Thoughts on a potential Philip Morris International acquisition of Swedish Match

Ticker: (STO: SWMA, OTC: SWMAY, SMWAF) and NYSE: PM.

On May 9th 2022, there was a confirmation that discussions have been taking place on a potential takeover of Swedish Match AB (STO: SWMA, OTC: SWMAY, SMWAF) by Philip Morris International (NYSE: PM). The next day it was announced a $16 billion deal was agreed on by the board and to be voted on by the shareholders.

Quick rundown on Swedish Match’s business:

Swedish Match is a leader in the spitless category of pouches particularly Swedish style Snus (General, Göteborgs Rapé) and nicotine pouches (Zyn). The business operates in 11 countries but the relevant markets for the business we want to talk about is Scandinavia and the US. Scandinavia makes up 29% of sales and the US makes up 64% of sales. They have various products marketed but the main two products that have a lot of brand power are the Swedish style Snus and Zyn.

In Scandinavia General and Göteborgs Rapé are iconic and historical brands to the Scandinavia market (think like Marlboro in the US) and have a strong 59% market share in the more traditional Snus categories. Zyn struggles at 15% market share in the country against British American’s Velo brand (formerly Dryft – different from the US brand)

In the US Snus which falls under the moist snuff category has a 9% market share while Zyn has a very strong and defensible 64% market share.

The business has strong growth a solid high single digit growth 8-9%, the highest in the tobacco industry which has supported share buybacks and small dividends/special dividends.

What does this mean for PMI?

It means that PMI wouldn’t be so heavily reliant on solely the IQOS products if the business is serious on transitioning towards a smoke-free future. The dynamics around tobacco today is that if there’s any shifts or trends from one tobacco product to another, there can be less risks to losing market share going from a PMI product to a non-PMI product. Example perhaps, someone goes from IQOS to a nicotine pouch like Zyn or Velo.

PMI is in a bit of a tough spot with the geo-political situation in Russia that meant that they like many other western corporations had to leave the Russian market which will hurt their growth in what was an emerging IQOS market as well as the traditional combustible business there.

Another interesting thought is that Swedish Match has never pushed their Swedish style Snus and nicotine pouches outside of the main two markets, I’m curious why that is. Perhaps an advantage here is that the distribution advantages that PMI holds can help introduce Swedish Match products to new markets that would have otherwise needed investments and some risks to accomplish.

Thoughts on the Acquisition?

My thoughts are that I was surprised about the acquisition and how willing they were to sell for the $16 billion valuation. I did not see a particular reason why the business had to be sold and at least they could have bargained a lot higher valuation vs the ~104 SEK that they will be receiving. It seems really cheap for a well-managed business with strong brands that allow PMI significant exposure into both the US and Scandinavian markets. Swedish Match put great care into how they distributed their products and the relationships with the regulators that kept them out of trouble. This of course is compared to the insane JUUL labs stake by Altria that paid $12.8 billion for a 35% stake of that business which wasn’t even for the entire company.

With all of that said I can’t help but feel like Swedish Match can deliver a ton of value to their owners being their own business as opposed to selling out for the small $16billion valuation and allowing PMI to reap all of the rewards out of their brands. The biggest benefit in the tobacco industry is that it’s a highly regulated industry that has extreme barriers to entry. If you have a great nicotine brand, you may have a very long run way to continue to deliver value to your shareholders. If you have a growing nicotine brand like the reduced risk oral tobacco niches that Swedish Match is exposed to, they may very well have decades of delivering good returns with very minimal risks to competition other than what already exists. They have an incredibly good niche in the snus and nicotine pouch categories but these tend to do really well in markets that have a history of oral tobacco use which the US and Scandinavian markets have 300+ year history of chewing tobacco.

If you had to put a fair value to what Swedish Match is worth, could you do it? In a more extreme example, lets say you are the 100% owner of Coca Cola in the 1980s and had to sell the entire business to someone for not anymore or less than the fair value, what would it be? Warren Buffett bought Coke for $1 billion dollars for 6.2% of the business in 1988 which put it’s at a market value of ~$16 billion dollars. Buffett’s stake today is worth $22 billion dollars and all of Coke is worth about $270 billion dollars and this was done while competing with Pepsi, Monster, Keurig Dr. Pepper, and a lot of other smaller brands. I’m not saying Swedish Match is Coke by any means, the management at Swedish Match has to be very careful and very aware of what decision they are about to make with as good of a product, as good of a brand and as good of an industry they’re operating in.

If they don’t sell the worst thing that can happen is that the shareholders continue to get their returns from a good business and the upside is that they could do slightly better than that. If they sell, the downside is that they can potentially sell the tobacco equivalent of a major strategic brand for far less than what all of the returns those assets can bring. It is unlikely that they can sell the business for something that resembles what the fair value of the business could be if they have possibly decades of life left in Zyn and Swedish Snus brands. This is all assuming that the business is still in great shape and there isn’t a serious underlying problem that we aren’t aware of, perhaps those who may know more than myself about Swedish Snus could say.

Dislosure: Not investment advice. Please do your own due diligence. This report is meant for educational purposes only.