Tobacco giant Philip Morris International (PM +0.99%) earns billions of dollars from the strength of its Marlboro and other premium cigarette brands. Yet lately, the company has been unusually outspoken about its commitment to look beyond traditional cigarettes, embracing reduced-risk products even though they threaten to change fundamentally the entire tobacco industry forever. Indeed, the work that the company has done with its iQOS heat-not-burn technology and its HeatSticks inserts for the system has paid off well in early tests, and Philip Morris' most impressive move in 2016 was moving forward with its decision to file an application with the U.S. Food and Drug Administration for approval of iQOS in the U.S. market. The benefits to Philip Morris could be huge, both in terms of direct revenue stemming from iQOS in the U.S. through its licensing arrangement with former parent Altria, as well as from the huge reputational boost Philip Morris will get as a result of the move.
Image source: Philip Morris International.
Philip Morris and its FDA application
In early December, Philip Morris International submitted a Modified Risk Tobacco Product application to the FDA for approval. By doing so, the tobacco giant made good on its promise to file with the FDA by the end of 2016, and it was only the first step in what could be a long process for the company in trying to gain regulatory approval for iQOS.
From there, the ball is now in the FDA's court on how the process will move forward. The regulatory agency typically takes 60 days or more just to perform an administrative review to gauge whether the application meets certain basic requirements and is worth closer examination. If the FDA gives the initial go-ahead, then the next step would be for the FDA to bring in the application for a more substantive review of Philip Morris International's claims with respect to iQOS. That process could take a much longer time to complete, and so investors need to be prepared for a potentially very long period of uncertainty with respect to whether iQOS will eventually win FDA approval.
Why Philip Morris thinks it can get FDA approval of iQOS
Yet Philip Morris is encouraged by what it sees as favorable trends in the regulatory environment. In its investor day presentations earlier this year, Philip Morris executives noted that government regulators around the world have been more receptive to the scientific evidence that the company and its researchers are generating concerning the actual reduction in harmful impacts that iQOS and other reduced-risk products could have compared to traditional cigarettes. Philip Morris has already seen some regulatory agencies consider reversing their early bans on e-cigarettes and similar products.
In addition, iQOS in particular stands out from other products in some key ways. First, it uses actual tobacco, for which there is already precedent for regulators to consider. By contrast, many of the e-cigarette products that competitors are pushing hard rely on flavoring as a way of generating interest, and that has raised the ire of consumer advocates arguing that e-cigarettes are marketed toward teens. At the same time, though, iQOS only heats tobacco rather than burning it, and regulators in areas like the European Union have granted HeatSticks a different status compared to combustible cigarettes as a result.
Still, the FDA is being careful in its role as regulator. Earlier this month, the agency partially rejected an application by Swedish Match for its snus oral-tobacco product, but it suggested that the company might still be able to make a claim that the produce poses substantially lower health risks than cigarettes if it focuses on specific claims linked to toxic chemicals or disease prevention. Philip Morris is likely to see the same comments if the FDA goes through its process with iQOS.
What's ahead for iQOS?
Meanwhile, iQOS is gaining traction across the world. Japan has been Philip Morris' primary test market, and market share for the product is already approaching the mid-single digits. European test markets are also seeing early success. Competitors are trying to develop similar technology, and that's one reason why Philip Morris is aggressively moving forward with the FDA application. If it can get approval before its competition, then Philip Morris and iQOS will have natural first-mover advantages that could last for years.
Philip Morris International's emphasis on reduced-risk products has come as a shock to some investors, many of whom figured that the tobacco giant would seek to squeeze as much as it could from traditional cigarettes as long as possible. Instead, a more forward-thinking approach has been inspiring, and the progress that Philip Morris has made is a sign of just how smart a move iQOS was for the company and its future.
