Philip Morris and Altria merger talks are off as Juul CEO steps down amid vaping fears

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Philip Morris International Inc. and Altria Group Inc. surprised the market on Wednesday with the news that they are ending the merger talks started in late August and will instead focus on launching a smokeless tobacco product in the U.S.

The news sent shares of Philip Morris PM, -0.21%  up 6%, while Altria MO, -1.30%

“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,” Altria Chief Executive Howard Willard said in a statement. “We look forward to continuing our commercialization of IQOS in the U.S. under our existing arrangement,” he said, referring to the smokeless product that is the linchpin of the companies’ strategy for growth as health officials across the world push to stamp out smoking and end nicotine addiction.

Separately, e-cigarette maker Juul Labs, in which Altria owns a 35% stake, said its Chief Executive Kevin Burns has decided to step down, and will be succeeded effective immediately by K.C. Crosthwaite, who was previously chief strategy and growth officer at Altria. Altria paid $12.8 billion to acquire its Juul stake in December, betting that the e-cigarette and vape market was ripe for expansion.

Juul said it’s suspending all broadcast, print and digital product advertising in the U.S., and will refrain from lobbying the Trump administration on its draft guidance. The announcement comes after a crackdown on e-cigarettes by the U.S. Food and Drug Administration, that has accelerated following a recent outbreak of severe lung disease that appears to be related to vaping. More than 530 Americans have been diagnosed with the illness and at least eight people have died. Juul is now the subject of a criminal probe in California.

See also: As Trump officials plan to ‘clear flavored e-cigarettes from the market,’ Juul signals some support for the move

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

Michel Legendre, associate campaign director for Corporate Accountability.Org, said given the health crisis announcements, criminal investigations and class-action lawsuits, it was time Juul ended its marketing in the U.S.

“PMI, Altria and Juul cannot hide behind corporate mergers, glossy ads, and K street any longer,” Legendre wrote in emailed commentary.

Wells Fargo analyst Bonnie Herzog said that while she was dismayed at the breakdown of the merger talks, she was not surprised, given the length of time they were taking and the constant stream of negative headlines from the FDA.

Read now: Vape sales are falling on fears about the outbreak of vaping-related lung illness

“We expect the stocks to trade up sharply (especially PM) since clearly the market wasn’t in favor of this combination, with PM trading up more than MO as concerns about JUUL have weighed on MO and will likely continue to weigh on MO’s multiple,” Herzog wrote in an early note to clients. “However, we continue to think those concerns are overblown and continue to recommend the stock.”

What’s more, Herzog expects talks to resume in the future once the environment improves. Philip Morris remains her top stock pick, she wrote.

Philip Morris and Altria had announced talks of a merger of equals in late August that would have reunited them after more than a decade apart. But the market appeared unimpressed with the stocks selling off on the news as analysts questioned the logic of the deal given the regulatory backdrop.

The FDA under former Commissioner Scott Gottlieb had waged an aggressive campaign against e-cigarette use by teenagers, in particular, and Juul was fast in his sights for marketing that he alleged specifically targeted young people. The company’s vape pens had become popular with teens, who were drawn to flavors, including crème brûlée, cucumber and mango, that are now banned from convenience stores and gas stations.

Gottlieb threatened to fully ban pod-based vaporizers such as Juul’s if underage vaping were to continue to increase. He described the popularity of the devices as an epidemic, a characterization that was echoed by the U.S. Surgeon General.

In the last week as concerns about the lung disease outbreak have grown, Walmart WMT, +0.13%  said it would stop selling e-cigarettes, Massachusetts announced a four-month ban on vaping products and California warned its citizens to stop vaping immediately.

Altria spun off Philip Morris in 2008 to allow it to focus on its international tobacco business and let Altria focus on the U.S. market. The two companies hold a portfolio of cigarette and tobacco brands led by Marlboro, which is sold by Altria in the U.S. and by Philip Morris overseas.

Analysts had questioned whether a deal between the two would really constitute a merger of equals.

“We see significant valuation risks from the perspective of PM shareholders, as we suspect that the combined entity would be unlikely to trade at PM’s premium valuation with ~40% of earnings exposed to U.S. regulatory risks and slower growing U.S. market,” Bernstein analyst Callum Elliott wrote when the talks were announced.

Altria has also expanded into the cannabis sector via a 45% stake in Canadian cannabis company Cronos Group Inc. CRON, -2.30%, for which it paid $1.8 billion last year. The company also owns a wine business and a stake in beer company Anheuser-Busch InBev BUD, -0.59%.

Read now: Former smokers are picking up some terrible habits that pose major health risks

The IQOS product is a heated tobacco product that is the only one to have premarket approval from the U.S. Food and Drug Administration.

“IQOS is not an e-vapor product,” the companies said in a statement. “PMI submitted a comprehensive body of scientific evidence in support of this premarket authorization and of the parallel applications for IQOS as a “Modified Risk Tobacco Product,” which the FDA continues to review.”

Related: Juul’s billionaire co-founder plays defense as House Democrats question company’s moves on youth vaping

Meanwhile, Altria tightened its full-year guidance and said it now expects adjusted per-share earnings to range from $4.19 to $4.27, versus a prior range of $4.15 to $4.27. The company is still expecting 2019 domestic cigarette industry volumes to fall 5% to 6%.

Philip Morris shares have gained 17.2% in 2019, while Altria has lost 17.5%. The S&P 500 SPX, -0.53% has gained 18.3% and the Dow Jones Industrial Average DJIA, -0.26% has gained 14.9% so far this year.

See now: Teens can spend $1,000 a year on vaping — and the crackdown on Juul is making it more expensive