Britain's Imperial Tobacco agreed to buy Franco-Spanish rival Altadis for 12.6 billion euros ($17.4 billion) on Wednesday in a deal that will see it jump to No 2 from 4 in Europe's cigarette industry.
Combined they will produce 312 billion cigarettes a year, including Imperial's Lambert & Butler and Richmond brands in Britain and West and Davidoff in Germany. Altadis makes Gauloises, Gitanes and Fortuna cigarettes and Montecristo cigars.
Imperial's offer of 50 euros in cash per Altadis share matches a rival indicative offer from CVC Capital Partners , putting pressure on one of Europe's largest private equity group to improve its offer or admit defeat and pull out.
Altadis said its board would recommend the offer to shareholders unless it received a higher bid,
CVC is now evaluating its options over Altadis, people familiar with the situation said, while CVC declined to comment.
The Imperial bid, which including acquired debt and the purchase of a minority stake in an Altadis subsidiary is worth 16.2 billion euros ($22.4 billion), will be funded by a rights issue of up to 5.4 billion pounds ($11 billion).
The deal comes as big tobacco groups look to cut costs to cope with declining western European markets hit by smoking bans in public places and seek to offset these mature markets by expanding in emerging markets such as Eastern Europe and Asia.
The move will strengthen Imperial's position as the world's fourth largest cigarette group as it joins with No 5 Altadis and closes the gap with the world's top three: Altria , British American Tobacco and Japan Tobacco.
In Europe, Imperial will become No 2 after Marlboro-maker Altria. It previously trailed Altria, BAT and Altadis.
The deal will yield cost savings of around 300 million euros a year, be earnings enhancing in its first full year, while Imperial hope for completion of the deal by November.
"This deal is a great strategic fit, creates value for shareholders and makes us a stronger and more diverse company. It ticks all the boxes for us," Imperial's Chief Executive Gareth Davis said on a conference call.
Imperial shares rose 2.5 percent to 22.57 pounds by 0950 GMT while Altadis shares increased 1.2 percent to 48.67 euros.
"The price looks high, but Imperial has an excellent record of making takeovers work and this is an essential deal to stay in touch with bigger groups," said one industry analyst.
The Imperial deal comes after Japan Tobacco bought Britain's Gallaher in a 7.5 billion pound deal earlier this year and is expected to be the last big deal for a while as regulatory concerns are likely to prevent another one, analysts said.
Imperial is paying 14.2 times Altadis's 2006 EBITDA core earnings after Japan Tobacco paid 13 times Gallaher's 2005 EBITDA for the Benson & Hedges and Silk Cut cigarette maker.
Imperial is the number one cigarette player in Britain, and number two in Germany after its Reemtsma deal in 2002 while Altadis in number two in France and Spain, and number one in Morocco, and also the leading cigar maker in the world.
Altadis said that since Imperial's initial approach in March, the Madrid-based group had paid dividends to its shareholders of 1.1 euros a share.
Altadis's chairman Jean-Dominique Comolli and Chief Executive Antonio Vazquez will join the Imperial board.
Imperial says the offer will be financed through new banking debt of 9.2 billion pounds, with a rights issue of up to 5.4 billion pounds planned in the next 12 months.
Speculation of an Imperial-Altadis deal first emerged in December 2004, and in March earlier this year Imperial made a indicative cash bid for Altadis at 45 euros a share and increased that to 47 euros in April, but both were rejected.
CVC and PAI Partners entered the fray in May with a 50 euro bid which prompted Altadis to open its financial books to both rival parties. But by the end of May, PAI had withdrawn and CVC said it was to go ahead alone with the bid.