With a rising number of smokers kicking the habit worldwide, tobacco companies need to work together, (where they can) to achieve the best returns for their shareholders. So then, it comes as no surprise that Philip Morris International (NYSE:PM) and Altria (NYSE:MO) recently announced that they will share the technology for electronic cigarettes, or e-cigs, and 'reduced-risk' products under several licensing, supply, and cooperation agreements.
Under the terms of this technology-sharing deal, Altria will make its e-cigarette products available exclusively to Philip Morris for commercialization outside of the United States. In exchange, Philip Morris will make two of its reduced-risk tobacco products available for Altria to market within the US.
This is actually a great deal for both companies. You see, to some extent Philip Morris, although a leader of the tobacco world, has gotten things wrong; the company has not taken the rise of the e-cig seriously. Specifically, while peers like Altria have had e-cig products under development for months, Philip Morris only announced its intent to enter the market in November of this year. As a result, Philip Morris has found itself lagging the field when it comes to the subject of e-cig technology.
Ahead of the game
In contrast, Altria has taken the threat of the e-cig seriously. The company rolled out its first e-cig product in August under the MarkTen brand name. Altria initially released its offering into 3,000 retail stores within Indiana and it has since expanded into Arizona. That being said, Altria has not released sales figures for its product within Indiana, which could be a bad thing. Actually, when questioned about sales figures by industry analysts, Altria CEO Marty Barrington said:
It is too early to talk about the numbers, because I just don't think they are well-developed enough to share and to be confident in them.
This may imply that sales figures were worse than expected. Still, what both Altria and Philip Morris International have is the world famous Marlboro brand name, which could be used to leverage their control over the e-cig market. With hundreds of e-cig products chasing a relatively small market in comparison with that of traditional tobacco, big tobacco companies like Altria and Philip Morris could easily become aggressive in trying to get e-cig sales, and their ownership of the Marlboro brand could give them the leverage they need.
Altria is also set to benefit from Philip Morris' donation of 'reduced-risk' products to the company's arsenal of products for sale within the United States. Reduced risk products are, according to Philip Morris, products that reduce the risk of tobacco-related illnesses. Altria already has several of these products on the market, such as the company's Verve chewable nicotine product and Denmark, a type of gum containing tobacco.
Not only are these reduced-risk products, but they also help smokers quit, so Altria is hedging its bets here.
Early mover struggling
These products should help Altria continue to gain market share within the United States' domestic tobacco market. Actually, Altria needs to market this move as the e-cig market within the US is starting to become somewhat saturated. Indeed, Lorillard (UNKNOWN:LO.DL), one of the first domestic tobacco companies to move into the e-cig market, is already reporting almost no profits from its e-cig operations as marketing and selling costs rise.
For example, looking through the respective earnings reports, we can see that Lorillard's e-cig gross margin has declined from 37%, reported during the first quarter of this year, to 32% during the second quarter , and finally 24% during the third quarter.
What's more, Lorillard's operating income and margin from its e-cig segment have declined from $7 million and 12%, respectively, in the first quarter of this year to 0 during the third quarter. That's right, Lorillard made no profit from its e-cig sales in the third quarter.
The reason for this? Well, the company rolled out a new, cheaper e-cig product and expanded its offering into an additional 127,000 stores, which damaged the gross margin. In addition, the company's marketing spend increased as it tried to beat competitors.
Far from a short-term issue, it seems as if higher marketing spending is going to become the norm as more competitors enter the e-cig market.
So all in all, tobacco giants Philip Morris and Altria are now working together in the e-cig and reduced risk markets and this combination should be beneficial for both companies, as it opens up markets that were previously outside of their reach.