Updated October 29, 2012, 6:42 p.m. ET
Philip Morris Seeks an Edge in China
By MIKE ESTERL
Marlboro is the world’s top-selling cigarette, but it has a minuscule 0.3% share of the market in China, where roughly a quarter of the population smokes.
Bloomberg News
About 40% of the world’s cigarettes are smoked in China.
Now, Philip Morris International Inc., PM +0.63%which makes and markets Marlboro outside the U.S., is trying to raise its profile in that enormous Asian nation by moving beyond simple smokes. In one curious effort, it is setting out to develop flu vaccines derived from a type of tobacco plant. In another project, closer to its core business, it is developing less harmful cigarettes, which it would aim to sell all over the world, but especially in China, where about 40% of the world’s cigarettes are smoked but state-owned China National Tobacco Corp. enjoys a virtual monopoly.
In September, Philip Morris said it would be licensing rights from Medicago Inc., MDG.T +1.10%a small Canadian biopharmaceutical company, to develop vaccines for sale in China. The seemingly incongruous move is underpinned and motivated by several different situations. Philip Morris already owns about 40% of Medicago. Philip Morris also has a goal of diversifying into different tobacco-related products.
More important, the vaccine agreement in China has as much to do with cultivating relations with government officials as diversifying into a new business that may or may not take root, highlighting how much of a long-term play China remains for Switzerland-based Philip Morris, the world’s second-largest cigarette company by volume, after China National Tobacco.
“This is one other way they could endear themselves to the Chinese,” said Bonnie Herzog, a global tobacco analyst at Wells Fargo WFC -0.26%.
At a recent investor conference, Philip Morris acknowledged traditional cigarettes from foreign companies will continue to be a hard sell in China, where the government generates tens of billions of dollars in profits from tobacco. Retail cigarette sales in the country topped $160 billion in 2011, roughly a quarter of the global market, according to estimates by Euromonitor, a data service.
“Why would they share their market?” Philip Morris Chairman and Chief Executive Louis Camilleri told investors in June. “To come up with new technology is really the only avenue to get into a place like China.”
Thus Philip Morris’s effort to develop next-generation cigarettes that are less harmful than current versions, with a serving of public health on the side.
There are rising health concerns about cigarettes in China. More than 1 million people die annually in the country from tobacco-related diseases and officials have warned the number could triple by 2030 without action. Health authorities have been pushing to turn more public buildings smoke-free.
Philip Morris is investing hundreds of millions of dollars trying to develop less-harmful cigarettes and executives have described the strategy as a potential “game changer” in China. One version generates smoke at temperatures below combustion, releasing fewer toxins, but aims to mimic traditional cigarettes more closely than alternatives already on the market such as electronic cigarettes.
Philip Morris has begun discussing its next-generation plans with CNTC and Chinese officials “are extremely interested,” Andre Calantzopoulos, Philip Morris’s chief operating officer, recently told investors. But he estimated the new cigarette products wouldn’t be launched before 2016 or 2017.
The vaccine is perhaps even further off in the future.
Philip Morris said its China flu business hinges on the successful completion of clinical trials and securing regulatory approvals. “We’re definitely talking years,” added a spokeswoman for Philip Morris.
Medicago specializes in producing flu vaccines from Nicotiana benthamiana, a relative of Nicotiana tabacum, the tobacco plant used in cigarettes. It represents one of several plant and cell-based alternatives to chicken eggs, which have been used for decades to make vaccines but are seen as slow and expensive.
China has been among the countries hardest hit by H5N1 over the past decade and was swept up in the H1N1 outbreak of 2009 and 2010, which killed an estimated 280,000 people world-wide, according to a recent estimate.
Under the Medicago deal announced in late September, Philip Morris will pay an initial $4.5 million for the rights to develop Medicago’s pandemic and seasonal influenza vaccines for China.
Medicago produced more than 10 million doses of an H1N1 or swine flu vaccine within 30 days earlier this year in a research project with the U.S. Department of Defense. It also has reported positive results from a Phase II clinical trial for an H5N1 or avian flu vaccine. The China program represents publicly traded Medicago’s first foreign-licensing deal.
Philip Morris began investing in Medicago in 2008, when it acquired a large minority stake in the Quebec-based company for roughly $15 million—pocket change for the cigarette maker.
Both the next-generation cigarettes and the flu vaccines are expected to take several years to come to market, if ever.
Philip Morris got its foot in the door in China in 2005, when it inked a strategic partnership with China National Tobacco, or CNTC. Under that arrangement, CNTC began producing Marlboros under license in China four years ago. Philip Morris also helps distribute CNTC brands outside China, including Poland and the Czech Republic.
But as of last year, CNTC still boasted a 97% market share in its home country, according to Euromonitor International. Marlboro’s 0.3% market share puts it behind more than three dozen CNTC brands including market-leading Hongtashan. China’s biggest foreign brand last year, British American Tobacco BATS.LN -0.26%PLC’s 555, had a 0.5% market share.
Write to Mike Esterl at mike.esterl@wsj.com
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