Why the tobacco giants favor the vaping and cannabis industries

Marlboro cigarette maker Altria Group has been making headlines with a series of major moves: not only is it acquiring two Canadian cannabis producers, but it is also investing in the largest e-cigarette company in the U.S. Media reports suggest that this marks Altria's entry into a whole new competitive field as traditional cigarette consumption declines year by year.

As one of the largest and most profitable tobacco companies in the world, Altria has always adhered to the principle of keeping a low profile while making substantial profits. However, it has recently broken its years of silence and appeared in major financial media.

Altria has been revealed to be involved in two surprising business actions: first, plans to acquire two Canadian cannabis producers, Cronos and Tilray, and second, to acquire a 35% stake in American e-cigarette startup Juul Labs.

Both Canadian "celebrity" cannabis companies Cronos and Tilray, as well as the rapidly rising e-cigarette startup Juul Labs, are currently riding the wave of popularity, with their valuations already quite high. To this end, Altria will spend at least $14 billion, which is even higher than its net profit for the entire fiscal year of 2018 ($10.7 billion).

In addition to the high costs, Altria's three capital transactions will drag it from one dilemma into another: pressured by the anti-smoking wave, Altria has had to put warnings on all cigarette packaging advising consumers not to smoke. Now, they are busy restructuring the tobacco market and entering new fields, a process that will inevitably encounter new challenges, especially in the cannabis industry.

What is the deeper meaning behind Altria's actions?

As CNBC commented: this marks Altria's entry into a whole new competitive field. Today's tobacco market, or nicotine market, is no longer the same tobacco market that has existed for centuries.

Traditional Tobacco Industry Transformation

From the perspective of stimulating human nerves to maintain excitement while also creating dependency, traditional cigarettes, e-cigarettes, and cannabis all share these characteristics. Their common core is nicotine. However, the three also have their differences.

Cannabis is the most heavily regulated. In most countries, including the U.S., consuming cannabis is still illegal. Although some states have gradually relaxed legislation, it is still not permitted at the federal level, and medical cannabis has strict usage restrictions.

E-cigarettes have become increasingly popular and widespread in recent years, especially among young people. However, many countries still impose strict controls on e-cigarettes, such as Singapore.

Traditional cigarettes have the longest history, are most familiar to smokers, and are legally permitted in the vast majority of countries. According to data from the World Health Organization, the number of traditional cigarettes sold worldwide each year reaches as high as 6.5 trillion, averaging 18 billion per day. The number of smokers has reached 1.1 billion. This massive consumer base has kept the tobacco industry among the most profitable sectors for many years.

China's tobacco consumption is particularly notable globally. According to the "Tobacco Atlas" published by the American Cancer Society and the World Lung Foundation, as early as 2016, tobacco purchased by Chinese smokers accounted for over 40% of the total global consumption:
However, as people's health awareness increases, the opposition to traditional cigarettes is also rising, with calls for smoking bans echoing everywhere.

At the same time, e-cigarettes are consuming an increasing share of the traditional cigarette market. In recent years, the consumption of traditional cigarettes has shown a declining trend year by year. According to data from the Centers for Disease Control and Prevention, the smoking rate in the U.S. dropped to a historic low last year.

The main reason for the decline in traditional cigarette consumption is e-cigarettes, which are taking over the market share of the former. Currently, the U.S., Japan, and the U.K. are the largest e-cigarette markets globally, with consumers in these three countries purchasing e-cigarettes and related products worth $16.3 billion in 2016. Wells Fargo analyst Bonnie Herzog estimates that the U.S. e-cigarette market is expected to reach $6.6 billion this year.

In addition to e-cigarettes, the cannabis industry is also expanding. According to the "Cannabis Business Daily," the total demand for legal and illegal cannabis sales is around $52.5 billion.

Tobacco Giants Betting on Multiple Fronts

Altria's three acquisition deals mentioned above show that this tobacco giant is eager to transform in the context of the gradually shrinking traditional cigarette market. They may believe that e-cigarettes and cannabis could be a remedy for their challenges.

Altria's Philip Morris has also expanded its business into the e-cigarette field, producing the IQOS brand of e-cigarettes. Once approved by the FDA, Altria will begin marketing and selling this product.

Additionally, Altria is rapidly expanding its business layout by purchasing Juul Labs, currently the most popular e-cigarette company in the U.S., while also achieving some form of risk hedging for the IQOS brand e-cigarettes.

Juul Labs currently holds up to 70% of the U.S. e-cigarette market share, selling products in Canada, the U.K., Israel, and Russia, and intends to expand into Europe and Asia.

The Wall Street Journal cited sources stating that Juul's gross margin is as high as 75%, far exceeding that of traditional tobacco companies, with annual revenue expected to reach $2 billion.

"Juul Labs is clearly a game changer in the nicotine-related industry," wrote Cowen & Co. analyst Vivien Azer in a research report.

Currently, Juul Labs is valued at about $38 billion, doubling in value from a few months ago, even surpassing the valuation of Elon Musk's commercial rocket company SpaceX (valued at $30.5 billion), which just raised $50 million, and is more than three times the valuation of Pinterest (valued at $12 billion), which plans to go public next year.

From the above, it is clear that the rapidly expanding Juul Labs perfectly meets the needs of the transforming Altria.

As the glory of traditional cigarettes gradually fades, Altria's stock price has plummeted significantly this year, down nearly 30% so far, although the decline is slightly lower than the overall tobacco sector. In fiscal year 2017, the company's net profit attributable to the parent company fell nearly 30% year-on-year. The following chart shows the changes in the company's net profit:
Altria stated in a statement: "We are taking significant actions to prepare for the future. In the future, the vast majority of adult smokers will choose non-combustible products over cigarettes. We have always believed that providing adult smokers with high-quality, satisfying products that can reduce health risks is the best way to achieve a reduction in tobacco harm." Canadian cannabis producers Cronos and Tilray have become star companies this year, and their rapid rise is due to a key background: cannabis has transitioned to a legal status in certain global markets and has become an alternative to certain alcoholic beverages in some contexts.

In mid-October, Canada became the second country in the world, after Uruguay, and the first G7 country to legalize recreational cannabis. Recently, Michigan in the U.S. decided to authorize individuals over the age of 21 to legally possess, use, and cultivate cannabis products.

A Wall Street Journal member-exclusive article mentioned that as many areas in North America begin to relax cannabis legalization, cannabis is showcasing its astonishing commercial prospects. Recreational cannabis is likely to compete with alcohol and cigarettes. Additionally, cannabis has already entered the pharmaceutical industry, impacting areas beyond elder care, providing significant effects for those undergoing cancer treatment or suffering from insomnia.

Giants are all targeting this emerging field. Recently, the world's largest beer manufacturer, AB InBev, announced that its Canadian subsidiary, Labatt Breweries, will partner with Tilray to invest $100 million in developing cannabis-infused beverages. Even Coca-Cola, founded in 1886, has entered the cannabis market in September, planning to collaborate with Canadian licensed cannabis producer Aurora Cannabis Inc. to develop beverages containing cannabidiol.

Potential Concerns

As mentioned earlier, Altria's bets on e-cigarettes and cannabis face numerous obstacles.

The most significant are the advocates against tobacco and cannabis. Many have criticized the two companies Altria is preparing to acquire for trying to attract young people to become potential lifelong users.

Matthew L. Myers, chairman of the Tobacco-Free Kids campaign, stated in a press release that this transaction is a truly shocking development for public health, bringing together two companies that have been quite successful in marketing their highly addictive products to children.

Matthew L. Myers called for the U.S. Food and Drug Administration (FDA) to take urgent action to prevent tobacco companies from undermining decades of progress in preventing addiction among the new generation of children.

In the U.S., the number of teenagers using e-cigarettes is rapidly increasing, with about one in five high school students using e-cigarettes. To address this, the FDA took action in September aimed at preventing children from using e-cigarettes. Currently, U.S. federal law prohibits the sale of e-cigarettes to individuals under 18.

Regarding Philip Morris's IQOS e-cigarette, the FDA stated earlier this year that there is currently no evidence that this product is a safe alternative to cigarettes.

Rating agency Moody's downgraded Altria's debt outlook from stable to negative following the announcement of Altria's acquisition of Juul, citing that the company will face dual regulatory risks in the e-cigarette and cannabis sectors and may become embroiled in potential litigation.