Smith already owns 50 per cent of Virgin Retail, the music and games chain built up by Richard Branson, following a joint venture established in 1991. That will be significantly expanded through the injection of Our Price's 304 outlets to the 24-strong Virgin chain.
In exchange, Smith's interest in the joint venture will be increased to 75 per cent, with Virgin, Mr Branson's holding company, retaining a 25 per cent stake.
There will be no cash consideration for the deal, which industry sources say has been under discussion for months. Neither Virgin nor Smith would comment yesterday, but it is believed that the disposal of Virgin Retail's 30 games stores outlets to Rhino Group last November helped to pave the way for the merger.
The deal will have to be approved by the Office of Fair Trading, which is already conducting a review of compact disc pricing. Virgin is believed to have about 7 per cent of the market while Our Price has about 18 per cent, But, if music sales through the W H Smith chain of stationery and newspaper shops are included, Smith's share rises to about 26 per cent.
The merger reflects Smith's desire to boost Our Price's sales of computer games and other home entertainment products. More than 80 per cent of its sales now come from music compared with about 50 per cent at Virgin's Megastores.
The joint venture will be headed by Simon Burke, managing director of Virgin Retail. The two chains will continue to be run separately but Virgin and Smith believe that Virgin's focus on home entertainment can be transferred into Our Price's high street outlets.
That will differentiate it more clearly from W H Smith record outlets and compete more effectively with Kingfisher's Woolworth chain, which is strong in both music and games and will be pushed into second place by the merger.
The number of Virgin megastores has risen from 11 to 24 since the joint venture was established and the two groups intend to double the number of outlets over the next two years. In the year to last May it made pounds 3.5m pre-tax profit on sales of pounds 108m and, although Smith's interim results show that it lost pounds 100,000 on its 50 per cent stake, profits for the year as a whole are expected to reach about pounds 4m.
Smith does not disclose the results of Our Price, but the chain did slip into loss last year. Repositioning and improved branding mean its profits are likely to improve in the current year, however.