Altria Group Inc. (NYSE: MO) has smartly tried to diversify beyond traditional tobacco products. But its investments in e-cigarettes and legal marijuana haven’t gone exactly as planned.

Now, the company’s foray into so-called “heat-not-burn” cigarettes has also run into trouble. Last week, the United States International Trade Commission (USITC) voted to investigate a legal dispute over Philip Morris International’s iQOS heated tobacco device.

Altria is selling the new products under a deal with Philip Morris International (NYSE: PM). Any disruption here would be another blow for the Henrico County, Virginia-based tobacco giant.

Altria stock is down 24.34% year to date, while Philip Morris International has dropped 16.92%. The S&P 500 is down 8.38% for the same period.

What Is ‘Heat-Not-Burn’?

Philip Morris says 10.6 million smokers have already transitioned to the iQOS system. The idea is that heating tobacco should theoretically be less harmful than smoking it. But the Food and Drug Administration (FDA) warns, “There is no safe tobacco product.”

The agency says heated tobacco devices “may help reduce the risk of tobacco-related harms” when switching from normal cigarettes. But “all tobacco products can lead to nicotine addiction and contain toxic, cancer-causing chemicals.”

On its website, Philip Morris says “the tobacco in a cigarette burns at temperatures in excess of 600°C, generating smoke that contains high levels of harmful chemicals. But [the iQOS device] heats tobacco to much lower temperatures, up to 350°C, without combustion, fire, ash, or smoke.” Heated tobacco produces lower levels of harmful chemicals than normal cigarette smoke, the company claims.

iQOS has a very modern design, with a pocket charger that looks suspiciously like an iPhone. Users place Marlboro-branded “HeatSticks” in the rechargeable holder, which looks like a fancy electronic pen.

Altria first rolled out the product in Atlanta last fall before expanding to Richmond, Virginia. Charlotte, North Carolina, was scheduled to be the next market.

The iQOS device (including 200 HeatSticks to start) sells for $80. A pack of Marlboro-branded HeatSticks costs about the same as a pack of regular cigarettes.

The coronavirus pandemic forced Altria to temporarily close its high-tech looking retail iQOS stores and stop person-to-person marketing efforts. But iQOS users can still buy replacement HeatSticks online or at convenience stores and gas stations in Atlanta and Richmond.

The Lawsuit

On April 9, British American Tobacco PLC (NYSE: BTI) sued Philip Morris International, Altria and Philip Morris USA for patent infringement. British American doesn’t yet have a heated-tobacco product on the market but claims it holds five patents that apply to iQOS.

Now the USITC says it will hold a hearing on British American’s complaints. British American is the parent company of RJ Reynolds Tobacco.

Philip Morris denies that its product violates any patent. If successful, the suit would prevent Altria from selling the iQOS in the U.S., unless it paid a licensing fee to British American. Suits are also pending in Germany and Japan.

The Bets on Other Products

Altria’s $12.8 billion investment in e-cigarette maker Juul hasn’t panned out so far. The 2018 deal gave Altria a 35% stake in Juul.

Juul faced regulatory scrutiny and a public relations backlash over charges that flavored e-cigarettes were targeting youth. Juul discontinued its popular fruit- and mint-flavored pods as a result, and the FDA later banned these.

Privately held Juul recently cut a third of its staff and reduced operations in Europe and Asia. Altria took a $4.5 billion writedown on its investment.

Altria is also battling the Federal Trade Commission, which says Altria and Juul were competitors until Altria ditched its MarkTen brand of e-cigarettes and made its investment in Juul. An FTC hearing is scheduled for January 2021. Altria said the company was “disappointed with the FTC’s decision [and believes it has] a strong defense and will vigorously defend our investment.”

Altria also wanted to diversify into legal cannabis. It invested $1.8 billion in Canadian pot grower Cronos Group Inc. in 2018, taking a 45% stake. Analysts say Altria overpaid for Cronos, which has a market cap of $2.05 billion. Cronos stock is down 23.21% year to date.

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