Wednesday28 August 2019 ★ FINANCIAL TIMES 13COMPANIES
SONG JUNG-A— SEOULSouth Korea’s top two duty-free groups
are bidding to operate the liquor and
tobacco shops at Singapore’s Changi
Airport, seeking to expand their over-
seas footprint as growth at home slows.LotteandShillasaidyesterday that they
were in the running, along with Ger-
many’sGebr Heinemann, for the tender
that closed on Monday. The opportunity
came about afterDFS Group, the long-
time operator, dropped out unexpect-
edly. A winner is expected to be
announced by year-end, the Korean
companies said.
Lotte and Shilla, the world’s second-
and third-largest duty-free chains
respectively, have been actively
expanding abroad in recent years as
they seek to counter market saturation
at home.
Duty-free sales in South Korea, the
world’s largest duty-free market, con-
tinue to grow but the pair have found it
challenging to maintain high margins as
competition has increased and the
number of Chinese tour groups visiting
the country has fallen in the wake of a
political spatover Seoul’s plans to host a
US missile defence system.
The winner will take over alcohol and
tobacco sales rights from DFS in mid-
2020, for all four Changi terminals for
six years. Hong Kong-based DFS is esti-mated to have generated $425m in sales
last year from the business, according to
industry journal Moodie Davitt Report.
DFS, which has held the Changi duty-
free rights for nearly 40 years, withdrew
from the race due to higher costs and
recent regulatory changes linked to glo-
bal economic uncertainties sparked by
the deepening China-US trade war.
“Changing regulations concerning the
sale of liquor and tobacco, against a glo-
bal context of geopolitical uncertainty,
meant that staying in Changi was not a
financially viable option,”Ed Brennan,
chairman and chief executive of DFS,
said in a statement.
Changi is one of the world’s busiestairports, handling a record 65.6m pas-
sengers last year, according to its web-
site. But Singapore has been tightening
rules on liquor and tobacco consump-
tion. In February, it said it would reduce
the duty-free alcohol allowance from
three litres to two litres, and it plans to
standardise tobacco packaging from
July next year with larger graphic health
warnings, which is expected to hurt
sales.
The higher costs of entry and rising
economic risks have deterred other
potential bidders, according to people
close to the deal, who said the winner
must pay an initial deposit of $20.5m
and shoulder heavy capital expenditure
requirements.
Lotte and Shilla are eager to expand
their overseas presence, banking on
their strong financial firepower. Shilla,
which already runs perfumes and cos-
metics duty-free shops at Changi, saw its
overseas sales surpass Won1tn ($824m)
last year, accounting for about a quarter
of overall sales. It has duty-free opera-
tions in five countries, all in Asia.
Lotte posted Won240bn in 2018 over-
seas sales, and aims to increase thatto
more than Won1tn by the end of next
year. It operates 13 duty-free shops in
seven countries in the Asia-Pacific
region. “We are actively expanding
abroad as domestic growth is limited,”
Lotte said.Retail
Korean duty-free groups circle Changi
Lotte and Shilla are looking abroad
as challenges mount at homeANDREW EDGECLIFFE-JOHNSON
AND ALICE HANCOCKWhen the world’s largest tobacco com-
pany announced in 2007 that it planned
to break in two, the rationale was that its
US and international operations faced
fundamentally different dynamics.
The 2008 split ofAltriaandPhilip
MorrisInternational would free a faster-
growing international division to pur-
sue the emerging markets consumers
who were trading upfrom the US opera-
tionhobbled by years of litigation and
staring at an inexorable decline in the
number of smokers.
That the two areexploring a merger
little more than a decade later speaks to
profound changes in their market-
places, technologies and attitudes
towards their core product.
The biggest of these is what Wells
Fargo analyst Bonnie Herzog described
as a “global arms race for reduced-risk
products”. After decades of fruitless and
sometimes halfhearted investments by
tobacco companies, two alternative
technologies are showing signs of per-
suading cigarette smokers to switch to
something less harmful. Altria and PMI
have a substantial interest in both.
PMI has invested $6bn in the past dec-
ade — more than any rival — to develop a
product that heats tobacco for a ciga-
rette-like experience that exposes
smokers to fewer harmful chemicals
than burning the leaf does.
Iqos, its third attempt at creating such
a product in 20 years, has performed
well in Asian markets, converting more
than 7m smokers. But its biggest test
awaits: Altria had planned tobegin test-
ing Iqosin Atlanta next month, with a
view to rolling out sales across the US.
That arrangement would have seen
Altria license the technology from PMI.
But under the common ownership the
merger talks are aiming for, PMI would
have access to the full economic benefits
if Iqos takes off among the 40m adult
smokers in the US, Ms Herzog noted.
Altria has made its own $13bn bet on
an alternative to cigarettes. It took a
35 per cent stake last year in Juul,
putting a $38bn valuation on the com-
pany that has seized more than 70 per
cent of the US ecigarette market on anexplicit mission to end smoking. The
deal gave Altria exposure to the most
successful vaping start-up. The appeal
for Juul was the prospect of Altria using
its marketing and distribution power to
promote the Juul brand from Marlboro
packets to retailers’ shelves.
Bernstein Research analysts cau-
tioned that non-compete clauses could
restrain any plan for PMI to promote
Juul internationally, but RobertWaldschmidt, a strategist at Liberum,
said bringing together the leading eciga-
rette business and heat-not-burn brand
would make a dangerous competitor for
tobacco rivals.
“I expect the existing incumbents of
Imperial, BAT, Japan Tobacco will need
to revisit their playbooks for M&A and
value creation,” he said.
However, the fact that shares in Altria
and PMI were under pressure after thecompanies disclosed the talks yesterday
underlines the task they face in convinc-
ing investors a deal is the best way to
address the looming disruption.
One of the biggest hurdles in the path
of a successful PMI-Altria recombina-
tion is the uncertainty about how regu-
lators will treat the new products on
which the industry’s growth depends.
In April, the US Food and Drug
Administration authorised Altria tostart selling PMI’s Iqos heated tobacco
system in the US, but analysts are con-
cerned the regulator could clamp down
on the ecigarette market, after warning
of an “epidemic” of youth vaping.
Ryan Tomkins, an analyst at Citi, said
the biggest threat to the deal was the
FDA, which has focused its efforts to
curtail vaping on Juul in particular due
to its high take-up among teenagers and
is investigating reports tying seizures to
vaping use.
Mr Tomkins added that a Centers for
Disease Control and Prevention survey
of youth tobacco use in the US was due
out any day, “the results for which could
be dangerous for Juul”.
Since their split, PMI and Altria have
diverged in other ways. Altrialast year
took agreed to take a C$2.4bn stake in
the Canadian cannabis company
Cronos, but PMI says it sees too many
risks in a market where international
regulators have found no consensus.
More profoundly, the two companies
have differed in their commitment to
killing off their main product. PMI talks
about “building a future on smoke-free
products”. Altria has framed its stance
more cautiously, emphasising smokers’
“consumer choice” alongside its com-
mitment to innovation and harm reduc-
tion.
Stifel analyst Christopher Growe said
a merger would boost PMI’s earnings
and extract $400m in savings, but
Altria’s higher regulatory burden and
slowing growth would reduce the multi-
ple at which PMI’s shares trade.
That concern had driven PMI’s shares
down almost 11 per cent from Friday’s
close by lunchtime yesterday in New
York, pointing to the potential that
investors’ concern could yet prove the
biggest obstacle to the deal.
If it does happen, however, it could be
just be a prelude to another split, Mr
Growe speculated: “Perhaps this merger
would allow the combined company to
create two separate businesses — one
focused on cigarettes and generating
strong free cash flow and one focused on
growth with new, innovative products
such as Iqos and Altria’s stake in Juul.”
Additional reporting by James Fontanella-
Khan in New YorkTobacco groups look to a post-cigarette future
Philip Morris and Altria face a challenge in convincing investors of the future merits of proposed $210bn merger
Altria’s revenue growth
Annual growth in revenue
by product type ( ) Smokeable
SmokelessSources: S&Q Capital IQ, FT calculationsPMI/Altria revenue
Total revenue (bn) Altria
Philip MorrisSource: S&P Capital IQAltria and Philip Morris’s M&A activity
Deals over m (deal value, bn)
Philip Morris AltriaSource: Dealogic Sep
UST ( )
Feb
Green Smoke
(e-vapor business)
After sale of SABMiller
Altria holds of AB InBevDec
Cronos ( )
Dec
JUUL Labs ( )
Jun
Burger Söhne ( )
Juul has taken
about 70 per
cent of the US
ecigarette
market— Gabby
Jones/Bloomberg‘I expect the
existingincumbents
will need torevisit their
playbooks’HANNAH KUCHLER— NEW YORKShares in US-listed opioid makers and
distributors fell yesterday on fears that
a loss forJohnson & Johnsoninacasein
Oklahoma could embolden prosecu-
tors in the thousands of lawsuits seek-
ing compensation for an epidemic that
has ravaged the US.Endo International, a pharmaceutical
company, fell 9 per cent to $2.65,Teva,
the Israeli drugmaker, lost 4.6 per cent
to $7.08, andMcKesson, a distributor,
fell 3 per cent to $142.55 in late-morning
trading in New York.
The falls come after an Oklahoma
judge on Monday ruled that J&J was
responsible for bills relating to the
state’s opioid crisis, with the US drug-
maker being ordered to pay $572m.Harry Nelson, an attorney and author
ofThe United States of Opioids, said that
Oklahoma paved the way for more cases
because it succeeded on a “public
nuisance theory”, proving only that J&J
manufactured a product that caused
harm — not that there was evidence of
fraud or conspiracy at the company.
“Failure to do anything — rather than
malicious intention — was more than
sufficient for a judge to hold J&J respon-
sible,” he said. “So all of the distributors
and more peripheral manufacturers can
now expect to be held responsible.”
The verdict was handed down as 22
opioid manufacturers, distributors and
pharmacies are trying to win permis-
sion to negotiate as a class in a multi-
district litigation case that is due to go to
court in October. The outcome in Okla-homa could embolden the plaintiffs to
push for more in any negotiation — and
even open up the possibility of more
cases.
Earlier this month, Endo announced
it had settled in principle by agreeing to
pay $10m and up to $1m in products to
two plaintiff counties in Ohio. The set-
tlement included no admission of
wrongdoing or liability.
Teva was also named in the Oklahoma
lawsuit butsettled on the eve of the trial
for $85m, without admitting liability or
wrongdoing. With net debt of about
$26.6bn, Teva is in a “tough financial
position,” said analysts at BTIG, espe-
cially if opioid liabilities rise far above
$3.5bn to $4bn. “We believe a major
driver for the shares will be the upcom-
ing multi-district litigation,” they said.Pharmaceuticals
Oklahoma ruling hits opioid industry
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