News that Philip Morris International (NYSE:PM) was awarded a reduced-risk label for its IQOS heated tobacco device indicates Altria (NYSE:MO) was smart to have a backup plan in place for the electronic cigarette market.
Because its investment in JUUL Labs has all but blown up in its face, Altria's ability to still profit from e-cigs through its IQOS marketing and distribution agreement with Philip Morris shows why a company should not put all of its eggs in one basket.
Betting on the top two horses
Altria had no way of knowing which horse would win the e-cig race. While the deal with Philip Morris came first as they agreed to jointly pursue reduced-risk product development for eventual manufacture, marketing, and distribution, the phenomenal success the global tobacco giant enjoyed when it launched the IQOS device in Japan hasn't been quite the same elsewhere in the world, though acceptance is still very positive.
There was also no knowing how it would perform in the U.S., since JUUL Labs had come from out of nowhere to run away with the market, eventually owning more than 80% of e-cig sales.
The wild card was the proposed draconian U.S. Food & Drug Administration (FDA) regulations that promised to crush the e-cig industry, if not completely wipe it out.
Yet since e-cigs are viewed by much of the rest of the world as beneficial in helping smokers give up traditional cigarettes, there was a good chance the industry would survive, so Altria's decision to back both the leading domestic brand and the international favorite was a smart bet to make.
A lot of unknowns
It took the FDA over two years to approve the Philip Morris application to just be able to sell the IQOS in the U.S. under Altria's Marlboro brand as HeatSticks. That it's been nearly four years to get a decision on its reduced-risk efficacy shows the high hurdle other e-cig manufacturers face.
To date, only British American Tobacco (NYSE:BTI) has submitted an application for e-cigarette marketing approval, for its Vuse e-cig (it submitted two additional applications this past April for its Vibe and Ciro brands). With the fall deadline fast approaching, no e-cig maker has submitted one to earn a modified-risk designation.
Although JUUL promises it will also be submitting a marketing application for its device, there is significant doubt about whether it can get approved. The FDA has come after JUUL with a vengeance for its alleged marketing of its e-cig to teens, so much so that the agency's former commissioner has expressed doubt it can succeed.
The run of the field
None of this was apparent when Altria made its $12.8 billion investment in JUUL, which has since seen three quarters of its value wiped out. But now that the heated tobacco device has earned the reduced-risk label, which says it is less harmful than cigarettes if users completely give up smoking, it has a marketing advantage over any other device that may be approved for sale. Maybe now the tobacco giant will accelerate IQOS availability.
Although Philip Morris won approval last year, Altria has slow-walked the rollout of the device, so it is being sold in just a handful of markets at the moment.
It's unlikely there will be much competition. It was estimated that the Philip Morris application was a million pages long and cost millions to produce, while British American said its application included 150,000 pages of supporting documents. Most small manufacturers won't have the financial ability or scientific acumen to comply by the deadline, meaning their products could be pulled from store shelves.
The winning play
Altria and Philip Morris International may end up with almost the entire e-cig market to themselves. Even if British American Tobacco is successful in getting approved, the IQOS will have a competitive advantage from being the only e-cig on the market that the agency has acknowledged "could help addicted adult smokers transition away from combusted cigarettes and reduce their exposure to harmful chemicals" if they completely switch. That's the case even though the FDA has explicitly said that IQOS isn't safe and urges those not currently using tobacco not to start using IQOS either.
The JUUL Labs investment was an expensive insurance policy that was necessary to make, but now Altria can focus all of its attention on IQOS and growing it into the major cigarette alternative in the country.
Editor's note: A previous version of this article incorrectly suggested that the FDA had approved IQOS as safer than regular cigarettes. The author and the Fool regret the error.