Tobacco company Philip Morris International (PM 1.98%) recently received an essential blessing from the EU for its pending acquisition of oral nicotine pouch company Swedish Match. The deal could close by year-end once Philip Morris satisfies a condition for the deal's approval. The deal is worth $15.7 billion, and Philip Morris is funding the deal with cash and debt.
It's a blockbuster deal that might remind some investors of Altria's disastrous Juul acquisition a few years back. But there are good reasons for shareholders to sleep at night in this instance despite the size of the move. Here is why Philip Morris will come out of this a stronger company in the long run.
The long-term upside of the U.S. market
Philip Morris was formed in 2008 when Altria spun off its international businesses. Philip Morris today is the world's largest public tobacco company by market capitalization, a powerful position in an industry that is slowly shrinking as smoking rates decline. Investors have long salivated over the upside of Philip Morris finding a way into the U.S. market, the world's most lucrative nicotine market outside China. Philip Morris and Altria briefly considered merging back together, but the move ultimately didn't pan out.
Swedish Match manufactures the Zyn brand of oral nicotine pouches, a growing alternative to traditional cigarettes. Zyn competes with Altria's brand on! in the U.S. and is leading that fight with a 64% market share in that category. It's a potentially significant development for Philip Morris, which now has a top product in the U.S. without having to tie itself to Altria.
The rift between Philip Morris and Altria widened last month when Philip Morris terminated its collaboration with Altria on IQOS, a heated tobacco product. That move, effective in 2024, will open the gateway for Philip Morris' IQOS device in the U.S. and could come at some cost to Altria, the incumbent market-share leader in tobacco products. Philip Morris thinks IQOS can take 10% of total U.S. cigarette and heated-tobacco volume by 2030, a potential needle mover for a company still growing in international markets.
Will there be short-term consequences?
The $15.7 billion acquisition will financially freeze up Philip Morris for a while. The company already has $27 billion in existing debt and will probably assume at least another $10 billion, considering that it has just $5.4 billion in cash. Management estimates that Philip Morris' balance sheet will be levered to a debt-to-EBITDA ratio of 3, which won't leave the company much room to borrow any more money.
PM Cash and Short-Term Investments (Quarterly) data by YCharts
Importantly, management plans on keeping the dividend intact; Philip Morris will target a 75% dividend payout ratio over time. They've already suspended the share-repurchase program, and shareholders should probably expect minimal dividend raises until debt comes back down. Fortunately, Philip Morris already has a 5.5% dividend yield, so investors are getting paid quite well to hold the stock.
A dividend stock for the long haul
The long-term goal for Philip Morris is to lead the global market in reduced-risk nicotine products. IQOS has been growing for nearly a decade and will soon enter the U.S. market in the upcoming years. Adding Zyn via Swedish Match puts Philip Morris in a legitimate leadership position that can fuel steady growth to keep the dividends coming.
The fluctuations in currency exchange rates often work against Philip Morris, and the stock's share price has barely budged in a decade. Therefore, I don't think investors should buy Philip Morris and expect to turn a small investment into a fortune. But you should consider the stock if you're looking for passive income with potential share-price upside as icing on the cake.
