Private Equity Is a Hero Next To Big Tobacco

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The battle between one of the world’s biggest private equity firms and the maker of Marlboro cigarettes over a health-care company focused on respiratory illnesses gives shareholders a clear choice. Accept a decent 958 million pounds ($1.3 billion) offered by funds run by Carlyle Group and sleep easy. Or take 6% more from Philip Morris International Inc. and endure a bitter aftertaste.

When trading shares, you usually don’t know or care who’s on the other side. Ethical blindness doesn’t apply in the sale of a whole company, especially the target here, Vectura Group Plc. A change of control has implications for staff and customers (or patients) that shouldn’t be ignored.

Carlyle has no prospect of winning this fight on price. It’s up against a company worth $155 billion. Hence it needs Vectura shareholders to feel more ashamed of selling to the tobacco industry than to a private equity fund. At 60% more than Vectura’s three-month average share price before bid talks became public, its offer merits acceptance in absolute terms. It also looks like a better steward.

The fundamental question behind Philip Morris’s higher offer is whether a U.K. maker of inhalers can become a more successful enterprise under Big Tobacco’s ownership. Vectura's board seems to think so, having endorsed the U.S. firm's first offer. But there must be doubts as to whether Vectura’s product development will improve as promised. Some health-care bodies have warned the deal could curb the company’s access to grants, while making doctors avoid prescribing its products. Patients might balk at treatments linked to a tobacco giant, and scientists may choose to work elsewhere.

Philip Morris’s reassurances are too vague to be convincing. The company “intends to operate Vectura as an autonomous business unit” but it hasn’t spelt out how this would work. It says it will increase Vectura’s spending on research and development, but it hasn’t backed those promises with solid numbers. These are merely non-binding statements of intent. The cost of breaking them is purely reputational.

It’s astonishing that Philip Morris didn't come up with anything more robust in today’s increasingly socially-conscious environment. It could have set out a clear arm’s length governance structure, potentially setting up a company with the sole purpose of monitoring Vectura. This could be staffed with a board of medical experts armed with a super-voting share.

With Vectura, Philip Morris would create a broad product pipeline both in healthcare and the “self-care wellness space,” previously defined as including botanical products, supplements and other products for “physical, mental, and emotional well-being.” The details behind this ambition matter. Investors may feel comfortable supporting vaping as an aid to stop smoking, but they should be wary of any strategy that allows e-cigarettes to be a gateway to smoking or other addictive inhaled products.

There are conflicting environmental, social and governance agendas here. It would be best if Philip Morris didn’t sell cigarettes, but its cash flow is also better spent on medical investments than on shareholder dividends. And its R&D expertise in inhalation has obvious applications for respiratory medicine. Similar arguments apply to oil and renewable energy.

But it would be easier to swallow this logic if Philip Morris’s diversification plan was more aggressive in exiting smoking altogether. It has said it expects to stop selling cigarettes in the U.K. in 10 years. Elon Musk could have reached Mars by then. Elsewhere, it simply says it believes it can stop selling cigarettes in “many countries” in the next 10-15 years.

If Philip Morris wants to be a health-care business, it needs to set firm deadlines worldwide and position its non-combustible products as solely for quitting smoking. There’s no singular corporate purpose in owning an inhaled therapeutic business alongside one that puts addictive chemicals in people’s lungs for recreation. Long-term safety data on vaping is a work in progress.

Philip Morris is clearly rattled, having re-jigged its bid with an acceptance condition of 50% plus one share, just enough for basic control, but potentially leaving a stubborn minority in situ. Merger arbitrageurs keen on getting the highest-priced deal may already have sufficient stock to get it there. A sweetened price might win over waverers. Being a public company means sucking up the fact that anyone can launch a takeover and shareholders have a right to accept — or refuse. Philip Morris’s battle for full control may just be beginning.

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

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

©2021 Bloomberg L.P.

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