Big Tobacco's Been Busy

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For a slow-growth industry, the tobacco sector has been busy recently. The biggest players have been taking advantage of their size to acquire smaller rivals and emerging products that could threaten their core fran chises even in a small way.

British American Tobacco (AMEX: BTI  ) stole a march on the global tobacco leader Philip Morris International (NYSE: PM  ) . The U.K. tobacco company scooped up Colombia's second-largest tobacco player, Productora Tabacalera de Colombia, for $452 million. Philip Morris agreed to purchase the company in 2009, but the Colombian government rejected the takeover on antitrust concerns last year.

The purchase positions British American as the second-ranked tobacco company in the nation, behind Philip Morris. Emerging markets such as Colombia represent a good growth opportunity for established tobacco companies, which are facing significant pressures in developed markets.

Philip Morris has been on its own acquisition path, despite the setback. The company has purchased the global patent rights to a technology that delivers nicotine to the lungs without smoking. The company will work with the technology's developer to create a commercially viable product, but don't expect anything soon. The company said it could take a few years before a product becomes available.

Philip Morris, British American, and Reynolds American (NYSE: RAI  ) have been moving into products that deliver nicotine without the actual burning of tobacco and the associated noxious substances created by smoking. In April, British American established Nicoventures to develop nontobacco nicotine products, while in 2009 Reynolds acquired Niconovum, a Swedish producer of smoking cessation aids. Such acquisitions position tobacco companies to nab any growth on the margins of their core franchises as the industry faces regulatory challenges.

A similar trend has been playing out in oral tobacco, as players such as Reynolds and Altria (NYSE: MO  ) increasingly market smokeless snus as a substitute for smoking in the face of smoke-free workplace regulations. While these products have seen some growth, they comprise just a small portion of tobacco companies' sales.

Another player, Star Scientific (Nasdaq: CIGX  ) , is focused heavily on non-traditional tobacco products. The company manufactures dissolvable tobacco products and is developing a process for curing tobacco that eliminates the carcinogens. Given the interest of Big Tobacco in defending its turf, could Star Scientific be a future acquisition? Is tobacco the place to invest in now?

Jim Royal, Ph.D., owns shares of Philip Morris. The Motley Fool owns shares of Philip Morris International and Altria. Motley Fool newsletter services have recommended buying shares of Philip Morris International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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  • Report this Comment On May 30, 2011, at 7:33 AM, DBManFool wrote:

    Based on the comments on Star Scientific, it doesn't look like the author bothered to get too busy in writing this article. Weak, off-point and somewhat inaccurate.

    Please don't tell me this guy is actually getting paid to write this when he can't even be bothered to read anything recent related to a stock he is writing about.

    Star could very well be on the short term horizon of becoming one of the biggest stock stories of the year. The following is my "pitch" I recently wrote on Cigx. It's not perfect, but at least I did some home work and I encourage people to read up on Star vs. RJR for themselves and make up their own mind.

    Compare the Alzheimer's thing to a typical biotech at your own risk.

    The compound is a neutraceutical who's active ingedient is already on the market. People are buying CigRx for their inflamed friends and family members as you read this.

    Direct ordering launched from their website March 31st and retail roll outs are apparently in progress. I am not suggesting sales are driving the rise. Even if this quarter's revenues surprise by 100% (which I think they will), or even triple - it's not nearly enough to justify this pps. It's true, it's up on hope and the story.

    Another difference from a biotech is that for as long as the Alzheimer's story continues to unfold positively, sales of CigRx will continue to be driven higher or until RCP-006 goes to market. If a loved one had Alzheimer's, wouldn't I try this?

    Regardless, the recent action is clearly driven by the story. However, the words and the pedigrees of the people doing the talking are fairly impressive. The CEO buying half a million shares on the open market adds a lot of weight.

    I agree with the realists posting warnings of the impending collapse. However, this lottery ticket has 2 jackpots and the 2nd development is a recent and what has driven the dramatic action over the last week. And the drawing for the winning numbers of this ticket are likely to be drawn before the RCP-006 prize numbers.

    Star's original 2001 patent infringement suit against R.J Reynolds eventually resulted in the patents being thrown out for inequitable conduct. The suit at the time was touted as the biggest infringement suit ever at 1 billion. In today's dollars and 10 more years of infringement later, a few billion is not unreasonable assuming the original 1 billion award was realistic.

    In recent days, the CAFC, who happen to be currently in the midst of deliberating and rendering a decision on Star's appeal - on the heels of the PTO confirming every claim of the original patents - has issued new guidance on the use of inequitable conduct by an accused infringer.

    The text of the order cites Star vs. RJR in a context that could be construed as an example of the kind of inequitable use of inequitable conduct that creates "the atomic bomb" of patent litigation because it can result in the patents being thrown out completely, which is what happened to Star's patents, regardless of the validity of their claims. And the PTO has recently reaffirmed each and every claim.

    During the original trial, RJR found a letter of a materially redundant nature that they claim was omitted from the prior art in an attempt to hoodwink the PTO. "The Burton letter" (read about it darn you)

    At one point, Star dismissed it's original defense team, and RJR wove a tale of this letter being at the heart of the reason for the dismissal and Star lost the trial and they lost enforceability of their patents.

    The new doctrine from the CAFC makes it quite clear that uses of inequitable conduct have to meet a much more stringent criteria. The old way of interpreting allowed too much irrelevancy to flow through and it clogged the system. They just did a flush and installed a filter. The new rules came out as part of the Abbot Labs decision and they mention Star vs RJR, again in the context of the kinds of travesties they hope to eliminate with the new rules.

    It truly looks like the CAFC has telegraphed, rather pointedly, where they are leaning on the Star vs. RJR appeal, which again, they are currently deliberating on and could issue a decision any time.

    If the impending decision finds in Star's favor, merely the prospect of a 2 billion dollar check compared to Star's 600M cap will be enough to drive it to at least $12 overnight.

    Long term prospects are worth hoping for, but not worth speculating on when there are 2 jackpots waiting to be drawn.

    In the short term, it seems reasonable that the 2 stories combined still have enough legs to drive this to $7 on no news on either front. A favorable decision from the CAFC could ping it to $12, like now, particularly given the current short interest.

    If either story bursts badly, the pps collapse that the bears foresee will be real. So if you buy the lottery tickets, also buy puts. You don't really know where the pps will go, but it seems obvious to me that one way or the other, that over the course of the next few months and very possibly weeks or even days, the pps is going to diverge drastically from the $5 mark where it currently teeters on an apex.

    I am long Cigx, but I will be O.K. if it doesn't work out short term. As long as the pps doesn't stabilize and remain around $5, I will receive a return on my investment. And even if I lose short term, I will still have my stock, so the game will not be over.

    It doesn't matter if the bulls or the bears turn out to be right - It's most likely that one will be right and one will be wrong as opposed to both being wrong. And anyone can make money off of that if they bite the bullet and invest in some insurance for their lottery ticket.

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