As they say, "If you can't beat 'em, join 'em." Tobacco giant Altria Group (NYSE:MO) is reportedly in talks to acquire a minority ownership stake in leading electronic cigarette manufacturer Juul Labs.

The company has withdrawn some of its own e-cigs from the market and is still awaiting a Food and Drug Administration determination on Philip Morris International's (NYSE:PM) IQOS device, which will be marketed under Altria's Marlboro brand in the U.S. -- if it's approved. But in the meantime, the cigarette giant is apparently interested in hedging its bets by linking up with a proven winner.

A JUUL e-cig plugged into a laptop

Image source: Juul Labs.

The jewel of the e-cig industry

Juul Labs, which was spun off from Pax Labs two years ago, has rocketed to the forefront of the e-cig business, capturing a market share of greater than 70%. In the process, it blew away the entries of long-established tobacco giants like Imperial Brands' blu eCig, British American Tobacco's Vuse, and Altria's GreenSmokes, which it recently pulled from store shelves along with its MarkTen brand. 

While JUUL devices use liquid-filled pods just like the devices of other manufacturers, both the substances the pods contain and the technology used to deliver the nicotine are different.

Rather than "freebase" nicotine, JUUL pods contain nicotine salts, which convey a hit that's reportedly almost identical to that of traditional cigarettes. Pax Labs' proprietary formulation using benzoic acid also provides what smokers describe as a smoother taste than either freebase nicotine or e-liquids that have nicotine salts dissolved in them.

That, and the fact the device resembles a sleek, oversized thumb drive, explains much of its appeal. Yet the dark side to this is that JUUL is also highly popular among teenagers -- a fact that has drawn the attention of the FDA. The agency recently seized records from Juul Labs to scrutinize how it's making and marketing its e-cigs.

The regulator also recently crafted new rules that would tighten sales controls on the industry, banning all e-cig flavors except tobacco, mint, and menthol from being sold anywhere outside of specialty stores, where minors are not allowed, and specifically targeting cartridge-type devices such as JUUL.

A backup plan

It was in part the possibility of e-cig regulation that led Altria to pull some of its own e-cig devices from the market. That could also be read as an attempt to curry favor with the FDA, which has the fate of IQOS in its hands. Although Altria still makes almost all of its money selling traditional cigarettes, it expects IQOS to help lead it into a future that Philip Morris has said will be smoke-free.

Altria spun off Philip Morris International in 2008 to market Marlboro and other cigarette brands internationally. Altria controls the brand here in the U.S. The two signed agreements in 2014 to commercialize each other's reduced-risk products in their respective markets. That meant Altria provided its MarkTen technology to Philip Morris to sell globally, and Philip Morris allowed Altria to market its IQOS and other devices here.

The IQOS technology is just as innovative as JUUL's. IQOS heats real tobacco to the point of creating a vapor to deliver nicotine -- but does not burn it.

The problem for both Altria and Philip Morris  (and their investors) is that it's still far from clear how well IQOS will perform from a sales perspective, even in the markets where it has already been introduced. In Japan -- its largest market -- it took off fast, garnering a JUUL-like 80% market share among e-cig users. But sales growth has fallen off sharply -- having drawn the lion's share of early e-cig adopters, the company now faces the more difficult task of convincing older, more conservative cigarette smokers to switch.

No sure thing

This helps explain why Altria wants in on Juul Labs. Regulations in Japan are unique: E-liquids are treated as pharmaceutical products, making them difficult to obtain and virtually eliminating any competition for the IQOS. Even with the new FDA regulations in place, IQOS will face numerous competitors offering all manner of e-cig and vaping styles, including so-called cigalikes such as the blu, which resemble traditional cigarettes; closed systems, in which the whole device is discarded after use; open systems, in which the e-liquid gets refilled; and the market-dominating JUUL.

Altria's decision to place a bet on the most successful e-cig maker doesn't mean it thinks IQOS won't succeed, but it hedges the company against a multitude of possible outcomes, including the possibility that the FDA doesn't approve IQOS. Assuming that a deal is reached, Altria will have a dog in the race no matter what happens.