By Heneage Mitchell

Philip Morris Philippines Manufacturing Inc. (PMPMI) and Fortune Tobacco Corporation (FTC) entered into an agreement last February 25, 2010 to unite the domestic business operations of both companies into a new entity called PMFTC Inc. (PMFTC).
Unlike a merger where one of the parties is absorbed into the other entity, PMPMI and FTC continue to exist, with PMPMI continuing its export business and FTC maintaining its contract manufacturing obligations.

Prior to the creation of PMFTC, Philip Morris and Fortune each had their respective strengths in the domestic market. Philip Morris led the high-priced segment through its main brands such as Marlboro and Philip Morris, while Fortune’s strength was in the low- and medium-price segments through its main brands Fortune, Champion, and Hope.PMFTC is an affiliate of Philip Morris International (PMI) and is engaged in the manufacture, sale and distribution of tobacco products in the Philippine domestic market.
PMFTC is jointly owned by PMPMI and FTC following a business combination where PMPMI and FTC transferred selected assets and liabilities in exchange for shares in the company, which is  estimated to have a 93.4% share of the Philippine domestic market.
Meanwhile, PMPMI, also an affiliate of PMI, is engaged in the business of exporting tobacco products manufactured in the Philippines.   
“The creation of the new company provides PMI with a great opportunity to significantly expand its business in the world’s 12th largest cigarette market and ensures  long-term success in this critical market,” according to Chris Nelson, managing director of PMPMI and president of PMFTC. “The business combination allows both parties to take advantage of each other’s strengths: PMI’s global experience, specifically in marketing brands like Marlboro and Philip Morris, with Fortune’s expertise in manufacturing and distributing local cigarette brands providing an excellent platform for future success.
While neither side will discuss the history and details of the business combination, the fact that the two companies have come to this agreement augurs well for the future success of PMFTC
“PMFTC is built on a very solid foundation provided by both companies,” according to Nelson. “Both parties are pleased with the agreement and view the combination as an excellent development for both.”
As each party holds an equal economic interest in PMFTC, profits will be distributed on a 50/50 basis.  PMFTC will declare dividends to distribute all its earnings subject to local statutory, working capital and capital expenditure requirements.
The board of directors of PMFTC has 11 members, 6 from PMI and 5 from FTC.  The new company’s management team includes executives from both companies, with Chris Nelson as president and Lucio Tan as chairman.

Strategies and speculations
Clearly, there is great potential for the newly formed company to flex its muscles in a number of areas, but for now the goals are clearly defined.
“In the near term, we are focusing our efforts in properly integrating the various business operations, such as the installation of systems to promote operational and financial efficiency as well as the migration of employees into PMFTC,” according to Nelson. “We are still in the process of evaluating what will be best for the new company, but generally there is no change in how we operate.”
PMFTC has maintained the sales and distribution structures existing prior to the transaction, and thereby distributes its products through third parties and distributors who in turn, sold these products to wholesalers and retailers in the Philippine domestic market.
“We shall continue to explore other arrangements to maximize synergies in logistics and further optimize existing distribution networks,” Nelson told Tobacco Asia. “Existing contractual obligations will generally be honored and we are committed to ensuring that PMFTC will not have any disruption in its supply chain and retail operations. As in any company, we are interested in reducing costs while maintaining the same quality in our products that consumers expect from a Philip Morris company. Thus, we are constantly in the look out for a supplier that can provide the company the materials it requires at the best price and quality.”
Nelson confirmed that, at least in the near-term, PMFTC will be supplying cigarettes for the domestic market only.

Leaf dynamics
Equally, there is a commitment to ensure that all products produced by the new company continue to get the support needed.
Both FTC and PMPMI have worked closely with tobacco growers in the Philippines in the past to enhance the quantity and quality of tobacco grown in the country, both to meet domestic demand and to make local tobacco more competitive in the global market.   “The creation of PMFTC. will allow us to combine and refine these programs with tobacco growers, thereby increasing their competitiveness, which will benefit tobacco growing communities and the Philippines economy overall,” Nelson, who has a long track record of promoting the interests of Philippine tobacco farmers, said.
To prove the popint, Nelson shared some interesting figures on leaf tobacco prices.
The average price of flue-cured is steadily going up, from Php50/kg (US$1.135), (compared to the Php39/kg floor price of the National Tobacco Administration (NTA) in 2005 to Php76/kg (Php53/kg NTA floor price) in 2009.
The average price of burley is also rising, from Php41/kg (vs Php27/kg NTA floor price) in 2005 to Php69/kg (Php37/kg NTA floor price) in 2009.
Underscoring the point, the NTA also noted a rise in the number of farmers planting tobacco, proving that the crop continues to bring in more cash compared to other agriculture products. In a report to the Department of Agriculture, the NTA said that there were 43,573 farmers that planted tobacco in 2009, compared to only 39,918 farmers in 2008.

Legislative climate
Despite the fact tobacco has long played an important role in the economy of the Philippines, and that the recently-elected president of the Philippines, Benigno “Nonoy” Aquino lll, is himself a smoker, and has refused to quit, despite pressure to do so from anti-smoking groups, the Philippines nonetheless actively discusses various additional legislative and excise measures that will undoubtedly impact the future dynamics of the market.
But Nelson remains undaunted and has an encouraging confidence in the future of this key Asia market.
“PMI is committed to the Philippines and the creation of PMFTC reflects the continued confidence we have in the future of the country, its economy and the tobacco industry,” he told us. “We believe that every administration has its own priorities and strategies on how to best improve the social and economic climate in the different sectors. We hope that the legislative and executive branches of government under the Aquino administration would come up with reasonable laws and regulations which will achieve both revenue generation and address public health goals. We wish to highlight that under Republic Act 9211 or the Tobacco Regulation Act of 2003, the government is mandated to institute a balanced policy towards tobacco products and public health concerns. As a company, Philip Morris supports reasonable regulations of the tobacco industry and this will not change under PMFTC,” he said, adding that: “We will continue to work with government for the passage of reasonable regulation for tobacco products, including regulations governing product advertising, public place smoking and preventing children from smoking.”
President Aquino had promised not to impose any taxes or increase the rate of such levies in all economic sectors on his election.
Congress, meantime, has started its public hearings on a new law for the excise tax for alcohol and tobacco products.
“We have to look at the government’s proposal - its impact to the cigarette industry and the livelihood of more than 2.7 million people dependent on the tobacco industry,” Nelson stressed. “As a company, we will be submitting our position paper to the House of Representatives. What we can say though is that: we will support a proposal that provides for reasonable tax increases every two years to allow the industry and our adult consumers to adjust to any price increase; we will support a proposal similar to the current excise tax system for tobacco and alcohol products (Republic Act 9334) that will be effective for at least six years as it provides a stable and predictable environment  within which our company will operate; and we will support an excise tax system that will not cause too much disruption in the market. Any abrupt and sudden change in the tax structure will result to unintended consequences, including the proliferation of smuggled and counterfeit products and too much down-trading resulting to lesser tax revenues, for example.

Bright future
Ten months after the establishment of PMFTC, the company is performing very well.
The Philip Morris International 2010 Q3 report cited the establishment of PMFTC as instrumental to the company’s expansion in the Asia-Pacific region. In part, the report said:
“As a result of this business combination, PMI’s shipments were up by over 100% in the third quarter of 2010, and market share was an estimated 93.4%, up by 0.6 points compared to the prior quarter. Excluding the favorable impact of this new business combination of 16.2 billion units, cigarette shipments of PMI brands increased by 8.7%, fueled by the growth of Marlboro and the Philip Morris brand.”
For Nelson, the road ahead is clearly defined.
“In the near term, we are focusing on completing the integration of all aspects of the business under PMFTC, including the transfer of employees from PMPMI and FTC,” he said. “The ultimate goal is to try to make the Philippines the number one market of PMI in terms of volume.”