The deal would create the world’s largest listed tobacco company by sales, and would return BAT to the US market 12 years after folding its US subsidiary Brown & Williamson — whose troubles the 1999 film The Insider were based on — into Reynolds for a large minority stake.

Reynolds has informally told BAT it is open to a deal, but will need its London-based rival to increase its cash and stock offer, according to people briefed on the negotiations. BAT is said to be ready to moderately increase its tender if needed, said two people briefed on the company’s strategy.

After receiving BAT’s bid, Reynolds hired Goldman Sachs to help them negotiate a better deal, those people said, while Jones Day is providing legal advice.

The offer is the latest blockbuster consolidation attempt in big tobacco, which has responded to years of legal pressure in the US and the loss of consumer interest in developed markets with a combination of dealmaking to squeeze out costs and new products such as ecigarettes and vaping kits.

BAT, whose best-known brands are Dunhill and Lucky Strike, has proposed to pay $20bn in cash and the remainder in its stock to acquire the remaining 58 per cent stake in Reynolds, which controls more than a third of the US market. At $56.50 per share, it values the US company at a 20 per cent premium to its closing price in New York on Thursday.

Shares in Reynolds jumped 16 per cent in morning New York trading on Friday to $54.88, giving it a market value of $80bn; BAT was up as much as 5 per cent in early London trading, but gave up its gains after it became clear it would have to pay more. BAT has a market value of £90bn.

By acquiring Reynolds, BAT would be able to consolidate the company’s earnings. The US would become BAT’s largest market, overtaking its other core operations in regions such as Brazil, eastern Europe, South Africa and Southeast Asia.

Reynolds accounted for about 34.6 per cent of the US market in the third quarter of this year. The brands Newport, Camel, Pall Mall and Natural American Spirit made up almost all of its sales.

Nicandro Durante, BAT chief executive, made the approach after the US market closed on Thursday to Susan Cameron, head of Reynolds, which is the second-biggest US tobacco company by market share behind Altria, the maker of Marlboro.

“The merger would allow the shareholders of the combined company to enjoy the long-term benefits of global scale, strength and diversification,” Mr Durante said in a letter to the Reynolds board.

Reynolds acknowledged the non-binding proposal from BAT on Friday morning. Top Reynolds executives were surprised with the timing and price offered, but informally expressed interest in finding a way to make the transaction happen, said a person close to the company’s senior managers.

This week, Reynolds said Ms Cameron would step down as chief executive and become executive chairman at the end of the year. Some industry experts pointed to the decision for her to retain the executive position until May as a sign that the US company was expecting an approach from BAT.

After years of expansion in emerging markets, investors are focusing again on the US cigarette market as a source of steady returns and have pushed earnings multiples higher as a result.

Prices per pack are lower in the US than most developed markets and competition is dominated by effectively two players, Reynolds and Altria. Furthermore, litigation risk has been limited after a series of court rulings in the US that have set caps on damages.

“A decade ago, being seen as in control of your US tobacco business was not a good thing,” said one person closely involved.

Shares in BAT, which operates predominantly outside the UK, have risen almost a fifth since the UK voted to leave the EU in June — although in dollar terms, the gains have largely been negated because of the sharp drop in sterling.

BAT plans to borrow in dollar terms to finance the cash portion of the acquisition and aims to achieve cost savings of about $400m.

Bonnie Herzog, a leading tobacco analyst at Wells Fargo, said Reynolds was “arguably” worth more and the company could seek a higher price, adding that it could spark further consolidation — raising the prospect of reuniting the two companies which own the Marlboro brand internationally.

“We don’t believe Philip Morris International would idly sit by, and believe this increases the probability that Philip Morris could acquire Altria,” Ms Herzog said. Altria owns the Marlboro brand in the US; Philip Morris International in the rest of the world.

The bid comes 12 years after BAT folded its Brown & Williamson business into what is now Reynolds. That arrangement, which saw BAT acquire 42.3 per cent of Reynolds, gave BAT five board seats out of 14. But it also agreed to a 10-year standstill with Reynolds. Two years ago, Reynolds combined with Lorillard, another major US rival, in a transaction that saw BAT inject around $4.7bn to retain the size of its holding.

“We expect this deal to go through quickly as there are no antitrust issues and the two boards are on friendly terms,” said analysts at Citi. “We always expected this deal to happen eventually, but we are surprised by the timing.”

Debra Crew is set to succeed Ms Cameron, who has led Reynolds since 2004, at the end of the year. The company last month added John Boehner, the former speaker of the US House of Representatives, who is a fan of Camel cigarettes, as a director.

Centerview Partners, Deutsche Bank and UBS are advising BAT, while Cravath, Swaine & Moore and Herbert Smith Freehills are legal advisers.

(Published by Financial Times - October 21, 2016)