The $ 200 billion merger of Altria-PMI would face the future with fewer cigarettes

For Altria and Philip Morris International, breaking the house was perhaps too difficult to do.

A decade after being separated, the two tobacco giants announced this week that they were considering a merger.

The potential merger would end years of speculation about the possible meeting of companies. Marlboro's maker, Altria, created PMI in 2008 to help international trade grow and protect it from US regulations and litigation.

If they recombine, the newly formed company would be a $ 200 billion giant that would match the market value of its next competitor, British American Tobacco, by about $ 120 billion. However, much has changed in the decade since the split, and Big Tobacco can no longer rely on the cigarettes on which its empire was built.

The only problem is that Altria's two main areas of growth – vaping and cannabis – are new areas in the face of regulatory challenges. Electronic cigarettes, in particular, are already paralyzed by investigations, litigation and charges of intentionally hooking minor children to addictive nicotine capsules.

The sale of cigarettes remains an extremely profitable business, even though it is decreasing. Smoking rates around the world are declining, with health officials around the world sounding the alarm about its long-term health consequences. In response, tobacco companies are developing alternative ways to deliver less carcinogenic nicotine, including electronic cigarettes, heated tobacco products and oral nicotine sachets that do not release known tobacco toxins. to cause cancer.

The merger of Altria's and PMI's activities would allow the merged company, which already sells the same brands of cigarettes, to work together on new products, or at least the intention to think so, according to people familiar with the company. opinion of the company. An agreement might not materialize, warned companies. And if an agreement is reached, the company's boards, shareholders, and regulators will have to approve.

However, Roberto Pozzi, an analyst at Moody's, said the merged company could use its weight to invest in new products, generate more profits and better manage the risks associated with new markets.

From 2013 to 2018, cigarette sales volume declined 9%, with 5.3 billion cigarettes sold worldwide last year, according to data from Euromonitor International's market research firm. But thanks to rising prices, global cigarette sales increased by 15% over the period, reaching $ 713.66 billion in 2018.

Consumers are interested in new products that promise to provide a solution to nicotine without all the harm caused by smoking. And some regulators accept the change. The US Food and Drug Administration recognizes that nicotine-based products exist on a continuum of risk, where cigarettes are the most dangerous way to consume nicotine and that other products, even if they do not. are harmful, probably have fewer risks.

The electronic cigarette has been until now the most popular alternative. According to Euromonitor, global sales rose by 324% between 2013 and 2018, reaching $ 15.69 billion in 2018. This still represents only 2% of the world's tobacco market, which totals $ 814.3 billion, but the potential growth margin is much larger than that of cigarettes.

The tobacco giants take note of the changing tastes of consumers. PMI has carefully reshaped its image with a new mission: "design a smoke-free future". Since 2008, PMI has invested more than $ 6 billion in iQOS, its smoking heater and other next-generation products.

IQOS looks more like an iPhone than a tobacco product. The white holder contains the slender device, which heats a small stick of tobacco that the PMI calls a "heatstick". Since its pilot launch in Italy and Japan in 2014, PMI has introduced iQOS in 48 markets around the world and already has about 11 million users.

Reduced-risk products, as called PMI, are becoming increasingly important in PMI's business. Last year, they accounted for about 14% of the company's total business figure, estimated at $ 29.63 billion, up from 3% in 2016.

IQOS will enter the US market next month after US regulators allow it in April. Altria will pay royalties to PMI for the sale of the device in the United States under a licensing agreement signed by the companies in 2013. The US market was much less crowded when the deal was announced.

An electronic cigarette called Juul entered the scene in 2015 and quickly captured about half of the nicotine vaping market, according to Altria. The company's internal brands, Mark Ten and Green Smoke, had captured a fraction and were closed in December, shortly before Altria announced its 35% stake in Juul for $ 12.8 billion.

With declining cigarette sales, Altria relies heavily on its risky cannabis bets, its success in conquering iQOS customers and the continued growth of Juul, which is being monitored. intense. The FDA and other regulators have been investigating corporate business practices, with officials largely responsible for the surge in youth adolescence.

Howard Willard, Altria's CEO, said the creation of a diversified portfolio would help Altria succeed. Altria has added the On brand of nicotine sachets derived from oral substances to its range, thanks to a $ 372 million contract signed by Burger Sohne in June.

In addition to its growing list of nicotine alternatives, Altria is involved in the cannabis industry. Altria invested $ 1.8 billion to acquire 45% of the Canadian Cronos cannabis company at the end of last year.

"The combination of Philip Morris International's iQOS, the best-selling heated tobacco product, and Altria's holdings in Juul, market leader in e-vapor, and cannabis can give birth to a dominant portfolio that exploits the sector's largest growth opportunities in the future "Ivan Genov, an analyst at Euromonitor, said in a statement.

Altria and PMI combined would have a full range of new products in a rapidly changing industry. But some are not sure that companies need to merge, especially now.

PMI could give Juul what Altria can not – help to grow internationally. But US regulators have still not approved Altria's investment in the e-cigarette business. Juul's headaches in the United States are growing. The FDA has threatened to suspend Juul's products in the midst of a "teen epidemic" steaming, with lawsuits across the country accusing him of targeting children and lawmakers looking into the company about its marketing practices.

PMI will already benefit from iQOS sales in the United States through the partnership agreement. The merger with Altria would expose PMI to the tumultuous market in the United States, where regulators are applying disruptive policies, such as reducing nicotine levels in cigarettes to minimal or non-addictive levels and banning menthol cigarettes.

"It's just not clear to me what they can do together that they can not do separately, especially when they are working together on some of these things, like the "IQOS," said Michael Lavery, analyst of Piper Jaffray.

-CNBC David Faber contributed to this report