Britain's Imperial Brands (IMB.L) has formed a joint venture with state-owned China National Tobacco (CNTC) in a move to gain a foothold in the world's largest cigarette market.
The joint venture announced on Wednesday could boost Imperial's long-term earnings potential and competitive position in the growing e-cigarette market and increase the chances of the world's fourth-biggest tobacco company attracting takeover interest as the industry consolidates, according to analysts.
Big tobacco companies are facing shrinking markets due to health concerns and are all investing heavily in developing less harmful alternatives to smoking tobacco.
Imperial's shares closed up 1 percent at 3,626.5 pence in London.
"We think today's news could make a bid more likely," said Jefferies analysts, citing speculation that Imperial could be swept up in a wave of consolidation brought on by British American Tobacco's (BATS.L) $47 billion bid for Reynolds American (RAI.N).
The joint venture, Global Horizon Ventures Limited (GHVL), will be based in Hong Kong and link Imperial with CNTC subsidiary Yunnan Tobacco, which controls over one-fifth of the Chinese market.
Imperial said the joint venture will expand Imperial's West and Davidoff brands in China, and Yunnan's Jade and Horizon brands internationally.
"Further tobacco and next-generation product launches, as well as potential M&A opportunities, will also be evaluated by GHVL in due course," it said in a statement.
China is by far the world's largest tobacco market, selling about 2.5 trillion cigarettes a year, or about one in every third cigarette smoked.
The market is dominated by state-owned monopoly CNTC, which struck partnerships with Marlboro maker Philip Morris International (PM.N) in 2005 and British American in 2013.
A partnership with China Tobacco could give Imperial more capital and scale with which to expand in the growing market for cigarette alternatives. So far it has stuck to e-cigarettes, which heat nicotine-laced liquid into vapour, unlike Philip Morris and BAT, which also have tobacco-heating devices they say may be more appealing to smokers who can't quit.
A successful initial partnership could pave the way for an all-out takeover bid down the road, Jefferies analysts said, noting it also makes Imperial more attractive to Japan Tobacco (2914.T), long seen as a likely suitor.
Imperial was advised by Vermilion Partners and Allen & Overy on the transaction, whose financial terms were not disclosed.
BAT is in talks with U.S. peer Reynolds about buying the 58 percent of the company it does not already own. Reynolds' next-generation technology is seen as a key driver for that move, as smoking declines in Western markets due to growing health consciousness.
(Additional reporting by Noor Zainab Hussain in Bengaluru; Editing by Alexander Smith, Greg Mahlich)