Altria Stock: Juul Vaporized, Almost (NYSE:MO)

Did Altria Know What It Was Buying?

Back on December 20th, 2018 The New York Times reported on Altria’s (NYSE:MO) $12.8 billion investment in Juul. What’s remarkable is that MO knew exactly what it was facing.

“We understand the controversy and skepticism that comes with an affiliation and partnership with the largest tobacco company in the U.S.,” said Kevin Burns, chief executive of Juul in a statement Thursday morning.

And, here’s more color from the same article:

The deal comes as the Food and Drug Administration escalates its crackdown on Juul and other e-cigarette makers. The agency’s commissioner, Dr. Scott Gottlieb, was initially a strong advocate for these new products, but has initiated a campaign to limit their reach now that youth vaping has soared.

The F.D.A. has been investigating Juul for months, and threatened to pull the devices off the shelves if the company couldn’t find a way to keep them away from teens.

In other words, MO knew exactly what it was buying, and what they were up against. Perhaps there was a bit of hubris in the C-suite. But maybe MO was getting worried about Juul’s extremely fast growth. From back in 2018:

Juul, which split from parent company Pax in 2017, captured 75 percent of the e-cigarette market in just three years, with most of the growth coming in the past year.

We also need to consider that analysts did approve of the deal. For example, Wells Fargo analyst Bonnie Herzog remarked:

“We think this would be the absolute right decision for [Altria] given where we think the reduced risk industry is heading and because Juul is the ‘it’ brand,” she said, reiterating her Outperform rating on Altria stock. “Ultimately, we believe [Altria’s] stake in Juul will help to catapult Juul’s growth internationally.”

All of this is important because it tells us that MO leadership didn’t deliberately invest in Juul expecting a major loss. Instead, it’s far more likely they felt threatened and the decided to pick up the best-in-class product. Furthermore, MO does have a track record of success when it comes to handling regulations, government oversight, and the “negative energy” directed at Big Nicotine.

In this article, we’ll spend a bit of time discussing lost perspective. Plus, there are a couple of interesting ideas that could shift perceptions. And, of course, we’ll see if Juul directly matters to MO’s bottom line right now.

Lost Perspective

Some investors have been very hard on MO about Juul. Here’s a good example from Seeking Alpha member searchlight:

Juul and its writedown represents a serious, extremely costly management failure. Dismissing this mess as a mere “sunk cost” is absurd. What about the opportunity cost — the potential future earnings Altria might have accrued from a profitable alternative investment? A $13 Billion loss absolutely affected shareholder value, and it raises serious questions about the competence and judgment of Altria’s executive suite.

There’s no doubt that $13 billion is serious money. But what’s swept under the rug is that Juul appeared to be a serious threat and shooting star. It was the quickest startup in history to hit $10 billion in valuation. That happened after it’s very first fundraising round. That was four times faster than Facebook, seven times faster than Twitter and nearly 11 times faster than Dropbox.

I’ve already mentioned that analysts liked the deal, but here’s why:

“From a balance sheet standpoint, we think the investment would be entirely ‘do-able’ for [Altria] given its very low leverage… and excellent cash flow,”

In 2018, I recall that a large number of retail investors panned the deal. However, this didn’t seem all that terrible to Wall Street. I’m not personally defending the deal – I thought it was lame. But I am making the point that leadership knew what it was doing, and Wall Street wasn’t against it.

Another Idea

This will start off in a weird place. Stick with me because I’ll bring it back around to MO soon enough. Fair? Let’s proceed.

Back in 2006, Chris Paine released Who Killed the Electric Car? Here’s part of the storyline:

This is an important film with an important message that not only calls to task the officials who squelched the Zero Emission Vehicle mandate, but all of the other accomplices, government, the car companies, Big Oil, even Eco-darling Hydrogen as well as consumers, who turned their backs on the car and embrace embracing instead the SUV.

Paine paints an interesting picture. Reviewers discussed the implications:

The EV1’s demise has sparked debate, with electric car enthusiasts, environmental groups, and former EV1 lessees accusing GM of deliberately sabotaging its electric car program in order to avoid potential losses in spare parts sales (forced by government regulations), as well as accusing the oil industry of conspiring to keep electric cars off the road.

So, General Motors (GM) jumped into this market and then killed the project. The not-so-subtle message is that GM did all of this on purpose, of course.

Likewise, there’s a conspiracy floating around that GM has a track record of wiping out competitors. Here’s a good summary from CBS News:

Back in the dawn of the Automobile Age, General Motors began systematically buying streetcar lines and then shutting them down, leaving millions of Americans without viable public transportation options. Its motive? To ensure a market for its still-novel personal transportation technology. Rather than walk, the idea was, people would buy Buicks.

Now, there’s plenty more that I could drop in here. The key idea is perhaps MO bought Juul because the plan was to kill the competition. That’s possible. But the size and scope of MO’s investment indicates that MO was quite serious and wanted success. They just took a big bite and choked. It wasn’t stupid or malicious. The bottom line is that Juul has been a victim of its own success and MO investors are likewise along for the painful ride.

Other Implications

There are two things happening right now that are highly related. First, we know that MO’s investment in Juul has collapsed. But, here’s the upside:

Altria’s stake in Juul is now worth just 3.5% of the original value, giving the tobacco giant the option to be released from it non-compete clause and invest or engage in the e-vapor business other than Juul.

However, Altria said it had opted not to be released from those obligations for now, as it still sees value in its investment rights, including substantial voting power, in Juul. [Emphasis: Author]

While they have not dropped Juul, they have tremendous power over Juul. They have extremely strong positioning. They have rights, they are having voting power. This kind of leverage probably isn’t worth $12.8 billion, but that influence gives them a lot more wiggle room than investors probably realize.

Second, MO still has the potential of tapping into the Philip Morris (PM) IQOS opportunity, as stated here:

In September 2021, the ITC imposed an importation ban and issued cease-and-desist orders (CDO) prohibiting the importation, sale, and marketing of IQOS and Marlboro HeatSticks. We disagree with the ITC’s decision as we believe that the plaintiff’s patents are invalid and that IQOS does not infringe those patents. The CDO took effect on November 29, 2021, making all IQOS and Marlboro HeatSticks products unavailable in the marketplace. IQOS is the only inhalable tobacco product to be granted a Premarket Tobacco Application and Modified Risk Tobacco Product Application by the FDA, meaning that the FDA determined IQOS is appropriate for the protection of public health and can be marketed with a reduced exposure claim. If IQOS cannot be imported into the U.S., then ~35 million adult smokers will no longer have access to the product, and those who have already switched to IQOS may choose to return to cigarettes, the most harmful form of tobacco. This would be a bad outcome for public health.

The news is bad regarding Juul. For now. The news is bad for IQOS for MO. For now. But the essential point is that MO is still in the space, looking for an opportunity to strike, when the winds change, or when a gap appears. They have relationships, ownership, and assets that they can leverage. It looks bad now, but with the right opening, Juul could possibly come back to life. IQOS is a similar wild card.

Wrap Up

So, Juul is no jewel. I explained that Juul contributed about 5-6% to MO’s sales but generated a net loss of $259 million on those sales. Juul is not a profit engine, so that’s not a problem. It’s a balance sheet issue. It’s about the assets, and misallocation of capital. But all is not lost. Time will tell if Juul truly is a loss, or not.

Ultimately, the market has absorbed the bad news, and uncertainty. There’s so much that’s still not known, and MO’s price shows that market doesn’t like it. There’s no doubt the lack of clarity going forward is suppressing MO. Yet, at the same time, for enterprising investors, MO is offering up a tremendous income opportunity, with a dividend hike coming soon. I see MO as a buy.