Offer for Reynolds would provide access to technology behind cigarette alternatives

By Tripp Mickle 

Last week's $47 billion offer by British American Tobacco PLC for full control of Reynolds American Inc., if accepted, could give the London-based giant a chance to catch up in a technological race that is reshaping the industry.

Consumers from the U.S. to Japan have been seeking alternatives to traditional cigarettes, forcing companies to spend billions of dollars over the years to create products with fewer risks.

But BAT has slipped behind bigger rival Philip Morris International Inc., which has found success with a fountain-pen-size gadget known as iQOS. The device it introduced in late 2014 sold two million units in Japan over the past year.

Unlike e-cigarettes, which heat nicotine-laced vapor, iQOS is a battery-powered device that heats cigarettes called Marlboro HeatSticks. They release a tobacco-flavored vapor that Philip Morris says reduces by 95% consumers' exposure to harmful constituents released by burning a regular smoke.

The sales volume of tobacco cigarettes has continued to decline world-wide, as some smokers cut back, switch to alternatives or kick the habit.

The HeatSticks have claimed 4.3% of Japan's cigarette market share and cut into cigarette sales of rivals such as Japan Tobacco Inc. and BAT, Philip Morris says. "They're eating market share in Tokyo at a pace we haven't seen in years," said David Sweanor, a tobacco-control expert and professor of law at the University of Ottawa.

Acquiring Reynolds, which has been spending heavily on research and development since the 1980s, could allow BAT to catch up, according to Wells Fargo tobacco analyst Bonnie Herzog.

Reynolds, which is based in Winston-Salem, N.C., said Friday that its board will evaluate the offer and respond. Analysts expect negotiations between Reynolds and BAT to result in a higher offer price.

BAT and Reynolds didn't immediately reply to requests for comment on Sunday.

Before Philip Morris introduced iQOS, Reynolds was regarded as the industry's leader in research and development. Reynolds pioneered the heat-not-burn category in 1989 when it introduced Premier -- a cigarette product so unpalatable even its own executives disliked the taste. More recently, it developed its own e-cig device, Vuse, that it manufactures in the U.S.

BAT has a technology-sharing agreement with Reynolds that allows the companies to license vapor products and collaborate on research and development, but acquiring Reynolds would give BAT a pipeline of products, policy advisers and leading scientists it wouldn't otherwise have, Mr. Sweanor said.

"This isn't the sole reason to buy Reynolds, but it's a critical factor, " Mr. Sweanor said. "This industry is in the midst of massive transition and companies that get this right are going to succeed while those that don't will go the way of Kodak."

Global sales of e-cigarettes have also been slowing, with many consumers trying and abandoning the products because they failed to provide the same flavor and nicotine effect as traditional smokes.

Liquid-heating e-cigs last year generated $8 billion in sales, up just 23% from a year earlier after growing an average of more than 70% over the previous three years, according to Euromonitor International.

Rather than releasing its own e-cig product in recent years, Philip Morris poured more than $2 billion into research and development aimed at producing a healthier cigarette alternative that more closely mirrored the taste and feel of a cigarette. It hired hundreds of people from the pharmaceutical industry and did extensive, peer-reviewed research to determine the health effects of iQOS.

Encouraged by the success in Japan, Philip Morris Chief Executive André Calantzopoulos told investors in September that he expects iQOS and Marlboro HeatSticks to add a potential $700 million to $1.2 billion in operating income by 2020.

The company, which will be selling iQOS across 20 markets by the end of the year, plans to submit millions of pages of research to the U.S. Food and Drug Administration in the coming months in hopes of gaining approval to sell the device in the U.S.

"The task is certainly enormous, but the size of the prize is worth every effort," Mr. Calantzopoulos said last month.

Write to Tripp Mickle at Tripp.Mickle@wsj.com

(END) Dow Jones Newswires

October 24, 2016 02:48 ET (06:48 GMT)