How To Light Shareholder Capital on Fire: Altria's Acquisition of Juul - 7investing
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How To Light Shareholder Capital on Fire: Altria’s Acquisition of Juul

September 22, 2021

One of the most important qualities of a great company is superb capital allocation.

Capital allocation is a fancy way to describe “how a business uses its profits.” You can think of it as the bridge between business performance and investment performance.

Some companies do this incredibly well, and use their money in ways that can compound for decades. Disney (NYSE: DIS) certainly made the right move when it acquired Marvel for $4 billion in 2009 — giving it many tenured franchises that it monetized through movies and merchandise. Amazon (Nasdaq: AMZN) similarly scored a big win when it acquired Kiva Robotics for $775 million in 2012. Its cute and efficient warehouse robots are now saving it tens of billions of dollars every year in logistical expenses.

But sometimes, companies make terrible capital allocation decisions that turn out to be disasters for their investors. And no one in recent history did it worse than the management team of Altria (NYSE: MO).

Altria is America’s largest cigarette maker, whose Marlboro brand commands a dominant market share. In its steadily-declining industry with high capital costs and few new competitors, Altria has been returning capital to shareholders for decades through steadily-rising dividends and share repurchases. Investors could compound their returns by reinvesting their dividends and buying more shares. Those shares are also priced at a discount to the company’s fundamental profits, due to its “sin-stock” nature and the ever-present threat of regulations.

Yet Altria got greedy a few years ago. It noticed that vaping was a rising trend that allowed people to inhale nicotine through devices rather than through combustible tobacco cigarettes. Eager to expand into this adjacent market, Altria spent $12.8 billion in December 2018 for a 35% stake in e-cigarette maker Juul. Juul reported an impressive 600% increase in sales during the previous year.

It was a reckless move, and it didn’t consider several looming concerns. Vaping devices and e-cigarettes were under scrutiny for being marketed to minors. Altria ignored the controversies and did the deal anyway. It valued Juul at a staggering $38 billion.

The fallout ensued almost immediately afterward. The FTC filed a lawsuit against Altria, claiming that it was participating in anticompetitive behavior even before the acquisition to support Juul’s growing sales. School districts began filing suits against Juul for mysterious lung illnesses that were linked to vaping. And Altria’s shareholders — trained to methodically expect returns through steadily-rising buybacks and dividends — were enraged that the company was now completely shifting gears. Paying a premium price for a highly-contentious acquisition isn’t exactly why they were invested in the stock.

The story didn’t end well. Less than twelve months after finalizing the deal, Altria wrote off 35% of its Juul stake — taking a $4.5 billion impairment on its $12.8 billion investment. It went on to write down its Juul investment several more times during the following year. By Halloween 2020, it determined that its Juul stake was worth a piddling $1.6 billion. It turned out to be a scary situation… one which many investors might even describe as a nightmare.

The moral of the story for investors was that Altria was reaching beyond its core competence. It was overvaluing Juul and was far too optimistic about its potential, without fully considering the regulatory risks.

The Juul fiasco ultimately lit $11.2 billion of Altria shareholder capital on fire. Had the company simply paid that impaired amount out as cash to its 1.9 billion shareholders, it would have equated to a $5.95 special dividend. Based on the share price at the time, that would have amounted to a 12% yield.

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