With Big Tobacco lying in the weeds, can Wall Street can smoke 'em out?
Cigarettes may have not only killed the Marlboro Man, they've also started chipping away at the stock of the company he represented for 25 years. While the stock market continued to skyrocket this summer, Philip Morris and other tobacco companies which agreed to pony up over $370 bn in a class-action lawsuit settled in June weren't as lucky. So far, Philip Morris is down over five points from June 19, the day prior to the deal, through mid-July. Over the same time period, RJR Nabisco, owners of RJR Reynolds Tobacco Company, fell four-and-half points and Loews Corporation, owners of Lorillard Tobacco Company, dropped four points too.
That dip in stock prices doesn't seem to faze Big Tobacco. Short of holding quickie conference calls to assuage concerned investors in the aftermath of the multi-billion dollar deal, tobacco company IROs seem content to sit back and wait out the negotiations surrounding the historic pact. Of the four major tobacco makers contacted for this story, only London-based BAT Industries, owners of Brown & Williamson Tobacco, would admit to taking specific steps - albeit minimal - to address the issue with investors.
'As it is, we're not doing much,' confesses Michael Prideaux, director of public affairs for BAT. 'All we did after the deal was announced was to host a conference the following Monday for analysts and investors. We took that opportunity to boil down the 64-page document clearly and informatively. We emphasized, though, that this deal has still a long way to go and nobody was really sure what the final deal would look like.'
Hold the Starch
Waiting it out is the strategy that investor relations professionals at the other leading tobacco companies are taking as negotiations between the US Government and tobacco industry lawyers play out this autumn. That attitude has - in the short term at least - taken some starch out of tobacco company stock performance in 1997. And combined with the uncertainty of the deal, it may have perilous long-term consequences for an industry that sold $45 bn worth of cigarettes in 1996. Under the hefty payout arrangement serving as the bedrock for the agreement, the tobacco giants suffer to the tune of an average $14.7 bn annually - or about double their profits from the sale of cigarettes in the US in 1996 alone.
Bond ratings as well as stock prices are suffering, and talk of downgrading more tobacco company bond issues is already brewing on Wall Street. The first salvo in that battle was fired on June 26 when Standard & Poor's assigned a BBB- rating to RJR Nabisco's $150 mn senior notes due 2004 and $200 mn senior notes due 2007. Calling the $370 bn payout a 'significant liability,' an S&P spokesperson says that 'over the next couple of months, as details emerge, S&P will explore the financial and business risk and determine the downside, if any, to issuers.'
What Are They Smoking?
While tobacco stocks held firm immediately after the deal was announced, with many investors believing that the worst-case tobacco scenario had just occurred, stocks slid further in mid-July. That was after President Clinton and former US surgeon general C Everett Koop, among other national figures, went on record saying the 'deeply flawed' deal was great for the tobacco companies and a bad one for the country (nicotine won't be regulated under the deal and the industry would win immunity from future class actions and from punitive damages for past actions). A New Jersey senator, Frank Lautenberg, summed up the feelings of the anti-tobacco forces by saying that 'if the tobacco industry thinks that the US Congress will rubber stamp this agreement, then what are they smoking?'
'Historically, the threat of huge lawsuits has dragged tobacco industry stocks,' explains Doug Cogan, former head of the Tobacco Information Service and now a consultant with the Washington, DC-based Investor Responsibility Research Center. 'But the proposed deal takes away the government's and the public's right to sue tobacco companies. That's a powerful incentive to invest in tobacco stocks and, even though there's a long way to go, it's providing some comfort to investors.'
According to Marc Cohen, tobacco industry analyst at Goldman Sachs, Big Tobacco playing its cards close to the vest is in the best interests of shareholders, even if current stock levels don't support such a strategy. 'The tobacco companies have been quiet about the deal for a good reason. It's a good deal for them and they understandably want to spend their time trying to ensure that it passes through Congress instead of talking to us about the deal.'
Others suggest the national media has already declared the settlement a decided victory for Big Tobacco. 'All you're hearing in the press is the favorable deal the tobacco companies are walking away with at the expense of the states,' notes Tim Swanson, tobacco analyst at AG Edwards. 'Investors are responding to that favorably because stock prices could be doing a lot worse right now.'
Some analysts say that investor relations staffers at the top-tier tobacco makers will likely play up the long-term prospects of their companies in a post-settlement, nicotine-friendly, litigation-free investment environment. 'Even if the tobacco companies concede some points during negotiations, companies like Philip Morris are still going to be great buying opportunities,' adds Rob Norfleet, an analyst at Richmond, Virginia-based Davenport & Company. 'Valuations for Philip Morris are still very solid; it's one of the top companies in the world trading under 20 times earnings. The company, in fact, should be trading at a premium based on brand name power alone when you consider that Gillette and Coca-Cola (the only American company with a higher brand name recognition than Philip Morris) are trading at 45 times earnings. And if the deal holds, look out.'
Exodus and Fallout
One area of concern is the exodus of big pension money, either for socially responsible reasons or from the financial fallout surrounding the new settlement. Florida had already quietly kicked its habit of investing in tobacco companies by selling $650 mn in tobacco stocks. The move came after a 2-1 vote by Florida's State Board of Administration, which oversees a $69 bn pension fund. The $650 mn represents almost 80 percent of the state's investment in tobacco stocks. The sell-off was orchestrated perfectly, as virtually all of the stock was unloaded just days prior to the settlement.
'I think Florida got out for social reasons,' says Norfleet. 'They didn't want any part of an industry that contributed to teenage smoking and heart disease.' He adds that other states, like Vermont and Washington, are set to follow Florida's lead. Massachusetts sold its $77 mn tobacco investment in 1996.
Whether divestiture makes investors happy or not is another story. After the Florida sell-off, Mark Neimesier, legislative director of the American Federation of State, County and Municipal Employees (AFSCME), told the Orlando Sentinel that pension managers should leave emotion out of their investment decisions and think long term. 'Hopefully, they'll be able to find new stocks that will perform as well as tobacco stocks over the long haul.
Therein lies the rub. If tobacco stocks rebound from their mid-summer doldrums and the industry manages to convince a skeptical Congress to sign off on the settlement, then the low-profile IR strategy embraced by the tobacco companies will have carried the day.
Already, the tea leaves suggest that the mammoth public relations wheels are set to churn further down Tobacco Road. Industry players have indicated they will raise the price of cigarettes 50 cents per package to help defray the massive payout fees of the deal. While that will pour cold water on already besieged smokers, the $12 bn that such a price increase is projected to pour into industry coffers annually will help offset the big checks cut to states annually. The agreement, tobacco companies estimate, will also shave $600 mn off of their annual legal bills. And lastly, whatever the cigarette makers lose in the US, they may well make up overseas, where demand for Marlboros and Kools remain strong.
While nothing is certain when you have two combustible elements like the tobacco industry and the US Congress working off the same blueprint, industry IR professionals are content to bide their time, bite their lips, and murmur a 'no comment' or two about what, if anything, they're telling investors these days. If that means a short-term decline in stock price then so be it. That's fine as long as the deal doesn't go up in smoke. But if it does, the exodus from the tobacco stocks will make the evacuation of Dunkirk look like the last five minutes of a Joe Camel fan club meeting. And that would be a hump the tobacco industry may never get over.