One strategy for a company to unlock value for shareholders is to break itself up. That is what happened when Altria Group Inc. (NYSE: MO) decided to split apart the international operations from the domestic tobacco operations. Hence, Philip Morris International Inc. (NYSE: PM) was born as a separate stock.

By splitting the companies, Altria was the surviving domestic tobacco operation that was effectively free and clear (or at least quantified) of its domestic liabilities tied to tobacco suits. Philip Morris was the rest of the world’s tobacco operations.

Now the world of tobacco is finding a new change. This is the rise of the e-cigs and vaping market. In a strange twist of fate, is it possible that Altria and Philip Morris would come back together again? At least one Wall Street analyst sees the potentiality of such a recombination, a move that would combine the $123 billion market cap of Altria and the $147 billion market cap of Philip Morris.

Wells Fargo reiterated its Outperform ratings on both Philip Morris and on Altria. The difference here is that Philip Morris just became the firm’s new Top Stock Pick of that sector.

Before thinking a merger of this magnitude is just too ludicrous, investors should consider Reynolds American Inc. (NYSE: RAI), which acquired Lorillard in a $27 billion or so deal that was completed in 2015. And now there is word that British American Tobacco PLC (NYSEMKT: BTI) is considering using its $106 billion market cap to acquire Reynolds American, which itself is worth $73 billion or so. That should maybe say, “acquire the rest of Reynolds that it doesn’t already own.”

British American already owns a $5 billion stake in Reynolds, and reports from the Telegraph suggested that British American is working with investment bankers to secure financing and strategies to buy the rest of Reynolds.

A lot of things ought to be considered here. First off, would Altria use the merger as an offshoring move? Both companies have their bases in New York, but what matters is the stream of revenues and income, and where the domicile of the revenue and income takes place in the world. Philip Morris had 2015 sales of $73.9 billion and net operating earnings $6.87 billion after taxes and interest. Altria’s 2015 figures were $25.4 billion in sales and $5.77 billion in net income from continuing operations after taxes and interest. You can see where things could get complicated quickly in the domestic versus offshoring argument, even if both companies are headquartered in New York City.
So, back to this analyst call that Altria and Philip Morris could recombine. It almost seems too good to be true. Wells Fargo’s Bonnie Herzog has a report showing that Philip Morris is changing the world one smoker at a time. The firm noted that the iQOS smokeless cigarette is redefining the smoking experience and is poised to drive transformative growth. Herzog’s view is that the Philip Morris new “Heat-Not-Burn” technology is set to revolutionize the global tobacco industry.

Herzog said that the iQOS could displace up to 30% of the combustible cigarette industry in the developed markets by the year 2025. It could also increase smoking prevalence and accelerate the premiumization of the overall market. Here is what was said about a potential recombination, with iQOS being the catalyst:

We strongly believe iQOS is a win-win for both Philip Morris and Altria and increasingly believe it could be the catalyst to reunite the companies, as speculated in a recent Bloomberg article without comment from management. Potential benefits could include: significant synergies/cost savings; geographic diversification; better aligned incentives and opportunities especially as it relates to new technologies such as iQOS; and the ability to more effectively compete on a global basis. However, regardless of a potential merger between the two companies, we believe Philip Morris’ strategic framework with Altria to commercialize reduced-risk tobacco products and e-cigs is a clear positive for both.

Before getting too excited about a merger here, it is important to understand that Wells Fargo is seeing big upside with or without any potential merger noise.

All in all, Wells Fargo’s report says that the market is underestimating the potential upside for both Altria and Philip Morris. Its 10-year discounted cash flow model suggests that iQOS could add an incremental value of $27 per share for Philip Morris and could add $10 per share for Altria. The firm decided to increase its valuation range by $15, up to $109 to $111, for Philip Morris and by another $5 to a range of $69 to $71 for Altria.

The Philip Morris stock price was last seen at $95.09, with a consensus analyst price of $91.69 and a 52-week range of $75.27 to $95.31. Altria shares were trading at $62.69, with a consensus analyst price of $64.88 and a 52-week range of $47.31 to $63.08.

A recombination of these two companies would be more than interesting — and more than problematic. Altria is now in a position where it can mostly quantify its smoking and tobacco suit liabilities. That might not be true for Philip Morris, due to how many countries it operates in.

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