaking down into $50.50 in cash and 0.2909 of a Reynolds share. As part of the deal, British American Tobacco plc will invest $4.7 billion to maintain its stake in the enlarged Reynolds at 42%, while the combined entity will sell $7.1 billion of assets, including the KOOL, Salem, Winston, Maverick and blu eCigs brands, to Imperial Tobacco Group plc.

Those disposals will generate net proceeds of $4.4 billion for the Winston Salem, N.C., seller and more than triple Bristol, England-based Imperial's share of the U.S. cigarette market, to 10%.

The agreement ended months of speculation about a Reynolds-Lorillard combination and will create an entity with more than $11 billion of sales, and operating profit of about $5 billion. That compares with Marlboro maker and global market leader Altria Inc.'s $24.5 billion of revenue in 2013, and operating profit of $8.1 billion. Lorillard shareholders will have 15% of the enlarged equity, the companies said.

"This transaction will result in substantial synergies as well as growth opportunities for the new company," said Reynolds president and CEO Susan Cameron in a video presentation.

She will retain that role, while Lorillard's Murray Kessler, who is president, chairman and CEO, will join the Reynolds board upon closing.

Reynolds said it expects to achieve cost savings of about $800 million from the purchase, which it said will boost Reynolds' earnings in the first full year, with strong double-digit accretion from the second year.

Reynolds said it is offering a 40.4% premium to Lorillard's closing price on Feb. 28, just before speculation began about a deal. But the target's shares fell 7%, or $4.73, to $62.50 in early New York trading, as Reynolds' shares declined 3.2%, or $2, to $61.18.

As well as the Reynolds brands, Imperial Tobacco will acquire Lorillard manufacturing and R&D facilities in Greensboro, N.C., and 2,900 employees, as part of the side-deal. Imperial's own shareholders need to approve that deal for it to proceed.

Imperial said the net cost will be $5.6 billion, after adjusting for tax benefits, or 6.9 times Ebitda.

It plans to finance the purchase through debt, and noted that it expects the deal to be "significantly EPS enhancing in the first full year." It added that it will suspend a £500 million ($858 million) annual share buyback program.

For its part, British American Tobacco said it would suspend its own £1.5 billion share buyback program after striking the investment deal with Reynolds. It will fund the purchase of new Reynolds shares with existing resources and debt, and will only proceed if Reynolds buys Lorillard.

British American Tobacco shares were down 1.2%. Imperial Tobacco shares were down 2.3% by midafternoon in London.

A Lazard team including Antonio Weiss, Maxence de Gennaro and Marc Weidner is lead adviser to Reynolds, which is also taking advice from JPMorgan Chase & Co. Reynolds received legal advice from a Jones Day team including Randi Lesnick, Jere Thomson, Craig Waldman, Joe Sims, Dan Hagen and Warren Nachlis.

Lorillard's financial advisers are Centerview Partners LLC and Barclays plc. Its legal adviser is a Simpson Thacher & Bartlett LLP team led by Rob Spatt.

British American Tobacco's financial advisers are Deutsche Bank AG's Nigel Meek, James Ibbotson and Jim Stynes; and UBS' Nick Reid and James Robertson.

A Cravath, Swaine & Moore LLP legal team led by Philip A. Gelston and Ting S. Chen and including Michael L. Schler and Christine A. Varney is advising British American Tobacco.

Imperial Tobacco's advisers are Credit Suisse Group AG's Ian Carnegie-Brown, Charles Donald and Dan Schleifman; and Goldman, Sachs & Co.'s Anthony Gutman, Philip Shelley and Owain Evans.

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