Philip Morris International Inc. (PM) and Altria Group Inc. (MO), two of the world’s largest tobacco companies, split up more than 10 years ago amid concerns over payouts to shareholders and smoking lawsuits. Now, they are talking about getting back together with sights set on dominating the rapidly-growing market for electronic cigarettes. The all-stock merger would create a company with a total market capitalization of more than $200 billion, making it the fourth largest M&A deal ever, according to Reuters.

Shares of Altria initially spiked on Tuesday’s news before falling after it was disclosed that shareholders would not receive a premium in the event of a deal, according to CNBC. The stock closed down nearly 4% on the day. Shares of Philip Morris were down close to 8% on Tuesday. Altria’s current market cap is $86.3 billion while Philip Morris’ stands at $129.4 billion.

What It Means for Investors

The two tobacco giants first broke apart in 2008 when Altria was spun off of Philip Morris. The move occurred due to pressure from U.S. investors wanting higher dividends and more share buybacks, and it was pitched as way to unleash the potential of faster-growing overseas operations amid smoker lawsuits facing the U.S. arm of the business, according to Bloomberg.

Altria remained focused on the U.S. domestic market, selling its Marlboro cigarettes, while Philip Morris centered its tobacco business on markets abroad. At the time the two companies bid farewell, cigarette sales were dwindling in the U.S. while increasing overseas. But since 2012, sales started to decline internationally. Between 2017 and 2018, Philip Morris saw its cigarette shipment volume fall as much as 3%. On an adjusted basis, industry-wide cigarette sales volumes fell by 4.5% in 2018.

But as traditional cigarette smoking has waned, a new, sleeker mode of inhaling tobacco has emerged—the e-cigarette. The e-cigarette market was worth around $11 billion in 2018 and is expected to grow at a more-than 8% annual pace over the next five years. Both companies have adapted to the change in consumer tastes, diversifying their portfolios to include tobacco products fitting for a more technological age.  

Philip Morris has plowed more than $6 billion into iQOS, a device that heats tobacco-filled sticks wrapped in paper, producing an aerosol containing nicotine. Already, the device has about 11 million users worldwide and has been introduced to 48 markets around the world. Earlier this year, iQOS was cleared for the U.S. market by the Food and Drug Administration (FDA) and is already able to be marketed by Altria under a previously negotiated licensing agreement with Philip Morris, according to Reuters.

But Altria also has made its own e-cigarette investments. The company has invested $12.8 billion for a 35% stake in Juul, the biggest e-cigarette firm in the U.S. Juul, whose e-cigarette vaporizes a nicotine-filled liquid, leads the e-vapor product market with an approximate 18% share of total retail sales value. The next four companies—Reynolds American, British American Tobacco, Imperial Brands, and Japan Tobacco—each have a 5% share or less. Altria also has a 45% stake in Canadian cannabis company Cronos Group Inc. (CRON). 

A merger with Philip Morris would help Altria fuel Juul’s international expansion, and make iQOS even more economical in the U.S. The deal, which has long been speculated about by analysts and investors, would give Philip Morris approximately 58% ownership of the combined company, while Altria would own the other 42%.

Bernstein analyst Callum Elliot recently wrote in a note to clients, “With disruption facing the world of tobacco, we can see some merit in a re-merger.” According to MarketWatch, Wells Fargo analyst Bonnie Herzog said that "there will be tremendous value" if a deal happens and that Phillip Morris will be able to "capture the full margin and accelerate the growth of iQOS in the U.S. given its full control over sales and distribution." Jefferies analyst Ryan Tomkins called it "strange timing" due to the "possible risk to Juul in the U.S. with regards to regulatory action." He added, "Maybe Philip Morris are willing to take this risk as they believe it can easily be offset by the potential international opportunity for Juul under their distribution and the value of fully owning IQOS in the world’s biggest reduced risk market.”

Looking Ahead

Any deal, however, still needs to gain approval from each company’s respective boards and shareholders. One hang-up that could pose a problem is the agreement between Juul and Altria, which prevents Altria from owning or working with a competitor in the e-vapor business. That means Philip Morris. Other risks to the potential merger could revolve around antitrust regulation, as the deal would render significant control of the vaping market to the new company.