U.S. Markets closed

Vaping Uproar Scuttles Tobacco Deal as Juul CEO Leaves

Tiffany Kary, Ed Hammond and Timothy Annett
Vaping Uproar Scuttles Tobacco Deal as Juul CEO Leaves

(Bloomberg) -- Altria Group Inc. moved to put its investment in embattled e-cigarette maker Juul Labs Inc. on firmer ground after a global vaping backlash threatened the startup’s survival and helped scuttle a potential reunion with Philip Morris International Inc.

One of Altria’s senior executives is taking the top job at Juul, which said it would halt its marketing and lobbying efforts following criticism from lawmakers, anti-smoking advocates and parents concerned about a surge in underage vaping. The news of high-level changes at Juul came as Altria and Philip Morris ended their negotiations on a potential merger without reaching a deal.

A combination of Altria and Philip Morris would have ranked among the largest deals so far this year, reuniting two companies put asunder after U.S. states won a groundbreaking legal battle against the tobacco industry more than a decade ago.

But conflicts over what shape the future would take extinguished any hopes that the companies could move on together from their past.

Philip Morris board members met on Tuesday and decided to pull the plug on the talks after concluding the regulatory scrutiny on Juul made the timing bad to pull off a big tobacco deal, according to a person familiar with the matter. Before then, the companies had been working toward completing the deal as recently as this week, with plans to get a fairness opinion from bankers on the proposed terms over the weekend, the person said.

Altria raised the potential of a leadership change at Juul to Philip Morris during the two tobacco companies’ recent talks about their merger, said a person familiar with the matter. Burns’s resignation reflected that Juul’s focus had changed -- it was no longer pushing for rapid growth in the U.S., but was instead trying to survive a suddenly perilous regulatory environment.

“Juul is an independent company that makes its own decisions, and this was Juul’s decision,” Altria spokesman Steven Callahan said in an telephone call.

Philip Morris shares closed up 5.2% on Wednesday, while Altria shares lost 0.4% in New York. Shares of both companies were little-changed Thursday.

Last year, Altria invested $12.8 billion in Juul, placing a big bet that e-cigarettes are an important part of the tobacco business, and that the startup’s stranglehold on the market represented a golden opportunity. The transaction valued Juul at about $38 billion, placing it in the most elite ranks of Silicon Valley unicorns.

Since then, Juul has been blamed for a jump in teen vaping, an escalating public-health crisis heightened by an outbreak of a mysterious lung disease that has killed seven people in the U.S. and sickened hundreds. Juul’s marketing has also been criticized by regulators, and it has faced a series of lawsuits by consumers.

Like Altria, Philip Morris wagered on electronic cigarettes, though its IQOS device took a quieter and more cautious path to market, running an approval gauntlet at the U.S. Food and Drug Administration. Altria will market IQOS, which uses a heat-not-burn technology that differs from vaporizers like Juul’s, in the U.S.

“While we believed the creation of a new merged company had the potential to create incremental revenue and cost synergies, we could not reach agreement,” said Howard Willard, Altria’s chairman and chief executive officer. He and Philip Morris CEO André Calantzopoulos said the companies would focus on launching IQOS in the U.S.

Regulatory Roadblock

The growing controversy over Juul proved too intense for Philip Morris, leading the company to abandon the talks, which had begun in August, on concern about regulatory changes that are expected from the FDA, according to people familiar with the deal talks.

The Trump administration said earlier this month that it would soon remove all flavored e-cigarette nicotine pods from the market, and only allow them back in stores after they had gained approval from the FDA. In the meantime, U.S. states including Michigan, New York, California and Massachusetts have unveiled vaping bans or restrictions.

“It appears to us the talks fell apart over Juul,” Bonnie Herzog, an analyst at Wells Fargo, said in a note. “Obviously the timing of the merger wasn’t right given escalating negative regulatory headlines.”

As the Philip Morris talks ended, Altria also appeared to tighten its grip on the reins at Juul, which said in a statement Wednesday that CEO Kevin Burns would step aside to make way for K.C. Crosthwaite, a former Altria executive who had served as the company’s observer on the Juul board, effective immediately.

Altria’s decision to buy the Juul stake had raised eyebrows in Washington, where regulators were grappling with a troubling surge in vaping by teenagers and young adults. Former FDA Commissioner Scott Gottlieb was critical of the deal, seeing it as the companies retreating on a promise to help reduce teen nicotine use. He’d summoned executives to Washington to explain how the transaction aligned with their commitments.

“I am aware of deeply concerning data showing that youth use of Juul represents a significant proportion of the overall use of e-cigarette products by children,” wrote Gottlieb in a letter to Altria’s Willard. “Manufacturers have an independent responsibility to take action to address the epidemic of youth use of their products.”

Lawmakers and regulators have faulted Juul over the marketing of its products, saying the company has inappropriately pitched them as a potential smoking-cessation tool. The FDA said in a warning letter to Juul this month that the company marketed its products as less risky than cigarettes without gaining the agency’s approval. Juul said at the time it was cooperating with the agency.

Lobbying Halt

Juul said in its statement on Wednesday that it would suspend all broadcast, print and digital advertising in the U.S., and refrain from lobbying the Trump administration on its guidance regarding proposed curbs on vaping products.

“I have long believed in a future where adult smokers overwhelmingly choose alternative products like Juul,” Crosthwaite said. “Unfortunately, today that future is at risk due to unacceptable levels of youth usage and eroding public confidence in our industry.”

Vaping has been touted as a safe and effective way for adult smokers to quit their cigarette habits, and investors have poured billions into Juul and companies like it. But a combination of candy-like flavorings, sleek, easy-to-hide devices and on-trend social-media marketing also lured kids.

Earlier this month, Health and Human Services Secretary Alex Azar said that 5 million kids reported having vaped this year, up from 3.6 million in 2018. More than a quarter of high school seniors said they’d vaped in the past 30 days.

Altria CEO Willard said at a conference in Washington on Wednesday that he expected vaping products to be bigger than burnt tobacco in the next decade, but that the furor over vaping had threatened that trend.

“We must acknowledge that a key component of harm reduction -- vaping -- is at an inflection point,” Willard said Wednesday. The company plans to continue to pursue heat-not-burn products like IQOS, vaping devices and pouch tobacco for the mouth, he said.

Crosthwaite, a 22-year veteran of Altria, had led the company’s charge to delve into new growth opportunities that offered a path beyond the declining cigarette market -- but also presented new risks. The former general manager for the Marlboro brand is now on the board of Cronos Group Inc., the Canadian cannabis company that got a $1.8 billion investment from Altria late last year.

Altria said in a securities filing Wednesday that Crosthwaite would be paid about $5 million in cash and be eligible to receive other payments under a long-term cash incentive plan.

Altria reaffirmed its full-year financial guidance Wednesday, and spokesman David Sutton also said the company remains “confident in our standalone plan.”

(Michael R. Bloomberg, the founder and majority owner of Bloomberg News parent Bloomberg LP, has campaigned and given money in support of a ban on flavored e-cigarettes and tobacco.)

(Updates with Altria comment in the seventh paragraph. An earlier version of this story corrected the characterization of the new Juul CEO’s appointment in second paragraph.)

--With assistance from Lisa Wolfson and Corinne Gretler.

To contact the reporters on this story: Tiffany Kary in New York at tkary@bloomberg.net;Ed Hammond in New York at ehammond12@bloomberg.net;Timothy Annett in New York at tannett@bloomberg.net

To contact the editors responsible for this story: Anne Riley Moffat at ariley17@bloomberg.net, Drew Armstrong

For more articles like this, please visit us at bloomberg.com

©2019 Bloomberg L.P.