A Paradigm Shift

    Photo: BAT


    For years, smokers weren’t interested in supposedly safer cigarettes. There were some attempts by R.J. Reynolds in the 1990s with a “heated not burned” cigarette in the U.S. (under the brand name Eclipse), Germany (HI.Q), Sweden (Inside) and Japan (Airs). But the time seemingly wasn’t ripe for novel products.

    Instead, the tobacco industry entered an era of consolidation, the majors embarking on a large acquisition spree to expand their sales and distribution reach and to build on the popularity of global brands. The alcohol companies followed a similar strategy. The one exception was Swedish Match, which sold off of its cigarette interests to prioritize less harmful snus. That was before the EU decided to impose a ban on the product.

    The emergence of vaping technology, alongside the continuing focus on the health impact of smoking and an increase in regulatory restrictions saw the arrival of startup companies like Blu, Ploom (now Juul), NJOY, E-Lites and Ruyan. These businesses were at the forefront of starting what Swedish Match originally envisaged—a widespread transition for smokers from tobacco to alternative nicotine-delivery products.

    The tobacco majors stood briefly on the sidelines but quickly began acquiring many of these businesses and renewing their investments in the previously trialed heated-tobacco technologies. Philip Morris International led the way, soon publicly proclaiming its intentions for a “smoke-free future” and committing to transition smokers to less harmful products. Indeed, PMI’s latest acquisitions in the pharmaceutical sector, including those of OtiTopic, Vectura and Fertin Pharma, are intended to transition their business even beyond the nicotine segment.

    But prevailing public perceptions of the tobacco industry are slow to change, and with increasing attention on environmental, social and governance (ESG) issues, many investors have taken a restrictive approach toward tobacco stocks. Whether or not compounded by the disruptive threat of new challenger technologies, tobacco stocks have shed circa $300 billion over the past five years. This is despite the industry’s history of paying generous dividends, which in theory should attract investors. Similarities with “stranded assets” in the oil, gas and coal-mining industries immediately come to mind.

    There is already a noticeable difference in valuations between faster and slower transitioning tobacco companies, skewered in favor of the more active ones. The meteoric rise of Juul (albeit one that has now somewhat deflated) and the explosive valuations afforded to the likes of Smoore and RELX are also indicative of where investors see the future value in nicotine businesses. 

    Increasing public health concerns and huge consumer demand for harm reduction products, set against a complex regulatory landscape, fuel the reduced-risk product (RRP) categories.

    PMI, Altria and BAT are prominent in outlining their significant investment in and commitment to a portfolio of RRPs and their plans to transition smokers away from combustible products. While Japan Tobacco may have appeared to prioritize combustibles, recent developments suggest an intention to increase its presence in the RRP category too. Imperial Brands, while still undergoing a change in the senior management team, is following a similar strategy.

    Tobacco companies are increasingly becoming lifestyle companies with broad product offerings but streamlined brand portfolios.

    Although not widely commented on, this development and the plans that the tobacco majors seemingly have for the RRP category will have significant consequences for a number of industry participants, not least tobacco leaf growers. Prominent tobacco-producing nations, such as Malawi and Zimbabwe, will therefore face significant challenges and will likely need to restructure their entire economies.

    As a result of these developments, tobacco companies are increasingly becoming lifestyle companies with broad product offerings but streamlined brand portfolios. PMI is the most ambitious, trying to converge lifestyle and pharmaceutical categories focusing on inhalation technologies, benefiting from PMI’s expertise in this area. However, the acquisition of U.K.-based Vectura met with protests. On the other hand, PMI’s acquisition of OtiTopic, a U.S. respiratory drug delivery development company did not trigger such a strong public outcry. While Japan Tobacco has long had a pharmaceutical division, no areas of overlap or corresponding synergies with the tobacco business have been made apparent.

    The entrepreneurial small-size and mid-size enterprises, who kickstarted the vaping industry from the grassroots, initiated the transition we’ve seen in the last 10 years. At the outset, public health and tobacco control activists in many countries considered grassroots vaping companies to be a welcome alternative to the large tobacco multinationals. The majority of those early vaping companies were preoccupied with product launch, sales and distribution and overlooked the importance of the public policy and regulatory arena. Many, such as Blu, Ploom, E-Lites, Logic and Juul, then accepted tobacco industry investment, but this led to a negative view toward the category for many in public health and tobacco control.

    Seemingly the stigma associated with the tobacco industry—the “Big Tobacco” factor—quickly attached itself to the vaping industry.

    It seems only a matter of time before history repeats itself in the cannabis industry. Altria, BAT, PMI and Imperial Brands have all made investments in cannabis. Whether a preemptive step or not, it’s certainly a cost-effective manner to understand the sector and thereby be positioned to participate as and when restrictions come to be lifted.

    Only a few years ago, the tobacco industry was considered to be a dinosaur set for extinction. Some industry participants, whether encouraged by early successes of vaping businesses or otherwise, took on the challenge and are reinventing themselves as lifestyle companies, and PMI is daringly entering the pharmaceutical sector. Those that are prepared to transition away from combustible tobacco products have been given a new and exciting line of life.

    The tobacco industry is only at the beginning of its paradigm shift. Special efforts to engage with regulators—which are not only the industry’s biggest partner but will ultimately decide on the success of the “new nicotine” sector—will be required. It seems likely that those industry players who make those efforts and who experiment with new technologies, new products and new business models will be those best placed to thrive in the future.

    This article was contributed by GMTL, a leading risk advisory, due diligence and corporate intelligence firm headquartered in London.