By Saabira Chaudhuri in London and Tripp Mickle in Atlanta 

British American Tobacco PLC made a $47 billion takeover offer for the roughly 58% of U.S. peer Reynolds American Inc. that it doesn't already own -- a move that would create the world's largest listed tobacco company by revenue and market value, and shows the rising value the U.S. holds for the shrinking global tobacco industry.

BAT already owns 42.2% of Reynolds, and is offering cash and BAT stock worth $56.50 a share for the rest of the company, representing a roughly 20% premium to Reynolds's closing share price Thursday. BAT said it hadn't had previous discussions with Reynolds's management about the offer before going directly to its board.

Reynolds said Friday that it acknowledges BAT's proposal, and its board will now evaluate the offer and respond. Analysts expect negotiations between Reynolds and BAT ultimately will lead to a higher offer price.

After years of spurning the U.S. because of mounting civil suits, international tobacco companies are returning as they confront declining cigarette volumes and expanding regulations around the globe.

Last year, Reynolds completed its own $25 billion acquisition of Lorillard Inc. after lengthy scrutiny by regulators. That deal upended and further consolidated the U.S. tobacco industry, prompting Reynolds to sell its Kool, Salem and Winston cigarette brands and Lorillard's Maverick to Britain's Imperial Tobacco Group PLC (now Imperial Brands PLC) for $7.1 billion.

Analysts say the elimination of No. 3 Lorillard gives Reynolds and Altria Group Inc., the U.S.'s largest tobacco company by revenue, more pricing power that would allow them to offset declining cigarette volumes with higher prices. The two companies have more than 80% of U.S. cigarette market share.

The U.S. also offers legal protections to the tobacco industry that aren't available overseas. Thanks to free-speech rights under the First Amendment, U.S. companies are protected from plain-packaging rules like the ones sweeping across Europe that require cigarettes be sold in packages without signature logos and colors.

Reynolds emerged from its Lorillard takeover as a much more attractive company because it now has one of the strongest cigarette brands in the U.S.: Newport. The menthol brand, which accounted for almost all of Lorillard's $7 billion in sales in 2014, has been increasing its market share as smokers under 30 years old increasingly opt for minty-flavored cigarettes over traditional smokes.

Beyond tobacco, a combined BAT and Reynolds would also be the world's largest player in so-called next-generation products -- largely e-cigarettes and other vaping products. The two companies already collaborate on this front, last year announcing a technology-sharing agreement for their vapor products.

BAT expects the deal to lead to relatively modest cost savings of $400 million, but said the deal would give it a major position in the U.S. tobacco market in addition to high-growth emerging markets across South America, Africa, the Middle East and Asia.

Despite that sprawling footprint, the deal is unlikely to face antitrust issues.

"The two companies compete in different markets," said Lawrence Hrebiniak, a management professor at the Wharton School of the University of Pennsylvania. "There is no overlap of their respective footprints, which will keep both U.S. and European sheriffs off their backs."

BAT, the world's No. 2 publicly traded tobacco company by volume, behind Philip Morris International Inc., owns cigarette brands including Dunhill, Lucky Strike and Pall Mall. Reynolds, the world's No. 6 by volume, owns Camel and Newport. The U.K. company has been a shareholder in Reynolds since the U.S. firm was created in 2004, and its stake accounts for a hefty chunk of BAT's profits.

The announcement's timing took some by surprise, with Citigroup analyst Adam Spielman noting that BAT could have bought Reynolds before it bought Lorillard, when shares were 57% lower.

BAT Chief Executive Nicandro Durante said BAT's board regularly reviews the shares of Reynolds it doesn't already own and had determined that "current unique industry and market conditions" made now a good time for the acquisition.

BAT's shares have jumped 13% since Britain's June 23 vote to leave the European Union, while Reynolds's have fallen about 7.5%, bringing the companies' price-to-earnings ratios more in line. That, coupled with low interest rates, helped inform BAT's thinking, according to a person familiar with the transaction.

The U.K. company's shares ended down 2.9% in Friday trading, after trading higher most of the London session. Reynolds shares were up 14.3% in midday New York trading.

The deal will hinge on the approval of Reynolds's board -- outside of BAT's own nominees -- which is expected to appoint a seven-person committee to consider the deal, according to a person familiar with the matter. Five people on Reynolds's 14-member board are BAT nominees. BAT said it also expects the deal to seek the approval of the majority of Reynolds shareholders outside of its own stake. Reynolds's top 10 shareholders own about 20% of BAT.

"We would have preferred to present this proposal to the board of Reynolds confidentially," Mr. Durante said. U.S. regulations require the company to announce the merger proposal promptly, which BAT said left it unable to hold prior negotiations with Reynolds regarding the merger.

BAT's offer comes at a moment of transition for Reynolds, which earlier this week said its chief executive, Susan Cameron, would step down next year. The company has struggled with declining tobacco volumes as well as slowing sales of e-cigarettes.

Meanwhile, London-based BAT, with its more diversified footprint, has successfully grown its cigarette volumes. On Friday, it reported organic revenue growth for the first nine months of the year at constant rates of exchange of 6.2%, with cigarette volumes up 0.9%.

The potential deal marks a reversal for the global tobacco industry, which split from the U.S. in the 2000s. In 2004, BAT merged its U.S. unit Brown & Williamson Tobacco Corp. with R.J. Reynolds Tobacco Holdings Inc. in a $4.2 billion deal that created Reynolds American. Four years later, Altria spun off its international business as Philip Morris International Inc., a move designed in part to insulate the fast-growing, lucrative non-U.S. business from American regulators.

BAT's offer increases the likelihood that rival Philip Morris could merge with Altria, Wells Fargo analyst Bonnie Herzog said in a note. She added that she believes Philip Morris won't "idly sit by" as its competitor increases in size and gains access to the lucrative U.S. market.

Philip Morris and Altria spokesmen declined to comment.

--Natalia Drozdiak in Brussels contributed to this article.

Write to Saabira Chaudhuri at saabira.chaudhuri@wsj.com and Tripp Mickle at Tripp.Mickle@wsj.com

 

(END) Dow Jones Newswires

October 21, 2016 14:31 ET (18:31 GMT)

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