Deals

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

Philip Morris International had a disappointing earnings report Tuesday -- sales volume was down and the strong dollar continued to prove painful. But buried deep within the report was a bright spot that happens to be the key reason Altria, its former parent company, might want the business back: 

A highlight of the quarter was our exceptional iQOS performance in Japan, where HeatSticks reached a national share for the quarter of 2.2 percent, demonstrating the tremendous potential of the reduced-risk products category.

What is iQOS? You can read this Bloomberg article about it here, but in a nutshell, it's a new smoking technology that involves heating tobacco rather than burning it -- something that Philip Morris International is hoping to claim reduces the risk of smoking-related diseases and will reignite its growth. As of now, the technology looks to be a real game-changer for the industry, and Philip Morris International has that first-mover advantage. The company says it's spent more than $2 billion on research and development of smoking alternatives, as conventional cigarette consumption wanes in many markets. 

Reversing The Trend
The U.S., where Altria generates all of its revenue, has had one of the steepest declines in smoking prevalence. Philip Morris's new iQOS products could be a much-needed growth driver for the company.
Source: Euromonitor International

Altria has a hand in the iQOS system because it has a partnership with Philip Morris International for coming up with these new products. However, the two are separate companies. They split apart in 2008, leaving Altria focused on the U.S. market, where it has tremendous pricing power but is losing smokers. They've launched iQOS products abroad, though, which is Philip Morris International's territory. And they're having success there.

This builds on the argument that the two should recombine officially, instead of just sharing R&D. While cigarettes remain a massive $700 billion global industry, these reduced-risk products look to be the tobacco giants' best chance at driving future sales. And even though marijuana could well be another growth area, it's still years away from becoming a legitimate industry that companies like Altria can move in on (but believe they're already prepping for it).

A hypothetical takeover of Philip Morris International, valued at $154 billion, would certainly set the M&A record this year. But it's not crazy to think Altria could do it. Altria owns about 27 percent of SABMiller, the $94 billion brewer that's now in the (long and grueling) process of being sold to Anheuser-Busch InBev. There are tax implications and whatnot, but simply put, Altria would have the wherewithal to pursue Philip Morris International. And with low interest rates, low leverage and sustainable cash flow, borrowing funds wouldn't be a problem either.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net