Philip Morris to 'Unleash the Beast'?

Analyst says 2008 will be an exciting year for the tobacco industry

NEW YORK -- Next year could be a lulu for the tobacco category if some of the predictions and expected strategy moves suggested by a prominent tobacco industry analysts come to pass.

"There's going to be a lot of action starting early next year, and it will be quite interesting," Citigroup tobacco analyst Bonnie Herzog said during CSPNetwork's Tobacco Update CyberConference on Wednesday. "There are some exciting things that could happen in the next year or two." (Click here to register for an OnDemand replay of the CyberConference.)

Kicking off the excitement will be the spinning off of Philip Morris International from Altria Group, which New York City-based Herzog is confident will occur in the first quarter of the year.

"There is a board meeting on January 30, where there will be more details provided. There's already been an SEC filing," she said. "So this is definitely going to happen, in my opinion."

And the likely result?

"I think it will make Philip Morris in the U.S. much more aggressive," she said, referring to the tobacco manufacturer's opportunity to "unleash the beast" within itself. "I think it will encourage them to become much more innovative. I think they will cut costs. I think they will buy back their stock. I think they will look at acquisitions."

The company has already shown an interest in acquisitions with its recent intent to purchase the John Middleton cigar company. Herzog said of that pending purchase, "It makes sense. It is small. It does fit with their adjacency strategy, which means that they're not going to be just a cigarette company; they're going to be a tobacco company. I do think it's a nice fit. There's a nice opportunity for Philip Morris to enter the cigar category, which is growing rapidly."

But perhaps more interestingly, the purchase sets up what Herzog said is Philip Morris' first real opportunity to battle Lorillard Tobacco Co.'s Newport menthol cigarettes. (See related story about Lorillard and Philip Morris in this issue of CSP Daily News.)

John Middleton's Black & Mild cigar brand "has done very well in parts of the inner cities, and there's always an opportunity to extend that brand and possibly create a menthol cigarette to compete with the very, very successful Newport brand in the future," Herzog said. "These are the types of things that I'm referring to when I say 'unleash the beast.' And these are the things that I hope will be happening for the company in the future and really will shake up the industry and hopefully create growth for everyone."

Further, Herzog speculated on additional acquisition opportunities, including the likelihood that Philip Morris could buy the Swedish Match smokeless tobacco company. "We have assigned over a 50% probability of that transaction occurring," she said. "I don't think they necessarily need to do it right now, but it does seem somewhat likely or possible. When you think outside of the box about how this company could evolve, it is quite interesting." (Click here to read more about a possible Philip Morris/Swedish Match deal.)

Further innovation could follow on the heels of the federal government taking on regulation of the tobacco industry. While Herzog doesn't expect approval of the current legislation that would put that regulation in the hands of the Food & Drug Administration (FDA), she said eventual regulation will occur, opening yet another door for Philip Morris and other tobacco manufacturers, as well as wholesalers and retailers. "If technology is [developed] such that it reduces the risk [of smoking], I think this is a home run," she said. "Consumers may be willing to pay more for that technology, and that also may be margin-enhancing for all of the manufacturers, as well as the wholesalers and retailers."

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