Sept. 6 (Bloomberg) -- Altria Group Inc.'s pursuit of snuff maker UST Inc. may mean that Lorillard Inc., the manufacturer of Newport menthol cigarettes, is the next target as the U.S. tobacco industry consolidates.

A UST acquisition might compel Reynolds American Inc., the second-largest U.S. tobacco company, to bid for the Greensboro, North Carolina-based cigarette manufacturer, said Nik Modi, an analyst at UBS Securities LLC, and investor Matthew Kaufler. Lorillard, with a market value of $12.9 billion, climbed 6.4 percent yesterday in New York trading.

Altria, the maker of the top-selling Marlboros, may offer at least $10 billion, or $68 a share, for UST, the producer of top-selling Skoal and Copenhagen snuff, people with knowledge of the talks said. Shrinking sales in the $70 billion U.S. cigarette industry may force companies to combine, while waning legal risk may attract international suitors.

Investors ``are sniffing out the next deal in tobacco,'' Kaufler said yesterday in an interview. He helps manage $2.8 billion, including 310,529 Lorillard shares, at Clover Capital Management in Rochester, New York. ``I would expect Lorillard to be next.''

Spokesmen David Sutton of Altria, the largest U.S. cigarette company, and Thomas Fitzgerald of UST declined to comment, as did Hannah Sloane at Lorillard and Seth Moskowitz at Reynolds.

UST, based in Stamford, Connecticut, rose $13.55, or 25 percent, to $67.55 yesterday in New York Stock Exchange composite trading. Altria climbed 29 cents to $20.95. Lorillard jumped $4.43 to $74.09, while Reynolds dropped 0.6 percent.

Cigarette Use

U.S. cigarette consumption will 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 Sachs Group Inc. analyst in New York, in a Aug. 25 note.

An increase of federal excise taxes, possible as early as 2009, would also damp demand, she said. She recommends buying Lorillard shares.

Altria, based in Richmond, Virginia, said in July it expects cigarette shipments to fall as much as 3.5 percent this year, faster than its projection of 2.5 percent to 3 percent in March.

``If an Altria-UST combination comes to pass, it will put pressure on Reynolds American to buy Lorillard,'' Modi said yesterday in an interview. The potential offer was reported Sept. 4 by the New York Times.

The addition of Newport would help Reynolds overcome slumping shipments of its Kool and Salem menthol cigarettes, UBS said in June. At the time, UBS estimated Reynolds might pay as much as $107 a share, 44 percent higher than today's closing price.

Close Headquarters

The headquarters of Reynolds in Winston-Salem and Lorillard in Greensboro are 27 miles apart, creating cost- cutting opportunities.

Reynolds may close one of the headquarters and shut Lorillard's cigarette factory in Greensboro and transfer production to Winston-Salem, according to UBS.

Lorillard dates to 1760, when entrepreneur Pierre Lorillard started America's first tobacco company in New York, according to its Web site.

As of Dec. 31, Lorillard had about 2,800 employees, with 1,042 represented by labor unions, according to a securities filing in February. Reynolds had about 7,300 employees at the end of 2007, a separate filing said.

Reynolds, which also makes Camel and Winston cigarettes, has expanded through acquisitions, including the 2004 purchase of Brown & Williamson Tobacco Corp. Chief Executive Officer Susan Ivey engineered the 2006 acquisition of Conwood Co., the second-largest U.S. snuff maker.

John Middleton

Altria bought cigar maker John Middleton Inc. last year for $2.9 billion. The company, which has been testing its own smokeless tobacco, plans to expand the Marlboro brand and possibly make acquisitions, Chief Executive Officer Michael Szymanczyk has told investors since March, when it spun off its international division.

``There are not a lot of assets left,'' Kaufler said. ``Everyone has turned over all of the rocks.''

Merrill Lynch & Co., Credit Suisse Group AG, and Lehman Brothers Holdings Inc. are among the biggest advisers on tobacco mergers since 2003, excluding spinoffs, according to data compiled by Bloomberg.

Merrill worked on both of the biggest mergers: U.K.-based Imperial Tobacco Group Plc's $18 billion purchase of Spain's Altadis SA, and Japan Tobacco Inc.'s $15 billion acquisition of the U.K.'s Gallaher Group Plc.

International Interest

Waning legal risk after U.S. tobacco makers prevailed in three multibillion-dollar lawsuits may draw overseas producers to the U.S., said Thomas Russo, a Gardner Russo Gardner principal who oversees more than $3 billion in assets. The Lancaster, Pennsylvania-based firm owned 3.3 million UST shares through June.

Imperial Tobacco, Europe's second-largest cigarette maker, acquired Commonwealth Brands, the U.S. maker of USA Gold discount cigarettes, in 2007.

British American Tobacco Plc, Europe's biggest cigarette company, is Reynolds American's largest investor, with 42 percent of the shares through Aug. 28.

``With the downplaying of what's long been fear of litigation risk, the U.S. market has become more open to international players,'' Russo said yesterday in an interview.

-- With reporting by Zachary Mider and Jonathan Keehner in New York and Thomas Mulier in Geneva Editors: Brad Skillman, Michael Nol.

To contact the reporter on this story: Chris Burritt in Greensboro, North Carolina, at 1348 or cburritt@bloomberg.net.

Last Updated: September 6, 2008 01:34 EDT