Gerald Ratner aside, it’s hard to find a company that makes great play of rubbishing its own products.

But that’s just what tobacco giant Philip Morris appears to be doing as it fights its side in a another controversial UK takeover battle. Somewhat incongruously, the tobacco business is taking over a pharma technology company specialising in respiratory medicine.

PMI’s £1bn-plus agreement to buy inhaler manufacturer Vectura, announced this month, was met with a mixture of disbelief and horror in some circles. How can a company that specialises in products that give people respiratory diseases buy a company looking to treat them?

Eyebrows were particularly raised by PMI’s claim to want to become a “healthcare and wellness company”, when its core products do anything but.

The company doubled down this weekend.

CEO Jacek Olczak told the Mail on Sunday it could stop selling cigarettes in the UK, including its flagship Marlboro brand, in as little as 10 years’ time.

Although caveated by the acknowledgement it could only happen as part of a wider regulatory crackdown on tobacco, Olczak appeared to be encouraging far stronger government action against his own products than anyone had previously suspected was on the cards.

“I want to allow this company to leave smoking behind,” he told the paper. “I think in the UK, 10 years from now maximum, you can completely solve the problem of smoking.”

Anti-smoking campaigners have already reacted to the comments by suggesting such claims shouldn’t be taken seriously.

Certainly there is a PR war going on centred on the Vectura deal, with shareholders coming under pressure to block the takeover. PMI is understandably keen to stress its previously stated commitment to produce half its revenues from non-combustible products by 2025 to demonstrate its “smoke-free strategy” isn’t mere window dressing.

There is some substance behind its messaging. It has invested some $8bn since 2008 in smoke-free products, while just a week before the Vectura news broke it also agreed to pay $820m for a Danish medical chewing gum manufacturer.

There is no doubt that tobacco is also a declining market. While it still accounts for around three quarter of its $28.7bn of annual revenues, PMI’s cigarette volumes were down 11.1% last year.

Most specifically, smoking is on the decline in developed western markets like the UK. The ONS found the percentage of UK smokers had dropped from 20.2% in 2011 to 14.1% in 2019 – with the key 18-24 group falling even faster from 25.7% to 16%.

All major tobacco firms have invested significantly in tobacco alternatives, but PMI has more reason than most to trumpet the move away from traditional products.

PMI is the undisputed industry leader in tobacco alternatives and any shift away from cigarettes strengthens its competitive advantage.

The quarter of net revenues PMI makes from tobacco alternatives – in its case primarily driven by its Iqos heating devices – is a vastly higher sum than its rivals (Altria is just under 10% and UK-listed British American Tobacco and Imperial Brands are at around 5% and 3% respectively).

Iqos also hasn’t attracted the ire of regulators in the same way as some tobacco alternatives have. 

While its heating technology has the green light from the US’ FDA, its major rival Juul (which counts PMI’s former parent Altria as a minority investor) is still waiting to hear whether it can continue selling its products in the US as the FDA considers PMTA applications from over 550 companies making electronic nicotine delivery systems (ENDS). Its value has slumped from $38bn to just $5bn.

Ending its sale of traditional tobacco products will also potentially open up PMI’s investor base and attract the majority of funds that have shunned investment in tobacco in recent decades – already PMI’s success with Iqos sees it trading at a higher multiple than its rivals.

There clearly remain strong causes for scepticism though.

Firstly, the tobacco industry’s activities in the west are very different to those in emerging markets, where 80% of smokers live and which provide the backbone of cigarette volumes and profits. It’s fair to say the drive to transition smokers from tobacco to alternatives is significantly less pronounced in these markets.

Secondly, even products like Iqos largely rely on converting existing smokers. With no new smokers, there is less need for tobacco alternatives. Regulators have become particularly sensitive to suggestions tobacco firms have encouraged young people to take up vaping – the longer-term prospects for tobacco alternatives ironically look less rosy the fewer people smoke in the first place.

You also have the moral question of whether consumer choices should be encouraged by old-fashioned mechanisms such as tax and pricing (as with the soft drinks levy), rather than more authoritarian outright bans. Even if the tobacco giants all follow suit, are we likely to see tobacco become a prohibited substance? If not, other smaller manufactures will surely just come in to fill the gap.

But if PMI – or its rivals – want to be seen as a wider healthcare company (and the growth opportunities that come with that rather than managed decline in a structurally declining business), then the fags have to go at some point.

It is not impossible that point is nearer than we thought.

Topics