LONDON (Reuters) - British American Tobacco BATS.L has agreed a $49.4 billion takeover of U.S. rival Reynolds American Inc RAI.N, creating the world's biggest listed tobacco company after it increased an earlier offer by more than $2 billion.

BAT, which already owned 42 percent of Reynolds, will pay $29.44 in cash and 0.5260 BAT shares for each Reynolds share, it said, a 26 percent premium over the price of the stock on Oct. 20, the day before BAT’s first offer was made public.

Reynolds, the maker of Camel and Newport cigarettes, rejected an initial approach in November, although the two sides remained in talks.

The deal, which values the whole of Reynolds at around $86 billion, will mark the return of BAT to the lucrative and highly regulated U.S. market after a 12-year absence, making it the only tobacco giant with a leading presence in American and international markets.

BAT Chief Executive Nicandro Durante said bringing the two companies together would create a market leader with brands including Newport, Lucky Strike, Camel and Pall Mall.

“It will create a stronger, global tobacco and NGP (next generation products) business with direct access for our products across the most attractive markets in the world,” he said on Tuesday.

The U.S. tobacco market was the most profitable outside China, he said in an interview, and BAT “figured there was some room to grow there.”

BAT left the United States in 2004 when it merged its subsidiary Brown & Williamson with R.J. Reynolds to form Reynolds American in 2004. A decade later, the U.S. group agreed to buy Lorillard in a $27.4 billion deal that added the Newport brand to its stable.

Durante said there was a clear rationale to bring the groups together, and an alignment in their relative trading multiples made an agreement possible.

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“This is the right moment to make the deal; the multiples of BAT and Reynolds are closer than ever before,” he said.

BAT would also be able to take Reynold’s NGP portfolio, led by vaping brand Vuse, into its international markets, he said.

IGNITING THE MARKET

The takeover could spark further deals, analyst have said, as Philip Morris International PM.N and Japan Tobacco 2914.T jostle for market share in an industry that is shrinking in the West as more people quit smoking.

"The sheer scale of the enlarged BAT raises the pressure on the remaining players to bulk up too, and attention is likely to turn to Britain's Imperial Brands IMB.L, who look more and more like a minnow swimming in a tank of big, hungry fish," said Hargreaves Lansdown fund manager Steve Clayton.

Some have predicted the deal could encourage current market leader Philip Morris International to reunite with its U.S. affiliate Altria, reversing a 2008 spin-off.

Shares in BAT reversed early gains as investors fretted about the price BAT was paying and the debt it was taking on.

BAT said it had agreed a $25 billion facility with a consortium of banks.

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BAT shares were down 3.8 percent at 45.80 pounds, below the level in October before the company announced its approach. Reynolds’ stock was trading up 3.1 percent at $57.72.

RBC Capital Markets said assuming BAT was able to achieve the annual cost savings of “at least $400 million” it has targeted, the deal would be financially neutral for BAT shares.

“We think (the deal) makes sense strategically and operationally and just about washes its face financially,” it said. “That said, a value-neutral acquisition does little to alter our view that the shares are already reasonably valued.”

BAT Fiance Director Ben Stevens told analysts the group now had a “lot more certainty” on the cost savings. “We hope that as we get closer to Reynolds we will find more cost savings than that,” he said.

Centerview Partners, Deutsche Bank and UBS advised BAT on the deal, while Lazard, JP Morgan and Jones Day worked for Reynolds American.