Where there's smoke there's fire, but in the case of Altria (NYSE: MO) and Philip Morris International (NYSE: PM) getting together again, it's all about the smokeless cigarette alternatives that are driving the deal.
Although the tobacco giants acknowledged only that they were in discussions about a potential all-stock merger of equals, without going into any of the rationale behind it, it's clear Altria's $12.8 billion in Juul Labs and Philip Morris' leading heated tobacco device IQOS are the primary forces pushing the two together.
Image source: Getty Images.
Breaking the smoking habit
Because cigarettes are a dying industry, albeit one with many years of puffing still to go before it gets stubbed out, smoking alternatives are recognized as the future growth driver. Juul is by far the leading electronic cigarette with a 75% share of the U.S. market, while IQOS is the global leader in most markets elsewhere around the world.
Juul is just ramping up its global ambitions and would benefit from Philip Morris' distribution network in foreign markets, where its cigarettes hold the No. 1 or No. 2 position, and IQOS is just launching in the U.S., where Altria will market, sell, and distribute the e-cig under its Marlboro brand. Putting the companies together again will allow them to operate more easily and efficiently worldwide.
But only if they can get past regulators. Particularly in the U.S., the Food & Drug Administration is cracking down on nicotine, which is leading it to push new graphic packaging rules on cigarettes to scare people into not smoking. It is also mulling over whether to mandate low-nicotine rules for cigarettes and cracking down on e-cigs because of purported teen use. The Federal Trade Commission is now also looking into Juul's marketing practices.
New nicotine delivery systems are key
That's one of the reasons the rise of alternatives such as snuff, snus, and tobacco-free nicotine pouches is intriguing. Led by Swedish Match (OTC: SWMAF), the global leader in snus, a finely ground tobacco product, the smoking alternative is one of the fastest-growing segments in the U.S. tobacco industry.
After Swedish Match launched the tobacco-free ZYN brand earlier this year, Altria acquired the international business of Burger Sohne to sell on!, a competing nicotine pouch brand. It made sure it was allowed to begin selling the product in the U.S. even before the deal was completed to get the most market share possible.
However, while a merger might help Altria sell on! in some foreign markets, snus is banned in the European Union, except for Scandinavia (where it is more popular than cigarettes). That limits their global potential somewhat.
Reversing divestiture decisions
A divestiture trend began in 2004 as tobacco companies sought to insulate their assets from the litigious U.S. market. That year British American Tobacco (NYSE: BTI) left the U.S. market, and Altria and Philip Morris International split in 2008. But this trend has recently reversed. British American acquired Reynolds-American in 2017, and now Altria and Philip Morris are considering reuniting, which would mean creating a company with a market cap in excess of $200 billion and $50 billion in sales.
While the merger might not trigger antitrust concerns over cigarettes because the two companies sell in different markets—when British American and Reynolds merged, regulators required them to divest brands to preserve competition—the vaping market might receive closer scrutiny. The Federal Trade Commission is now investigating Juul's marketing practices.
Assuming regulators don't regulate the industry out of existence, the respective leadership positions of Altria and Philip Morris, coupled with IQOS being introduced in the U.S., might make regulators hesitant to cede that much control to one company.
Two are better than one
While there are a number of reasons an Altria-Philip Morris merger might not fly with investors, there are several strong reasons it should.
Because the U.S. cigarette market is in freefall, Altria would gain from being able to enjoy the global profits of its Marlboro brand and others that were transferred to Philip Morris during the separation. But Philip Morris would also benefit from being able to keep all the profits from IQOS sales in the U.S. without have to split them with Altria. Also, as Juul expands internationally, Philip Morris could reap some of the benefits, too, along with potential cannabis sales from Altria's investment in Canopy Growth (NYSE: CGC).
The tobacco market is a very different one from when Altria and Philip Morris divorced 11 years ago, as cigarettes are no longer the defining product of their respective businesses. It is now in smoking alternatives that future growth lies, and the two industry giants have a better shot at superior performance if they merge.
10 stocks we like better than Altria Group
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*
David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and Altria Group wasn't one of them! That's right -- they think these 10 stocks are even better buys.
*Stock Advisor returns as of June 1, 2019
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.