When you are a wildly profitable company, you have a few ways to allocate your excess riches:
- Reinvest into your business.
- Buy other businesses.
- Reduce your debt.
- Return money to shareholders via dividends or share repurchases.
- Throw the money into a woodchipper.
Sometimes 2 and 5 are hard to tell apart.
On Friday, Altria announced exchanging its minority stake in JUUL for a license to certain heated tobacco intellectual property from JUUL. The commentary surrounding the deal has been disproportionally alarmist; no doubt a visceral reaction, quickly pointing to the still-healing wounds left by the company’s less-than-stellar capital allocation decisions of the past. Pair this with the spreading rumors of Altria’s interest in acquiring vaping company NJOY Holdings, and you have yourself a good old-fashioned panic.
The reactions aren’t entirely unwarranted, but they may be over the top. While Altria’s investment history isn’t flawless, as a whole, it isn’t anywhere near as bad as you might think.
Let’s revisit how we got here.
In 1976, Philip Morris looked unstoppable. The company commanded an impressive 25% share of the U.S. cigarette market, a 5% share of the international market, and held nearly 12% of the U.S. beer market thanks to having purchased the Miller Brewing Company 7 years earlier. In that timeframe, revenues, net income, and earnings per share had nearly tripled. The period’s optimism is perfectly preserved in the archived piece below:
But as operations continued to hum along, the company found itself in a conundrum. The tide of the domestic market was turning, with health, litigation, and regulatory concerns mounting. Seeing the success of the Miller Brewing acquisition, Philip Morris decided to further diversify, and in 1985 completed its acquisition of the General Foods Corp for a staggering $5.6 billion, including the assumption of ~$4 billion in debt. Roger Spencer, an analyst with PaineWebber in Chicago at the time, was quoted in The Chicago Tribune
“Down deep, Philip Morris knows that the tobacco business is going down.”
“Chances are that, in five years, you’re going to be making more in food than you are now, whereas in tobacco, you know that is going down.”
CEO Joseph F. Cullman III retired two years later, leaving behind an exceptional legacy, including the success of the Marlboro Man campaign, turning the company’s flagship brand into a nearly incomparable cash machine - flowing riches future management would continue to diversify with. In 1988, Philip Morris paid a whopping $13.1 billion in cash to acquire Kraft Foods, Inc, and the following year merged General Foods Corp into it to create Kraft General Foods.
Then things took an ugly turn.
There was Marlboro Friday
in 1993 when shares of Philip Morris fell by 26% in a single day. 5 years after that was the 1998 Master Settlement Agreement
, which was hailed as the end of Big Tobacco. But Philip Morris kept moving forward, and in 2000, paid an eye-popping $18.9 billion, including the assumption of $4 billion in debt, for Nabisco, from rival tobacco company R.J. Reynolds. A year later, Philip Morris IPO’d a partial stake in Kraft. Another year went by, and then Miller Brewing merged with South African Breweries (SAB) to form SABMiller. With SAB assuming ~$2 billion of debt as well as providing Miller with additional equity, Philip Morris found itself with a 36% stake in the new company.
Philip Morris rebranded to Altria the following year.
But even with the new name, Altria was the old, stuffy company that people loved to hate. The company foolishly divested its foods division Kraft in 2007 and then spun off its international tobacco division, Philip Morris International
, in 2008. Just a year later, the Family Smoking Prevention and Tobacco Control Act was passed, further crushing Altria’s autonomy and leaving it all out of tricks. Or at least that’s how so many people spin the tale.
Backing up to December 2007, right in between the Kraft and PMI spins, Altria acquired cigar company John Middleton. While some analysts applauded the deal, it received plenty of criticism, with those against arguing that the $2.9 billion sticker price, paid in cash, should have been paid out to shareholders instead.
What was Altria buying? For the full-year 2007, John Middleton was expected to generate $360m in sales and $182m in operating income. The price paid equates to about x16 EBIT. Perhaps reasonable for an absurdly high-margin business that for the previous 4 years grew revenues and operating income at CAGRs of 10% and 13%, respectively. However, that’s still not the whole picture. The terms of the transaction also gave Altria $700 million in present-value tax benefits. Subtracting that out nets a purchase price of $2.2 billion, or x12 EBIT.
While cigarette volumes continued to decline, Middleton cigar volume remained near-stagnant for half a decade and then began to grow:
Critically, along with holding a >30% share of the machine-made cigar market, Altria increased prices on cigar products every single year. Here are just the last several years disclosed:
Mind you, the machine-made cigars already had absurdly high margins which were also understated as the revenue figure cited includes excise taxes billed to customers. On top of this, there has been minimal reinvestment need, and the operations are outrageously capital-light - as per the terms:
"Assets purchased in the Middleton acquisition consist primarily of non-amortizable intangible assets related to acquired brands of $2.6 billion, amortizable intangible assets of $0.1 billion, goodwill of $0.1 billion and other assets of $0.1 billion, partially offset by accrued liabilities assumed in the acquisition."
The exact contribution of cigars to operating income is not disclosed by Altria and is instead consolidated into Smokeable Products along with cigarettes. Nonetheless, with rough math, associated operating income has increased several times over, and it’s hard to conclude anything other than this was a wonderful deal made.
In 2009, 2 years after acquiring JMC, and a mere 5 months before the Family Smoking Prevention and Tobacco Control Act was passed, Altria acquired UST Inc by offering UST shareholders $69.50/share; a 28.9% premium to the previous closing price. The deal had a...
Continue reading at the link below: