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Shares of both Lorillard Inc. (LO - Analyst Report) and Reynolds American Inc. (RAI - Analyst Report) reached their 52-week highs on Mar 4 after a media report stated that Reynolds American is considering the takeover of its rival Lorillard. Shares of Lorillard touched a 52-week high of $56.85 and eventually closed at $55.26, whereas Reynolds American’s shares attained a high of $56.48 and closed at $56.31 on Mar 4.

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On Mar 3, Financial Times reported that Reynolds - the maker of Camel brand cigarettes has hired Lazard Ltd (LAZ - Analyst Report), which operates as a financial advisory and asset management firm, to look for a possible deal with the third largest U.S. cigarette company, Lorillard. The report also stated that the purchase price could be more than $20 billion. However, it is unclear whether Reynolds plans to bid for the whole company or only a portion of it.

Reynolds’ acquisition of Lorillard, if it materializes, is expected to consolidate the tobacco industry and bring in growth opportunities. Lorillard’s Newport brand holds the number one position in the menthol cigarettes market in the U.S. Lorillard also has a solid footprint in the profitable electronic cigarettes market with its blu e-Cigs brand (acquired in Apr 2012) and UK-based SKYCIG (acquired in Oct 2013).

Both Reynolds and Lorillard are the biggest tobacco sellers in the U.S. after peer Altria Group Inc. (MO - Analyst Report), which makes Marlboro cigarettes. While a combination of these two companies and their leading brands would change industry dynamics – possibly creating one of the strongest global tobacco companies, it might also pose a threat to Altria. However, Reynolds’ largest shareholder, U.K.-based British American Tobacco (BATS), which owns 42% share in the company, would have to approve the deal. Regulators could also pose an obstacle to the deal to protect the U.S. tobacco industry from becoming a duopoly.

Tobacco companies have been facing declining cigarette volumes and regulatory restrictions for years. The slowdown in the tobacco industry, increasing health consciousness among consumers and significantly higher prices of cigarettes have impacted volumes. In addition, a rise in the number of people who quit smoking has also impacted sales. E-cigarettes and menthol variants are also under scrutiny by health regulators. The tobacco industry in Europe also received a blow after the Presidency of the Council of the European Union (EU) and the Members of European parliament reached a settlement recently on a draft legislation, which could curb the growth of the e-cigarettes industry. Any setback on these fronts could hinder any such tobacco deal.

Currently, Lorillard has a Zacks Rank #3 (Hold), while Reynolds holds a Zacks Rank #4 (Sell).

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