Last December, Altria (MO -0.86%), America's biggest tobacco company, bought a 35% stake in Juul, the country's top e-cigarette company, for $12.8 billion. The deal was widely criticized because it valued Juul, which only generated about $1.5 billion in annual revenue, at $38 billion.
The outlook for Juul has dimmed considerably since Altria's investment. The FDA probed Juul's marketing strategies, the CDC recently reported that 27.5% of U.S. high school students had used an e-cigarette in the past month, and a series of vaping-related accidents and deaths sparked safety concerns. The Trump Administration also called on the FDA to ban all non-tobacco flavored e-cigarettes to curb teen vaping rates.
Juul's management doesn't even seem confident in its own future. In a recent interview on CBS This Morning, Juul CEO Kevin Burns warned viewers: "Don't vape. Don't use Juul." Juul's overseas expansion also recently hit a brick wall as India banned all e-cigarettes and China's top online marketplaces pulled Juul's products just a few days after their initial launch.
Simply put, Altria's investment in Juul was overvalued and terribly timed, and it clearly indicates that the tobacco giant is running out of ways to grow as its traditional cigarette shipments decline. That's the main reason Altria recently proposed to reunite with Philip Morris International (PM -1.98%), its former international unit which was spun off eleven years ago.
I recently argued that the merger -- which would require Altria and PMI investors to exchange their shares for shares of a new company -- would benefit the former but hurt the latter. I stand by that opinion, and I think Altria's Juul disaster presents PMI the perfect reason to walk away from the deal.
Why Philip Morris International doesn't need Altria
Altria believes that its stake in Juul complements its $1.8 billion stake in Canadian cannabinoid company Cronos, and that both investments could diversify its business away from traditional cigarettes. Altria wants to sell Juul overseas through PMI's international distribution channels. However, PMI CEO André Calantzopoulos recently blamed Juul for causing a teen vaping "epidemic" in the U.S., and stated that he wasn't interested in investing in cannabis.
Instead, PMI prefers to focus on the growth of iQOS, a device that heats (but doesn't burn) thinner tobacco "HeatSticks" for a less toxic smoking experience. The device also faces far less regulatory scrutiny than e-cigarettes. Last quarter, shipments of PMI's traditional cigarettes dipped 4% annually to 183.8 billion units, but shipments of its heated tobacco products surged 37% to 15.06 billion.
PMI's total revenue stayed nearly flat annually at $7.7 billion, indicating that price hikes for traditional cigarettes and higher sales of iQOS devices were offsetting its lower cigarette shipments.
PMI's revenue growth was also throttled by a strong dollar. On a constant currency like-for-like basis, its revenue actually rose 9% annually. Its revenue also rose on a constant currency basis across all of its regions except for Latin America and Canada. If the dollar weakens, PMI's reported growth would quickly rebound.
PMI also has higher gross margins than Altria, and its long-term debt is declining as Altria's is rising, mainly due to the latter's big investments in Juul and Cronos. In other words, Altria needs PMI far more than PMI needs Altria.
PMI's stock would rally if it walked away
When PMI and Altria disclosed that they were in merger talks, PMI's stock plunged. Investors clearly didn't think that it would be wise for PMI, which was originally split from Altria to tap into higher-growth overseas markets, to reunite with its struggling domestic counterpart.
Altria already sells iQOS in the U.S., and the two companies already pool their resources for the development of new alternative smoking products. Therefore there's no need for PMI to merge with Altria, and the latter's misguided faith in Juul presents the perfect reason for PMI to walk away.