Sept. 8 (Bloomberg) -- Altria Group Inc. agreed to buy UST Inc. for $10.3 billion to combine Copenhagen and Skoal snuff with its Marlboro cigarettes and vault ahead of Reynolds American Inc. as the biggest seller of smokeless tobacco.

The purchase values Stamford, Connecticut-based UST at $69.50 a share, 29 percent more than its price before the New York Times reported Sept. 4 that Altria would bid for the maker of Skoal.

The combination boosts Altria from ``virtually no position'' in the $3.7 billion snuff market, the fastest- growing segment of the tobacco industry, Chief Executive Officer Michael Szymanczyk told analysts today. It may alleviate investor concerns that Altria was too focused on U.S. cigarette sales, which the company expects to shrink by 3.5 percent this year, and counter falling demand for Marlboros.

``Altria is buying two tremendous brands in Skoal and Copenhagen, which it can drop quite profitably into its own distribution network,'' Thomas Russo, who manages more than $3 billion at Gardner Russo & Gardner, said today in an interview. The Lancaster, Pennsylvania-based firm owns 6 million Altria shares and 3.3 million UST shares.

The agreement comes after Altria started testing Marlboro smokeless tobacco and said in March it was considering an acquisition of a snuff maker. The purchase also includes about $1.3 billion in debt, valuing the transaction at $11.7 billion, Altria said.

UST climbed $1.35, or 2 percent, to $68.90 at 4:01 p.m. in composite trading on the New York Stock Exchange. Altria, the largest U.S. cigarette maker, gained 2 cents to $20.97.

Deal Financing

The cigarette maker received $7 billion in financing from Goldman, Sachs & Co. and JPMorgan Chase & Co. Altria will receive a $250 million breakup fee if the deal ends under certain circumstances, while UST might receive $200 million if Altria abandons it.

Altria still sees full-year adjusted profit of $1.63 to $1.67 a share and estimated annual cost savings may reach $250 million by 2011.

If Altria had owned UST since the start of 2008, its first-half revenue would have increased 10.3 percent to $10.4 billion, Altria said. The actual revenue was $9.46 billion, a 3.4 percent gain.

UST has roots dating back to 1822, when George Weyman, the inventor of Copenhagen snuff, opened a tobacco shop in Pittsburgh, according to UST's Web site.

Skoal, Copenhagen

Skoal and Copenhagen are the biggest U.S. brands of snuff, finely ground tobacco that a user tucks between the lip and gum to extract nicotine and flavoring such as wintergreen.

U.S. producers also sell a Swedish product called snus, which consists of tobacco in small pouches that requires less spitting and is therefore acceptable to use in more places. A user extracts flavor and nicotine and discards the pouch, shaped like a miniature pillow, like chewing gum.

Some of the earliest smokeless tobacco products consisted of cured tobacco pressed into a plug or twisted in a knot. Another form is chewing tobacco, such as Swedish Match AB's Red Man, that requires the user to spit, or else get sick from the juice.

Szymanczyk, 59, said he called UST CEO Murray Kessler in May to discuss combining the two companies, two months after Altria spun off its overseas unit into Philip Morris International Inc.

Declining Share

Altria's declining cigarette shipments and market share of brands such as Virginia Slims give it ``experience'' that can help UST cope with the decreasing market share of Skoal and Copenhagen as consumers purchase lower-priced snuff, Szymanczyk told analysts.

Kessler, 49, said he ``wasn't happy that we weren't growing as fast as the category.'' Even so, the company was poised to deliver shareholder returns of 10 percent a year. At Altria, he'll serve as vice chairman and report to Szymanczyk.

Szymanczyk declined to discuss how costs may be cut. He said he expects Altria to keep UST's ``manufacturing setup,'' which consists of factories in Nashville, Tennessee, Franklin Park, Illinois, and Hopkinsville, Kentucky.

Altria is also gaining UST's St. Michelle Wine Estates unit, which it may sell. Wine contributed 18 percent of UST's $1.89 billion in revenue last year.

``It's a great business,'' Szymanczyk told analysts. ``We'd like to understand it a bit better, and ultimately we'll make some decisions about how to get the best value out of it for shareholders.''

Wine Status

Managers of UST's wine unit may lead a buyout or liquor makers Brown-Forman Corp. ``could weigh in'' and make offers, Russo said.

Brown-Forman's policy is to not comment on ``rumors of acquisitions,'' said spokesman Phil Lynch.

Acquisitions have been the preferred means of entry to the smokeless market. Reynolds, the second-largest U.S. tobacco company, bought snuff maker Conwood Co. in 2006 and is selling Camel snus in New York and other cities.

U.S. cigarette consumption may drop 3.5 percent this year and fall 3 percent in subsequent years as manufacturers raise prices and states boost excise taxes, estimated Judy Hong, a Goldman analyst in New York, in an Aug. 25 note.

An increase of federal excise taxes, possible as early as 2009, would also damp demand, she said.

Goldman, Centerview Partners LLP and JPMorgan acted as financial advisers to Altria, while UST received similar advice from Citigroup Inc.

Hunton & Williams LLP, Arnold & Porter LLP and Sutherland Asbill & Brennan LLP acted as counsel for Altria, and Skadden, Arps, Slate, Meagher & Flom LLP was lead legal counsel for UST.

Perella Weinberg Partners LP was primary financial adviser and Sullivan & Cromwell LLP was lead legal counsel to UST's board.

To contact the reporters on this story: Chris Burritt in Greensboro, North Carolina, at cburritt@bloomberg.net;

Last Updated: September 8, 2008 16:12 EDT