Updated from 9:39 a.m. EDT to include updated share prices.

NEW YORK (TheStreet) –– Reynolds American (RAI) confirmed Friday it was in talks to acquire smaller rival Lorillard (LO) following news that London-based Imperial Tobacco said it would buy certain assets and brands owned by both companies, essentially forcing the hand of the companies to admit to merger talks.

In a statement, Greensboro, N.C.-based Lorillard said, "No agreement has been reached and there can be no assurances that any transactions will result. Unless circumstances dictate otherwise, Lorillard does not intend to make any additional comments regarding this matter."

The news comes after Reuters first confirmed the talks in May, citing sources close to the negotiations.

Any deal would have to be approved by London-based British American Tobacco (BTI), since it owns 42% of Reynolds American. As part of the deal, Imperial Tobacco would potentially buy up to $7 billion worth of brands from the combined companies, who are best known for brands such as Newport (Lorillard) and Camel (Reynolds), putting pressure on Philip Morris USA, a division of Altria (MO)as the largest tobacco maker in the United States. Newport is the largest menthol cigarette brand in the U.S., while Lorillard's blu eCigs brand, is "the clear U.S. electronic cigarette category leader, achieving a 45% dollar market share," according to the company's first-quarter results.

Lorillard also noted that its total retail market share of cigarettes exceeded 15% for the first time ever, coming in at 15.2% for the first quarter.

Shares of Lorillard finished sharply higher Friday, gaining 4.6% to $66.01, while Reynolds American shares fell 0.82% to $61.75. 

Altria is set to issue second-quarter results on July 22. Analysts surveyed by Thomson Reuters expect the company to earn 66 cents a share on $4.59 billion in revenue. Altria, which owns the Marlboro brand, had 43.7% of the domestic U.S. cigarette market, and 50.6% of the overall market when including other brands in 2013, according to the company's Web site.

Tobacco stocks have performed well this year, with Altria gaining 11.9% year to date while Reynolds American and Lorillard have performed even better, largely due to the merger talks. Reynolds American shares have gained 24.5% year to date, as have shares of Lorillard.

On the back of these confirmed merger talks, here's what a few Wall Street analysts said recently about the tobacco industry, as consolidation becomes a large part of the discussion and investment thesis.

Nomura analysts

"While we still see upside for Reynolds (Buy, USD 66 TP) on a standalone basis should a Reynolds merger not materialise, the risk for Lorillard (Reduce, USD 54 TP) is that if this does not happen, there is potential for significant downside. We have already suggested in another note that discussions could in fact be aimed/limited to a contract manufacturing agreement (Not all relationships need to be consummated, dated 18 June)."

Wells Fargo analyst Bonnie Herzog

"Based on reports from both the Financial Times and Bloomberg tonight (7/10), it appears a deal between RAI and LO, with the blessing of BAT, could be announced very soon. We reiterate our Outperform ratings on both RAI and LO and our 90%+ probability that this deal is going to happen, creating value for both RAI and LO shareholders. Based on our updated acquisition analysis, we expect RAI to pay a 20% premium to LO's 7/10 closing price of $63.09 incorporating synergies and cost savings of over $500MM, with the deal to be accretive immediately. We continue to anticipate Imperial/Commonwealth will acquire several of the smaller/non-priority brands in an attempt to pre-empt any potential FTC anti-trust issues. Finally, we anticipate that BAT could inject some capital by retaining its current 42% ownership of RAI in the combined entity as well as announce a strategic
partnership with the combined RAI/LO entity to market and distribute both Vuse and blu e-cigs internationally. Bottom line, this transaction in our view will be very positive for the global tobacco industry and could be just the beginning of future transactions with e-cigs/vapor being the underlying catalyst. We reiterate our Overweight sector rating and expect both RAI and LO to trade up sharply tomorrow."

Cowen analyst Vivian Azer

"We are initiating coverage of U.S. tobacco, and rate MO Outperform, RAI and PM Market Perform, and LO Underperform. We continue to believe U.S. category fundamentals remain healthy, but worry about valuations in the absence of M&A. Internationally, the outlook is more murky, as headwinds in key markets continue to present challenges for PM."

We think LO's valuation is stretched as we do not believe an acquisition will occur. At the right price, we think a deal could have made sense, but we expect that regulators will require a sale of Camel (given the HHI implications for a Camel + Newport merger when considering HHI's specific to 18-25 year old consumers, as well as the menthol sub-category). A sale of Camel limits some the accretion benefits, and thus should make RAI more valuation-sensitive, given the notable multiple expansion we have seen for LO."

-- Written by Chris Ciaccia in New York

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