By Ciara Linnane, MarketWatch
Altria Inc.’s stock soared more than 8% Tuesday before surrendering those gains, while shares of Philip Morris International Inc. fell 8%, after the latter confirmed speculation that the two are in talks on a potential merger of equals that would reunite them after more than 10 years apart.
Altria /zigman2/quotes/208895754/composite MO +0.62% spun off Philip Morris in 2008 to allow it to focus on the international tobacco business, and to let Altria focus on the U.S. market. The two companies hold a portfolio of cigarette and tobacco brands led by Marlboro, which is sold by Altria in the U.S. and by Philip Morris /zigman2/quotes/201611010/composite PM -0.20% overseas.
Both companies have been grappling with declining sales as anti-tobacco health campaigns encourage more people to quit smoking and younger people are drawn to e-cigarettes sold by companies including Juul. Altria acquired a 35% stake in Juul last year for $12.8 billion.
Wells Fargo analyst Bonnie Herzog noted unusual trading in both stocks on Monday and said it might have to do with renewed speculation that the two were planning to merge, “a call we first made in December 2016 and we still very much believe will happen.”
Herzog wrote in a note to clients that the reasons a deal is now more likely include that Altria looks more attractive because of its Juul stake, as Juul would make a strong partner for Philip Morris given its dominance of the U.S. e-cigarette and vapor market and its international ambitions. At the same time, Philip Morris’s ownership of iQOS, the electronic device that heats tobacco-filled sticks wrapped in paper to generate a nicotine aerosol, would be worth more to it if it owned Altria, she said.
“Philip Morris will capture the full margin and accelerate the growth of iQOS in the U.S. given its full control over sales and distribution,” Herzog wrote. The company would further have the chance to invest Altria’s strong U.S. free cash flow to promote iQOS sales globally.
“As such, we think there will be tremendous value created if a deal in fact happens,” said the analyst, reiterating outperform ratings from Wells Fargo on both Philip Morris and Altria.
Jefferies analyst Ryan Tomkins said the news seems a bit odd, in that the outlook for Juul is clouded by litigation and investigations by the Food and Drug Administration and a congressional committee over e-cigarette use by teenagers. The company's vape pens are popular with young people, who are especially keen on flavors, including crème brûlée, cucumber and mango, that are now banned from convenience stores and gas stations.
The March ban came after an FDA crackdown spearheaded by former commissioner Scott Gottlieb, who threatened to fully ban pod-based vaporizers such as Juul’s if underage vaping were to continue to increase. Gottlieb has described the popularity of the devices as an epidemic, a characterization that has been echoed by the U.S. Surgeon General.
“While this merger makes sense and will create a more valuable company when combined (in our view) we do think it is strange timing given possible risk to Juul in the U.S. with regards to regulatory action,” Tomkins wrote in a note to clients. “Maybe Philip Morris are willing to take this risk as they believe it can easily be offset by the potential international opportunity for Juul under their distribution and the value of fully owning IQOS in the world’s biggest reduced risk market.”
However, just last week a lawsuit brought by a 19-year-old accuses Juul and Philip Morris of illegally marketing their products to minors and deceiving them about the risks of addiction and health hazards. The suit alleges that the companies violated the Racketeer Influenced and Corrupt Organizations Act, known as RICO, that the Justice Department used to sue the tobacco industry in the late 1990s.