We do not understand the market's negative reaction to the news that Philip Morris International (PM) and Altria (MO) are in talks regarding a potential all-stock merger of equals. The decline in the market value of PMI is particularly surprising, given the absence of a valuation premium. It has been our long-held view that this combination would occur, primarily to align the interests of both parties in the distribution of iQOS in the United States, but also because of the potential for cost synergies, the ability to manage the world's largest cigarette, heated tobacco, and vaping brands under one roof, and for PMI, the natural foreign-exchange hedge that U.S. distribution will bring. We reiterate our fair value estimates for both companies and think the sell-off creates an attractive entry point to an already undervalued group.
The combination of PMI and Altria would be a reversal of the decision to separate 11 years ago. In some ways, that strategy has become redundant: The class-action litigation risk that Altria was trying to isolate within the U.S. entity has eased, while value was arguably not created by separating the international business. PMI traded at around 15 times forward earnings before this announcement, and Altria at 11 times--the same multiples they were valued at after the split in 2008. In the 11 years since, however, the market has changed significantly. The advent of cigarette substitutes has driven the decline rate of cigarette volume higher, from around 3% a decade ago to 5% now, and prompted a race among manufacturers to build portfolios of new products across multiple categories. Regulatory risk has grown, with more-assertive regulators clamping down on marketing in both cigarettes and emerging categories. Higher risk and accelerating volume declines may explain investors' negative reaction to the talks.
To view this article, become a Morningstar Basic member.
Philip Gorham does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.