Philip Morris in merger talks with Altria; e-cigs a focus

Philip Morris International Inc and Altria Group Inc are discussing an all-stock merger, potentially reuniting two of the world's largest tobacco companies after more than a decade, in a deal aimed at domination of the fast-growing electronic-cigarette market.

Altria's shares initially rose more than 6%, while Philip Morris fell almost 10%. A merger of the two would create a company with a market value of more than $200 billion.

Analysts and investors have long speculated that the companies would merge, given mounting pressure from declining cigarette sales and the need to invest in other sources of revenue.

Industry-wide cigarette sales volumes tumbled 4.5% on an adjusted basis in 2018, according to analysts at Cowen. In contrast, the e-cigarette market was worth about $11 billion in 2018 and is expected to grow at more than 8% annually over the next five years, according to research firm Mordor Intelligence.

In April, Phillip Morris won approval from the US Food and Drug Administration to sell a heated tobacco product called iQOS in the United States, a big win for a company looking to move beyond traditional cigarettes.

"The potential to reunite the companies has been often discussed, but we did not believe this would occur given the heavy regulatory burden in the US market and its weakening growth profile," said Stifel analyst Christopher Growe.

In noting that the FDA's approval of iQOS may have changed the equation, he added: "But we do not believe that was sufficient to reconsider a combination of these companies."

Unlike combustible cigarettes, iQOS devices heat tobacco-filled sticks wrapped in paper, generating an aerosol that contains nicotine. They are different from e-cigarettes such as the popular Juul device, which vaporizes a nicotine-filled liquid.

Altria, which owns a 35% stake in Juul Labs Inc, already markets iQOS as part of a licensing agreement with Philip Morris.

In a note to clients on Monday, Wells Fargo analyst Bonnie Herzog said Juul would have an ideal partner for its international expansion in Philip Morris.

Herzog added that Philip Morris could speed up the growth of iQOS in the United States if it had full control over sales and distribution.

Philip Morris has annual revenue of nearly $30 billion, while Altria generated about $20 billion last year. Both companies said there could be no assurance a deal would be reached.

Any deal would need to be approved by the companies' respective boards and shareholders, and would likely face stiff regulatory approval.

"The regulatory environment in the US has been volatile and more burdensome for tobacco companies over the past 5 years and it is clear that the FDA has combustible cigarettes in its cross-hairs," said Stifel's Growe.

After nearly two hours of trading on Wall Street, Philip Morris' shares were down 7.5% and Altria was up 3.5%.