ALTRIA GROUP (PHM)

By Brad Dorfman

The New York Times reported that a deal worth more than $10 billion could be announced on Monday or even sooner. The source could not confirm the price or say when a deal might be announced.

UST shares rose 22.6 percent to $66.22 in afternoon trading on the New York Stock Exchange. At $10 billion, the bid would value UST at almost $68 a share, based on shares outstanding as of July 31, a price some analysts think is rich for the company, given its focus on premium brands that face pricing pressure.

Altria spokesman David Sylvia declined to comment on speculation about a deal, as did UST spokesman Tom Fitzgerald.

Buying UST would be a quick way for Altria to expand in the growing smokeless tobacco market as the company looks to branch out from a U.S. cigarette market in steady decline. Altria, whose Philip Morris USA unit makes Marlboro cigarettes, has already tried to expand by test-marketing smokeless tobacco products under the Marlboro name.

"It expands their portfolio," Ken Harris of consumer products consulting firm Cannondale Associates said of a possible deal for UST. "They get into a major smokeless tobacco business."

UST is the industry leader with almost 58 percent of the U.S. smokeless tobacco market in the 26 weeks ended June 14, according to the company's latest earnings report.

But its main business, the premium segment, has been pressured by soaring gasoline prices and the weak U.S. economy.

"They're paying a high price for a poorly positioned company that needs a lot of fixing," said one institutional investor who owns Altria shares and had been short UST. The investor declined to be quoted by name.

Still, the smokeless segment is attractive as a counter to a declining U.S. cigarette market.

U.S. cigarette consumption has fallen steadily since 1981 as more bans on smoking in public areas have been put in place and health messages against cigarettes become more prevalent and aggressive.

Cigarette makers also face marketing limitations from a 1998 tobacco litigation settlement with U.S. states. The restriction of cigarette use has also helped spur growth in the U.S. smokeless tobacco market.

LONG-AWAITED DEAL

Altria has long been seen as the likely buyer of UST. Speculation about a deal picked up in February as Altria was spinning off its international tobacco arm, Philip Morris International.

Sources told Reuters at the time that an agreement to purchase UST could be reached within months but that price was the main sticking point. On Thursday, Morningstar analyst Gregg Warren said Altria would need to offer $65 to $70 per share to make the deal attractive to UST shareholders.

Some analysts think UST, which also markets premium wines, will have to cut prices in order to compete with lower-priced products. So far, UST has used only targeted promotions in certain markets to protect its market share.

One analyst questioned if Altria would be able to afford to lower prices if it ends up buying UST.

"UST is exposed to the growing smokeless market, but its exposure is to the nongrowing premium sector," Citigroup Global Markets analyst Adam Spielman wrote in a note. "The price gaps are huge; we doubt (Altria) will be able to afford to change this short-term."

One issue that exacerbates the price gaps is that smokeless tobacco is taxed based on price, which means higher-priced products like Copenhagen cost even more for consumers than lower priced brands like competitor Grizzly. Altria rival Reynolds American Inc <RAI.N> bought Grizzly smokeless tobacco maker Conwood in 2006 and has also tested smokeless tobacco products under the Camel brand, adding to the competitive pressure on UST.

But analysts said Altria might have the clout in Washington to help in UST's battle to get the tax structure changed to one similar to cigarettes, which have a set tax per pack.

"If there's one thing Altria can do well, it's change legislation in their favor," UBS analyst Nik Modi said.

Reports of Altria buying UST fueled speculation about other consolidation in the tobacco market, which helped lift shares of potential takeover target Lorillard Inc <LO.N> 3.7 percent to $72.25. Lorillard makes Newport cigarettes.

Altria shares were up 15 cents to $20.81 on the New York Stock Exchange. The shares have traded in a range of $24.55 and $19.85 in the past 52 weeks.

(Reporting by Brad Dorfman; Additional reporting by Aarthi Sivaraman and Sarah Coffey in New York and Saumyadeb Chakrabarty in Bangalore; Editing by John Wallace and Dave Zimmerman)