No Smoking at Cigarette Giants' Reunion

(Bloomberg Opinion) -- Philip Morris and Altria, two tobacco giants valued at about $100 billion each, are in talks to merge in what would be the industry’s biggest deal ever. Their goal: join forces to quickly concentrate nicotine addicts around new non-cigarette products before competition heats up or more people quit smoking altogether. 

On Tuesday, amid recent M&A speculation, Philip Morris International Inc. confirmed that it is, in fact, in discussions to recombine with its sister company, Altria Inc., from which it was spun off in 2008. The deal, if consummated, would give Philip Morris 58% ownership of the combined entity and would award no premium to Altria shareholders, a person familiar with the matter told Bloomberg News. I’ve written about the merits of a possible transaction again and again and again, and now it may actually happen. The main reasons, in a nutshell, are cash flow and something called IQOS (more on that in a moment). 

No Smoking at Cigarette Giants' Reunion

Altria is best known for producing Marlboro, the top-selling cigarette both in the U.S. and globally. Philip Morris is responsible for selling the brand in international markets. But while cigarettes are still the overwhelming source of their profits, you’d never know it from looking at either of their corporate websites. In fact, it’d be easy to mistake them for organizations advocating against smoking, rather than profiting from it. Altria’s online homepage talks of “Tobacco Harm Reduction,” and you’d be hard-pressed to find any mentions of their cigarette brands. Here’s a snippet from Philip Morris’s rather artful landing page:

No Smoking at Cigarette Giants' Reunion

Altria and Philip Morris have tried to remake their images in recent years into something more wholesome-seeming, diverting attention and resources to what they call “smoke-free” products, such as tobacco-heating sticks and e-cigarettes that yield vapors instead. This about-face comes as the prevalence of smoking in the U.S. falls to about 13%, down from more than 20% a decade ago, a precipitous trend that’s similar around the world. 

No Smoking at Cigarette Giants' Reunion

The companies’ key new product is called IQOS (pronounced eye-kose) that heats tobacco rather than burning it. Philip Morris has been selling IQOS in Europe and Japan, and in last month’s earnings statement it explained why the product is gaining such strong traction – just like regular sticks, it’s reliably addictive:

IQOS delivers nicotine in levels close to combustible cigarettes suggesting a likelihood that IQOS users may be able to completely transition away from combustible cigarettes and use IQOS exclusively.

Altria has the exclusive license to sell IQOS in the U.S. beginning next month, making its debut in Atlanta stores, after gaining U.S. Food and Drug Administration approval earlier this year. By acquiring Altria, Philip Morris will get to keep the IQOS profits that come from the U.S. instead of having to split them. Altria also has a 45% stake in Cronos Group Inc., one of Canada’s fast-growing cannabis companies, and a 35% economic interest in Juul Labs Inc., the controversial maker of the leading e-cigarette. Last week, an Illinois adult resident became the first recorded death from a mystery respiratory ailment that health officials believe is linked to e-cigarettes.

Altria throws off $6 billion to $8 billion of free cash flow every year, according to data compiled by Bloomberg. That would enable Philip Morris to make a greater push for IQOS and Juul globally, as well as help fund future dividends and share buybacks.

Valuations for both companies have languished in recent years. To the extent the cigarette giants’ grip on consumers was also slipping, this is how to get it back.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Tara Lachapelle is a Bloomberg Opinion columnist covering the business of entertainment and telecommunications, as well as broader deals. She previously wrote an M&A column for Bloomberg News.

©2019 Bloomberg L.P.

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