Altria (MO -0.33%) faces the prospect of unwinding its $12.8 billion investment in leading electronic cigarette manufacturer JUUL Labs if the Federal Trade Commission successfully advances its case against the tobacco giant.

The agency contends Altria actually exited the e-cig market not because of the increasingly difficult regulatory environment the tobacco company cited, but rather because its non-compete agreement with JUUL in exchange for a share in the company would allow it to share in Juul's profits.

Two commissioners believe the complaint against Altria actually doesn't go far enough because they contend Altria's investment in Juul was really a "conspiracy to monopolize" the e-cig market for which it should have been charged.  

Juul electronic cigarette and pods

Image source: JUUL Labs.

The FTC alleges Altria originally wanted a dual-track plan allowing it to invest in JUUL while also selling its own MarkTen e-cigs, but JUUL refused unless Altria exited the market. It notes that in December 2018, Altria announced it was withdrawing from the e-cig market and, two weeks later, announced its JUUL investment.

Ian Conner, director of the FTC's Bureau of Competition, said in a statement, "Altria and Juul turned from competitors to collaborators by eliminating competition and sharing in Juul's profits."

It amounted to an unlawful restraint of trade in violation of the Sherman Act and lessened competition, which violated the Clayton Act. The Acts were passed in 1890 and 1914, respectively, and seek to prohibit monopolies and anticompetitive behavior.

Altria contends the investment is not anticompetitive, and the regulatory agency "misunderstood the facts."

A high mountain to climb

JUUL's device dominates the electronic cigarette market as its slim, sleek design caught on with smokers looking to quit cigarettes.

Where Lorillard's blu eCig had been an early industry leader, its impact was diminished after it was sold to Imperial Brands (IMBB.Y 0.29%) to pave the way for Reynolds to acquire Lorillard.

Reynolds' Vuse brand then became the market leader, but that too was short-lived as JUUL, which entered the market in 2015, surpassed Vuse and the rest of the industry in late 2017 and has not looked back since. 

Despite the FTC's contention Altria's MarkTen brand was the second biggest brand at the time of the agreement, Wells Fargo analysis has never placed Altria's best-selling MarkTen XL brand higher than third place.

Just prior to Altria announcing it was withdrawing all of its e-cig products from the market, it had a combined 8.6% share of the e-cig market, compared to British American Tobacco's (BTI -0.36%) Vuse brand, which had nearly double the share, or 17.5%.

Juul was simply running away with the market, ending 2018 with a 76% share. S&P Global Market Intelligence reports it sold over $1.9 billion worth of e-cigs that year, versus $429 million for Vuse and less than $215 million for Altria. It's clear the tobacco giant was fighting a losing battle, and would be hard-pressed to overtake Vuse let alone Juul.

Altria's back to the wall 

While the FTC says a series of meetings between Altria and JUUL in 2018 cemented the deal, but only after the tobacco giant agreed not to compete against the e-cig maker, the regulatory agency's complaint ignores any of the dynamics occurring in the marketplace at the time.

The FDA started cracking down on electronic cigarettes because of rising teen use of the devices, which it subsequently labeled an "epidemic." And though the FTC complaint mentions Philip Morris International's (PM 0.28%) IQOS heat not burn device gaining marketing approval from the FDA, nowhere does it point out that Altria would soon begin manufacturing, marketing, and selling the IQOS under its Marlboro brand, meaning it didn't necessarily need to have its own e-cigs on the market to profit from the industry.  

Altria and Philip Morris had signed collaborative agreements for reduced-risk products years prior, and IQOS became the first (and to this day only) e-cig granted marketing approval by the FDA. That would give the device a massive competitive advantage, particularly as other manufacturers will have a difficult time surmounting the regulatory hurdle the agency had erected for compliance.

Even the FTC's complaint says Altria "may significantly underestimate" the costs associated with navigating the FDA's regulatory labyrinth, so it was financially smart for Altria to avoid going through the expensive, time-consuming compliance process for its MarkTen brand. It could instead focus on selling pre-approved IQOS devices while assisting the market-dominating Juul navigate the regulatory maze.

Not worth tilting at windmills

Although JUUL may have insisted on an investor not competing against it, an equally charitable view of the negotiations -- and arguably a more appropriate reading -- could see Altria realizing its MarkTen brand would never amount to much. JUUL had an indomitable lead in e-cigs, British American's Vuse was solidly in second place, and Philip Morris was entering the market with what could end up being one of the few e-cigs left on the market.

Focusing its resources where they could offer the greatest return for shareholders, rather than wasting them in a quixotic campaign was actually a sensible decision for the tobacco giant to make.

The FTC, however, says "consumers lost the benefit of current and future head-to-head competition" between Altria and Juul, as well as with other brands. It also eliminated a threat to Juul's market ownership of the e-cig market while giving Altria improper oversight to a rival's operations.

 That could be a stretch of the competitive landscape, though.

An even more expensive investment

Unwinding Altria's $12.8 billion investment in JUUL would be an extremely costly endeavor, not least because the tobacco company has written off two-thirds of the value of the investment already.

The FDA's unrelenting attacks on the e-cig maker, along with investigations over its marketing practices by the FTC and the SEC, have driven down the value of the company. Altria has taken charges against the investment worth over $8 billion.

And as the FTC's complaint notes, the vast majority of Altria's investment was distributed to Juul employees and shareholders. Clawing back the money won't be easy, and would hurt the e-cig maker's workers.

A good argument can be made that, as the tobacco giant says, the investment in JUUL does not harm competition and is why it believes it has "a strong defense and will vigorously defend our investment."