Will Cigarette Maker Reynolds Try Kicking the Habit?

Reports that Reynolds American may acquire a stop-smoking outfit suggest a new level of tobacco-industry diversification

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It would be either one of the most cynical diversifications ever—or a brilliant stroke of synergy.

If a report in The Wall Street Journal is correct, America's second-largest seller of cigarettes may soon be peddling products that help people quit smoking. The Journal reported on Nov. 9 that Reynolds American (RAI), the distributor of Pall Mall, Camel, and Natural American Spirit cigarette brands as well as smokeless tobacco, is in "advanced talks" with Niconovum, a Swedish manufacturer of nicotine replacement products such as gum and mouth spray. University of Ottawa law professor David Sweanor told the Journal he was briefed by people close to the deal.

The move would mark the first time that a big tobacco company also sold smoking-cessation products, according to industry analysts. But it would be in line with the industry's efforts to diversify as cigarette purchases shrink in the U.S. One analyst referred to a purchase of Niconovum as a "cheap hedge" against the smoking decline.

Smoking has been falling off in the U.S. for years—from more than 490 billion cigarettes sold in 1995 to 345 billion in 2008, according to Philip Gorham, a stock analyst at Morningstar (MORN). Adult smoking in the U.S. has declined by half since 1965; in 2006, 26 million men and 21 million women in the U.S. smoked, according to the National Center for Health Statistics. Overseas, the picture is different: Some 1.1 billion people smoked worldwide in 1999, a number the World Bank expects to swell to 1.6 billion by 2025.

"If a smoker wants to quit, they'll quit," says Gorham. "If they're spending money trying to quit anyway, I think Reynolds is thinking, 'Why not let us sell them that product, too?' "

Expanding Product Lineups

Tobacco companies are broadening their product lineups to adapt to the spread of regulations that prohibit where people can smoke, while providing more socially acceptable alternatives. And smokeless products, which make up about 7.5% of the tobacco market, are growing by about 8% a year. R.J. Reynolds, a subsidiary of Reynolds American, unveiled its latest creation of smokeless and spitless tobacco in three test markets across the country starting in January. Camel Sticks, Camel Orbs, and Camel Strips are marketed as a dissolvable alternative to smoking, made from a combination of finely milled tobacco and food-grade binding agents and flavoring.

The industry leaders—Reynolds has 28% of the U.S. market; Altria (MO), the parent company of Philip Morris and seller of Marlboros in the U.S., has a 50% share—depend on deals for their growth. "There's been a lot of merger and consolidation activity in tobacco—it's really a no-growth or negative-growth industry, so companies have to acquire if they want to grow," says Jack Russo, an analyst at Edward Jones. In the third quarter, Reynolds posted slight gains in market share with its Pall Mall brand and offerings like Grizzly by its Conwood division, said Thilo Wrede, an analyst at Credit Suisse (CS), in an Oct. 22 research note. But Camel, the company's flagship brand, lost market share, while the total number of cigarettes that R.J. Reynolds shipped fell by 11% year-over-year. That was a much steeper decline than what analysts had expected.