Blu e-cigarette deal was crucial to Lorillard takeover -source

By Jilian Mincer, Anjali Athavaley and Anjuli Davies

NEW YORK/LONDON, July 15 (Reuters) - Reynolds American Inc (NYSE: RAI - news)

had no choice but to sell Lorillard Inc (NYSE: LO - news) 's

top-selling blu electronic cigarettes brand after Britain's

Imperial Tobacco Group Plc insisted it be part of a

wider portfolio of assets it is buying, a source familiar with

the transaction said.

The U.S. companies said on Tuesday that they were selling

blu and a group of traditional cigarette brands to Imperial to

ease antitrust concerns about Reynolds' proposed $27.4 billion

acquisition of Lorillard.

Keeping blu would have given Lorillard and Reynolds more

than 50 percent of the tiny but crucial U.S. e-cigarette market,

further complicating a deal that was already expected to face

heavy antitrust scrutiny.

"I think the widespread perception is if the deal stood as

it was, it would have been off," said Steve Marascia, director

of research at Capitol Securities Management.

Imperial will also acquire Reynolds' Kool, Salem and Winston

brands as well as Lorillard's Maverick. But blu was a key

sweetener to bring the British company into the deal, which

would make it a credible third competitor in the U.S. market.

"It was very important for Imperial in terms of their

competitiveness and their go-forward," Reynolds Chief Executive

Officer Susan Cameron told Reuters.

Reynolds believed its newer Vuse brand was "superior

technology," she added.

The source said blu was part of the negotiations.

"Imperial said they're only doing this if they get blu,"

said the source.

VUSE VS. BLU

E-cigarettes are slim, reusable, metal tube devices

containing nicotine-laced liquids that come in exotic flavors.

When users puff, the nicotine is heated and released as a vapor

containing no tar, unlike conventional cigarette smoke.

While Vuse's market share is significantly smaller than

blu's 47 percent, Reynolds is the only one of the three largest

U.S. tobacco companies to make its e-cigarettes in its home

turf, at a factory in Kansas.

Reynolds executives have said they believe the domestic

production gives them greater oversight and control of the

ingredients and manufacturing of a product that has already

drawn close scrutiny from the U.S. Food and Drug Administration

and other regulators.

The company, which started selling Vuse roughly a year ago

in Colorado and Utah, is rolling out the product nationwide this

quarter.

Reynolds expects to share e-cigarette technology with top

stakeholder British American Tobacco Plc (LSE: BATS.L - news) and to

cooperate on next-generation tobacco products such as

heat-not-burn cigarettes and vapor cigarettes, said a company

spokesman.

"This agreement with BAT holds great promise for global

growth in those categories and will enhance value for all

shareholders," he said.

Keeping blu would have at least temporarily given Reynolds

and Lorillard, which bought the brand two years ago, a

potentially unbeatable head start in the U.S. e-cigarette

market.

That market share has been contracting, however, as Reynolds

and Altria Group Inc (NYSE: MO - news) rolled out their brands nationwide.

The e-cigarette category is still evolving, said Morningstar

analyst Philip Gorham. While blu is the market leader now, he

said, "we don't know for sure whether this technology will still

be the leader in five years time or even two."

(Editing by Lisa Von Ahn)