NEW YORK (Reuters Breakingviews) - With the world turning against smokers, Philip Morris International hopes its new cigarette substitute IQOS will bring back the spark. Investors in the $126 billion Marlboro maker aren’t buying it.
PMI’s main product will, statistically, kill half its customers. So the company wants to convert smokers to devices that heat rather than burn tobacco, which it says are safer. These are still a fairly small source of sales – they accounted for under 18% of net revenue, which excludes sales incentives and excise tax, in the third quarter of 2019. But the business is growing rapidly, while cigarettes are in decline.
Imagine IQOS takes off. A Breakingviews interactive calculator lays out what would happen if PMI can achieve roughly the same annual revenue from smokeless products a decade from now that it makes from old-school products today, around $25 billion. Assume by then IQOS and other devices make a 40% EBITDA margin, similar to regular cigarettes, and that PMI spends the equivalent of around 4% of revenue on capital expenditure. Using a discounted cash flow valuation, smokeless smokes could be worth $67 billion today.
PMI’s current valuation doesn’t factor in anything like that. The cigarette enterprise is probably worth 12 times EBITDA, roughly where the company has traded for the past few years, giving it a value of $115 billion today, or $88 billion in equity value after deducting net debt. The implication is shareholders are valuing PMI’s smokeless products at only about $38 billion, only just over half Breakingviews’ valuation.
Why so skeptical? IQOS only started limited U.S. sales this month. Moreover, liquid-based vaping products like those sold by Altria-backed Juul Labs have been linked to lung injuries that have killed 33 people, according to the Centers for Disease Control and Prevention. IQOS isn’t vaping, so it might win customers from Juul. Or the two might get lumped together despite their differences.
Philip Morris has learned from some of Juul’s mistakes, eschewing fruity flavors. And IQOS has marketing approval from the U.S. Food and Drug Administration, which will want to know the product isn’t targeting teenagers. That means it may not have Juul’s breakneck adoption rates. For shareholders that could be a bonus, because it might also mean PMI avoids incinerating its market before it has even begun.
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