For a long time, investors in Philip Morris International (NYSE:PM) believed that they would have a huge competitive advantage against U.S.-focused companies. The reason had to do with the perception that international regulation of tobacco products would remain much more lax than those that Reynolds American and other domestic companies faced. Yet the English High Court dealt a severe blow to that notion on Thursday when it rejected a legal challenge from Philip Morris International and some of its global peers against the U.K.'s plans to implement plain-packaging regulations. The move continues a worldwide trend that Philip Morris has seen recently, and the impact could be substantial over the long haul.
What the English High Court decided
The legal dispute started last year, when Philip Morris International, British American Tobacco, and other major tobacco players in the U.K. market fought against new rules on plain packaging for cigarettes that were due to take effect today. The tobacco companies argued that the rules would amount to a taking of their intellectual property and brand value without appropriate compensation. The reduction in consumer loyalty to brands represented an impermissible takeaway of value for the companies in their eyes. They also believed that the regulations wouldn't actually be effective in reducing smoking rates, which was one of their intended purposes. In particular, Philip Morris pointed to its experience in Australia, which has also adopted similar plain packaging regulations. There, the company argued that smoking levels have not been reduced following passage of the law.
The court, however, said that Philip Morris International and its peers didn't have a right to compensation because the regulations were suitable and appropriate in meeting the regulatory purpose of helping to keep children from becoming smokers. It cited the financial burden in bearing medical costs that it said result from smoking, and the fact that tobacco companies work in a business that creates those additional costs played an apparent role in the court's thought process in coming to the decision.
The setback continues the trend against global tobacco that Australia had started, and it came as a disappointment. One reason was that tobacco companies didn't have as high of a burden in fighting against the regulation in the U.K. compared to Australia, because the legal systems didn't require Philip Morris and its peers to prove that the government benefits at their expense.
How Philip Morris responded
Philip Morris International quickly commented on the court ruling, expressing its surprise at how the court conducted proceedings. As the company's general counsel said:
We are certainly disappointed but understand that the English Court ultimately deferred to the Parliament's judgment about cigarette packaging. Inexplicably, however, the Court's reasoning relies heavily on a 2006 decision by a judge in the United States in a case about U.S. law to which PMI was not even a party, and did not concern plain packaging.
The attorney went on to note that that reliance on a U.S. court decision was in conflict with court procedural rules and that parties weren't asked to address the decision in their hearing. Nevertheless, even though he concluded that the move would open grounds for appeal, Philip Morris International has decided not to do so, arguing that it "makes the most sense for the 7 million adult smokers in the U.K."
Instead, Philip Morris intends to push forward with its broader strategy for growing its business. The tobacco company continues to believe that its emphasis on reduced-risk products will eventually carry the day, giving consumers an alternative to traditional cigarettes that will meet customer needs while also avoiding some of the contentious issues that have plagued the industry for years. By creating and marketing products that have scientific evidence backing claims of improved impact on public health, Philip Morris thinks it can move beyond the debate that prompted plain packaging in the first place.
Going forward, Philip Morris investors will want to keep a close eye on plain packaging regulations around the world. As the movement picks up momentum, Philip Morris will feel even more pressure to seek ways to engage more positively with current and prospective customers in order to sustain the value of its brand. If it can't, then shareholders will eventually feel the pinch.