FILE - This file photo made Oct. 21, 2009, shows Camel cigarettes, a Reynolds American brand, in Philadelphia. Reynolds American Inc.'s third-quarter profit grew nearly 7 percent as higher prices and smokeless tobacco gains helped offset a decline in the number of cigarettes it sold. The nation's second-biggest tobacco company on Tuesday, Oct. 23, 2012 reported net income of $420 million, or 74 cents per share, for the three-month period ended September 30. That's up from $394 million, or 67 cents per share, a year ago. Adjusted earnings were 79 cents per share, matching beating analysts' expectations.(AP Photo/Matt Rourke, File)

By Martinne Geller and Kate Holton

LONDON, July 11 (Reuters) - U.S. cigarette maker Reynolds American Inc is in talks to acquire rival Lorillard Inc in a multi-billion dollar deal that would reshape one of the world's biggest and most profitable tobacco markets, the companies said on Friday.

A deal would also involve the sale of some brands to Britain's Imperial Tobacco Group to address potential antitrust concerns, as well as the purchase of more shares in Reynolds by British American Tobacco (BATS), its largest shareholder.

In a statement confirming what people familiar with the matter previously told Reuters, Reynolds, No.2 player in the United States with brands including Camel and Pall Mall, said the talks were consistent with its strategy of weighing options that would help boost shareholder value.

Buying Lorillard, which had a stock market value of $22.9 billion on Thursday, would give Reynolds the leading U.S. menthol cigarette Newport and its leading e-cigarette blu.

Analysts say the combination could also generate $500 million in annual cost savings, helping the No.2 and No.3 U.S. players compete with Marlboro maker and No.1 Altria Group Inc in a market where sales volume is falling about 4 percent a year as more Americans quit smoking.

Despite the decline, the U.S. remains the biggest tobacco market in the world after China and the most profitable.

"Reynolds is getting both a fantastic brand in Newport and strong intellectual property in the e-cig category," said analyst Philip Gorham at research firm Morningstar. "It's a good deal strategically, we just need to know what they're paying. If they pay a premium to today's price, it's going to be on the rich end of historical deals."

Historically, he said tobacco deals have fetched an average enterprise value (equity plus debt) of about 12 times earnings before interest, tax, depreciation and amortization, which is about where Lorillard's stock was trading on Friday, up 4.8 percent in New York.

SUPPORTING THE DEAL

BAT, which owns 42 percent of Reynolds, said that if the deal proceeds, it would expect to support it by buying more shares in Reynolds with the aim of maintaining its current stake, which is the company's only exposure to the U.S. market.

Over the last 50 years, the United States has seen several waves of lawsuits against tobacco firms, including complaints by individuals, class action suits and a massive racketeering case. Cases have concerned the industry's negligence, disclosure of health risks and advertising practices.

Litigation risks contributed to the 2008 separation of Altria and Philip Morris International, which is now the world No.1 selling Marlboros everywhere except the United States. But analysts say the litigation risk has waned, so there is now more openness to trade there.

"A lot of the more extreme class action suits haven't really made the progress people thought they might," said Jefferies analyst Martin Deboo, who questioned whether by buying into the United States, Imperial would be taking on additional risk.

"I'd have thought that given Imperial's leverage in the negotiations, they will be able to insist that they don't," he said.

Imperial, known for its Gauloises and Davidoff cigarettes, said it was in talks with Reynolds and Lorillard about buying certain assets they might sell but saw no guarantee the proposed deal would come off.

A source familiar with the situation said Imperial was lining up about $7 billion to finance the potential purchase of brands such as Kool and Salem, which would ease antitrust concerns thrown up by a Reynolds-Lorillard combination.

Reynolds, Lorillard and BAT said there were no assurances a deal will be reached. They added that unless circumstances dictate otherwise, they did not intend to comment further.

Imperial shares closed up 3 percent at 2,740 pence, while BAT shares ended up 0.2 percent. (Editing by David Holmes and Mark Potter)