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Morningstar | Altria Rumoured to Be Interested in Juul Stake But Is a Little Late to the Table

Altria is in talks to acquire a "significant minority" stake in U.S. vaping startup Juul Labs, according to a report in The Wall Street Journal. We are not at all surprised by this development, but we have reservations over the timing of the deal and potential valuation. We are retaining our $64 fair value estimate for Altria until any deal is announced.

Despite its wide moats, which relate to brand equity in the cigarette business, Big Tobacco has lost the battle in the U.S. vaping category to Juul. The Juul device was launched in 2015 and since then, sales have skyrocketed. According to Nielsen data cited by CNBC, the company held a 75% share of the U.S. vaping market in the four weeks ended Oct. 6, 2018. In aggregate, Altria, British American Tobacco, and Imperial Brands commanded a share of 22%. The success of Juul is not only taking share from the cigarette makers in vaping, but it is also nibbling away at volumes in their cigarette businesses. The U.S. cigarette market is on course to decline by 4.5% this year, an acceleration of almost a percentage point versus its decline rate of just a few years ago.

Acquiring a stake in Juul is, arguably, a no-brainer for Altria, because if these trends continue, the equity income growth will shield some of its earnings from category share loss. We think there are legitimate questions over the timing and valuation of the deal, however. If the recently announced measures to implement tighter age verification at the point of sale do not slow the rate of teenage nicotine consumption, we would expect the FDA to impose more Draconian measures on vaping products. This would have a negative impact on Juul, whose astonishing growth has coincided with the recent rise in vaping product consumption among school children. The FDA recently cited data from the 2018 National Youth Tobacco Survey indicating there was a 78% increase in the number of U.S. high school children using e-cigarettes in 2017-2018 over the year-ago period.

Our other concern over a potential deal would be over valuation. In July 2018, Juul raised $1.24 billion in capital, valuing the company at $16 billion, which represents eye-watering multiples of 64 times 2018 EBITDA and 17 times sales in a year in which revenue is anticipated to grow by almost 320%, according to Pitchbook data. The capital was raised for overseas expansion. On one hand it seems likely that Juul's market value should be lower following the recent clampdown by the FDA on flavoured liquids, but on the other hand, having raised this capital in July, Juul appears to have a strong hand in its price negotiations with Altria. This may be mitigated by the desire to derisk in light of the more assertive approach of the FDA in recent months. On balance, $16 billion could be a reasonable valuation estimate for any potential equity sale to Altria.