Under the deal, Reynolds agreed to pay $68.88 a share in cash and stock, presenting a premium of 2.5 percent to Lorillard’s Monday closing. (Click here to see the latest quote.)
As part of the transaction, U.K. based British American Tobacco will also buy new shares in Reynolds so that its stake in the company remains at 42 percent.
Reynolds also said it would sell its Kool, Salem, Winston, Maverick and blu eCigs brands and other assets to Imperial Tobacco Group for $7.1 billion in cash.
Reynolds, which also owns Camel, is the second-largest U.S. tobacco company by sales after Marlboro parent Altria. After combining with Lorillard, maker of menthol-flavored Newport cigarettes, Reynolds will be slightly smaller than Altria, which controls about half the market.
Speculation over a deal began earlier this year and prompted a rally in tobacco stocks. Reynolds has gained 26 percent this year while Lorillard has gained 33 percent.
Reynolds, based in Winston Salem, North Carolina, is expected to enjoy substantial cost savings through the deal. Lorillard is located in nearby Greensboro, and the companies have some overlapping production capacity that can probably be eliminated.
One reason a deal is possible is that the threat of devastating litigation against tobacco companies has waned over the last decade, analysts say. While litigation continues, the number of cases has shrunk, and companies have proven that the legal expenses are manageable.
While BAT is only buying sufficient Reynolds shares to keep its ownership at the same percentage, it will soon have the option to buy more. Reynolds was created back in 2004 when BAT merged its Brown & Williamson division with R.J. Reynolds. That merger, which left BAT with a 42 percent stake in Reynolds, included a standstill agreement preventing the British company from increasing its stake until July 30, 2014.