By Jennifer Maloney and Dana Mattioli
RICHMOND, Va. -- The biggest U.S. tobacco company has made a
$12.8 billion bet on a company whose stated goal is to get smokers
to drop cigarettes. The calculated gamble: The move will help the
Marlboro maker keep up with a quickly changing market. The risk: It
could hasten its own decline.
Facing an accelerating fall in cigarette sales, Altria Group
Inc. in December put billions into Juul Labs Inc., a controversial
startup whose sleek, nicotine-packed vaporizers have fueled a surge
in the e-cigarette market.
Addressing employees gathered at the company's headquarters
after the deal, CEO Howard Willard said a bold change was
necessary. Smokers were switching to vaping, and Altria's own
e-cigarettes were unlikely ever to catch up to Juul. But some
workers were worried the new boss was undermining the company's
core business, which churns out more than 300 million sticks a
day.
The investment for a 35% stake in Juul -- plus a $1.8 billion
bet on a Canadian marijuana grower the same month -- upended a
century-old company known for its steady share price and reliable,
generous dividends. Altria's credit rating was downgraded.
Investors dumped the stock. Hundreds of scientists, designers,
lawyers and other staff lost their jobs in restructuring after the
partnership.
The deal also intensified scrutiny of Altria by federal
regulators, who blame Juul's products for an increase in underage
vaping and who have already moved to restrict their sales.
It's the dilemma facing many established companies in mature
markets. How should one respond to new entrants that are disrupting
the status quo, when the classic strategy -- buy the disrupter --
could potentially speed the decline of the legacy business? PepsiCo
Inc. and Coca-Cola Co. have shifted away from sugary sodas by
scooping up coconut water, coffee and kombucha. Big media companies
such as Walt Disney Co. and AT&T Inc. are launching their own
streaming services as they chase consumers who are cutting the
cord. Walmart Inc. has invested billions in e-commerce sites such
as Jet.com and India's Flipkart as the retail giant works to fend
off Amazon.com Inc.
Mr. Willard, 55 years old, said the leap into fast-growing Juul
is the surest way to preserve the profits the company generates
today by making 5 out of every 10 cigarettes sold in the U.S. "At a
time when e-vapor is going to grow rapidly and likely cannibalize
the consumers we have in our core business, if you don't invest in
the new areas you potentially put your ability to deliver that
financial result at risk," he said in an interview.
By Altria's count, there are already 12 million adult vapers in
the U.S., and the number is growing quickly. Many of those are
cigarette smokers looking for a less harmful way to get their
nicotine fix. Other vapers are children and teenagers who have
never smoked before, and who acquire the devices even though sales
are legally restricted to adults at least 18 years old. Youth use
of e-cigarettes jumped 78% between 2017 and 2018 -- to one out of
every five high-school students -- thanks largely to the popularity
of Juul.
The FDA this month announced new restrictions on retail sales of
e-cigarettes in the fruity and sweet flavors the agency said appeal
to youngsters. If underage use continues to increase, the agency
could institute an outright ban on devices such as Juul's, said
Scott Gottlieb, the outgoing Food and Drug Administration
chief.
Mr. Willard wooed Juul for more than a year. Altria first tried
to buy the entire company in late 2017 or early 2018 with an
informal offer of as much as $8 billion, according to people
familiar with the matter. That approach, previously unreported, was
rebuffed. Mr. Willard eventually sweetened the offer and settled
for a minority stake. He also agreed to put Juul coupons on packs
of Marlboros, giving his own consumers an incentive to try
Juul.
The longtime Altria insider, who took over as CEO in May 2018,
said he did it because the future is coming faster than he or his
colleagues expected.
"I've never believed this before: 10 years from now the majority
of the tobacco products that are sold could very well be
noncombustible products," said Mr. Willard, his 6-foot-6-inch frame
folded into a white leather chair at Altria's headquarters.
That would mark a major consumer shift. U.S. sales of
cigarettes, cigars and smoking tobacco were nearly $107 billion
last year, compared with about $15 billion in sales of smokeless
tobacco and vaping products, according to Euromonitor International
estimates, which include web sales. Vaping products made up $5.6
billion of those sales.
Although fewer and fewer Americans smoke each year, Altria has
squeezed growing profits out of a market it has dominated for
decades. Price increases have offset lower volumes, and the
Marlboro brand has kept its grip on a U.S. market that for years
has been shrinking 3% or 4% a year.
In 2017, three events stepped up pressure on the market leader.
In January, British American Tobacco PLC struck a $49.4 billion
deal to take control of Reynolds American, which sells Camel and
Newports.
In July, the FDA announced a regulatory overhaul that threatened
to turn the tobacco industry upside down. Dr. Gottlieb said that he
would seek to reduce nicotine levels in all cigarettes so they
would no longer be addictive and ban menthol cigarettes, moves
expected to take years. At the same time, he said he wanted to help
manufacturers bring to market less harmful products such as
e-cigarettes, which heat a nicotine-laced liquid to deliver a vapor
instead of burning tobacco, thereby avoiding many of the compounds
in cigarette smoke known to cause cancer and other diseases.
Then, late in the year, Juul took off.
Juul's vaporizers used snap-in pods with added flavors such as
mango and cucumber, and looked nothing like cigarettes. The
black-and-gray rectangular device was shaped like a USB flash drive
and could be plugged into a laptop to charge.
The company's sales surged. Juul's advertising on social media
and other platforms had pitched the brand as a cool lifestyle
accessory with images of people in their 20s and 30s, which critics
said made the brand attractive to teens. Later, Juul-related posts
on Instagram and Twitter exploded, with much of the content posted
by young people using the product. After two decades of declining
teen cigarette use, "Juuling" was suddenly a verb for a trendy
activity.
Altria had been trying for years to develop a successful
e-cigarette. But the company's careful, cautious culture made it
difficult to innovate, former employees said.
Formerly known as Philip Morris, Altria was once a marketing
powerhouse that blanketed American televisions, magazines and
billboards. But a landmark legal settlement in the 1990s over the
mounting public-health costs of cigarettes restricted the
industry's marketing. In the words of one former executive, it
became "a law firm with a manufacturing arm."
Altria's MarkTen e-cigarettes, launched nationally in 2014, had
a look, shape and feel that mimicked a traditional cigarette, based
on Altria's belief that smokers were looking to switch to something
that felt familiar. Ultimately sales didn't support that idea.
Altria also didn't advertise MarkTen on social media.
As Juul sales surged, Altria doubled down on its own e-cigarette
technology. Executives prepared to expand distribution of a
pod-based vaporizer called MarkTen Elite with flavors such as
Strawberry Brulee and Hazelnut Cream, and to expand online sales of
Apex by MarkTen, which had prefilled tanks in Spiced Fruit, Piña
Colada and other flavors.
But by early 2018, Mr. Willard, who was then the chief operating
officer and in line to take over as CEO, was privately concerned
that Altria's own e-cigarettes couldn't catch Juul. While publicly
expressing confidence in the strength of the cigarette market, he
was talking to the startup.
Although Juul had become a status symbol among new, teenage
vapers, the company presented itself as a disrupter of Big Tobacco,
aiming to convert adult cigarette smokers to its product. It was
initially skeptical of Altria's intentions.
Altria already knew many of its cigarette smokers were looking
for an alternative and had been working to offer them options.
Before launching MarkTen e-cigarettes, it had bought the maker of
Skoal and Copenhagen smokeless tobacco. And it was waiting for FDA
approval on a heat-not-burn tobacco device called IQOS it planned
to market in partnership with Philip Morris International.
Many e-cigarettes didn't deliver enough nicotine to satisfy the
cravings of smokers. Juul had a stronger kick. By May 2018, Juul
had captured 64% of e-cigarette sales in stores tracked by Nielsen,
according to Wells Fargo.
Speaking to staff for the first time as their CEO that month,
Mr. Willard warned that Altria was facing a rapidly changing
landscape. They would have to be more agile, he told the crowd
gathered in an auditorium at a cigarette manufacturing facility in
Richmond. And they would have to take a more blunt assessment of
their weaknesses, particularly in e-cigarettes. MarkTen was now a
distant third behind Juul and BAT's Vuse. Any new product would
have to go through a yearslong approval process, since the FDA in
2016 had issued rules for new products entering the market.
By the fall, Mr. Willard was privately making plans to scrap
Altria's own e-cigarette efforts.
"It was an emotional decision for us because we had put our best
people to work on the e-vapor organic effort," the Altria CEO said,
in the interview. "It just so happened that in the end, Juul came
up with a more compelling product."
Mr. Willard was an ardent suitor. He had never smoked until 2015
when he took the No. 2 job at Altria and became an occasional user
of its products. In negotiations with Juul, he brandished a Juul
vaporizer and once in a while took puffs. He courted Juul's
investors and Juul CEO Kevin Burns with pledges to help convert
smokers. "I was surprised how quickly Howard got there and said he
was committed to our mission," Mr. Burns said in an interview.
Still, Juul couldn't be swayed: It wouldn't sell a majority
stake.
Juul told Altria that another tobacco company had approached the
startup. The company was BAT, Altria's biggest rival, according to
people familiar with the discussions. Juul's negotiators also told
Altria the startup was analyzing a potential initial public
offering that would value the company north of $30 billion,
according to other people familiar with the discussions.
Mr. Willard went to his board members to talk again about Juul.
Now, his plan was bigger and riskier. He wanted to buy a minority
stake at a valuation above $30 billion. The Altria boss said he
faced tough questions from them. How could he justify such a rich
price? And how would a minority stake in a competing product help
Altria?
He argued that U.S. cigarette volumes would continue to decline
at a faster clip, while e-cigarette volumes would increase 15% to
20% a year. Altria expected Juul's international revenue to equal
its domestic revenue by 2023. Juul's overseas sales wouldn't
compete with Altria, which has sold only in the U.S. since 2008,
after splitting off its international business, Philip Morris
International.
Altria could see a return on its investment through a potential
IPO of the startup or through a share of Juul's profits.
Mr. Willard believed that Juul's rapid growth wasn't a fad but a
lasting brand that could attract smokers around the globe even as
U.S. regulators cracked down.
By early November, both Altria and Juul had come under pressure
from the FDA to address the spike in teen vaping. Altria announced
it was pulling some of its flavored e-cigarettes from the market.
Juul said it would limit its bricks-and-mortar sales to tobacco,
mint and menthol flavors, although other flavors remain for sale on
its website, which has age-verification controls.
At the 11th hour in negotiations, Juul made a big demand,
according to people familiar with the matter. It wanted access to
Altria's consumer mailing list -- a direct line to Altria's
consumers that a company would normally protect from rivals. Altria
agreed to send out communications on Juul's behalf.
Altria, for its part, secured an agreement that largely prevents
Juul from entering partnerships with other tobacco players.
In early December, Altria announced it was shutting down its
e-cigarette business altogether. Two weeks later, it signed a deal
with Juul valuing the three-year-old brand at $38 billion.
Some Altria employees were angry they were facing job cuts.
About 900 jobs, or 10% of Altria's total workforce, have been
eliminated, while the Juul investment has made some of the
startup's employees millionaires overnight.
"Large-scale organizational change is hard," Mr. Willard said.
"For a long time, we had a pretty stable business, and we had a
somewhat risk-averse culture." The company needs to leave some of
that behind and be more innovative, he said.
Reaction to Altria's pivot has been mixed. Some industry
observers called it a brilliant move. Others such as Morgan Stanley
analyst Pamela Kaufman said that cigarette price increases could
accelerate Juul's cannibalization rate, and that Altria's share of
Juul's profits is unlikely to offset the lost profitability on a
pack of cigarettes.
Altria's shares have partially rebounded this year as the
company's chief has explained in more detail the rationale behind
the deal. He also has said rival BAT brands such as Newport and
Camel have more to lose in the U.S. than Marlboro from
e-cigarettes, because they are more popular with smokers aged 21 to
29 -- the cohort most interested in switching from cigarettes.
Juul projects its 2019 global sales at $3.4 billion.
One big unknown is how the FDA will regulate vaping. Convenience
stores and gas stations will effectively be banned from selling
most flavored e-cigarettes under the restrictions announced earlier
this month.
"Now that Altria and Juul are controlling the leading pod-based
flavored product that seems to be the most favored product among
kids, they're going to be a key to trying to address this crisis,"
Dr. Gottlieb said in an interview. The FDA boss said he plans to
depart the agency, leaving in question the fate of the broader
regulatory overhaul he had proposed for the tobacco industry.
Mr. Willard said Altria supports efforts to combat youth use,
and is lobbying to raise the minimum purchase age for any tobacco
product to 21 from 18. Juul has strengthened the age-verification
tools on its website and closed its Facebook and Instagram accounts
in the U.S. The startup has said it never targeted teens and that
its marketing now features adult cigarette smokers who have
switched to Juul.
Altria also said last month that it would limit its retail
support of Juul this year, expanding its distribution into no more
than 20,000 additional stores.
One sales point that hasn't changed: the convenience store for
Altria employees inside its Richmond research center. It sells
bottled water, snacks and Marlboro cigarettes. It doesn't have
plans to add Juul.
Write to Jennifer Maloney at jennifer.maloney@wsj.com and Dana
Mattioli at dana.mattioli@wsj.com
(END) Dow Jones Newswires
March 23, 2019 00:15 ET (04:15 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.
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