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07/01/97 13:53 69 202 6220081
DEPSEC TREAS
lub-rro- Dry elsus SW 001
OFFICE OF THE DEPUTY SECRETARY
DEPARTMENT OF THE TREASURY
JAF
1500 PENNSYLVANIA AVENUE, NW
AHM
WASHINGTON, D.C. 20220
C$
FACSIMILE COVER SHEET
July 1, 1997
MM)
FOR:
Dr. Janet Yellen
MJT
Phone:
395-5042
Fax:
395-6958
TOTAL PAGES:
8
FROM:
Lawrence Summers
PHONE:
202/622-1080
FAX:
202/622-0081
MESSAGE:
Please see attached - FYI.
07/01/97 13:53 69 9 202 6220081
DEPSEC TREAS
002
JUL 01 '97 12:17PM YALE SOM
P.1
cer ! wolm
To: Larry Summers
Griber
From: Jeremy Balow
Yellih
203-432-3721
203-389-0724
7 pages including this one.
Larry, getting ahold of some
I'M also from three securities another firms.
reports Hopefully I'll have those in
day or two.
Jeremy
Jeremy's concerns
lewyers fees 5/6 written into ded x negatived
as to total ant
would prefer quentity restriction
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003
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:
The Tobacco Settlement
1. Economics of Cigarettes
Per Pack:
Retail Price 1.85
Fed. Tax
.24
State Taxes .34
Distributors .44
Wholesale .83
Wholesale .83
Marketing
.23
Legal
.025
Other
.25
Profits
.33
Industrywide:
Retail Sales $45 billion
Taxes
$14 billion
Distributors $11 billion
Manufacturers $20 billion
Of which: $5.5 billion marketing and advertising
$600 million legal
$8.4 billion operating profits
2. Industrial Organization
Premium cigarettes are about 30 cents more per pack at wholesale than discount
cigarettes. Operating profits are much more closely related to premium cigarette
sales than to overall sales. Economic profits may be thought of as proportional to
premium sales.
Elasticity of demand is approximately -.4 or -.5.
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Sales (Market Shares)
Premium
Discount
Total
Philip Morris
194.8
(56.3)
36.0
(26.2)
230.8
(47.8)
RJR Nabisco
75.0
(21.7)
44.1
(32.1)
119.1
(24.6)
BAT*
35.7
(10.3)
48.1
(35.1)
83.9
(17.3)
Lorillard
38.1
(11.0)
2.3
(1.7)
40.4
(8.4)
Liggett
2.4
(0.7)
6.7
(4.9)
9.0
(1.9)
Total
346.0
(71.6)
137.2
(28.4)
483.2
(100.0)
BAT (Brown & Williamson) information was calculated as a residual from
industry information and the information available from the other companies'
10K reports.
Philip Morris has 2.43 billion shares outstanding at about $42 per share, for a
total market value of $102 billion.
Philip Morris earns 1/3 of its profits in domestic tobacco and 1/3 in foreign
tobacco. Foreign sales are about 660 billion vs. 230 billion domestically, but
margins are much lower in foreign sales. However, the foreign business is
growing while the sales of domestic cigarettes are following a long term trend of
falling 1-2 percent per year.
3. Financial Terms of the Settlement
$10 billion will be paid upfront, in proportion to market value. So Philip Morris
will pay about $6.5 billion. The agreement specifies that this amount will be
tax deductible, meaning that the cost is equal to approximately 14 months'
pretax profits for the industry. I don't know whether settlements in tort claims
are normally deductible business expenses. These costs should be treated the
same way as normal tort settlements for tax purposes.
The industry also agrees to pay an excise tax per pack of cigarettes sold. The pre
pack figures given below are overstated by the fraction of the tax to be borne by
smokeless tobacco. These taxes should be, and will be, deductible as ordinary
business expenses.
1998 35 cents a pack.
1999 39 cents a pack.
2000 48 cents a pack.
2001 58 cents a pack.
2002 62 cents a pack.
After 2002: 62 cents a pack.
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All taxes are to be adjusted for inflation, defined as the maximum of the CPI
adjustment and 3%. If consumption remains unchanged, the tax will raise $8.5
billion in 1998 and $15 billion in 2002 and thereafter. Predictions based on the
elasticity of demand is that consumption should fall 15% once the full tax is
phased in, beyond the normal trend of 1-2% per year.
There is also an excess profits tax of 25% of the industry's real domestic tobacco
profit growth, up to the point where the total tax bill would be the same as if
there were no reduction from 1996 sales. I assume that this sum will also be paid
through a further increase in the tax rate rather than by companies actually
having to pay a portion of their profits.
The "Public Health Trust" receives $2.5 billion the first two years, then $3.5
billion, then $4 billion, then $5 billion, then $2.5 billion. Among the mandated
uses of the money is $75 million for ten years to compensate events, teams, or
participants (race car drivers) who lose tobacco sponsorship money.
No class action or punitive damage claims. In any event, total payments will not
be more than $2 billion per year for all tort claims. (Any excess is rolled over and
queued up.) Any leftover money, if the $2 billion is not reached, is distributed by
a commission appointed by the President. Note the awful incentive problem.
The tobacco companies are totally insured against all such judgements, and in
fact would have no incentive to defend against them. However, the public
health and government entities that would be the residual claimants on these
funds would have an incentive to minimize payouts.
4. How to Value the Settlement
The 14 months' pretax profits that must fund the initial settlement may be worth
about 14% of the domestic businesses of the companies. This assumes that real
profits will decline by 2% a year, and should be discounted by 10% a year. This
imputes a value to the business of roughly $40 billion (for after tax profits of
about $5 billion), once the litigation is settled.
However, we must also consider the business lost because of the tax increase.
One estimate would be that because business is supposed to drop 15% the long
run value of the businesses will be 15% lower. There are arguments that can be
made to raise (or lower) this number, principally based on whether prices will
rise by more or less than 100% of the tax. You can have theoretical models that
go either way. If the tax is passed ordollar for dollar, maybe the 15% number is
right, and the companies are taking a 29% hit.
There is also the issue of how the lawyers are to be compensated. If that is
additional money that does not come from the current agreement, then the total
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cost to the companies may be substantially more. If the lawyers are to be paid an
extra $5 billion in expectation, for example, then (a) the total cost of the
settlement to the companies rises to 35% and (b) we can be sure that the money
comes from funds that otherwise would go to the states. More on lawyers later.
5. Youth Smoking
If youth smoking falls by less than 35% over the next 10 years, an additional tax
of 8 cents per pack will be added to the price. However, if companies can show
that they took appropriate measures to attempt to reduce such smoking, then the
tax is reduced by 75 percent. If youth smoking is reduced by 35-60 percent the
tax is reduced linearly.
Given the estimate that youth smoking has an elasticity of demand of perhaps -1,
the 40 percent increase in initial prices combined with the secular fall in cigarette
demand should make the youth smoking goal attainable. In any event,
depending on how the requirements for receiving the tax reduction are enforced,
the tax might be very small anyway.
A better approach might be to raise the age for smoking from 18 to 21, perhaps
over a five year period. This would eliminate legal smoking by all high school
students, and make it much less likely that the typical 15-17 year old would
have close friends with easy, regular access to cigarettes. Presumably there is
some data on this.
Using some of the money collected to pay a workmen's compensation program
type program of disability payments to smokers who became disabled before
normal retirement age might be a way to improve the incidence of the program.
It would also be a good way of discriminating between young and old smokers,
so that the young would face high prices while the old would suffer less from the
incidence.
6. What makes the program a tax?
*Payments are (essentially) a fixed amount times number of packs sold.
"New entrants to the business, who are not liable for any past damages, would
still be required to pay the same amount per pack
7. Lawyers' Fees
The lawyers have managed to keep their fees out of the agreement. I think that it
is essential that those fees be resolved as part of the agreement, and that they be
related to the upfront payments rather than to the tax payments.
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There are two kinds of lawyers involved. The class action lawyers will be paid
based on the determinations of an arbitrator. The Wall St. Journal estimates that
these lawyers may get $1 billion. It is junclear that their clients will get anything,
unless they subsequently file individual suits. The lawyers representing the
states have varying agreements. Some have said that they will use the arbitrator.
The Wall St. Journal estimated that these lawyers may try to get as much as 3% of
the gross value of the next 25 years' tax revenues, or $11 billion. Some of these
lawyers have contingency fee arrangements that give them 25% of what the state
collects.
It seems to me to be a very bad idea to let the lawyers get a percentage of the
money that is raised by their facilitating a tax increase. States should be able to
raise their cigarette taxes without having to turn over a portion of the revenue to
their cigarette tort lawyers. Besides, we have had several tort suits where the
customers have only been compensated with coupons
in this case many of the
"beneficiaries" are being compensated with negative coupons!!!
My recommendation is that the agreement follow these terms: Overall legal fees
should be capped at some percentage of the amounts paid up front, ideally with
a maximum of, say $2 billion. An arbitrator can examine all claims, and if the
claims approved are in excess of $2 billion then claims of under $1 million can be
given first priority, claims between $1-5 million next priority, etc. If the lawyers
are paid in this way then we can rest assured that any final settlement will
involve an adequate up-front payment by the companies.
8. Summary of Potential Improvements to the Tobacco Deal
(i) Raise the smoking age to 21 over 5 years. This and the price increase should
do more than telling kids not to smoke and strangling Joe Camel. 16 and 17
year olds will know less people who can buy legally, and no one in high
school would be able to buy cigarettes legally.
(ii) CAFÉ-style caps on the average level of tar and nicotine in a company's
cigarettes. (Current deal limits tar and nicotine to 12 mgs/cigarette but says
nothing about averages.)
(jii) Incentivize the companies to fight tort lawsuits by individuals. As the
proposal stands, the marginal cost oflany tort settlements is borne by the
government and health agencies who will not want to be put in the position of
fighting these plaintiffs.
(iv) To improve incidence, have most of the tort money put into a"no fault" type
workmen's compensation fund that would pay medical bills and lost wages for
smokers with lung cancer and emphysima. Could also be applied to smokers
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P.7
who have died or become disabled in recent years. This enables the price of
cigarettes to rise, cutting youth smoking, while reducing the regressiveness of
the plan. It also helps with the incentive problem cited in (iii).
(v) Put a cap on legal fees in return for a larger lump sum payment. If legal fees
are capped at 20% of the lump sum then the companies should be willing to
pay a larger lump sum, assuming that the legal fees are not to come out of the
tax revenues. Such a cap could help states negotiate claims with their
lawyers, some of whom will undoubtedly try to claim contingency fees based
on the amount of tax revenue raised rather than the amount of damages paid.
With the legal fees made a percentage of the lump sum, we can be sure that
the attorneys will negotiate a lump sum that is an appropriate punishment
for the companies. Lawyer claims can be submitted to an arbitrator, but if the
total of all claims approved exceeds 20% of the lump sum, then rationing can
be used in a manner similar to that proposed for tort claimants if total
approved payments exceed the cap.
(vi) Instead of raising taxes, institute a licensing system which sells the
companies a fixed (and declining) quantity of cigarette stamps. By using
quantity rather than price, and auctioning off the licenses, we will substantially
reduce the incentive for the industry to recruit new customers. With a tax, once
this bill is passed, the companies have a reduced incentive to go after underage
smokers but every incentive to recruit new smokers age 18 or over. With licenses
similar to the pollution licenses used in the Clean Air Act, we will get gradual,
progressive, predictable reductions in smoking. Because there is a small number
of companies in the industry it is likely that the auctions will not be fully
competitive. To protect against collusion leading to excess profits, floor prices
can be set on the licenses that gradually rise to 62 cents per pack.
tobacco
economy
Memorandum
July 3, 1997
From:
Chad Stone, CEA
Jon Gruber, Treasury
To:
Elizabeth Drye, DPC
Subject:
Progress Report on Economics Task Force, Domestic Issues
Attached are several undigested pieces of material that are part of what will feed into a draft
report we hope to complete next week:
1.
An outline/progress report of the tasks being undertaken
2.
Preliminary fact sheets on the domestic industry (foreign stuff to come)
3.
Preliminary set of working assumptions feeding into the analysi
4.
Preliminary bibliography of key economic articles, etc. for estimating elasticities and
other effects.
5.
Memorandum from DOJ antitrust division assessing the settlement
6.
Memorandum from USDA on effects on tobacco farmers.
7.
Preliminary Treasury assessment of "lookback"
All of these are preliminary and many are undigested and not integrated into the analysis.
Outline/Progress Report - Industry and Financial Issues
The domestic industry task force is gathering information to describe the likely impact of the
settlement on the domestic tobacco industry. How will economic and financial incentives be
changed by the settlement and how will the evolution of the industry and other affected sectors
be different from what would have happened in the absence of a settlement? The policy
framework informing this assessment of the facts assumes the objective of the settlement is to
reduce smoking by raising the price of cigarettes and other tobacco products, with special
attention paid to reducing youth smoking. An additional objective is to prevent the tobacco
industry from profiting unduly from the settlement in order that the "profits" from raising
cigarette prices can be diverted to specificed public health and other purposes.
Outline of tasks:
A) Fact Sheet on industry structure and performance
Domestic
International
B) Effect of settlement on prices
Can view this as an excise tax
How are excise taxes passed through to prices in the tobacco industry?
C) Effect of settlement on smoking
Incorporate effect on prices and advertising restrictions
-- effect overall, and by age group
-- cohort projections
D) Impact on the industry
Effects on prices and labor demand
Two methods
-- primary analysis (back of the envelope calculations), based on FDA research
-- summary of market analysis, including stock price response
Overall, and company-by-company
E) Spillover Effects
Rough magnitudes of effects on other sectors, from FDA research
USDA is computing specific effects on farmers
F) Health Effects
FDA and CDC are computing mortality by group and cohort
G) Government revenue effects
Treasury's Tax Policy group is computing revenue effects of settlement
-- how much is collected through this implicit excise tax
-- corporate tax receipt effects, accounting for deductibility
-- excise tax spillovers
Estimate incidence of this implicit excise tax increase
Compare properties to traditional excise tax change
H) Government spending effects
Treasury's Economic Policy group is computing effects on
-- Social Security/SSI/DI
-- Medicare
-- Medicaid
Effects on PBGC through bankruptcies of smaller tobacco firms - DoL
Effects on other government spending - OMB
I) Incentive Effects
Industry
-- product substitution
-- youth smoking incentives through lookback provisions
- is the penalty set at an appropriate level?
Consumers
-- product substitution
Government/Legal system
-- legal incentives through structure of punitive damage pools
-- distribution of initial $10 billion across parties
DRAFT,
July 3, 1997
FACT SHEET
ON THE U.S. TOBACCO INDUSTRY
Production
The United States was the world's second largest tobacco producer in
1994, accounting for about 9 percent of the estimated 6.44 million metric tons
that were produced worldwide.
Top 10 Leaf Tobacco Producers
Metric Tons
1.
China
2,559,700
2.
United States
575,389
3.
India
524,500
4.
Brazil
398,000
5.
Turkey
219,983
6.
Zimbabwe
209,042
7.
Indonesia
171,400
8.
Greece
131,875
9.
Malawi
130,686
10.
Italy
130,400
The U.S. tobacco crop in 1995 was worth almost $2.3 billion, making it the
seventh largest cash crop for the nation and representing approximately
2.7 percent of the total for all cash crops and farm commodities.
The manufacture of tobacco products accounted for $16.6 billion or
0.2 percent of gross domestic product in 1994, down from 0.6 percent in the
early 1960's.
U.S. factories produced 760 billion cigarettes in 1995, of which 234 billion
(nearly one-third) were shipped abroad for foreign consumption.
The manufacture of tobacco products accounts for 1.2 percent of U.S.
industrial output.
Production slid from early 1991 through most of 1993 [will find out what
was going on], but by mid-1994 returned to levels that prevailed in the late
1980's. (See chart on the next page.)
2
TOBACCO PRODUCTION
Relative to All Manufacturing
Index Jan. 1987 = 100
140
Recession
130
Manufacturing
120
110
Tobacco
100
90
80
70
87
88
89
90
91
92
93
94
95
96
97
Consumption
Per-capita cigarette consumption has been on a long-term decline in the
United States from a record high of 4,345 in 1963 (based on the population 18
years and over) to 2,515 in 1995 -- a drop of 42 percent. [Will try to get time
series. Chart might be interesting.]
--
About 25 percent of all adults currently smoke.
--
Shares are generally even higher for older adolescents: 30.4 percent
of 10th graders, 34.0 percent of 12th graders report that they have smoked
in the past 30 days, according to the Michigan survey. Smoking is much
more highly concentrated among white than black teens (38.1 vs. 14.2
percent for 12th graders).
Consumers spent $47.2 billion on tobacco products in 1995, or 1.0 percent of
all consumer expenditures.
93 percent of the money was spent on cigarettes. U.S. consumption was
divided as follows:
--
487 billion cigarettes
--
2.5 billion cigars and cigarillos
--
14.2 million pounds of pipe and roll-your-own tobacco
--
63.3 million pounds of chewing tobacco
--
60 million pounds of snuff
3
The 1995 consumer expenditure survey shows that the average household
spent $269 that year on tobacco products and smoking supplies, with
households in the lowest income quintiles spending more of their budget
on tobacco.
Tobacco Expenditures by Income Quintile in 1995
Lowest 20%
Second 20%
Third 20%
Fourth 20%
Highest 20%
Tobacco
$204
$242
$327
$307
$278
Share of total
1.4%
1.1%
1.1%
0.8%
0.4%
expenditures
Employment and Wages
Tobacco manufacturing's contribution to payroll employment is minuscule.
In 1996, 41,000 workers were employed in the tobacco manufacturing industry
(which includes processing of tobacco, as well as production of cigarettes,
cigars, etc.), or only 0.03 percent of the 119.5 million workers on nonfarm
payrolls. More than 100,000 workers (0.23 percent of nonfarm employment) had
been employed in the industry in the early 1950's.
--
[Employment in major states to be added]
Production workers in the tobacco industry earned $19.44 an hour last year,
52 percent more than the average worker in manufacturing. Tobacco industry
wages have climbed steadily from less than 75 percent of the average factory
wage in the early 1950's. Few other industries can boast comparable wages
(coal mining, steel, petroleum and coal product manufacturing also have
earnings that top $19 an hour).
Average Hourly Earnings in 1996
Private nonfarm
$11.81
Manufacturing
12.77
Tobacco
19.44
Of course, agricultural jobs are also provided in the cultivation of tobacco,
which tends to be exceptionally labor-intensive, requiring 250 work hours per
acre harvested compared to 3 hours for wheat. In 1995, 124,270 farms raised
tobacco, harvesting 674,300 acres. A rough estimate would suggest that some
80,000 full-time equivalent jobs might be tied to raising tobacco.
4
Prices
Tobacco products have a weight of only 1.6 percent in the CPI. Thus, it
would take a change of 6.25 percent in tobacco prices to move the CPI by
0.1 percent.
Over the past decade, tobacco prices have risen at a 6.3 percent annual
rate, compared to 3.7 percent for "core" consumer prices (excluding food
and energy). Faster growth was mainly the result of a sharp uptrend prior to
1993. (See chart below.)
In 1993, there was a steep downward adjustment in prices [am
getting clarification on the reason], after which tobacco prices grew at
about the same pace as the core.
This year, tobacco prices have sped up again, increasing at nearly an
8 percent annual rate through May.
CONSUMER TOBACCO PRICES
Relative to the "Core" CPI
Index 1982-84 = 100
280
Percent Change, Annual Rate
Tobacco
Core
CPI
Dec.86-Apr.93
10.2
4.4
240
Tobacco
Apr.93-Nov.93
-15.8
2.8
Nov.93-Dec.96
3.0
2.8
Dec.96-May 97
7.9
2.6
200
"Core" CPI
160
120
80
87
88
89
90
91
92
93
94
95
96
97
Industry Composition
The market is dominated by Philip Morris, which accounts for half of cigarette
sales in the United States. (See table on the next page [need to find out from
Jeremy Bulow just what these sales numbers represent].)
5
The Cigarette Market in 1996
Sales
Market
(Mil.$[?])
Share (%)
Philip Morris
230.8
47.8
RJR Nabisco
119.1
24.6
BAT
83.9
17.3
Lorillard
40.4
8.4
Liggitt
9.0
1.9
TOTAL
483.2
100.0
Advertising Expenditures
Magazine advertising for tobacco and related smoking materials accounted for
$285 million, or 3.4 percent, of the $8.5 billion spent by all industries in 1994.
Prepared by
Treas./Econ.Policy/K.Hendershof
Tobacco Settlement Parameters and Assumptions
Draft -- July 3, 1997
Parameters and Assumptions for Tobacco Settlement Calculations
Per Pack Cost of Cigarettes
Retail Price
1.85
Federal Tax
0.24
Average State Tax
0.32 (0.025 to 0.815)
Distributors
0.44
Wholesale
0.83
Marketing
0.23
Legal
0.025
Other
0.25
Profits
0.33
Cigarettes per pack: 20
Total packs of cigarettes sold in 1996 (U.S.): 24.4 billion
(Not surprisingly, multiplying the number of smokers by the average packs smoked give a lower
total of 18.8 million. This is probably due to under reporting and perhaps a few "nonsmokers"
who bought a few packs.)
Total large cigars and cigarillos sold in 1996 (U.S.): 2.5 billion
(This is the total, I don't know how many per pack.)
Total pounds of pipe and roll-your-own tobacco sold in 1996 (U.S.): 14.2 million
Total Number of Adult Smokers: about 50.5 million
(based on 1987, 1991 rates)
Total Number of Underage Smokers: about 3.1 million (1994 Surgeon General's Report)
New Underage Smokers: about 1 million per year (FDA Analysis)
If about 25% of 17 year-olds smoke, about 925,000 smokers turn 18 every year. If the FDA's 1
million number is correct, these smokers who become adults are being more than replenished by
new young smokers.
Average number of Packs Smoked (Adults): about 1 pack per day (18.2 cigarettes)
Distribution of packs smoked: 36.6% <15, 41.9% 15-24, and 21.5% 25+
Average Number of Packs Smoked (Underage): about ½ pack per day (For 1991, "teenage"
cigarette consumption is estimated at about 516 million packs. Assuming that there are about 3.1
Tobacco Settlement Parameters and Assumptions
Draft -- July 3, 1997
million teenage smokers -- these are from different studies SO they may not really be comparable
-- that translates to about ½ pack per day per smoker.)
Kids per Age Cohort: About 3.8 million
Youth Smoking Rates ("Daily" is used for the Lookback provisions)
Age
30-day
Daily
½ pack+/day
# of Daily
8th graders
21.0
10.4
4.3
395. thousand
10th graders
30.4
18.3
9.4
695 thousand
12th graders
34.0
22.3
13.0
847 thousand
Adult Smoking Rates
Current
Former
Never
Adults 18+
25.7
24.1
50.2
18-24
22.9
7.7
69.3
25-44
30.4
19.4
50.2
45-64
26.9
32.9
40.2
65+
13.3
36.4
50.3
(Adult population is about 190 million.)
Adult "Quit" Rates
(percent of eversmokers who are former smokers)
Adults 18+
48.5
18-24
25.2
25-44
38.9
45-64
55.1
65+
73.3
Spending on Tobacco by Income Level (CBO 1990)
1990 Adj.
Average
% of After-Tax
% of
Quintile
Post-Tax Income
Expenditure
Income
Expenditure
1st
8,228
327
4.0
1.6
2nd
18,101
380
2.1
1.5
3rd
27,314
426
1.6
1.4
4th
37,581
427
1.1
1.1
5th
77,622
383
0.5
0.7
Demand Elasticities: A consensus estimate for overall demand elasticity is -0.4. The following
table from the Surgeon General's report gives elasticities by age (and is consistent with the
literature):
Age Group
Total
Participation
Quantity per Smoker
12-17
-1.40
-1.20
-0.25
20-25
-0.89
-0.74
-0.20
26-35
-0.47
-0.44
-0.04
36-74
-0.45
-0.15
-0.15
All Adults (20-74)
-0.42
-0.26
-0.10
All Ages (12-74)
-0.47
-0.31
-0.11
Industrial Organization and prices: For now we are assuming a 1 to 1 pass through of any
"tax" to prices, but a number of people are looking into the validity of this assumption. More to
come soon.
TOBACCO BIBLIOGRAPHY
Title
Author
Year
Advertising
Advertising Bans and Product Demand: How Does
Marketing Affect Demand for a Differentiated
1 Product?
McGuinness, Tony et
1995 International Review of Applied Economics
The State Antismoking Campaign and the Industry
Response: The Effects of Advertising on Cigarette
2 Consumption in California
Hu, Teh-Wei et al.
May-95 American Economic Review
Cigarette Warnings: The Perils of the Cipollone
3 Decision
Viscusi, W. Kip et al.
1993 Supreme Court Economic Review
4 Consumers' Surplus and the Demand for Cigarettes
Reekie, W. Duncan et May-June Managerial and Decision Economics
5 Competition and the Cigarette TV Advertising Ban
Eckard, E. Woodrow,
Jan-91 Economic Inquiry
The Demand for Cigarettes: Advertising, the Health
6 Scare, and the Cigarette Advertising Ban
Hamilton, James L.
Nov-72 Review of Economics and Statistics
7 Information, Educating, and Marketing in Health Care Hu, Teh-Wei et al.
May-95 American Economic Review
Finessing the Political System: The Cigarette
8 Advertising Ban
Mitchell, Mark L. et al. ?
?
9 Marketing and Advertising Regulation
Murphy, Patrick E. et
May-92 Federal Trade Commission
Elasticities (Demand)
Price, Tobacco Control Policies and Smoking Among
10 Young Adults
Chaloupka, Frank J. e
Feb-95 NBER Working Paper
Cigarette Taxes and Smoking Restrictions: Impacts
11 and Policy Implications
Brown, A. Blake et al.
Nov-95 American Journal of Agricultural Economic
A Working Model for Predicting the Consumption and
Revenue Impacts of Large Increases in the US
12 Federal Cigarette Excise Tax
Harris, Jeffrey E. et al
Jul-94 NBER Working Paper
13 Cigarette Taxation and Demand: An Empirical Model
Sung, Hai-Yen et al.
Jul-94 Contemporary Economic Policy
The effects of excise taxes and regulations on
14 cigarette smoking
Wasserman et al.
1991 Journal of Health Economics
15 The demand for cigarettes
Grossman, Michael
1991 Journal of Health Economics
TOBACCO BIBLIOGRAPHY
16 Rational Addictive Behavior and Cigarette Smoking
Chaloupka, Frank
1991 Journal of Political Economy
Age Variation in Risk Perception and Smoking
17 Decisions
Viscusi, W. Kip
Nov-91 The Review of Economics and Statistics
Promoting Smokers' Welfare with Responsible
18 Taxation
Viscusi, W. Kip
?
National Tax Journal
19 Death and Tobacco Taxes
Moore, Michael J.
Jun-95 NBER Working Paper
Cigarette Taxation and the Social Consequences of
20 Smoking
Viscusi, W. Kip
1994 NBER Conference
Federal Taxation of Tobacco, Alcoholic Beverages,
21 and Motor Fuels
The Congress of the
Aug-90 Congress of the United States
22 Cigarette Taxes and Teenage Smoking
Grossman, Michael et
Jun-97 Public Health Reports
Taxation, regulation, and addiction: a demand for
23 cigarettes based on time-series evidence
Keeler, T.E. et al.
1993 Journal of Health Economics
The Impact of Cigarette Excise Taxes on Smoking
24 Among Children and Adults
Manley, Marc et al.
Aug-93 Cancer Control Science Program
The Potential for Using Excise Taxes to Reduce
25 Smoking
Lewitt, Eugene M. et
Feb-82 Journal of Health Economics
The Effects of Government Regulation on Teenage
26 Smoking
Lewit, Eugene M. et a
Dec-81 Journal of Law and Economics
IO (Supply)
Do Cigarette Producers Price-Discriminate by State?
An Empirical Analysis of Local Cigarette Pricing and
27 Taxation
Keeler, Theodore E. e
Aug-96 Journal of Health Economics
28 Pricing Practices for Tobacco Products
Howell, Craig et al.
Dec-94 Monthly Labor Review
Trade and Efficiency Effects of Domestic Content
Protection: The Australian Tobacco and Cigarette
29 Industries
Beghin, John C. et al
Nov-93 Review of Economics and Statistics
30 A Note on the Effects of Cost Changes on Prices
Bulow, Jeremy I. et al
Feb-83 Journal of Political Economy
Nonparametric Tests of Market Structure: An
31 Application to the Cigarette Industry
Ashenfelter, Orley et
Jun-87 Joural of Industrial Economics
Cigarette Taxes to Fund Health Care Reform: An
32 Economic Analysis
Gravelle, Jane G. et a
Mar-94 CRS Report for Congress
Price, Tobacco Control Policies, and Smoking
33 Among Young Adults
Chaloupka, Frank J. e
Mar-95 NBER Working Paper
TOBACCO BIBLIOGRAPHY
Federal Taxation of Tobacco, Alcoholic Beverages,
34 and Motor Fuels
The Congress of the
Aug-90 Congress of the United States
FROM
(WED) 7. 2'97 19:21/ST. 19:20/NO. 4260608569 F 1
U.S. Department of Justice
EVENTS THE
Antitrust Division
Economic Analysis Group
Economic Litigation Section
FAX: (202) 307-3372
Phone# 395-5086 Date: 7/2
TO: Chad Stone Fax# 395-6809
Atlanta F.O., (410) 331-7110
FOIA, 616-4529
I
Chicago F.O., (312) 353-1046
Foreign Commerce, 514-4508
Cleveland F.O., (216) 522-7214
ISSG, 633-2528
-
Dallas F.O., (214) 880-9423
Legal Policy, 514-9082
New York F.O., (212) 264-7453
LT. I, 514-6525
I
Philadelphia F.O., (215) 597-8838
LT. II, 307-6283
-
San Francisco F.O., (415) 436-6683
Merger Task, 307-5802
I
AAG, 3109 Main, 616-2645
Operations, 514-1629
Appellate, 514-0536
11
Personnel, 514-0580
ATR Library, 514-9099
PIP, 514-1517
-
CTF, 307-9952
Pre-Merger, 514-2363
-
C&F, 616-8544
Support Services, 514-2200
-
DAAG; 3113 Main, 514-0306
TEA, 307-2784
-
Fiscal, 514-6738
Telecommunications Task, 514-6381
I
FROM: Ken Heyer, Antitiust Division
Comments: Here's the Memo Doug melamed had Promised
Total Pages Transmitted: 12 (Including Transmittal Sheet)
1,
If you do not receive all pages, please call (202) 307-6665.
11
FROM
(WED) 7. 2'97 19:21/ST. 19:20/NO. 4260608569 P 2
I. The settlement has 5 major goals:
(A) Prevent youth smoking;
-highest priority because most smokers start before
they are legal age
(B) Get current smokers to quit or reduce smoking;
(C) Make tobacco less hazardous for those that continue to
smoke;
(D) Avoid protracted litigation;
-it is expensive for all parties
(E) Reduce involuntary exposure to smoking.
II. This memorandum focusses primarily on the key portions of
the proposed Act that are designed to implement the first three
goals.
III. A general observation about the settlement:
A slight familiarity with the details of the settlement
would lead one to believe that the cigarette companies will
be paying large sums of money out of their own pockets. In
reality a large portion of the settlement will be borne by
consumers. To the extent that one believes that the purpose
of the settlement should be to punish the cigarette
manufacturers, one would be disappointed to learn that
consumers will be paying a large amount of the settlement.
However, to the extent that one believes the most important
objective of the settlement should be to reduce youth
smoking, then having consumers pay for settlement, through
higher prices, is preferable to having the money come from
the tobacco companies.
IV. In this section we describe the two major economic proposals
of the settlement.
(A) The Base Annual Payments
-there are annual payments specified for a period of 25
years
-there is an inflation factor applied to the payments
-when - tobacco sales increase, the payment increases
proportionately. When tobacco sales decrease, the
payment declines if adult tobacco sales have declined
relative to the base year. Under these circumstances,
the payment declines proportionately to adult sales.
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(WED) 7. 2'97 19:21/ST. 19:20/NO. 4260608569 F 3
-if there is a reduction in the base payment, if
industry profits increase above the industry's base
year net operating profits, then the annual payment
reduction will be reduced by 25%.
(B) The Surcharge
-is a penalty if the industry fails to meet certain
targets for reducing youth smoking.
-the surcharge is $80 million per percentage point the
industry fails to meet the target. There is a
$2 Billion cap per year for the industry.
-the $80 million may be reduced by up to 75% (the
abatement) if firms meet youth marketing and other
restrictions
-the $80 million number will be adjusted
proportionately for percentage increases or decreases
compared to base year profit.
-Each tobacco firm pays its portion of the surcharge on
the basis of its market share.
V.
Problems with the Actual Settlement Terms
(A) Here's how the base payment scheme would actually work:
(1) If total volume of smoking increases, the
settlement increases proportionately. In other words,
for increases in total volume the payment scheme is
equivalent to an excise tax per pack. 1 [While not
strictly an excise tax (in the sense that a per pack
tax is not tacked on at the sales register), tobacco
companies will recognize that their total payment, when
they come due, will be dependent on how many packs are
sold. Thus, the economic effect is as if they were
faced with an excise tax].
(2) If youth smoking declines and adult volume is
¹Here's an example: Suppose that total base volume is 200,
100 each for adult and youth, and the base payment is $10. This
can be thought of as a 5% excise tax. If total volume increases
25% to 250, the payment increases 25%, since the formula is
(total volume/total base volume) X $10 = (250/200) X $10 =
$12.50
Therefore, for increases in volume, the payment is a stable tax
per pack.
2
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(WED) 7. 2'97 19:22/ST. 19:20/NO. 4260608569 F 4
unchanged, the "excise tax" per pack increases. 2
(3) If adult smoking declines and youth smoking is
unchanged, the "excise tax" per pack decreases.
(4) If youth and adult smoking decline proportionately,
the "excise tax" per pack is unchanged.
²Here's an example that illustrates this point. Suppose
that adult volume and youth volume are initially 100 each and
that the base payment is $10. Suppose that youth smoking
declines to 70 while adult smoking stays at 100. Using the
formula for the payment in case of a decline in total volume
(actual adult volume/actual adult base volume) X $10 =
(100/100) X $10 = $10
However, since the payment is made over a smaller total volume,
170, the excise tax rate is
$10/170 = 5.9%.
That is, the excise tax increases.
¹Here's an example that illustrates this point. Suppose as
before adult and youth volume are 100 each and the payment is
$10. Now suppose that youth smoking is unchanged, but that adult
smoking declines to 70. Using the formula for the new payment,
we have
(70/100) X $10 = $7
volume To convert to an excise tax rate we divide the payment by total
$7/170 = 4.1%
Thus, when adult smoking declines and youth smoking is unchanged,
the excise tax declines.
"Suppose the base numbers are as before. Now, suppose both
adult and youth volume decline to 70. Using the formula for the
new payment, we have
(70/100) X $10 = $7
volume To convert to an excise tax, we divide the payment by total
3
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(WED) 7. 2'97 19:22/ST. 19:20/NO. 4260608569 P 5
(B) Comments on the base payment scheme:
(1) Why the asymmetry of (2) and (3) above? It's not
clear from the language of the Settlement itself,
however, as noted below, this could easily be rectified
by having the actual payment be made equal to the base
payment times actual volume over base volume.
(2) To the extent that Act is trying to reduce smoking,
the fact that the base payment scheme operates as an
excise tax rather than a lump sum payment is good.
Excise taxes are a proven method of reducing smoking,
especially for young smokers. Although true lump sum
taxes penalize the tobacco companies, they do nothing
to reduce smoking.
(3) Although the base payment scheme is basically an
excise tax, which is good, there is an open question as
to what is the correct level of the excise tax. While
excise taxes can be an efficient method of forcing
individuals to internalize any negative externalities
produced by their behavior, a cursory view of the
empirical literature on the subject is mixed on whether
current cigarette prices (which already include
substantial excise taxes) are high enough fully to
internalize externalities from smoking.
(4) Higher taxes to reduce consumption, even if not
justifiable on standard "externality" grounds, could
perhaps be justified on grounds of paternalism towards
addicted adults.
(C) Here's how the surcharge will actually work:
From the tobacco companies' perspective, the surcharge
over and above "Base payments" due is essentially a tax
per youth smoker. This is because every youth that
keeps smoking costs the industry. How much? Assume
there are 18 million people from ages 13 to 17 (the age
groups in Apendix V, section A), of which 14.5% smoke
on a daily basis [a rough, though not completely
accurate, estimate taken from "Monitoring the
Future"] - -that's 2,520,000 tcenage smokers. 1% of this
number is 25,200. The tobacco companies pay 80 million
for every 25,200 teenagers that do not quit - that's
$7/140 = 5%
The excise tax rate is unchanged.
4
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(WED) 7. 2'97 19:22/ST. 19:20/NO. 4260608569 P 6
$3,175 per youth smoker.
From the smoker's perspective the surcharge will work
as an excise tax. Suppose that the industry has to pay
the maximum tax: $2 Billion. Sales of cigarettes
approximate 25 Billion. That's 8 cents per pack.
However, the tax per youth smoker and the excise tax
due to youth smoking are likely to be appreciably
smaller:
First, it is plausible that the cigarette companies
will work hard to do whatever it takes to meet the "no
marketing to youth" and other restrictions in order to
qualify for the 75% abatement from the maximum $2
billion in surcharges. If this happens, then the tax
per youth smoker drops to $794, and the excise tax due
to the surcharge drops to 2 cents a pack. Second, if
profits in the cigarette industry fall, then the
abatement falls proportionately. Experience shows that
if companies are regulated on the basis of their
profits in a particular line of business, they will
find ways of lowering profits, such as taking profits
in other lines of business and incurring higher costs.
Suppose that due to the new incentives, industry
profits drop by ½. Then the per youth smoker drops to
$397 and the excise tax drops to 1 cent a pack.
We do not wish to suggest that these numbers above are
highly accurate estimates. However, the above rough
estimates do suggest that the youth surcharge may not
have much economic punch, with the exception of
incentivizing the tobacco companies to comply with the
minimum specified restrictions on youth marketing, etc.
that would enable them to qualify for the abatement.
(D) Problems with the Surcharge
(1) The Free Rider Problem with respect to the penalty
-Recall that each firm pays for its share of the
surcharge according to its market share. This
allocation lead to a free rider problem because a
firm that recruits an underage smoker gets the
full benefit of that smoker patronage, but the
surcharge is split among its competitors based on
their total market share, so a firm still has an
incentive to attract underage smokers.
-This may be a situation where antitrust immunity
could enable the industry to overcome the free
rider problem, however there are more direct ways
5
FROM
(WED) 7. 2'97 19:22/ST. 19:20/NO. 4260608569 P 7
of dealing with this particular problem. In
particular, basing each firm's surcharge on the
change in its sales of cigarettes to youth
(2) Problems with using profits
-As mentioned above, there is a strong reason to
suspect that if the industry payment is tied to
profits, that the tobacco, companies will have an
incentive to allocate profits to other non-tobacco
lines of business and deviate from cost
minimization by converting profits to higher
salaries and waste.
-The free rider problem may also be relevant here,
since the Act uses industry average profit
(3) Problem with using the abatement
-rewards meeting minimum standards rather than
results (but note that there is no free rider
issue here, since the abatement process looks at
individual firm effort)
-could be counterproductive, if all it does is
encourage youth smoking by increasing the
"forbidden fruit" aspect of smoking (almost
certainly there must be public health studies that
look at cross-state and cross-national variations
of the effects of implementing laws making
cigarettes more difficult for teenagers to buy and
banning certain types of advertising. (Note: To
the extent that cigarette advertising and
marketing are simply a fight among firms for one
another's existing customers, requirements to
reduce these activities (and thereby qualify for
the abatement) are profit-enhancing for tobacco
companies, especially those that have relatively
ineffective campaigns. In effect, banning certain
of these activities may enhance industry
profitability without much affecting total demand
for their products.)
VI. Other Potential Problems with the Settlement
A. Disincentives for Desirable Innovations
--Mandatory cross-licensing could lessen the incentives of
participating companies' to innovate reduced risk tobacco
products.
One goal of the proposed legislation is to foster
production of reduced risk tobacco products. The proposed
legislation contains several elements designed to prompt such
6
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(WED) 7. 2'97 19:23/ST. 19:20/NO. 4260608569 P 8
innovation by the participating companies. We strongly
suspect, however, that at least some of these claimed
incentives to innovate may end up having precisely the
opposite result. In particular,
Title I (E) (4) provides that:
The manufacturers will be required to notify FDA of any
technology that they develop or acquire and that reduces the risk
from tobacco products and, for a commercially reasonable fee, to
cross license all such technology, but only to those companies
also covered by the same obligations.
Title T (E) (4), Proposal at 14. Requiring cross-licensing of
this technology may reduce research and development
competition among tobacco companies because a firm with
leading technology would not be able to benefit from its
innovations to the exclusion of other firms with less valuable
innovations. A rough, but useful, analogy might be to
proposing a repeal of the patent laws (or property rights
generally) and requiring mandatory licensing by firms or
individuals that develop valuable innovations. The primary
economic rationale for patent protection is, however, that
rights to one's innovation provide the prospect of economic
reward to the innovator, without which investment and
innovation are far less likely to occur in the first place.
If the participating tobacco companies are, in fact, the most
likely source for new reduced risk technology, this
cross-licensing mandate would seem to lessen the likelihood
that the companies will allocate the research and development
funds necessary to develop these reduced risk tobacco
products, and therefore that they will not be developed at
all. It therefore seems likely that incentives to innovate
reduced risk tobacco technology would be increased--and the
public heath better served--if this provision were deleted
from the proposed legislation.
B. Unclear Scope of Antitrust Exemption
Beyond the proposal to, in effect, raise cigarette prices
through imposition of what would essentially be an additional
"excise tax," the agreement goes further by proposing an
exemption to the antitrust laws. The proposed antitrust
exemption broadly states:
In order to achieve the goals of this agreement and the Act
relating to tobacco use by children and adolescents, the tobacco
product manufacturers may, notwithstanding the provisions of the
Sherman Act, the Clayton Act, or any other federal or state
antitrust law, act unilaterally, or may jointly confer,
coordinate or act in concert, for this limited purpose.
7
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(WED) 7. 2'97 19:23/ST. 19:20/NO. 4260608569 F 9
Appendix IV (C) (2), Proposal at 50.
The agreement goes on to provide that the Department must
approve any such "process or plan" that is to be exempt from
the antitrust laws:
Manufacturers must obtain prior approval from the Department of
Justice of any plan or process for taking action pursuant to this
section; however, no approval shall be required for specific
actions taken in accordance with an approved plan.
Appendix IV (C) (2), Proposal at 50. This draft provision
provides no procedural guidance to the Department or to the
participating companies regarding such approvals. The draft
provision sets no standard for granting such approvals; it
does not set a time limit for Departmental approval; and it
does not provide for any remedy if companies act before the
Department approves proposed activity. Most fundamentally,
this proposal raises policy questions regarding the extent to
whether tobacco companies ought to be permitted to act in
concert to raise prices. If (as seems likely) the monopoly
price for cigarettes is above the price that would be produced
by the annual payments-generated "excise tax, antitrust
immunity would lead to a) higher prices (largely, one would
expect, to already addicted (i.e., inelastic) smokers), b)
reduced cigarette consumption (the precise reduction would
depend on the demand elasticity for cigarettes in the relevant
range), and c) higher profits to the cigarette companies.
One could make an economic case for raising prices and cutting
cigarette consumption by the amounts implied by this proposal
if there is good reason to believe that, at pre-collusion
prices, cigarette smoking produces a combination of a) strong
negative externalities (an issue on which, as noted below, the
evidence seems to be mixed), and/or b) still too much smoking
by youths who are probably too immature to make intelligent
decisions about whether or not to smoke, c) paternalistic
motives towards those who are already hooked⁵. Otherwise, the
usual deadweight loss arguments for antitrust scrutiny of
collusive behavior would seem to apply. If one were to
expressly authorize monopoly pricing, there is an additional
issue of who gets to keep the monopoly profits. The large
⁵It is worth noting an obvious tension between, on the one
hand, seeking to help addicted smokers by getting them to cut
back on cigarettes while at the same time charging them more
money in the process. Insofar as a smoker quits, you may have
done him a favor. Insofar as a smoker remains hooked, he is now
not only suffering from cigarettes, he is poorer as well.
8
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(WED) 7. 2'97 19:24/ST. 19:20/NO. 4260603569 P 10
transfer of consumer surplus to tobacco companies could, if
society wishes, be taxed away in some lump-sum fashion. One
possibility might be to estimate in advance the profitability
to the tobacco companies of colluding under the provisions of
this settlement and impose a lump-sum tax of that size up
front. Alternatively, one might adjust the terms of the
settlement SO as to raise the "excise tax" closer to that
which would generate closer to monopoly pricing in the
industry. This way more (though not necessarily all) of the
monopoly rents would be handed back to the government.
VII. What might an "Ideal" settlement look like?
The answer depends on just what goals we are trying to
achieve. The following identifies some of the goals implicit
(or explicit) in the settlement, and describes very briefly
proposed ways of achieving them most efficiently.
Goal (A) : Reduce smoking generally
(1) insofar as smokers do not consider the costs of
secondhand smoke and the higher expected health care costs
they impose on society (assuming those costs exceed the
pension benefits they lose due to their early deaths), they
tend to smoke too much (i.e., the full cost of smoking
includes those costs that smokers don't pay for, inosfar as
their smoking decisions do not take them fully into account,
they smoke too much)
(2) solved by excise tax = costs they impose on
society (with such a tax, a decision to smoke based only on
the price of cigarettes and factors internal to the smoker
would reflect the full costs of smoking)
(3) recent externality estimates range from 19 cents
a pack to $4.80 a pack (a range that's too broad to be of much
use since it runs from a fraction of the current excise tax to
a multiple of it and thus leaves us uncertain as to whether
smokers impose costs on society or subsidize non-smokers)
(4) paternalism could be yet another appropriate
motive for raising excise taxes by more than estimated
negative externalities
Goal (B) : reduce underage smoking
(1) underage smokers seem to act relatively
myopically (Chaloupka JPE 1991 pp. 722-42 finds that smoking
by older smokers supports the Becker-Murphy model for rational
consumption of addictive goods, but smoking by younger smokers
9
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does not)
(2) solved by an excise tax on underage smoking with
each firm's tax based on number of kids smoking its brands
Goal (C) : punish tobacco firms for fraud/deception
optimal fincs are lump sum (otherwise cost passes
through)
Goal (D) : Get companies to accept settlement. This may require
not punishing them severely.
VIII. Practical improvements in the settlement
(A) Have the base payment adjustment be more purely an
excise tax. Instead of the formula described and critiqued
above, make the payment equal to sales times a constant tax
rate (i.e., make it simple and straightforward with incentives
pointing in the right direction)
(B) Calculate each firm's surcharge on the basis of the
change in its sales to kids to eliminate the free rider
problem
(C) Base adjustments in the surcharge not on profits
(which are hard to observe and easy to distort) but on
revenue. This would help ensure that the surcharge is not
avoided by accounting gimmicks and tobacco firms would have
every incentive to minimize their costs.
(D) The 75% surcharge abatement makes the settlement for
underage smoking 75% regulatory command and control and only
25% market incentives. Consider reducing the extent to which
companies can get around the full surcharge by meeting
criteria other than performance targets (i.e., reductions in
number of kids hooked).
(E) If the externality evidence for adult smokers is
weak, consider trading off some of the base payment for more
surcharge
(F) Greater guidance needed on just what types of
"industry cooperation" the antitrust authorities are to be
approving. One possibility would be to have antitrust
immunity attach only in certain limited circumstances; for
example where, in the view of the antitrust authorities, the
joint conduct of the participating companies will be primarily
to reduce the sale to children and adolescents in the United
States of tobacco products produced by the parties. No
blanket exemption for cartel behavior across the board.
10
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Finally, consider fixing certain drafting problems in the
proposed resolution. For example,
1) change p. 8 to a ban on tobacco companies distributing
non-tobacco merchandise (rather than a ban on possession of
such merchandise).
(2) p. 19 should exempt cigarette papers from the ban on use
of non-tobacco ingredients (since otherwise it would likely
ban all manufacture of cigarettes).
(3) p. 30 should exempt homes and private apartments from the
ban on smoking (i.e., 10 people can be a big family or a
weekly party).
11
JUL-03-1997 09:49
USDA CHIEF ECONOMIST
202 690 4915
P.02 05
Effects of the Tobacco Settlement on Tobacco Farmers and the USDA
Price Support Program
The Tobacco Settlement between numerous States' Attorneys General and the Tobacco
Industry on Friday June 20 is aimed at resolving issues relating to underage smoking and
reimbursements to States for Medicaid expenditures related to tobacco-related illnesses.
The Settlement also sets national standards controlling the manufacture of tobacco
products, restricts advertising alternatives, and mandates a nationwide smoking cessation
program. There are no immediate and direct implications for tobacco farmers or the
USDA price support program. Nonetheless, there will be indirect effects resulting from
the Settlement as the industry restructures in compliance with the 9 titles included in the
Settlement.
Agriculture as Addressed by the Settlement
Direct mention of the USDA or tobacco farming occur in two instances within the
agreement. The first simply states that tobacco farmers will not be subject to additional
regulations over and above those existing for other producers of raw products. "Tobacco
farmers will face no greater regulatory burden than the producers of other raw products
regulated by the federal government." [Title I, Subtitle E. (See appendix)]
The second mention of agriculture addresses the issue of limitations on FDA regulatory
jurisdiction and states: Grower Limitation: FDA jurisdiction does not extend to the
growing, cultivation or curing of raw tobacco (USDA has exclusive authority)." [Title V,
Subtitle A. (See appendix)]
Indirect Implications of the Settlement for farmers
The primary implication of the Settlement for tobacco growers is added impetus to
discourage consumption of tobacco products, reducing the demand for leaf tobacco used
in domestic manufacturing.
Declining consumption due to reduced underage smoking
Currently, the proportion of total consumption attributable to underage smokers is not
known with certainty. Estimates range from 3 to 5 percent. U.S. consumption in 1996
was 487 billion cigarettes of which between 15 to 24 billion could have been consumed by
underage smokers. The Settlement seeks to reduce underage smoking significantly over
the next decade and maintain the reduction thereafter:
Underage use of cigarette products must decline by at least 30% from estimated levels
over the last decade by the fifth year after the legislation takes effect, by at least 50%
from estimated levels over the last decade by the seventh year after the legislation
JUL-03-1997 09:49
USDA CHIEF ECONOMIST
202 690 4915 P.00 05
takes effect, by at least 60% from estimated levels over the last decade by the tenth
year after the legislation takes effect, and remain at such reduced levels or below
thereafter. [Title II]
If the Settlement reduces underage consumption by 30 percent by the fifth year,
consumption will decline between 5 to 8 billion pieces, assuming underage consumption of
15 to 24 billion cigarettes annually. This is the equivalent of 5.7 to 9.2 million pounds of
tobacco (farm sales weight), based on current domestic leaf use per cigarette. U.S.
tobacco production in 1996 was 1,517 million pounds.
The Settlement also covers smokless tobacco products in much the same terms as
cigarettes. This increases the number of leaf types that may be affected.
Declining adult consumption may result if prices rise because of the Settlement.
At this point, it is difficult to tell how the Settlement will affect retail cigarette prices.
Cigarette companies are liable for huge payments under the agreement, beginning with an
up-front payment of $10 billion at signing and $8.5 billion due at the end of the first full
calendar year following signing. The up-front penalty equals approximately 41 cents per
pack (20 cigarettes) based on 1996 U.S. consumption and 26 cents per pack based on
total output (including exports). Adding the first annual payment raises the amount to 76
cents per pack for domestic sales and 49 cents for total output. Retail cigarette prices
averaged $1.91 nationwide in 1996. Wholesale prices were 99 cents per pack for
premium cigarettes, which make up about 72 percent of total output.
Given the imperfectly competitive structure of the cigarette industry and inelastic
consumer demand, we would expect much of the additional costs to be transferred to
consumers. However, in the past, the cigarette industry has reduced wholesale prices,
such as in 1993 when the prices for premium cigarettes were slashed to regain market
share from discount brands.
Some respected Wall Street analysts are forecasting a 50-cent per pack increase at the
wholesale level, combined with a consumption decline of about 11-percent.
Using a commonly accepted price elasticity of demand for cigarettes, the following table
illustrates potential changes in cigarette consumption with 4 levels of retail price increases.
The change in cigarette consumption is converted to change in domestic leaf use for each
price change, These estimates assume no change in the proportion of imported tobacco
leaf used in U.S. manufactured cigarettes. A $1.00 increase in the retail price of a pack of
cigarettes results in a 20.9 percent decrease in cigarette consumption and a 116.7 million
pound decrease in domestic leaf use, about 8 percent of U.S. production in 1996.
Likewise, a 25 cent increase in the retail price results in a 5.2 percent decline in cigarette
consumption and a 29.2 million pound decline in domestic tobacco use, about 2 percent of
1996 U.S. production.
JUL-03-1997
09:50
USDA CHIEF ECONOMIST
202 690 4915
P.0 05
Entimated effects of cigarette price Increases
1996 average price per pack ($)
1,91
1996 total U.S. consumption (billion cigarettes)
487
Price elasticity of demand
-0.40
domestic
use per
1,000
domestic
price change
pct chrig price
pct chng vol
quantity
cigarettes
use
pct chng
est chng
cents
percent
percent
billions
(bs.
mil. lbs.
mil. lbs.
25
13,1
-5.2
462
1.144
528
-5.2
-29.2
50
26.2
-10.5
438
1.144
499
-10.5
-68.3
76
39.3
-15.7
411
1,144
470
-15.7
-87.5
100
52.4
-20.9
385
1.144
440
-20.9
-116.7
The cigarette industry uses both domestically grown and imported tobacco leaf to
manufacture cigarettes. In 1995, the most recent data available, U.S.-manufactured
cigarettes contained about 35 percent foreign tobacco leaf. U.S. tobacco growers likewise
supply both domestic cigarette manufacturers and the export market. In 1996, leaf
exports accounted for about 33 percent of U.S. production. U.S.-manufactured cigarettes
are consumed domestically and exported. In 1996, 32 percent of the cigarettes
manufactured in the United States were shipped overseas.
The effects of changes in domestic consumption of cigarettes on tobacco growers are
tempered by prospects for foreign demand for U.S. cigarettes and the proportion of
foreign tobacco used by U.S. cigarette manufacturers. The impact of the Settlement and
associated price changes on the mix of domestic and foreign leaf used by manufacturers,
and the level of leaf imports, is difficult to determine. As manufacturers attempt to cut
costs, use of lower-priced imported leaf may rise, accentuating downward price pressures
on U.S. tobacco leaf. If, however, facing declining domestic consumption, manufacturers
export more cigarettes, that could temper any downward price pressure on U.S. tobacco
leaf. Currently tobacco leaf imports are limited by a tariff rate quota; however, in the past
year, only about 68 percent of the quota was utilized. In addition, imported leaf which is
used to manufacture cigarettes subsequently exported is subject to a duty drawback. If
domestic consumption is relatively stable, manufacturers will likely continue using the
same proportions of domestic and foreign leaf.
The increase in retail cigarette prices may be less than indicated by the size of the penalties
to be paid by the manufacturers. The Settlement contains a provision [Title VI B. S. (See
appendix)] which rebates part of the penalty paid by manufacturers if adult consumption
falls below the 1996 level. This provision should negate some of the price effect of the
penalty by enabling manufacturers to use the rebate to lower prices and thus regain sales.
In addition, the penalties are paid using pre-tax dollars, further lessening the financial
burden of cigarette manufacturers and reducing amount prices might be increased.
Advertising expenditures, which total about $6 billion annually for the industry, are likely
JUL-03-1997 09:50
USDA CHIEF ECONOMIST
202 690 4915 P.05 05
to decline also.
Indirect Implications for the USDA Tobacco Program
The indirect implications for the USDA program are mainly political in nature.
Congressional attention focused on the Settlement has already spawned tangential
tobacco-related legislative proposals, such as the bill introduced by Senator Mitch
McConnell to have cigarette manufacturers cover the costs of the Tobacco Program. In
recent sessions of Congress, the Tobacco Program has come under attack and narrowly
survived.
TOTAL 2.05
(Preliminary - NOT final)
THE "LOOK BACK" SURCHARGE
The settlement attempts to provide economic incentives to promote "dramatic and immediate
reductions in the number of underage consumers of tobacco products." Manufacturers would
face surcharges if the tobacco-use reduction targets are not met. Surcharges will be imposed on
the basis of a "look back" comparing actual teen tobacco use percentages to the targeted
reduction percentages.
Will the surcharge be effective? No.
Our initial calculations indicate that the present value of the stream of profits from a higher
percentage of teen tobacco use exceeds the
cost of the surcharge by a factor in the
Underage Daily Tobacco Use Percentages and Targets
range of 3 to 6 -- hence, the economic
Michigan Survey Data and Settlement Look Back Targets
Percent
incentive to firms to reduce teen smoking
20
will not be effective.
18
The daily tobacco use percentage
16
for underage teens in 1996 was
14
18.2 % -- well above the target
Use reduction targets
12
base of 15.2 % (calculated from
Historical data
data over the past 11 years).
10
8
The surcharge would be imposed
beginning in the 5th year after
6
enactment and every year
4
thereafter based on the difference
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
in the actual and targeted
percentage reductions in underage use -- at the rate of $80 million for each percentage
point (adjusted for changes in the size of the relevant population and industry profits).
For the case of no change in the level of teen daily use (staying at 18.2 %), the surcharge
for the fifth year would be about $660 million (in 1997 dollars). The present value of the
future profit stream from the additional smokers above the target would be much higher
at about $3.6 billion -- 5-1/2 times greater than the cost of the surcharge. (After-tax
comparisons would yield the same ratio under the assumption that the profits tax rate
remains unchanged through time.) Similar ratios apply to the surcharges in other years.
If we assume that teen use declines because of higher cigarette prices from higher excise
taxes, the use percentage falls to about 13-1/2 percent and the surcharge in the fifth year
would be about $400 billion and the present value of profits would be about $1.4 billion
for a ratio of about 3-1/2.
These results indicate that to be effective, the surcharge would have to be increased by a factor of
about 3-1/2 to 5-1/2, or somewhere in the range of $280 million to $440 million per percentage
point.
Some Assumptions:
Discount rate:
4.0%
Profit per pack:
$0.30
Intensity of use:
1 pack a day
Survival probability: taken from FDA rule in Federal Register
Teen population:
Census middle series
Teen price elasticity: -1.0
(second scenario assumes that % decline in use translates in to %
decline in users)
tobacco
coronies
Memorandum
July 3, 1997
From:
Chad Stone, CEA
Jon Gruber, Treasury
To:
Elizabeth Drye, DPC
Subject:
Progress Report on Economics Task Force, Domestic Issues
Attached are several undigested pieces of material that are part of what will feed into a draft
report we hope to complete next week:
1.
An outline/progress report of the tasks being undertaken
2.
Preliminary fact sheets on the domestic industry (foreign stuff to come)
3.
Preliminary set of working assumptions feeding into the analysi
4.
Preliminary bibliography of key economic articles, etc. for estimating elasticities and
other effects.
5.
Memorandum from DOJ antitrust division assessing the settlement
6.
Memorandum from USDA on effects on tobacco farmers.
7.
Preliminary Treasury assessment of "lookback"
All of these are preliminary and many are undigested and not integrated into the analysis.
tohnces
Clonomics
By MICHAEL M: PHILLIPS
sions. Few believe the industry will walk
declines. Dr. Harris estimates U.S. ciga-
And SUEIN L. HWANG
away from the deal, although RJR's sup-
rette sales, already dropping, could fall to
Staff Reporters of THE WALL STREET JOURNAL
The sweeping tobacco settlement
port seems the more fragile.
18.4 billion packs annually in 25 years from
sounds like a huge burden for Big Tobacco:
"Philip Morris is most on board,' one
around 24.2 billion packs last year. So
How can an industry with $8.4 billion in
person familiar with the matter says. If the
instead of paying $15 billion, the compa-
annual pretax operating profits afford to
deal does go through, economists say the
nies would only have to pay $11.4 billion in
pay out $368.5 billion over 25 years, almost
industry as a whole will still do well.
the fifth year. Over 25 years, Dr. Harris
$15 billion a year?
Among the reasons:
calculates the settlement would cost the
The fact is, it can. Tobacco will simply
Tobacco demand is inelastic, Smokers
industry perhaps $304.3 billion, not the
pass along the costs to millions of addicted
don't cut their intake much even when
$368.5 billion frequently cited.
customers and reap the rewards of higher
prices rise. Frank J. Chaloupka, associate
And payments are deductible. "At year
Why Tobacco Pact Won't Industry
stock prices. economists say. "The deal is
professor of economics at the University of
five, take a corporate tax rate of 40%; that
a very good deal for the tobacco industry,
Illinois in Chicago. figures adult cigarette-
means a $15 billion payment results in tax
Cigarette Makers Can Easily Raise Prices to Cover Payouts
says Gary Black, a tobacco analyst at
smoking declines only about 4% for every
savings of $6 billion," says one person
investment firm Sanford C. Bernstein &
10% cigarette-price increase (half from
familiar with the industry's thinking.
Co.
reduced intake, half from people quitting).
Costs would spread over time. An
The explanation for this seeming con-
"It's addictive behavior,' says the profes-
amount paid over time is less costly than
tradiction draws on the lessons of elemen-
sor. making an assertion long disputed by
the same sum paid up front, a textbook
tary economics, bringing from classroom
tobacco makers.
concept economists call present discounted
to cash register classic textbook terms as
There aren obvious substitutes. If or-
value. If the companies wanted to, econo-
supply and demand and present value. But
ange juice prices soar, consumers can buy
mists say, they could spend about $194.5
perhaps the most important economic con-
lemonade. Smokers have no such easy
billion today to buy 7% bonds that would
cept highlighted by the settlement is oli-
choice.
pay off $304.3 billion over 25 years.
ECONOMY
gopoly. In short, a small number of compa-
Because of new limits placed on adver-
Prices will pick up the slack. Because
nies hold the market in such a tight grip
tising and store displays, the companies
every major producer has agreed to set-
that they can easily jack up prices 30% or
are also likely to save some of the $6 billion
tle - tiny Liggett settled separately - it is
more'as the settlement envisions without
they currently spend battling for market
unlikely any one company would undercut
inducing new competitors to rush in, econ-
share. The industry's $8.4 billion in annual
the others. In fact, the settlement proposal
omists say.
pretax operating profit might shrink by
envisions an antitrust exemption to allow
"It has basically been an oligopoly with
just $700 million to $800 million, Mr. Black
companies to raise prices jointly.
high barriers to entry for half a century,'
predicts, and if companies cut marketing
says Jeffrey E. Harris, an economics pro--
Both Dr. Harris and W. Kip Viscusi, a
sharply, they might avoid any profit de-
fessor at the Massachusetts Institute of
Harvard Law School economist and expert
cline at all.
Technology and a physician at Massachu-
witness for the tobacco industry, believe
When the industry says it cannot afford
setts General Hospital. Dr. Harris served
the price of a pack of cigarettes will rise 62
more money, "people in Washington
as an expert witness for Florida in its effort
cents on average within five years to
laugh," Mr. Black says. But RJR, isn't
to extract Medicaid costs from the tobacco
provide the companies with enough reve-
laughing. Some industry people expect
companies.
nue to pay off the plaintiffs. "This isn't a
volumes of more-profitable premium ciga-
A handful of companies dominate the
$15 billion [a year] pure payment- this is a
rettes to fade as smokers switch to
Please Turn to Раче A10, Column 1
market - Philip Morris Cos., RJR Nabisco
cheaper, less-profitable brands. RJR
Holdings Corp., Loews Corp.'s Lorillard
Continued From Page A2
would be among the most affected; its debt
Tobacco Co., B.A.T Industries Ltd.'s
62-cent-per-pack tax" in effect, says Bern-
rating only recently was raised to so-called
stein's Mr. Black.
investment grade. With passage of the
Brown & Williamson Tobacco Corp.,
That's assuming cigarettes cover the
settlement, "RJR's upside isn't as clear as
Brooke Group Ltd.'s Liggett Group Inc.
and UST Inc., a leader in smokeless to-
whole amount. If smokeless-tobacco prices
Philip Morris's," says one tobacco execu-
bacco. And there is virtually no threat that
also rise, cigarettes could go up a little less
tive. "This is the cost of the LBO."
new contenders will challenge the oligop-
than 60 cents a pack. Congress also re-
oly. Brand names are well established and
cently approved a 15-cent-a-pack excise
start-up obstacles daunting.
tax. After the industry settled suits filed by
That's not to say the industry is made
Florida and Mississippi, the companies
up of equally strong players. Some in the
recently boosted cigarette prices 7.6%-the
industry fear the deal and its advertising
right amount to cover that move, analysts
restrictions will add to the No. 1 player's
believe.
enormous clout, giving Philip Morris a
Penalties seem survivable now. Teen-
nearly overwhelming edge at the expense
agers are about three times as sensitive as
of weaker rivals. That fear now is contrib-
adults to cigarette price boosts, Prof. Cha-
uting to Washington delays in advancing
loupka says. The national settlement
the settlement, which still needs President
would limit advertising, boost minimum-
Clinton's response and congressional ap-
age enforcement and provide $500 million
proval for the industry to win broad liabil-
annually for antismoking publicity. But all
ity protection.
that plus a 62-cent price increase isn't
Fueled by its super-hot Marlboro
generally expected to reduce the number
brand. Philip Morris controls half of the
of teen smokers enough to meet targets
U.S. market, and shows no sign of slowing
included in the national agreement-a 60%
down world-wide. RJR Nabisco, an in-
cut in 10 years. Based upon price alone,
creasingly distant No. 2. is hobbled by
cigarettes would have to double to about $4
aging. eroding brands such as Winston, a
a pack to hit the target. Cigarette compa-
heavy reliance on the U.S. market (where
nies might balk at boosting prices that
its share is about 25%) and debt left from
much but the currently proposed penalty
its 1989 leveraged buyout. Much-smaller
for missing the target is at most $2 billion.
Brown & Williamson and Lorillard rely
Possible penalties could change.
heavily on menthol; Liggett, seller of dis-
The horizon would clear. The settlement
count cigarettes, is barely a blip on the
would simultaneously settle suits by 40
screen.
states that claim the industry should pay
All of which spells more wrangling in
for tobacco related Medicaid costs, II also
Washington where pottcy makers mistst
would provide broad liability protection
the existing settlement is too favorable for
against future lawsuits.
cigarette companies yet the companies are
For years, tobacco stocks have been
reluctant to make more financial conces-
hobbled by litigation fears. According to
Smith Barney Inc.'s analyst Martin Feld-
man, RJR could jump as much as 34% to
$46 after the deal passes Congress. Philip
Morris, he estimates, could jump 54% to
THE WALL STREET JOURNAL FRIDAY, SEPTEMBER 12, 1997
$65.
Some costs could shrink. Settlement
payments fall if cigarette consumption
Leadership Woes
Mr. West also said that the Army,
spurred by complaints from some in Con-
gress and the NAACP that the Aberdeen
Blamed by Army
investigation disproportionately targeted
black sergeants who had sex with white
women, will review its conduct of that
For Sex Scandals
investigation.
Despite his insistence that the Aber-
deen mess was a unique circumstance, the
By THOMAS E. RICKS
remedies Mr. West announced will be
Staff Reporter of THE WALL STREET JOURNAL
applied across the board, at all Army
WASHINGTON - The Army took a long
training installations. Among other things,
look in the mirror and decided it didn't like
he said that screening and supervision of
what it saw.
drill sergeants will be tightened. Boot
In self-cpitiques commissioned in the
camp will be lengthened by a week to nine
wake of its Aberdeen sexual-abuse scandal
weeks. and the additional time will be used
and issued yesterday, two different Army
to place more emphasis on values, history
reports concluded that many in the rank
and tradition:
and file feel poorly led. Also, soldiers
distrust the Army's system for handling
Interestingly, this move comes about a
sexual-harassment complaints. As a re-
year after the Marine Corps, which in
sult, one study found, sexual discrimina-
recent years has placed enormous em-
tion and harassment are more widespread
phasis on values and tradition in its own
than the service's leadership had be-
two boot camps, decided to lengthen its
lieved.
recruit training to 12 weeks from 11. Most
"Plain and simple, this is a leadership
of all, Gen. Reimer indicated that the
issue," said the Army's top officer, Gen.
Army needed to renew its focus on team-
Dennis Reimer, in presenting the two
work, discipline and values. "We' got to
reports that in many ways took aim at him
get back to the basic fundamentals," he
and other top generals. "I think we need to
said. But Gen. Reimer insisted he had seen
place more emphasis on values." While the
nothing to persuade him that the Army
reports are harsh, they may have suc-
should follow another Marine method and
ceeded in helping the Army fend off an
train men and women separately in boot
outside investigation of its handling of
camp.
sexual-abuse problems. One of the Army's
The officials also said that the Army
top priorities in responding to the Aber-
will create a structure to monitor the
deen sexual-abuse cases that became pub-
implementation of these changes. and then
lic last November has been to avoid being
in about a year conduct a full-scale review
subjected to outside investigations. Con-
of its progress.
gressional reaction to the reports was
positive.
The Army's panel on sexual harass-
ment, in an unprecedented survey of more
than 30,000 soldiers conducted at 59 Army
installations, concluded that "passive
THE WALL STREET JOURNAL FRIDAY, SEPTEMBER 12, 1997
leadership" had permitted sexual harass-
ment to persist across the Army. The
panel. made up of four generals, two
civilian defense, officials, and a senior
sergeant. generally was scathing about the
poor quality of leadership in today's Army,
identifying "a huge gap" between senior
Army leaders and younger enlisted sol-
diers.
Many soldiers believe their officers
don't care about them, and really are
concerned "only about themselves and
their careers, the panel reported. Both
males and females agreed in their distrust
of the way they are being led, with more
than 40% of those surveyed saying their
leaders are more interested in looking
good than in being good.
Interestingly, both males and females
perceived more racial or ethnic discrimi-
nation in their units (about 25% of females
reported seeing it) than sexual harass-
ment (which was perceived by 17% of
females).
The complementary study by the
Army's inspector general of sexual-harass-
ment policies in boot camp came to similar
conclusions.
Army Secretary Togo West insisted
that the events at Aberdeen, the Army
base in Maryland where several drill ser-
geants and a company commander were
found guilty of charges ranging from rape
to fraternization with female soldiers,
were an "aberration." He indicated that
the chain of command at that base failed to
adequately supervise trainers there, and
said that, among others, two lieutenant
colonels, one colonel, and one general are
receiving letters of reprimand for that
failure. Such letters, which are placed in
personnel files, are generally seen as
ending a career.
Tobacco
Economics
ANNUAL COSTS OF THESE PAYMENTS
1. Annual cost of transition payments and quota compensation: At the bottom of the page
containing the tables is the summation of the cost of these purchases. Based on these
calculations, it will cost $411.725 million per year for each of the next 8 years to compensate
farmers.
2. Annual cost of transition payments, quota compensation, and retiring all tobacco quota
after 8 years. When this amount of a total quota buy-out after 8 years is counted in with the
other two payments, it averages out to $672.205 million per year for the next eight years.
Page 1
Tobaccomes
SM
153)
eolg
100
in
5
International Tobacco Fund
Early in the next century, tobacco will be the leading global cause of premature death and
preventable illness. According to the World Health Organization (WHO), worldwide deaths
from tobacco are likely to exceed ten million per year by 2025, with 70 percent of those deaths
occurring in developing countries. While the proposed tobacco industry settlement addresses the
industry's future in the United States, it is silent with regards to the overseas impact.
Tobacco consumption, and its deleterious effects, are a global problem which should not be
ignored; the problem cannot simply be exported away. The United States Government should
take the opportunity offered by the proposed settlement to take the lead mobilizing the
international health community to reduce the consumption of tobacco products, particularly as it
affects the health of children and youth. Such an undertaking will have many facets, but should
pd.
leverage efforts already underway in bilateral and multilateral, official and non-governmental
fora. However, resources that currently can be brought to bear are tiny in relation to both the
scope of the problem and the resources that can be brought to bear by the tobacco industry.
j.s.6 WINGO
<
We can begin to address this imbalance through a creation of a new fund [with a portion of
settlement proceeds] that will focus efforts in international public health and education efforts.
These efforts include:
My $15 Sprind
Bilateral Collaborations, including cooperative agreements with key countries to
promote the development of national and international tobacco control and prevention programs.
Funds can be mobilized to deliver comprehensive technical assistance, including training,
exchange of public health experts, organization of workshops and symposia, and exchange of
publications and information related to tobacco control and prevention. The goal should be to
promote globally consistent and reinforcing regulations that restrict tobacco advertising and
minors' access to tobacco products, for example.
Regional and Multilateral Collaborations, including working with UN agencies, the
multilateral development banks (MDBs), and other development organizations to expand their
tobacco use reduction efforts, and promoting efforts to expand or create regional alliances to
facilitate and promote collaboration and cooperation on tobacco-related issues, such as the
prevention of cigarette smuggling. Grants could be used to supplement MDB financing for
existing activities and/or to establish new programs aimed at discouraging tobacco usage and
production, as well as to help offset the medical costs of tobacco use. Other technical assistance
can be provided through the MDBs, including policy advice they give to borrowing governments
relating to regulatory issues (such as advertising bans); trade policies (to incorporate effective
health and safety measures); and tax and fiscal policies (to help governments reduce reliance on
revenues from tobacco sales).
Global Strategies, such as increased support for the WHO's Tobacco or Health Plan of
Action (1996-2000), which promotes comprehensive national tobacco programs, advocates
strong tobacco control policies, and disseminates global and country-specific health data and
tobacco prevention and control strategies. Increased funding can help to enhance staffing and
Issues for Industry/Economic Analysis
What is the counterfactual?
The central question for evaluating this settlement is a detailed understanding of the
counterfactual: what would the world be like without a tobacco settlement? How much would
the tobacco companies lose in this alternative world, and how much does the rest of society gain?
This establishes the "threat point" of each of the parties to this settlement, and thereby the
mutually acceptable range of agreement. This calculation consists of a number of components,
some easier to compute than others. A number of these questions require probabilistic answers,
both in terms of the economics and the politics:
What would happen to FDA regulation of cigarettes in the absence of a deal, and what
would that imply for cigarette sales/profits?
How much could we raise through cigarette taxation in the absence of a deal, and what
would that imply for sales/profits?
- what is the political will for a tobacco tax rise instead?
- does the settlement "crowd out" a tobacco tax increase?
- does a collapse of the settlement make it hard to immediately raise taxes?
What would be the net litigation costs to the tobacco companies and to the rest of society
in the absence of a deal?
What would happen to smoking in the absence of a deal
- youth vs. adult tobacco use
- public health costs
What is the cost of the settlement to the companies?
Compute after-tax payment amount
Compute post-settlement profit stream
What are the gains to settlement for the government?
Compute net payments from tobacco settlement, incorporating tax deductibility, and
"leakage" from existing excise taxation as prices rise
- Divide these net payments into federal and state/local components
Compute effects on social insurance programs - SS, Medicare, Medicaid
- possibility of changing behevior/
Market based analysis of the settlement
o.j. Form to avoid payments
Gather Wall Street paper on the settlement
Event study analysis of settlement
Concerns with collusion
Coordinate concerns with DOJ antitrust division
Estimate effects of the agreement on pricing
What would happen if we made payments conditional on past market share?
- what about other restrictions on entry through advertising/marketing rules?
Understanding the details of the deal
Explicit description of the uses of the settlement money
Concerns about parameters of the deal
Tax Issues
Should the settlement be tax deductible?
Are there sufficient protections against foreign spinoffs to avoid profit taxation?
Targeting & Penalties
What is the correct share of incremental profits that should be retained by tobacco
companies (currently 75%)?
Should the lookback provisions apply company by company?
What is the correct rule for determining future stream of payments - e.g. to what units
should payments be tied, and how?
- if you tie to unit sales, incentives to increase tar
- if you tie just to cigarettes, incentives to move to other forms of smoking (roll-
your-own or little cigars)
Are the lookback penalties (roughly $80 million for each percentage point shortfall of
youth smoking target, with cap of $2 billion) large enough, relative to stream of future
profits lost from reduced youth smoking?
What does state experience teach us about the most effective means of reducing youth
smoking, and is that reflected in the parameters of the deal?
Implications of using a quota, auctioned off across companies, rather than a tax?
Spillover effects
Concerns about other sectors:
- advertising
- vending
- sporting events
- retail
- hospitality
Effect on farmers
Effect on labor demand - employment and wages
- tobacco directly (lots of "good jobs")
- other sectors indirectly
Smoking cessation sector will benefit - tobacco company ownership issues?
Other issues
Why should we preclude future class action suits?
Should we ignore the rest of the world?
Are we tough enough/too tough on environmental (second-hand smoke) issues?
Why are (effectively) tax dollars going to pay the cost of plaintiffs' attorneys?
Distribution of spending of settlement dollars
Should we diversify beyond kids health?
Should we compensate smokers who die before 65?
Should we finance buy-in to Medicare (tied to smoking because benefits those who don't
live until Medicare eligibility age)
Should the federal government insist on 57% (federal Medicaid share) of the non-
earmarked dollars (dollars not going to liability fund, smoking cessation, etc.)? (EP)
World Market Shere (from WSJ)
Philip Morris
16.2%
BAT
12.8%
RJR
5.9%
Japen Tobacco
5.1%
Rathmans
4.2%
6/20/97
3 pm
TITLE VI: Programs/Funding
TOTAL 25 YEAR PACKAGE FACE VALUE - $368.5 Billion
A.
Up Front Commitment - Lump Sum Cash Payment - $10 Billion
1.
Payable on Statute Signing Date.
B.
Base Annual Payments 25 Year Total Face Value is $358.5
Billion (Figures Subject to Inflation Protection and Market
Volume Adjustments)
1.
Duration - - annual payments in perpetuity
2.
Commencement - - 12/31 of first full year after statute signing
-
3.
Face Amounts (includes payments from all industry sources):
Payment
Year
1
2
3
4
5
6-8
9
-+ -
Total
Payments
$8.5B
$9.5B
$11.5B
$14B
$15B
$15B
$15B
$15B
Base
Amount:
$6B
$7B
$8B
$10B
$10B
$12.5B
$15B
$15B
Public
Health
Trust
$2.5B
$2.5B
$3.5B
$4B
$5B
$2.5B
4.
Inflation Protection for Annual Payments
Greater of 3% or CPI applied each year on previous year,
beginning with first annual payment.
5.
Adjustment for Volume Decrease (Adult Volume Only) or Total
Volume Increase
Beginning in year 1; payment made equal to scheduled
annual payment times the ratio of actual relevant domestic
tobacco product unit sales volume to relevant base volume.
In the event of a decline in volume, relevant actual volume
and relevant base volume are adult volume figures; in the
event of an increase in volume, relevant actual volume and
-34-
relevant base volume are total volume figures. Base volume
is 1996 volume.
Any reduction in an annual payment will be reduced by 25%
of any increase above the industry's base year net operating
profits (after application of inflator discussed above) from
domestic sales of tobacco products.
6.
Payment Protection
Provide for payment priority/continuation during bankruptcy/
reorganization proceedings. Protocol cannot be rejected in
bankruptcy. Obligation for annual payments responsibility
only of entities selling into domestic market.
7.
Pass-Through
In order to promote maximum reduction in youth smoking, the
statute would provide for the Annual Payments to be reflected
in the prices manufacturers charge for tobacco products.
C.
Applicability
1.
Applicable to All Sellers of Tobacco Products
Through protocol and statute to protocol signatories.
Through alternative statutory provisions to non-signatories.
D.
Tax Treatment
All payments pursuant to this Agreement (including those pursuant to Title
II) shall be deemed ordinary and necessary business expenses for the year
of payment, and no part thereof is either in settlement of an actual or
potential liability for a fine or penalty (civil or criminal) or the cost of a
tangible or intangible asset.
-35-
TITLE VII: Public Health Funds From Tobacco Settlement
As Recommended By The Attorneys General For Consideration
By The President And The Congress
BASED ON THE PREMISE OF $ 1 BILLION FOR THE FIRST YEAR
AND GRADUALLY INCREASING TO $1.5 BILLION THEREAFTER, ADJUSTED
FOR INFLATION AFTER THE FIRST YEAR.
BASED ON THE PREMISE OF $1 BILLION FOR SMOKING
CESSATION FOR THE FIRST 4 YEARS AND $1.5 BILLION THEREAFTER,
ADJUSTED FOR INFLATION.
(A) . ALLOCATION OF GRANT MONIES AMONG PROGRAMS - The use of
moneys under this Section shall be limited to programs established under this
Section, shall be adjusted for inflation annually from the effective date, and shall
be allocated among such programs as follows:
(1)
$125,000,000 for the first three years and $225,000,000 annually
thereafter to the Secretary of HHS to accomplish the purposes described in
Paragraph (B) of this Section (Reduction in Tobacco Usage);
(2) $300,000,000 annually for the FDA to carry out its obligations
under and to enforce the terms of this Act, including for grants to the states to
assist in the enforcement of the provisions of the Act;
(3) $75,000,000 for the first two years, $100,000,000 in the third year,
and $125,000,000 annually thereafter to fund state and local tobacco control
community based efforts modeled on the ASSIST program, designed to
encourage community involvement in reducing tobacco use and the enactment
and implementation of policies designed to reduce the use of tobacco products;
(4)
$100,000,000 annually to fund research and the development of
methods for how to discourage individuals from starting to use tobacco and how
to help individuals to quit using tobacco;
(5)
Beginning in the second year, $75,000,000 annually for a period
of ten (10) years to compensate events, teams or entries in such events, who
lose sponsorship by the tobacco industry as a result of this Act, or who currently
receive tobacco industry funding to sponsor events and elect to replace that
-36-
funding, provided that the event, team, or entry is otherwise unable to replace its
tobacco industry sponsorship during those given years. Funds used for this
purpose shall promote a Quit Tobacco Use theme. After a ten year period, no
additional funds shall be used for this purpose and the funds previously allocated
to this purpose shall be used as follows: 50% to supplement funding of the multi-
media campaigns in paragraph (1) of this subsection; 25% to supplement the
funding of the enforcement provisions of paragraph (2) of this subsection; and
25% to supplement the funding of community action programs in paragraph (3)
of this subsection.
(B)
ESTABLISHMENT OF PROGRAMS BY THE SECRETARY - The
Secretary shall establish programs to accomplish the following purposes-
(1) the reduction of tobacco product usage, both by seeking to
discourage the initiation of tobacco use by persons under the age of 18 and by
encouraging current tobacco users to quit through media-based and non-media
based education, prevention and cessation campaigns. The Secretary may
make grants to state health departments to assist in carrying out the purposes of
this provision.
(2) the research into and development and public dissemination of
technologies and methods to reduce the risk of dependence and injury from
tobacco product usage and exposure;
(3)
the identification, testing and evaluation of the health effects of
both tobacco and non-tobacco constituents of tobacco products;
(4) the promulgation of such other rules and regulations as are
necessary and proper to carry out the provisions of this Act, as well as the
development of such other programs as the Secretary determines are consistent
with the goals of the Act.
(C)
Public Education Campaign - $500,000,000 shall be spent annually in
such multi-media campaigns designed to discourage and de-glamorize the use
to tobacco products. To carry out such efforts, an independent non-profit
organization with a Board made up of prestigious individuals and the leaders of
the major public health organizations shall be created which shall contract or
make grants to non-profit private entities who are unaffiliated with tobacco
manufacturers or tobacco importers, who have a demonstrated record of working
effectively to reduce tobacco product use and expertise in multi-media
communications campaigns. The independent body shall be authorized to
contract with state health departments, where appropriate, to run campaigns for
-37-
their states and communities. In creating the program the Secretary or
independent body shall also take into account the needs of particular
populations. The goal shall be the reduction of tobacco product usage, both by
seeking to discourage the initiation of tobacco use by persons under the age of
18 and by encouraging current tobacco users to quit.
(D) Tobacco Use Cessation - For the first 4 years, $1 billion, and thereafter,
$1.5 billion of the total amount paid by the tobacco industry shall be paid into a
Trust Fund to be used to assist individuals who want to quit using tobacco to do
so. Within 12 months the Secretary shall promulgate regulations to govern (1)
the establishment of criteria for and a procedure for the approval of cessation
programs and devices for which payment may be made under the program, (2)
the eligibility requirements for individuals seeking to use moneys from the trust to
fund the tobacco cessation efforts, and (3) the procedures to govern the tobacco
cessation program.
The goal of the tobacco cessation program shall to enable the most
tobacco users possible to receive assistance in their effort to quit using tobacco
by providing financial assistance and identifying the programs, techniques, and
devices that have been shown to be safe and effective. Benefits to individuals
should not be limited to a single effort, but should be tailored to the needs of
individual smokers according to standards established by the Secretary using the
best available scientific guidelines.
(E) Public Health Trust Fund Presidential Commission - A Presidential
commission will be appointed to include representatives of the public health
community, Attorneys General, Castano attorneys and others to determine the
specific tobacco-related medical research for which the $25 Billion Public Health
Trust Fund will be used.
-38-
Tobacco Settlement Review
6/23/97
President hes set 30-day time limit for review
Agreement incorportes if to $368B of spending
- idea is to see if the
Other working groups
Heelth investments
FDA revew
Environment /workplece
Smoking canation
industry incentives
Liability litigation
Health EFFect
Package of health investment included in greement
is an important element in President's evcluation
of the package
- should make sure this tobacco meterial
complement + does not undermine Longet negationship
Estimated cost of setting up these Funds is 50-75 cent
per pack
Agreement is set up in perpetivity assumes that
payments are increased for 3% /yr CPI (theugh J)
payment would be reduced if tobacco sales
Next mts Mondey 10am (June 30.)
could get 75% of its money back.
Says John Banzhaf, a George Washing
The way this works is that the industry,
Philip Morris's Outlook
ton University law professor and smoking
after paying its fine, can petition the FDA
The outlook is even rosier for Philip
foe: "This is going to be the Lawyers's
for a hearing If the companies can estab
Morris whose uggernaut Marlboro brand
Relief Act in terms of all these defini
lish they pursued all "reasonably available
dominates the global tobacco market.
tions
measures to reduce youth smoking and
Huge cash flow means, the company can
did nothing to undermine the pact's goals
easily afford its settlement/share. And its
Still, there are accouple of wild cards
they get 75% of their money back. If the
surging sales overseas make the fate of the
Perhaps most worrisome for the industry
U.S. market less important
is the possibility that developing countries,
FDA turns them down, the companies can
Because Philip Morris has much to
where cigarette sales are exploding will
appeal the matter in court
gain from a settlement its rivals sniped:
one day decide to import the U.S. regula
Health Consciousness
throughout the talks that it was willing to
tory and liability scheme to their shores.
These provisions have been very well
give away the store. At one point, Philip
During the talks, no company was more
lawyered by the tobacco industry to thwart
Morris contemplated making billions of
vociferous in its objections to the FDA's
gains already made, charges former FDA
dollars worth of grants to restaurateurs for
Commissioner. David Kessler. who
state of the ventilation to rid the last
encroachment than Brown & Williamson.
launched the Clinton administration war
wisp of smoke from, dining areas. Its
The reason: Brown & Williamson's London
on youth smoking and has emerged as the
competitors nixed the plan. A Philip
parent is the most entrenched overseas:
settlement's most vocal opponent
Morris spokesman declined to comment.
While B.A.T controls only 17% of the U.S.
Even as the industry sells its conven:
The industry's astonishing gamble is
market, it derives fully 75% of its tobacco
tional smokes, it is expected to start to
predicated on legal calculations, too.
volumes from developing markets like
peddle health-consciousness. too. With the
Smokers likely will discover that their
China, India and Eastern Europe.
threat of liability reduced and the FDA's
newfound knowledge of additives and nico
Until now, though, antitobacco cru-
role spelled out, companies are expected to
tine will be of scant use in the courtroom
sades in these countries have been embry
introduce safer cigarettes and even smok
Under the settlement's terms; class action
onic, at best. Publicly, B.A.T's Mr.
cessation products. Smokers have
overwhelmingly rejected the few such
and states lawsuits would be barred out
Broughton plays down the prospect that
safe-cigarette products that have come to
right. Despite the industry's fears, there
bureaucrats in other countries will clone
market so far most notably Reynolds's
would probably be little economic incen
the U.S. settlement.
no-smoke Premier
tive for smokers to bring individual suits.
For some, the proposed tobacco settle-
Now the settlement creates powerful
In the end a number of plaintiffs' lawyers
ment will clearly yield an unprecedented
incentives to make these products work
say the industry has the immunity was
windfall. All 50 states will reap 40%
One big lure: Safer cigarettes would be
seeking all along.
to 50% of the industry largess, negotiators
exempt from the agreement's Draconian
These lawyers say that by banning
say The plaintiffs' lawyers who worked on
marketing curbs. Already smaller rivals
class suits the agreement strips
the settlement are likely to pocket giant
are gearing up. Star Tobacco, a tiny mar
keter of discount cigarettes in Petersburg
plaintiffs of the economies of scale that
fees.
Va., has just filed&papers seeking FDA
make it possible to take on Big Tobacco,
Even the FDA and the Department of
approval for alnew way of processing
which spends $600 million a year on its
Health and Human Services, among the
tobacco that eliminates nitrosamines the
legal tab Without the incentive of recoup-
settlement St most implacable foes, will
most abundant carcinogens in cigarettes
ing punitive damages, pursuing individual
collect more than $1.5 billion a year for
Success in safer cigarettes is particu
claims for compensatory damages would
enforcement activities and other initia
larly crucial to RJR. Pointing to its rela
be even more prohibitive. Another layer of
tives like research and a massive cam-
tively small presence abroad and some
complication involves the potentially ex
paign aimed at youths.
aging brands observers believe RJR
plosive documents on smoking and health
There will be economic losers, too.
hopes that research and development will
that the industry has agreed to release
Among them: magazines like Rolling
now count for more than camels and
cowboys. To the extent fewer marketing
The three judge panel appointed.to resolve
Stone and Details that cater to young
tools will be available, product attributes
document disputes with the industry will
readers and enjoy streams of ad dollars
may become more of a selling feature, an
take away the decision from local judges
from cigarette ads; the billboard industry;
RJR spokesman savs
handling the cases, making smoker litiga
and the thousands of stores and supermar
tion even more protracted.
kets that will face onerous new restrictions
Test Market
Cottage Industry
on selling cigarettes.
Already, Reynolds has spent more than
For now the landmark tobacco settle-
billion working on Premier and more
But the industry's most potent legal
recently. Eclipse, a low smoke product that
ment faces a bruising fight in Congress,
weapon may be: quite simply the 68-page
functions largely by heating tobacco, not
which it is expected to survive. But regard
Proposed Resolution" itself The agree
burning Eclipse, being marketed in
less of the outcome; the place of cigarettes
ment contains scores of terms and defini
Tennessee, has taken about 0.5% of that
in American culture and society will never
tions that are certain to create a new
market. While oneperson inside Reynolds
again be the same:
describes it in both taste and useability as
cottage industry for lawyers. Just one
Cigarettes have always been associ
probably like what Tab wasito/colas, he
example: a requirement that companies
ated with risk, menace and the intimation
promises there will be more to come.
give the FDA access to all records about
of mortality, says Richard Klein, author
(Philip Morris has been working on a
their ingredients with protection of pro
of 'Smoking Is Sublime: The more you
cigarette that heats tobacco since the early
prietary information.
interdict them, the more people enjoy the
1990s.)
Even SO, the settlement represents a
danger of transgressing
high-stakes gamble for Reynolds, which
But with the stripping away of the
had just begun to crawl out from under the
deception and manipulation that for four
huge debt load of its celebrated 1989 lever
decades have marked the relationship be
aged buyout. With an annual cash flow of
tween smokers and.sellers, cigarettes, an
just S650million a year it may have to turn
enduring outlaw symbol, are on the verge
tojbanks or public markets to pay its share
of the S10 billionjupfront payment.
to comment the matter
WALI STREET JOURNAL
of going respectable; they are about to
become a regulated drug marketed with
One personanvolyed in the talks recalls
full disclosure of its risks. On paper at
that at one point when antitobacco negotia
tors were pressing for S15 billion, an RJR
least, wringing every last shred of mys
representative If you want us
tique out of the cigarette business prom
bankrupt.. go ahead. By the end of the
ises to make for a more honest compact
talks, Mr. Goldstone was even more upset
between buyer and seller. In the process of
Congress was also considering levying a
this catharsis, tobacco executives clearly
20 cents-per pack excise tax. RJR declined
hope to dispel their merchant of death
upside. with removal of the legal
Goldstone an early supporter of settle-
AVONOW
image [too:
As Mr Goldstone put it in his letter to
clouds RJR shareholders including Mr
RJR employees on Friday: Most-impor
ment talks - stand to make a fortune by
tant, the agreement secures: the tobacco
completing a contemplated spinoffo
industry So rightful place in the main
the company S# Nabisco food operations.
stream of legitimate U.S commerce
RJR management feared that a spinoff
-MiloGeyelin
could face allegal challenge;on the ground
contributed to this article
the company.was shielding Nabisco
from: tobacco:liabilities
2/2
levels of nicotine in cigarettes-pert its
instant criticism from $ è public
th
Pact's Limits
tool for bringing smoking ra
down.
advoca
lawmakers, who argued
But don 1 hold your breath. Although a
that negotiators gave away too
to an
landmark federal-court ruling this year
industry on the ropes. Nonetheless, inside
Loopholes
said the FDAshas the power, to regulate
the tobacco camp. some officials were
nicotine as a drug the settlement creates a
shaken as they totted up the damage of a
fierce Debate
new set of hurdles before the agency can
settlement that gave up far more than they
take that step.
ever imagined.
Among them, the FDA would have to
When the CEOs of RJR and industry
prove that ratcheting down nicotine in U.S.
leader Philip Morris Cos. kicked off negoti
Print: Hurdles
cigarettes wouldn ticreate significant de
ations on April 3, they intended to pay
mand for contraband. Regulators freely
about $200 billion in exchange for full
and a Rebate
concede they have any idea how to
protection from liability lawsuits. Instead,
if Smoking Falls
prove that
they would be forced to pay/almost double
Shadowy Subject
that amount for legal insulation that falls
The agreement also stipulates that the
far short of what they had hoped
There are about 600 individual liability
Safer Cigarettes
industry can take the agency to court to
dispute its evidence, and orders judges to
suits pending against the tobacco industry
that aren't erased by the agreement. (It
defer to the FDA's judgment only in areas
M.
FREEDMAN
where the agency has expertise. Nobody
affects only suits brought by 40, state
L. HWANG
expectsithe FDA to claim expertise on the
governments and another group of state
class action suits. Current and former
WALL STREET JOURNAL
shadowy subject of contraband.
smokers would remain free to press
a) scorching national
Indeed, some industry chieftains are
the cigarette industry
already offering reassurances that the
claims, with no limits on compensatory
damages.
the historic tobacco set
pact won't be a major disruption in the
Moreover, the tobacco industry fears
weet a deal
cigarette business:
those claims would be strengthened by
Friday by a host of
After the shock of the 15% drop over
general, plaintiffs law
the next couple of years, thereafter we II be
Internal industry documents on smoking
and health that could become available to
back to the normal trend, predicts Martin
Broughton, chief executive of B.A.T Indus
any U.S. citizen under the deal. The
and Butts
tries PLC, whose Brown & Williamson
potential class of plaintiffs is still humon-
and the White
Tobacco Corp. is the U.S.'s No. 3 cigarette
gous, one negotiator says. The upper-
and changes in the to
but in the end it's
supplier. This shareholders and
class plaintiffs bar will be less interested in
law Article on page
employees more certainty and consumers
representing plaintiffs because they can't
thit a $10 million home run, but a whole new
a respite from the constant demonization
bar will be created in America.
lawyers may total
of cigarettes
B1
In an interview, Mr.: Broughton, who
Warning Labels
already thinking up
emerged as the most stiff-spined chief
The cigarette industry has a long his:
smokes, B11
executive in the settlement talks, says he
takes more than
tory of shrewdly turning what appeared to
B10.
isn worried about the FDA ever regulat-
be crushing defeat to its advantage While
believe the long term
Please Turn to Page A6, Column 1
the companies fought warning labels on
stocks is good, C1. A E
Continued From First Page
cigarette packs when they were first man
battle is just getting
dated in 1965, they later used the little-read
WALL JOURNAI
ing nicotine. "It's an unlikely prospect
warnings as a shield against lawsuits
he says The contraband part gives me
In 1971, after voluntarily removing
advocates and the na
the most comfort.
their ads from the airwaves to blunt in
would place sweep
And in a letter to employees the day the
MONDAY
creasingly effective antismoking spots, the
America's most lethal
settlement was announced, Steven Gold
companies simply shifted their brand im
That would have been
stone, chief executive of No. 2 player RJR
agery to frequently televised sporting
ecently as a year ago.
Nabisco Holdings Corp. said the had
events and lavish giveaways like Camel
it the "Industry
every confidence' that the tobacco com-
Cash and Mariboro Unlimited. They saved
over the next 25;
pany will be able. to make critically
millions on "V-advertising expenses, and
to a ban on billboards,
important financial contributions" to the
the TV ban made it hard for upstart brands
promotions and
parent/company. He added that RJR has
to claim market share.
cartoon characters
already been operating in heavily.regu
If the settlement goes through, regula
and the Mariboro Man
lated overseas markets, an area the ciga
tors concede they have no plans to fiddle
by the Food and
rette makers are actively exploring, and
with cigarettes partly because they have
and print dire new
we don't see any, reason to doubt the
only begun to educate themselves about
as Smoking Can Kill
future of the domestic market under sim
one of the most highly engineered products
stop hiding what it
lar.conditions.
in the U.S. market. Under the terms of the
effects of smok
Public Debate
agreement itself reducing or purging ciga
telling smokers just
Thus, as Congress and the White House
rettes of nicotine and its nearly 600 addi
nicotine they are really
launch a review of the agreement that is
tives would be virtually impossible.
the additives be
certain to be long and bruising; the pact
Until now, FDA rulings couldn't be
cigarettes among the
thrusts the nation into a wrenching public
overturned unless a judge deemed them
debate over how to regulate its most
arbitrary and capricious. But under this
banged together after
controversial product ever
settlement, the agency would have to pro-
of fractious negotia-
The debate will be shaped by powerful
vide 'substantial evidence to back up its
cigarette industry by
crosscurrents running through America at
assertions a tough new standard that
huge new market
the end of the century: On the one hand
makes it far easier for the industry to block
designs that manu
thanks to a surging reverence for individ
the FDA in court
shied away from for
ual responsibility, there is a widely held
In addition, every time the FDAitried to
red flag to liability
belief that smokers should be accountable
modify cigarettes either to reduce addic-
settlement is pock
for their own behavior and don't need the
tiveness or eliminate certain hazardous
that would probably
FDA to wean them off nicotine. The ciga-
compounds it would have to go through
keep racking up
rette industry has pressed this point suc
an intricate process called formal rule
dicted smokers, while
cessfully over and over to avoid courtroom
making similar to a trial How intricate?
in the courtroom.
losses and regulations it branded unduly
The last time the FDA recalls having used
paternalistic.
it was in the late 1960s, when It took almost
to pass along to
At the same time, the industry has until
10 years to determine the percentage of
settlement bill in the
now maneuvered to be virtually untouched
peanuts that had to be in peanut butter
of 35 to 50 cents a
by the wave of consumer and environmen-
One of the settlement's most touted
that the one-time
tal protection that has transformed so
provisions for reducing youth smoking is
the ranks of the
many other industries The result: A prod
the 'lookback. It is designed to guarantee
by aduring
ruct believed to be responsible for 425,000
that cigarette makers will drive down
But oneimechanism in
deaths each-year gets less government
youth smoking rates by 30% in five years,
enticould ensure that
oversight of its contents and marketing
50% in seven years and 60% in 10 years by
too many smokers
than cream. And supporters of harsh
levying stiff penalties of as much as $2
regulation of cigarettes have made their
billion annually if those targets are
purchased by
cause hugely popular by focusing on the
missed. But here is the catch: The industry
96"levels companies
heavy toll on minors
May 16 1997
TOBACCO INDUSTRY
1575
11
The Tobacco Industry has been a hot topic since
INDUSTRY TIMELINESS:
53 (of 95)
our February review. Settlement talks between
1750
Big Tobacco and its foes, as well as developments
Second, RJR won the Connor U. RJ Reynolds case, in
rder of
on the litigation front, have fueled the fires raging
which the jury found that the company was not
ving
around this group. Consequently, tobacco stocks
responsible for the death of a smoker who died of lung
Ing
have been more volatile than usual over the past
cancer The victory replaces some of the negotiating
three months.
leverage Big Tobacco lost in Judge Osteen's decision.
1997
The group's Timeliness rank has fallen below
In the months ahead, the results of several other
the median of the Value Line universe, owing
important may influence the settlement
THY:
lary ely to the decline in RJR Nabisco's rank (from
talks and investors' opinions of tobacco equities Among
2 to 3). Philip Morris remains timely, and most of
the trials scheduled, the industry faces class action suits
veral
Ve are
the tobacco stocks we track hold above-average
involving nicotine addiction and second-hand smoke
long term total-return prospects.
damages, as well as separate cases in which the states
1747,
of Florida Mississippi, and Texas are each suing for
now
Settlement Talks
@reimbursement of Medicaid payments made to treat
683,
For
Last month, Philip Morris and RJR Nabisco began illnesses allegedly related to tobacco:
imal
discussing a sweeping litigation settlement with anti
Although it is clearly impossible to know or quantify
old-
tobacco officials, which include state attorneys general,
plaintiffs lawyers, and public health advocates. It was a
the ultimate outcome of the settlement talks or lawsuits
n as
landmark development because it was the first time
pending against tobacco companies, it appears that an
giant PM agreed to even acknowledge the possibility, of
industrywide tobacco settlement would help the stocks:
in
OCT
a settlement. The initial proposed deal includes agree
ment by tobacco companies to accept strict marketing Operations
restrictions and to pay $300 billion in damages over the
Ona business-as-usual basis, tobacco firms appear to
next 25 years in exchange for protection from legal
be in fine shape. Although U.S. tobacco consumption is
liabilities. But an eventual settlement, if any, may well
basically flat, domestic consumers are generally buying
look much different.
more higher-margin premium cigarettes, helping to
ex
ore,
Big Tobacco is likely to demand complete immunity
keep domestic profits at respectable levels. On the other
from all litigation, while many health advocates oppose
hand, international earnings are growing at a strong
the very idea of a deal. And many in the anti-tobacco
double-digit pace. Improving economies and rising
camp have declared that $300 billion is not a large
disposable incomes around the world are giving more
se-
consumers in foreign markets the wherewithal to buy
d it
enough payment. But if the monetary demands are too
tobacco products In fact, the major multinational
age
high, tobacco firms' incentive to settle would decrease
Too, a major settlement would require congressional
tobacco firms-PM, RJR, and B.A.T Industries-are all
approval which would not come easily.
expanding their global cigarette production capacity in
order to keep up with demand
oot
Litigation
Two recent legal decisions are particularly important Investment Guidelines
for
tobacco
companies.
First
the
Hon.
William
We expect tobacco stocks to continue trading rather
ng
Osteen ruled that the Food & Drug Administration may
erratically over the next three to six months Rising
ng
regulate tobacco as a drug. This had been a topic of
speculation regarding an ultimate settlement between
negotiation in the settlement talks described above; but
Big Tobacco and its foes as well as a busy litigation
calendar through August, will probably increase the
are
the federal judge's decision transformed the issue into
law. Judge Osteen also ruled that the FDA lacks the
volatility of the stocks in this group going forward. As
ge
authority to restrict tobacco firms advertising and
such, conservative investors should avoid tobacco stocks
promotional practices. Notably, though, the Federal
for
now.
Trade Commission is now focusing more sharply on the
Nick Primavera
to
ot-
industry's marketing techniques.
ge
Composite Statistics: TOBACCO INDUSTRY
Tobacco
RELATIVE STRENGTH (Rotio of Industry to Value Line Comp.)
40
1993
1994
1995
1996
1997
1998
00-02
1200
41
132986
138308
142926
154096
160000
170000
Sales ($mill)
220000
42
14.1%
15.8%
16.9%
17.1%
18.0%
18.5%
Operating Margin
20.0%
43
3846.3
3989.8
3958.1
3971.6
4150
4200
Depreciation ($mill)
5000
14
900
15
6993.6
9067.7
10149
11467.3
13000
:14000
Net Profit ($mill)
20000
16
38.3%
38.7%
39.2%
39.7%
40.0%
40.0%
Income Tax Rate
40.0%
5.3%
6.6%
7.1%
7.4%
8.0%
8.2%
Net Profit Margin
9.1%
17
1178.2
2513.9
3173.7
2258.8
2850
3000
Working Cap'l ($mil)
4500
600
io
34622
30325
29627
30857.1
30000
30000
Long-Term Debt ($mill)
30000
36449
39427
41664
42499.4
45000
47000
Net Worth ($mill)
65000
12.0%
14.9%
16.2%
15.6%
17.5%
18.0%
% Earned Total Cap'l
21.0%
19.2%
23.0%
24.4%
27.0%
-29.0%
30.0%
% Earned Net Worth
30.5%
8.1%
12.2%
11.5%
11.0%
11.5%
11.5%
% Retained to Com Eq
15.0%
60%
49%
55%
58%
60%
60%
% All Div'ds to Net Prof
60%
14.1
11.0
11.4
11.5
Avg Ann'l P/E Ratio
12.0
Bold figures are
300
83
72
.72
Value Line
Relative P/E Ratio
85
1991
1992
1993
1994
1995
1996
1997
4.1%
4.2%
4.7%
4.8%
estimates
Avg Ann'l Div'd Yield
5.0%
Index: June, 1967 - 100
Factual material is obtained from sources believed to be reliable; but the publisher is not responsible for any errors or omissions contained herein. For the con-
To subscribe call 1-800-833-0046
fidential use of subscribers: Reprinting copying; and distribution by permission only. Copyright 1997 by Value Line Publishing Inc. ® Reg. TM-Value Line; Inc.
A ERICAN BRANDS
RECENT
PRICE
54
P/Es
RATIO
15.6
Tralling: 16.4
RELATIVE
NYSE-AMB
Median: 11.0
P/E RATIO
0.95
DIV'D
3.7%
VALUE
YLD
LINE
1576
B.A.TI
TIMELINESS
High:
26.3
30.0
35.9
40.9
41.6
47.6
49.9
40.6
38.4
47.3
50.1
56.0
Target Price Range
TIMELINESS
Relative Price Perform-
Low:
15.7
-18.3
21.1
30.6
30.9
35.6
39.0
28.5
29.4
36.6
39.9
47.8
2000
2001
2002
Relative Price
ance Next 12A
ance Next Mos.
SAFETY
SAFETY
Highest
10.0
Cash
100
2-tor-1
plit
80
(Scale: 1 Highest
(Scale: 1 Highest to 5 Lowest)
a
64
BETA 1.10
BETA 1.00
(1.00 Market)
1
48
2000-02
2000-02 PROJECTIONS
40
Ann'l Total
32
Price
Price
Gain
Return
High
40
High
70
(+30%)
10%
24
Low
30
Low
60
(+10%)
6%
20
16
Insider Deci
Insider Decisions
N
V12
NOT RE
to 87000000000
Relative
Price
Options 2
Strengt
8
to Sell
0.0.1.0
0
0.0
2
3
Shaded area
Institutional Decisions
indicates
U.S. Institut
recession
2014
30'M
40%
Percent 9.0
Buy
Buy
146
146
166
shares
6.0
to Sell
178
Options: ASE
to Sall
14
176
168
traded
3.0
Hkla(000)
15709
Hid's(000) 91539 87742 89368
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
© VALUE LINE PUB., INC.
00-02
1981
1982
72.75
78.15
Revenues per shi A
100.00
191
1.61
29.83
29.48
32.27
31.75
33.37
38.55
41:57
64.13
62.24
68.78
68.97
72.19
68.31
65.34
63.81
67.89
2.06
2.01
2.14
2.26
2.35
2.67
2.85
3.95
4.29
4.90
5.26
5:82
4.92
4.63
4.49
4.86
5.25
5.65
"Cash Flow" per sh
7.00
12.17
12.74
1.80
1.84
2.09
2.21
2.72
3.26
3.76
3.91
4.29
3.39
3.06
2.90
3.20
3.50
3.85
Earnings per sh AB
5.00
55.65
.7(
1.67
1.64
1.69
.80
.88
.89
.93
.98
1.02
1.06
1.13
1.26
1.40
1.59
1.81
1.97
1.99
2.00
2.00
2.00
2.00
Div'ds Decl'd per sh .
2.00
01:48
5
.74
67
62
74
:77
1.16
83
1.26
1.34
1.48
1.15
1.42
1.25
1.00
1.17
1.40
1.35
1.40
Cap'l Spending per sh
1.65
18.13
21.14
21.21
22.97
21.69
21.52
22.10
22.80
Book Value per sh D
26.65
102137
3
8.33
8.72
9.22
9.60
10.86
11.56
13.32
13.34
15.34
20.42
2.2.91
219.19
220.66
219.79
220.34
219.00
219.71
220.18
186.80
191.54
200.36
203.92
202.58
200.58
201:21
178.13
170.57
165.00
160.00
150.00
3.0
Common Shs Outst'g
1454.1
1454.5
5.8
6.4
7.6
:8.1
8.6
10.3
10.8
9.0
10.7
9.2
10.7
10.5
9.9
11.0
13.9
14.1
Bold fig
are
Avg Ann'l P/E Ratio
13.0
36
4.2
95
.70
71
.64
,75
.70
70
72
75
17:81
.68
.64
58
72
.95
.88
Value
Line
Relative P/E Ratio
estimates
N.44
4
8.3%
18.3%
'6.9%'
6.3%
6.2%
4.8%
4.4%
4.6%
13.6%!
4.1%
3.8%
4.0%
5.9%
5.9%
5.0%
4.4%
Avg Ann'l Div'd Yield
3.1%
8.4%
5.1%
CAPITAL STRUCTURE as of 3/31/97
9152.9
11980
11921
13781
14064
14624
13701
13147
11367
11579
12000
12500
Revenues ($mill)
15000
CAPITAL STR
Debt $1546.1 mill. Due In 5 Yrs $1000.0 mill,
10.8%
12.0%
12.8%
12.4%
12.6%
13.5%
12.7%
11.8%
11:4%
11.9%
12.0%
12.5%
Operating Margin
13.0%
Total Debt $89
LT Debt $1452 mill. LT Interest $130.0 mill.
141.0
211.9
206.0
250.5
281.2
304.1
308.9
314.4
257.5
274.8
275
275
Depreciation ($mill)
300
LT Debt
(LT interest earned: 8.5x;
total interest coverage: 6.5x)
(28%
of
Cap'l)
502.7
540.8
630.8
1745.1
806.1
883.8
686.4
618.1
543.1
R554.6
590
625
Net Profit ($mill)
750
Tinterest ear
total interest CC
40.0%
40.0%
Income Tax Rate
40.0%
B
38
41.2%
45.1%
40.6%
37.0%
34.9%
36.8%
37.9%
39.3%
39.2%
40.3%
5.5%
4.5%
-5.3%
5.4%
F-5.7%
6.0%
5.0%
4.7%
4.8%
4,8%
4.9%
5.0%
Net Profit Margin
5.0%
Pension Liability None
924.1
417.1
457.8
525.8
463.1
531.2
575.4
1555.4
752.7
178.1
200
1:250
Working Cap'l ($mill)
500
Leases,
Pfd
Stock
$12.9
mill.
Ptd
Div'd
$1.2
mill
1154.6
1598.3
1500
1500
Long-Term Debt ($mill)
1500
Pfd Stock
Incl. 444,012 shs. $2.67 pid (no par), each convert-
1631.5
2359.2
1717.4
2433.8
2551.9
2406.8
2492.4
1512.1
ible into 4.08 com. shs
(less than 1% of Cap'l)
3103.9
2660.7
3101.5
3790.0
4316.0
4301.6
4271.4
4637.5
3877.2
3684.2
3650
3650
Net Worth ($mill)
4000
Common Stoci
11.9%
12.8%
15.2%
13.6%
13.3%
15.0%
11.6%
11.6%
12.2%
1.1.8%
12.5%
13.5%
% Earned Total Cap'l
15.0%
(equivalent to 1,
16.2%
20.3%
20.3%
19.7%
18.7%
20.5%
18.1%
13.3%
14.0%
15:1%
16.0%
17.0%
% Earned Net Worth
20.0%
Common Stock 170, 181,658 shares (72% of Cap'l)
10.0%
8:7%
12:2%
-12.9%
12.6%
11.3%
11.8%
6.8%
4.7%
4.3%
5.6%
7.0%
8.0%
% Retained to Com Eq
CURRENT POSITION
1995
1996
3/31/97
49%
44%
$140%
39%
42%
43%
58%
65%
70%
63%
60%
50%
% All Div' to Net Prof
40%
CURRENT POS
Cash Assets
(SMILL)
Cash Assets
139.9
119.7
129:3
BUSINESS: American Brands is a diversified consumer products
Franklin Life Ins., 1/95; U.S. tobacco ops., 12/94. Acq. Cobra Goll,
Receivables
Receivables
984.4
1125.0
1828.4
Inventory (FIFO)
1840.2
holding company. Product lines: International tobacco (59% of '96
1/96. Employs about 28,000, has about 55,000 stkholders. Off./Dir.
2256.2
1498.8
Other
372,5
own about 1.5% of common (3/97, Proxy). Chairman & CEO
Others inventory (Avg
199.5
344.3
revenues, 41% operating income) includes Gallaher Tobacco Ltd.
Current
Current Assets
3164.0
3873.4
3800.8
the market leader in the U.K. with about a 39% market share; Office
Thomas C: Hays. President & C.O.O.: John T. Ludes. Inc.: DE
Accts Payable
301.9
475.2
NA
(11%, 10%); Hardware and -improvement (12%, 18%); Dis-
Address: 1700 East Putnam Ave. Old Greenwich, CT 06870
Accts Payable
Debt Due
Debt Due
710.8
536.8
93.7
tilled spirits (11%) 20%); and Golf & leisure (7%, 11%). Sold
Telephone: 203-898-5000. Web site:
Other
Other
1398.6
2683.3
3518.9
Current Liab
2411.3
3695.3
American Brands is preparing to pass new Cobra clubs: For the full year, each of
Current Liab.
3612.6
into history. In the coming weeks, the AB's divisions will likely post higher sales
ANNUAL RATE
ANNUAL RATES Past
Past Est'd '94-'96
of change (per sh)
10 Yrs.
Yrs.
to
company plans to spin off its U.K based and profits
change (per AD
'00-'02
Revenues
6.5%
-0.5%
7.5%
Gallaher tobacco division and rename its AB is taking steps to improve future
Sales
"Cash Flow"
'Cash Flow
6.5%
-0.5%
7.0%
non-tobacco businesses Fortune Brands. operations. It plans to merge the man-
Earnings
Earnings
5.0%
-3.5%
8.5%
Dividends
7.5%
7.0%
Nil
(Note that our estimates and projections do agement of its; hardware & home- which
Dividends Book Value
Book Value
7.5%
4.0%
3.0%
not include the effect of the proposed improvement and office segments,
spinoff shareholders would receive compose about half of what would become
8
QI
Cal-
QUARTERLY REVENUES mill) A.
Full
American Depository Receipts in Gallaher Fortune Brands And AB is consolidation
Mar.3
endar
Mar.31 Jun.30 Sep.30 Dec.31
Year
Tobacco (proposed symbol GLH) and stock U.K. cigarette production in Northern
1994
:7802
1994
3001
3041
3355
3750
13147
in Fortune Brands (proposed symbol: FO): Ireland, while expanding plant capacity
1995
8674
2792
2595
2895
C3085
11367
2738
3435
As part of the spinoff, GLH will indemnify the former Soviet Union, wherë demand
1996
2486
2920
11579
FO against any financial liability arising very strong The reorganization will
1997
10065
2845
2600
3055
3500
12000
1993
10500
1998
2900
2800
3200
12500
from tobacco-related issues Investors have costly, but should significantly
EARNINGS PER SHARE B
cheered the move, bidding AB stock up the long-term profitability of
endar
Full
Mar.31
Cal-
ender
Mar.31
Jun.30
Sep.30
Dec.31
Year
about 25% since the spinoff was announc- Brands and Gallaher Tobacco
1994
64
75
.65
1.02
3.06
60
was speculation that a spun-off Gallaher these unranked shares
ed last October Contributing to the rise We think investors should hold Assuming on
31
1995
63
.82
2.90
1996
.85
69
-1.01
may be acquired by B.A.T Industries. the tobacco spinoff goes
through
#538
1996
70
80
3.20
1997
80
75
.90
On a business-as-usual basis, AB's planned, AB stockholders will realize
-37
1998
1.05
3.50
.40
1998
85
80
1.00
1.20
3.85
share net should grow by about 10%, effective 15% dividend boost, thanks
Cap:
QUARTERLY DIVIDENDS PAID
to $3.50, in 1997, thanks to higher profits U.K. tax refund.
Full
Mar.31
Cal-
endar
Mar
Jun.30
Sep.30
Dec.
31
Year
and more-share repurchases First-quarter
though
conservative
1993
493
493
493
493
1.97
sales and earnings were up, year over would do well to exercise
1994
.492
.50
.50
.50
1.99
year, in all of the company's operating Gallaher Tobacco stock will probably
331
1995
50
50
50
.50
2.00
segments except the golf unit, which volatile and not suitable for the
.358
1996
50
.50
50
.50
2.00
reported higher sales but lower profits due averse
1997
423
May
16,
1997
.50
to elevated manufacturing costs related to Nick Primavera
yearend:
(A) Includes American Tobacco Co. and
'93, ($1.07); 90, (77c). Next earnings report
Dividend relnvestment plan available
Company's Financial Strength
Frimary earnir
Franklin Life,
due late July. (C) Next dividend meeting about
(D) Incl. intang. In '96, $3.9 bill., 86/sh.)
Stock's Price Stability
acct'a
not
&
(B) P
earnings Excludes n/r gains
July 30th. Next ex date about Aug. 3rd.
(E) In millions, adjusted for stock splits.
Price Growth Persistence
Next
ear
(losses): vd, (40c)::
(1c): '94, 58c;
F
1 dates: 1st of
June, Sept., Dec.
(F) Unranked due to the pending spinoff
Earnings Predictability
Factual material obtained from
To subscribe call 833-0046
material
is
pelieved to be reliable, but the publisher is,not is
for any
or
B contained herein. For the con-
use
of
cubs
fidential use of subscribers! Reprinting, copying, and distribution by permission only. Copyright by Value Line Pubishing, inc. ® Reg. Line, Inc.
B.A.T INDUSTRIES
RECENT
18
P/E
10.9
Trailing: 11.3
RELATIVE
ASE-BTI
Median: 11.0
P/E RATIO
0.66
DIV'D
(ADR)
PRICE
YLD
6.4%
VALUE
RATIO
LINE
1577
;0
TIMELINESS
3
Average
High:
7.0
$11.8
8.8
$15.0
$13.9
13.6
15.6
17.3
17.0
8.18.4
18.18.1
18.5
2
Relative Price Perform
Low:
4.5
Target Price Range
6.7
8.0
196
10.4
$ 10.6
$12.1
$11.4
4-12.9
A13.1
ance Next 12 Mos.
15.5
2000
2001
2002
0
SAFETY
3
Average
(Scale: Highest to 5 Lowest)
reverse
150
10
12.0
Cash
Flow P.
ADR
2
aplit
40
i4
BETA
(1.00 Market)
solit
32
18
2000-02 PROJECTIONS
24:
10
Ann'l Total
20
2
Price
Gain
Return
High
40
(+120%)
26%
IIII
16
COMP
:4
Low
30
(+65%)
18%
12
20
Insider Decisions
10:
16
12
NOT REPORTED
6
8
4
U.S. Institutional Decisions
Shaded area
6
Relative
Price
Strength
Indicates
20'M
MM
40'M
Buy
21
20
Percent 0.6
recession
23
to Sell
14
shares:
0.4
19
Hkl's(000)
15709
traded
13702
13211
0.2
Options: None
2
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
VALUE LINE PUB! INC.
00-02
$1.91
1.00
1.61
1:45
00:16
00:1:45
B:1:48
1.89
1.81
N0.1.61
1.93
1.87
1.51
1.50
1.53
71.55
381.71
16.1:65
EN1:65
12.17
Translation Rate ($/£) A
k1.65
12.74
.00
191,1.76
12.18
0.14.38
2.16.47
18.62
17.54
19.37
16.83
17.40
616.63
20.53
20.99
23.44
27.12
6'27.75
29.00
Sales per ADR
35.50
PS.65
70
74
5.00
36.91
23.1.05
1.30
00.1.42
1.53
62
75
1.91
1.49
1.56
$1.75
1.93
2.05
2.15
"Cash Flow" per ADR
2.85
05.48
50
55
1.00
2.00
*.1.14
$1.24
.46
.52
68
1.16
1.20
1.48
1.60
1.75
1.85
Earning per ADR B
2.50
05:11
#11
12
12
.32
1.65
.60
74
.88
74
47
.85
1.10
1.20
Gross Divd's Decl'd ADR
c
1.50
02.37
.38
32
43
.43
.40
.45
.47
45
5.65
:.12
.26
28
33
37
36
36
35
35
Cap'l Spending per ADR
35
2.91
3,01
3.15
3.36
3.61
4.15
4.99
4.29
4.95
3.77
3.78
4.12
4.94
4.56
5.55
6.02
6.45
7.10
Book Value per ADR
065
1454.1
1454.5
1460.3
1476.9
1476.3
1488.3
-1496.1
1520.9
1521.91
1473.2
1476.9
1448.9
1517.0
1540.5
1545.8
13.0
1543.0
1550.00
1550.00
Equiv ADRs Outst'g
DO
3.6
4.3
4.3
5.2
-6.2
7.6
9.0
6.8
9.0
25.3
22.6
19.8
12.2
11.5
10.6
9.8
.95
Bold
figures are
Avg Ann'l P/E Ratio
14.0
44
.47
36
48
.50
52
.60
.56
68
1.88
1.44
1.20
.72
75
71
.62
Value
Line
3.1%
Relative P/E Ratio
1.00
6.4%
5.1%
5.0%
3.8%
4.4%
3.5%
3.6%
6.3%
5.7%
5.2%
6.3%
6.6%
5.2%
3.4%
5.4%
6.3%
Avg Ann'l Div'd Yield
4.3
CAPITAL STRUCTURE as of 12/31/96
27857
26678
29477
24799
Total Debt $8911.3 mill. Due In 5 Yrs $4500 mil.
25696
24097
31150
32338
36233
41847
43000
45000
13.0%
Sales ($mill)
LT Debt $5800.3 mill. Interest $500.0 mill
9.2%
10.4%
11.3%
8.5%
8.9%
9.3%
9.0%
9.6%
12.6%
-10.6%
12.0%
13.0%
Operating Margin
13.5%:
300
(LT Interest earned:
454.0
445.0
441.0
225.8
342.2
320.0
363.0
390.2
430.9
395.0
450
500
Depreciation ($mill)
750
total interest coverage: 8.0x)
1487.0
1718.0
1887.0
685.2
770.4
995.7
1891.1
2013.5
2281.6
2575.3
2750
2850
Net Profit ($mill)
10.0%
(38% of Cap'l)
37.7%
36.7%
37.7%
54.6%
54.0%
41.5%
28.8%
25.4%
32.9%
34.2%
35.0%
35.0%
Income Tax Rate
35.0%
50%
5.3%
6.4%
6.4%
2.8%
3.0%
4.1%
6.1%
"6.2%
6.3%
6.2%
6.4%
6.7%
Net Profit Margin
7.1%
Leases, Uncapitalized Annual rentals $200.0 mill.
3814.0
606.0
1188.0
887.8
d1363
d196.5
174.9
344.3
590.5
344.3
Pfd Stock None
500
500
Working Cap1 ($mill)
2334.0
3852.0
3874.0
3757.7
3833.5
4207.0
3548.5
3494.5
4553.9
5800.3
5000
5000
(dimg)
Long-Term Debt ($mil)
7458.0
Common Stock 3,086 mill. common sha
6518.0
7540.0
5546.8
5589.4
5962.5
7500.0
7019.6
8571.5
9281.9
10000
11000
Net Worth ($mill)
15.0%
(equivalent to 1,543.0 million ADRs)
15.9%
17.2%
17.1%
9.0%
9.8%
11.3%
18.3%
20.7%
20.6%
18.8%
20.0%
20.0%
% Earned Total Cap'l
20.0%
20.0%
(62% of Cap'l)
19.9%
26.4%
25.0%
12.4%
13.8%
16.7%
25.2%
28.7%
26.6%
27.7%
25.0%
25.0%
% Earned Net Worth
25.0%
10.0%
13.6%
18.1%
-15.6%
NMF
NMF
NMF
14.1%
18.4%
CURRENT POSITION
11:1%
1994
$11.5%
12.0%
1995
10.5%
12/31/96
% Retained to Com Eq
10.5%
40%
32%
31%
38%
NMF
C111%
NMF
44%
2.36%
6:58%
661%
65%
60%
Cash Assets
% All Divd's to Net Prof
1924.7 2216.5 2388.9
Golf,
Receivables
1941.6 1855.4 2250.4
BUSINESS: B.A.T Industries PLC is the world's second-largest to-
ff./Dir.
Inventory (Avg Cst)
3283.4
2/95.395 (oper., prof. by seg. Tob., 63%(58%) Insur
3382.1
3567.1
Other-3
bacco company. Owns Brown & Williamson (3rd biggest in U.S.)
24%(42%); Oth:, 13%(0%). Owns 40% of Imasco (Can. tob.
&
E.O.
Current Assets
7149.7
7454.0
8206.4
and British-American Tobacco Brands Include GPC Approved,
bank.) Has 170,000 employees; 158,908 shareholders. Off. & Dir.
DE
Accts Payable
426.9
454.2
501.2
Kool and in selected markets: Benson & Hedges, Lucky Strike, and
own less than 1% of common. Chairman. P. Sheehy. Inc.: U.K.
)6870.
Debt Due
2523.0
2941.9
3111.0
Kent. Owns Eagle Star and Allied Dunbar Insurance in U.K. and
Add. Windsor House, 50 Victoria St., London SW1H ONL U.S.
DM.
Other
3855.5
3467.4
4249.9
Farmers Group Insurance in U.S. Acquired American Tobacco
add.: Landmark Sq., Stamford, CT 06901. Tel.: 203-961-0660.
ch of
Current Llab
6805.4
6863.5
7862.1
B.A.T Industries stock has been extra
ultimate tobacco settlement and a hectic
sales
ANNUAL RATES Past
Past Est'd '94-'96
volatile
recently,
owing
to
some
U.S. litigation schedule through August
of change (per ADR)
10
Yrs.
Yrs.
to '00-'02
Sales
5.5%
noteworthy developments. Last month; We have trimmed our 1997 share-net
4.0%
7.0%
iture
"Cash Flow,
7.0%
6.0%
8.5%
Philip Morris and RJR Nabisco began estimate by a nickel, to $1.75, to reflect
man-
Earnings
7.5%
6.0%
10.0%
negotiating a sweeping settlement on be- somewhat. lower expectations for B.A.T's
home-
Dividends
17.0%
3.5%
12.0%
Book Value
which
4.0%
3.0%
10.0%
half of the industry with members of the tobacco operations and a strong sterling.
anti-tobacco community. Too, a federal The company's financial services division
ecome
Cal-
QUARTERLY SALES mill)
Full
judge ruled that tobacco may be regulated has shown signs of improvement, most
dating
endar
Mar.31 Jun.30 Sep.30 Dec.31
Year
as a drug by the FDA; and RJR gained an notably at U.S.-based Farmers Group, but
rthern
1994
7802
7765
8415
8356
32338
important victory in a very controversial the gains will probably be offset by slower
city in
1995
8674
8886
9241
9432
36233
lawsuit. It is clearly impossible to know or growth in tobacco profits We expect
and is
1996
9696 10162 10486 11503
41847
quantify the eventual ramifications of elevated legal and marketing costs in the
will be
1997
10065 10435 11000 11500
43000
1998
10500 10500 12000 12000
45000
these recent events, although it appears U.S., where B.A.T's market share recently
crease
that an industrywide tobacco settlement fell from 17.5% to 16.3%, to dampen the
ortune
Cal-
EARNINGS PER ADR
Full
would help the stocks.
bottom
line
ender
Mar.31 Jun.30 Sep.30 Dec.31
Year
Neutrally ranked B.A.T shares have a Earnings prospects through 2000-2002
on to
1994
25
33
28
1.20
compelling valuation Based on the remain bright. B.A.T. is well positioned
suming
1995
35
1.48
1996
gh
50.38
48
company's present fundamentals, its U.S. in the global tobacco market, especially in
as
146
28
1:60
1997
.37
50
50
38
1.75
tobacco unit seems to carry at negative emerging markets, where rising disposable
lize an
1998
.40
:55
50
40
1.85
valuation Indeed, merely adjusting the incomes are permitting more consumers to
KB to a
GROSS QUARTERLY DIV'DS PAID
division's weight to naught would likely purchase tobacco products. In fact, the
Cal-
Full
counts
endar
Mar.31 Jun.30 Sep.30 Dec.31
Year
increase 10%-20% this equity's share price by company is substantially expanding its
cigarette-production capacity around the
aution.
1993
298
74
1994
but only aggressive investors world to keep pace with the increasing
bly be
467
47
e risk-
1995
331
533
should consider a commitment here. demand. Our model calls for 5% average
.86
1996
358
562
92
We expect B.A.T stock to continue to trade annual profit growth for the financial-
1997
423
inconsistently over the next several services segment.
6, 1997
months, owing to speculation regarding an Nick Primavera
May 16, 1997
A+
(A) At yearend
(c) Before 15% U.K. tax to U.S. residents.
1992, most dividends paid early January and
(B) Primary earnings, based on U.K. aoct'g
Includes ref'd of U.K. adv. corp. tax. Excludes
Company's Financial Strength
B++
85
mid-July.
(U.S. acct'g. not available Excludes n/r gain:
92 stock div: offer. Next div. meeting early
Stock's Price Stability
65
40
(D) In millions; adjusted for stock splits.
75
90, 40g. Next earnings report due late July
June. Next ex date about mid-August. After
Price Growth Persistence
45
Each ADR is equivalent to 2 common
Factual material is obtained from i
Earnings Predictability
50
3-0046.
believed to be reliable, but the publisher is not responsible for any errors or omissions contained
For the con-
use of subscribers. Reprinting, copying, and distribution by permission only. Copyright 1997 by Value Line Publishing, Inc. ® Reg. IM-Value Line. Inc.
subscribe
IMASCO LTD
RECENT
38
P/E
14.3
Trailing: 14.6
RELATIVE
PRICE
Median: 12.0
P/E RATIO
0.87
DIV'D
TSE-IMS.TO
H
YLD
3.2%
VALUE
RATIO
LINE
1578
TIMELINESS
3
Average
High:
20.0
19.8
PH
14.8
20.3
19,1
18.4
20.7
20.8
22.1
27.3
34.8
40.0
Relative Price Perform-
Low:
12.1
11.4
Target Price Range
11.9
13.9
12.8
13.3
15.8
ance Next 12 Mos.
$17.1
16.0
19.3
24.4
32.3
2000
2001
2002
TIMEL
SAFETY
Above
80
Relati
Average
ance
(Scale: 1 Highest to 5 Lowest)
2-fc
split
60
SAFET
TA
.85
(1.00 Market)
50
(Scale:
2000-02 PROJECTIONS
40
A
Ann'l Total
2-for-1
plit
32
Price
Gain
Return
20
24
High
60
(+60%)
15%
20
Low
45
(+20%)
8%
16
Insider Decisions
High
Relative Price Strength
12
Low
10
Insid
NOT REPORTED
8
6
to Buy
Institutional Decisions
Shaded area
Onlines
indicates
1
2004
20%
40'88
4
Percent 3.0
recession
Insti
Buy
to Sell
shares
1
2.0
0
Hid's(000)
179
traded
1.0
157
400
Options: TCO
to Buy
1981
to Sell
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
P.VALUE LINE PUB:; INC.
00-02
Hid's(0)
11.64
14.06
14:07
19.99
24.45
23.61
19.35
25.17
24.00
21.97
22.78
33.54
33.44
34.84
37.20
40.92
38.15
39.40
Revenues per sh AF
1981
45.45
.88
1.12
1.29
1.59
1.82
1:46
1.48
1.92
-2.09
1.78
1.98
2.80
3.07
3.67
3.82
4.11
4.25
4.50
"Cash Flow". per sh
6.20
3.6
66
:81
95
1:13
1.20
87
.98
1.26
1.44
1.11
1.28
1.49
1.69
2.16
2.30
2.55
2.65
2.85
Earnings per sh B
4.25
18
20
25
33
.38
44
.36
.52
.56
.64
.64
.68
74
.78
.96
1.08
1.20
1.32
Div'ds Decl'd per sh c
1.70
57
:59
51
93
.85
.98
1.00
1.27
.98
.87
50
49
63
47
1.44
1.05
1.10
1.15
Cap'i Spending per sh
1.40
3.12
4.23
4.81
6.06
6.94
7.96
8.56
8.62
9.45
9.92
10.48
11.34
12.35
13.71
13.47
14.65
15.85
17.10
Book Value per sh D
22.90
188.22
193.01
204.22
217.80
217.82
238.25
238.38
238.38
238.49
238.23
238.49
238.20
238.37
233.48
232.29
230.61
228.00
226.00
Common Shs Outst'g G
220.00
1.
7.1
7.9
'8.9
19.7
11.0
20.0
15.9
10.6
12.1
15.2
11.9
12.5
11.2
8.7
10.2
11.1
Bold
res are
Avg Ann'l P/E Ratio
12.0
3009
86
.87
75
.90
.89
1.36
1.06
.88
.92
1.13
.76
76
.66
.57
.68
.70
Value
Line
Relative P/E Ratio
85
3.7%
3.1%
3.0%
3.0%
2.8%
2.5%
2.3%
3.9%
3.2%
3.8%
4.2%
3.7%
3.9%
4.1%
4.1%
3.8%
estimates
Avg Ann'l Div'd Yield
3.0%
1.
CAPITAL STRUCTURE as of 12/31/96
4.1
Debt $2091.0 mill. Due in 5 Yrs $594.0 mill."
4613.4
6000.6
5724.7
5234.0
5432.5
7989.8
7972.0
8134.0
8641.0
9436.0
8700
8900
Revenues ($mill) AF
10000
LT Debt $1966.0 mill. M LT Interest $150.0 mill.
10.6%
10.4%
11.6%
12.5%
12.1%
CAF
13.6%
14.5%
17.6%
16.9%
16.5%
18.5%
19.0%
Operating Margin
22.0%
Tot:
Incl. $15.0 mill. capitalized leases.
118.9
158.5
157:7
158.6
168.6
314.1
328.0
346.0
350.0
356.0
365
375
Depreciation ($mill)
425
LT
(LT interest earned: 8,0x)
(36% of Cap'l)
245.0
314.3
366.1
291.4
331.6
380.4
424.0
521.0
546.0
601.0
610
655
Net Profit ($mill)
945
24.0%
19.5%
21.1%
23.7%
22.5%
30.6%
Leases, Uncapitalized Annual rentals $150.0 mill.
30.5%
37.7%
38.0%
39.3%
40.0%
40.0%
Income Tax Rate
40.0%
(LT
Pension Liability None
5.3%
5.2%
6.4%
5.6%
6.1%
4.8%
5.3%
6.4%
6.3%
6.4%
7.0%
7.4%
Net Profit Margin
9.5%
COV
644.5
566.4
616.5
273.1
168.7
427.3
428.0
363.0
379.0
531.0
790
620
Working Cap'l ($mill)
960
2454.1
Per
Pfd Stock $135.0 mill. Pfd Div'd $9.0 mill
2143.6
1840.6
2072.3
1835.8
1958.9
1896.0
1927.0
1781.0
1966.0
1700
1450
Long-Term Debt ($mill)
1500
'94.
Incl. 270 shs. 6.9% Perpetual First Preference
2247.2
2261.0
2610.4
2719.9
2855.2
3057,8
3100.0
3337.0
3264.0
3514.0
3745
4005
Net Worth ($mill)
5170
Shares Series D
(2% of Cap'1)
6.8%
9.7%
10.4%
78.2%
8.7%
-9.4%
10.2%
11.5%
12.5%
(12.3%
12.5%
13.5%
% Earned Total Cap'
15.0%
Pfd
10.9%
.13.9%
14.0%
Common Stock 230,614,624 shs. (62% of Cap'l)
10.7%
11.6%
12.4%
13.7%
15.6%
16.7%
17,1%
16.5%
16.5%
% Earned Net Worth
18.5%
7.2%
8.5%
9.2%
4.7%
(6.1%
7.1%
7.7%
10.2%
Co
10.0%
10.1%
9.0%
9.0%
% Retained to Com Eq
11.0%
CURRENT POSITION
1994
1995
12/31/96
40%
44%
43%
62%
54%
(Ad
Cash (SMILL) Assets
50%
.46%
38%
43%
43%
46%
46%
% All Div ds to Net Prof
41%
148
71
15
Receivables
384
356
531
BUSINESS Imasco Ltd. is a diversified Canadian company. Im-
CU.
Federal of Rochester, 4/91. Sold Peoples Drug Stores, 9/90; UCS.
Inventory
18012
838
-1158
perial Tobacco controls about 67% of the Canadian cigarette mar-
Group, 9/95; Roy Rogers, 8/96; First Federal; 3/97; Hardee's Food
Ca:
Other
ket (Player's and du, Maurier). CT Financial Services is market
Re
Current Assets
Systems; 4/97. '96 Deprec. rate: 14.2%. B.A.T Inds. owns about
1333
1265
1704
Inv
leader in personal finacial services with 470 branches. Shoppers
40% of common. Offcs: and Dirs. own less than 2% of common ('96
Ot'
Accts Payable
680,
693
889
Debt Due
Drug Mart/Pharmaprix has 819 drug stores. Genstar, Development
125
annual). Pres. & C.E.O.; Brian Levitt. Inc Canada. Addr. 600'de
C.
712
54
Other
219
139
159
creates residential communities. Acquired Roy Rogers, 4/90; First
Maisonneuve Blvd: West, Montreal, H3A 3K7: Tel.: 514-982-9111
Ac
Current
Liab.
(1,970
886
1173
Imasco has pared off a couple of non- pace of acquisitions, but only in its es-
De
Oti
ANNUAL RATES Past
Past Est'd '94-'96
strategic assets. The company divested tablished fields. Imasco purchased
Cu
of change (per sh)
Yrs.
Yrs.
to
:00-02
its U.S. financial subsidiary, First Federal, Meloche, Monnex, a Montreal-based prop-
Revenues OT. 5.0% 10.5% 3.0%
Al
"Cash Flow
9.0%
14.5%
8.0%
Savings of Rochester, for C$928 million erty and casualty insurance business, for
Earnings
8.0%
13.0%
10.5%
March. Imasco recorded a C$246 million, $142 million in April. Merger mania has
S:
Dividends
9.5%
9.0%
10.5%
or 1.07-per-share, nonrecurring gain also hit' the Canadian banking market;
Value
7.0%
7.0%
8.5%
the sale in the first quarter. Although and the company will likely be requiredoto
E
D
Cat
QUARTERLY REVENUES ($ mill) A
Full
First Federal has made a solid contribu- make further investments to compete ef-
endar
Mar. Jun 30
Year
tion! ton the bottom line over. the past fectively down the road. In addition to ac
1994Y
1855 2081 2102 2096
8134.0
several years, heavy consolidation within quisitions, some of the proceeds from the
1995
2042 2232 2202 2165
8641.0
the U.S. banking industry has (recently [aforementioned sales will be utilized to
1996
2110 2375 2389 2562
9436.0
placed the subsidiary at somewhat of repurchase stock and reduce debt
1997
2690 2000 2000 2010,
8700
competitive disadvantage, Imasco also sold, Meanwhile continues to build
1998
2150 2200 2250 2300
8900
ts-Hardee's Food Systems month for on its dominant position in the Cana-
Cal
$
EARNINGS PER SHARE A B
Full
approximately C$457 million. Unlike First dian cigarette market. The company
endar
Mar.31. 30 Sep.30 Dec.31
Year
Federal; Hardee's has long been now commands 67,3% crofit Canadian
1994
64
63
2.16
batross around the company's neck, lower- cigarette sales, up from 66.2% the previous
1995
63
2.30
ing (earnings) by C$10 million in 1996 year. However. a recently enacted Canadi-
1996
META
9.74d
70
2.55
despite repeated turnaround, efforts The an law. severely restricts the promotion of
1997
70sam7 70
2.65
Hardee's sale will result in a write-off of tobacco products Imasco is currently fight-
1998,
55
75
78
77
2.85
deferred tax assets of-roughly C$60 mil- ing the new legislation in court.
Cal-
QUARTERLY DIVIDENDS PAID Co
Full
lion, plus an additional C$60 million provi- Investors should do better elsewhere.
endar.
Mar.31, Jun.30 Sep.30 Dec.31
Year.
sion to cover, liabilities and costs associa- The stock's 3-anto, 5-year appreciation
1993
185
:185
185
185
74
ted: with the deal. Nevertheless given Im- potential is not too exciting Moreover, the
1994
:195 1951 5.195 :195
78
asco's looming battles on the tobacco company may be subject to costly tobacco
1995
24g 24, 24 24
.96
(see below) the divestiture is certainly litigation over the long haul. The equity is
1996
27
27
27.7
27
1,08
welcome news
1997,
30
an average selection for the year ahead
The company will likely pick up the Perry H.: Roth
May 16, 1997
(A) Cal. yr. beg. 12/87; ended Mar. 31, from
$1.07. Next egs., rpt: due late July. (C) Before:
plan avail. (D) Incl. intang. 96: $264 mill.
15% tax to U.S. res: Next div'd about Aug.
Company's Financial Strength
VARI
'86. (B) Prtm. egs. Excl. nonrec. gain (loss):
'81, 3c; '82, 3c; '83, 6c; '86 (13c); '88, (46c);
14/sh. (E) Mostly avg. cost. (F) Fin. sub.
10. Goes ex about Aug. 17:Dlvd pmt. dates:
Stock's Price Stability
85 m)
Incl. on eqty, basis until 91, consol. thereafter.
'90, 2c; '93, (6c); '94, (7s); ($1,39); 97,
30th of Mar.; June, Sept. Dec. . Div'd reinvest.
(G) in mill., adj. for splits. (H) All figs. in Cdn. $.
Price Growth Persistence 07510 6511
fidential use of subscribers. Reprinting, copying, and distribution by permission publisher only. Copyright
Factual
material
is
obtained
from
Earnings Predictability
sources
believed
to
be
reliable,
but
the
la
not
responsible
for any enrors or omissions contained herein. For the con-
by Value Line Publishing, Inc, R Reg. TM Value Line, Inc.
To subscribe call 8330046.
1578
RECENT
PRICE
41
P/E
RATIO
14.2(
Trailing: 15.4
RELATIVE
Median: 12.0
P/E RATIO
0.86
DIV'D
PHILIP MORRIS NYSE-MO
YLD
4.3%
VALUE
LINE
1579
Price Range
2001
2002
TIMELINESS
2
Above
High:
6.5
10.4
8.5
15.3
17.3
27.3
28.9
25.9
21:5
31.5
39.7
46.6
Target Price Range
Relative Price Perform-
Average
Low:
3.7
6.1
6.7
8.3
12.0
16.1
23.4
15.0
15.8
18.6
28.5
36.0
2000
2001
2002
80
ance Next 12 Mos.
SAFETY
3
100
80
Average
80
50
(Scale: 1 Highest to 5 Lowest)
3-for-1-spl
in
64
$
BETA 1.20
32
(1.00 Market)
48
2000-02 PROJECTIONS
40
24
Ann'l Total
32
20
Price
Gain
Return
4-101-1
pin
16
High
95
(+130%)
26%
24
10.0
Cash
low
1.97%
12
Low
65
(+60%)
16%
20
Insider Decisions
16
10
8
JJASONDJF
12
C.O-D
0.0.0
C
6
Buy
000001000
000
000
000
Options 00003.0.003
to Sell 0-1-10-22-003
00
au
"
Shaded area
Rela
Institutional Decisions
Price
Strength
indicates KTU
FUL
recession
ruths
20%
XN
40'M
Percent 9.0
Be
to Buy
281
320
346
shares
6.0
to 1448 Jr389
Options: ASE
325
traded
3.0
00-02
Hid's{000) 529126 466787 516588
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
©VALUE LINE P.UB., INC.
00-02
45.45
6.20
7.62
3.88
4.33
4.4.74
"
5.57
8.90
16.9.75
8:11.45
16.07
18.42
20:48
21.07
23.15
$25.45
26.50
$28.46
30.63
34.80
Sales per sh
55.00
05.2.87
"Cash Flow" per sh
19
7.00
4.25
02:30
.35
41
.90
5.03
1.43
801.77
82.07
$2.31
0:1.97
2.52
10.3.29
3.75
4:35
81.70
50.22
26
30
42
C 1.01
1:28
L*1.51
1.82
1.35
1.82
06.2.17
-2.56
3.00
JCM3.55
Earnings per sh
6.05
1.40
38.08
10
12
14
.26
.42
.52
64
78
87
1.01
$1.47
1.70
404.90
Div'ds Decl' per sh
$2.50
22.90
JJ.134
.30
12
24
25
45
49
#
57
.56
.61
.67
.85
10%
90
Cap'l Spending per sh
1.05
220.00
071.10
1.21
141.34
V1.40
$1.65
24.1.98
2.40
2.77
3.44
$4.30
054.53
4.48
4.42
5.00
5.61
-5.85
6.40
6.95
Book Value per sh
14.05
12.0
3009.6
3021.5
2999.6
2913.5
2864.4
2854.3
2839.5
2772.4
2785.6
2778.7
2759.6
2806.0
2631.3
2558.6
2493.5
2431.3
2400.00
2300.00
Common Shs Outst'g
2000.00
.85
C-9.3
8.4
8.8
8.5
8.2
10.6
11.8
10.3
11.7
11.6
14.8
14.4
13.5
10.3
11.4
-12.6
Bold
are
Avg Ann'l P/E Ratio
OR 13.0
1.13
°.67
72
79
.86
.89
.86
.95
.87
.80
.68
.76
.79
Value
Line
Relative P/E Ratio
95
3.0%
.93
74
.79
4.1%
4.6%
4.6%
4.7%
4.8%
3.8%
3.4%
4.5%
3.5%
3.5%
2.8%
3.0%
4.7%
5.4%
4.9%
4.5%
estimates
Avg Ann'l Div'd Yield
3.1%
10000
CAPITAL STRUCTURE as of 12/31/96
22.0%
27695
31742
44759
51169
56458
59131
60901
65125
66071
69204
73500
80000
Sales ($mill)
Total Debt $13,933 mill. Due In 5 Yrs $7,970 mill
18.2%
16.1%
17.2%
16.5%
20.3%
21.0%
21.5%
425
Operating Margin
LT Interest $945 mill.
17.0%
16.3%
17.2%
18.7%
20.5%
22.0%
LT Debt $11,827 mill.
945
704.0
779.0
1194.0
1367.0
1497.0
1542.0
1619.0
1722.0
1671.0
1691.0
1750
1780
Depreciation ($mill)
40.0%
(LT interest earned: 12.3x; total Interest
1864.0
2064.0
2794.0
3540.0
4202.0
4939.0
3568.0
4725.0
5478.0
6303.0
7210
8170
Net Profit ($mill)
12110
9.5%
coverage: 10.0x)
44.3%
44.6%
41.6%
43.9%
43.4%
42.6%
42.4%
42.5%
41.4%
41.0%
42.0%
42.0%
Income Tax Rate
42.0%
(45% of Cap'l)
960
6.7%
6.5%
6.2%
6.9%
-7.4%
8.4%
5.9%
7.3%
8.3%
9.1%
9.8%
10.2%
Net Profit Margin
12.2%
Pension Liability $743 mill. in '96 VS. $712 mill. in
11396.0
-182.0
437.0
1007.0
-770.0
643.0
d731.0
943.0
606.0
-323.0
385
:525
Working Cap'l ($mill)
750
94
5170
one
5222.0
15882
13646
15285
13420
13407
14358
14085
-12324
11827
12500
12500
L'ong-Term Debt ($mill)
15.0%
Pfd Stock None
02211
6823.0
7679.0
9571.0
11947
12512
12563
11627
12786
13985
14218
15345
15970
Net Worth ($mill)
18.5%
17.4%
10.2%
14.1%
15.3%
18.4%
21.5%
16.4%
19.9%
22.9%
26.0%
27.5%
30.5%
% Earned Total Cap'l
29.5%
Common Stock 2,431,346,191 shs. (55% of Cap'l)
27.3%
26.9%
29.2%
29.6%
33.6%
39.3%
30.7%
37.0%
39.2%
44.3%
47.0%
51.0%
% Earned Net Worth
43.0%
11.0%
(Adjusted for 3-for-1 stock split paid 4/10/97)
41%
P16.3%
15.2%
17.7%
18.3%
20.2%
232%
11.0%
17.5%
18.2%
20.0%
20.5%
22.5%
% Retained to Com Eq
22.0%
CURRENT POSITION 1994 1995 12/31/96"
40%
43%
39%
38%
40%
41%
64%
53%
54%
55%
57%
56%
% All Div' to Net Prof
50%
UCS
(SM/LL)
Food
Cash Assets
184
1138
240
BUSINESS: Philip Morris Companies Inc. is a leading consumer
(1%,
2%) Has a 50% share of U.S. Industry shipments of
Receivables
4382
4508
4466
about
Inventory (LIFO)
7987
7862
9002
products company with four major segments: tobacco (53% of 96
cigarettes Acq'd General Foods, 11/85; Kraft, 12/88;
(96.)
Other
1355
1371
1482
revs. 67% of op. prof.) Incl. Martboro, Benson & Hedges, Merit, Vir-
Suchard AG,8/90; Freia Marabou, 4/93. Has 151,000 employees,
de
Current Assets
13908 14879 15190
ginia Slims, Lark, food (40%,27%) Ind. coffee, Post cereals, and
144,400 stockholders. FMR Corp. owns 7.9% of stock; off /dir., less
Accts Payable
3789 3364 3409
packaged foods Kool-Aid, Oscar Mayer, Kraft, Velveeta,
than 1% proxy). Chrmn C.E.O.: Geoffrey C. Bible: Inc. VA
Debt Due
893 2048 2106
Miracle Whip); Miller beer (6%; 4%); and financial evcs/real est
Address: 120 Park Ave., New York, NY 10017. Tel.: 212-880-5000
es-
Other
8283 8861 9352
sed
Current Liab.
12965 14273 14867
Philip Morris is finally entertaining in the neighborhood of $200 to $300 billion
op-
the prospect of a comprehensive to- over the next 25 years The company's por-
ANNUAL RATES Past
Past Est'd 94'96
for
of change (per sh)
10 Yrs.
5 Yrs.
to
'00-'02
bacco litigation settlement. The compa tion alone could well exceed $5 billion an
has
Sales
15.5% 8.0% 12.5%
ny, along with its domestic tobacco peers, nually. As large as this amount seems,
et;
"Cash Flow"
17.0% 10.5% 16.0%
started preliminary discussions last month boosting cigarette prices by a relatively
Earnings
17.5% 11.5% 18.5%
to
with White House aides and attorneys modest $0.25 to $0.50 per. pack should
Dividends
22.0% 18.5% 12.5%
Book Value
12.5% 6.0% 17.0%
general from several states. More than 20
cover these costs.
c-
states are suing the tobacco industry for The company is well positioned for
Cal-
QUARTERLY SALES mill)
Full
endar
Mar.31 Jun.30 Sep.30 Dec.31
Year
medical costs, and there are at least 15 ad- strong earnings gains: in 1997 and
to
ditional class-action lawsuits pending. A 1998. At retail, Phillip Morris cigarettes
1994
15500 16414 16710 16501
65125
recent court ruling has granted the FDA now account for 50.3% of all brands sold in
1995
16517 17129 16689 15736
66071
Id
1996
17491 17509 17414 16790
69204
partial jurisdiction over tobacco, a move the U.S., up from 48.7% during the same
1997
18217 18483 18700 18100
73500
vigorously opposed by the industry. period last year The company's market
1998
19500 19800 20200 20500
80000
Mounting litigation and attorney fees have share of the premium segment is even
EARNINGS PER SHARE
A
pushed Philip Morris to the bargaining higher, currently standing at 57.5%. In the
Cal-
Full
is
Mar.31 Jun.30 Sep.30 Dec.31
table; but the world's leading tobacco firm meantime, Philip Morris continues to
endar
Year
will work hard to get favorable terms be- make strong inroads overseas. Foreign to-
1994
45
47
47
43
1.82
1995
53
56
57
51
fore signing on the dotted line
bacco revenues and income both increased
2.17
1996
63
66
67
60
2.56
R.J. Reynolds' recent court victory in by a healthy 15% in the first quarter.
1997
73
77
78
72
3.00
Florida should provide some leverage These shares are still timely. The possi-
1998
.88
91
90
86
3.55
for the industry. A Florida jury ruled bility of a tobacco settlement, coupled with
QUARTERLY DIVIDENDS PAID
that Reynolds was not culpable for Jean the aforementioned court victory, has
Cal-
Full
endar
Mar.31 Jun.30 Sep.30 Dec.31
Year
Connor's cancer. The plaintiff's lawyer had lifted the stock price of late Nevertheless,
1993
217 217 .217 217
87
previously won a case against the industry the equity's 3- to 5-year appreciation
1994
217 23 23 275
.95
last summer: Big Tobacco's first notable potential still remains attractive:
1995
275 275 275 333
1.16
court defeat. Philip Morris and its compe- (Note: All per-share figures are adjusted
1996
333 334 40 40
1.47
titors are seeking immunity from future for the 1 stock split paid 10/97.)
1997
40
40
lawsuits in exchange for payouts ranging Perry H. Roth
May 16, 1997
(A) Based on avg. shares out. Excl. nonrecur.
Next earnings report due mid-July. (B) Next
ment plan available. (c) Incl. intangibles. '96:
Company's Financial Strength
A+
gains (losses): 84, (30#); '85, 8c; '87, (1c); '88,
div'd meeting about May 27th. Goes ex about
$19.0 bill.; $7.81/sh. (D) In millions, adjusted
Stock's Price Stability
50
29c; '89, 16c; "91, 1.29); '93, (54c); 95, (3c).
June 11th. Approx. payment dates: 10th of
for stock splits. (E) Excl. fin'l services and real
Price Growth Persistence
70
Earnings may not sum due to changes In s/o:
January, April, July, October. - Div'd reinvest-
estate subsidiary.
Earnings Predictability
70
Factual material is obtained from sources believed to be reliable, but the publisher is not responsible for any errors or omissions contained herein. For the con-
To subscribe call 1-800-833-0046.
fidential use of subscribers. Reprinting copying, and distribution by permission only. Copyright 1997 by Value Line Publishing, Inc. ® Reg. TM-Value Line, Inc.
RJR'NABISCO HLDGS NYSE-RN
RECENT
30
P/E
10.5
Trailing: 11.2
RELATIVE
Median:NMF
P/E RATIO
0.64
DIV'D
PRICE
RATIO
YLD
6.8%
VALUE
LINE
1580
TIMELINESS
3
High:
275.6
355.6
472.5
491.9
0.0
65.0
58.1,
46.3
40.0
34.6
35.3
38.9
Average
Target Price Range
Relative Price Perform-
Low:
155.0
172.5
220.0
448.8
0.0
28.1
39.4
21.9
26.9
25.3
25.1
27.0
2000
2001
2002
ance Next 12 Mos.
3
"Cash Flow" sh
SAFETY
Average
100
-for-5
(Scale: 1 Highest to 5 Lowest)
80
reverse splt
TA 95
(1.00 = Market)
64
2000-02 PROJECTIONS
48
Ann'l Total
40
Price
Gain
III
Return
THE
th
32
High
70 (+135%) 28%
24
Low 50 (+65%) 19%
20
Insider Decisions
16
JJASONDJF
Relative
Price Strength
12
to Buy 001000000
Options 000000000
to Self 0.0000.0000
e
Shaded area
Institutional Decisions
indicates
6
20"
2024
40"
recession
Percent 12.0
to Buy
113
114
141
shares 8.0.
to Sall
117 10111 106
traded 4.0
Options: PHLE, ASE, CBOE
Hid's(000) 187429 180522 221121
TOB
RJR Nabisco was taken private by
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
© VALUE LINE PUB.; INC.
00-02
Kohlberg Kravis Roberts & Co. in 1989. In
318.69
375.75
207.15
119.64
66.82
69.33
66.36
56.42
58.68
62.37
67.90
73.10
Sales per sh A
88.00
Feb., 1991, RJR resumed public trading of
37.01
44.30
5.89
7.28
6.20
10.33
4.06
5.59
6.34
7.38
8.20
9.00
"Cash Flow" per sh:
12.50
its common stock at a price of about $30 a
23.50
29.60
d19.30
d5.95
1.10
2.60
d.25
2.05
2.30
2.62
3.00
3.50
Earnings per sh B
5.00
(adjusted for splits). On January 26,
8.80
10.30
1.50
1.85
2.05
2.50
Div'ds Deci'd per sh c
3.50
1
RJR completed an initial public offer-
18.92
25.31
8.47
3.67
2.05
2.29
2.70
2.46
2.73
2.71
3.30
3.10
Cap'l Spending per sh
4.00
ing of 19.5% of its Nabisco food subsidiary
122.05
128.95
20.08
21.50
35.96
35.35
33.26
34.55
35.87
35.13
42.45
44.25
Book Value per sh D
48.00
at a price of $24.50 a share. In March, 1995
49.47
45.13
61.62
116.00
224.33
226.93
227.60
272.33
272.81
273.57
265.00
260.00
Common Shs Outst'g E
250.00
KKR sold its remaining interest in RJR.
12.0
9.7
48.6
18.1
15.7
12.6
11.8
Bold
figures are
Avg Ann't P/E Ratio
12.0
CAPITAL STRUCTURE as of 12/31/96
:80
81
3.10
(-1.10
1.03
.84
.74
Value
Line
Relative P/E Ratio
.85
Debt $9,928 mill. Due in 5 Yrs $4,735 mill.
3.1%
3.6%
5.2%
5.7%
estimates
Avg Ann'l Div'd Yield
5.8%
LT Debt $9,256 mill.
LT Interest $850 mill.
(Total interest coverage: 3.0x)
(46% of Cap'l)
15766
16956
12764
13879
14989
15734
15104
15366
16008
17063
18000
19000
Sales ($mill) A
22000
20.3%
20.5%
24.6%
28.4%
27.1%
29.6%
16.7%
24.1%
22.9%
23.2%
23.5%
23.5%
Operating Margin
25.0%
Pension Liability None
652.0
621.0
1535.0
1306.0
1228.0
1782.0
1168.0
1152.0
1171.0
1174.0
1200
1200
Depreciation ($mill)
1500
1209.0
1393.0
d1172
d462.0
368.0
776.0
d3.0
1764.0
834.0
898.0
1000
1150
Net Profit ($mill)
1600
Pfd Stock $1,495 mill. Pfd Div'd $275.0 mill.
41.5%
39.1%
43.2%
46.7%
NMF
44.4%
41.4%
47.7%
42.0%
44.0%
Income Tax Rate
44.0%
Series B 9.25% Pld., 12.04 mill. shs. Series C 10%
7.7%
8.2%
NMF
NMF
Conv: Pid.; 53.35 mill. shs. each convertable Into 2
2.5%
14.9%
NMF
5.0%
5.2%
$5.3%
5.6%
6.1%
Net Profit Margin
7.3%
shs. with automatic conversion 5/15/97 Trust
1717.0
1901.0
106.0
d1089
165.0
730.0
202.0
d1231
436.0
445.0
500
500
Working Cap'l ($mill)
500
Originated Pid. C, 10% yield, 37.956 mill: shs.
3884.0
4975.0
21948
16955
13149
13541
12005
8883.0
9429.0
9256.0
9000
8500
Long-Term Debt ($mill)
7000
(7% of Cap'l)
6211.0
5819.0
1237.0
4289.0
8419.0
8376.0
9070.0
10908
11283
11102
11250
11500
Net Worth ($mill)
12000
14.2%
15.4%
8%
4.0%
4.3%
6.6%
2.5%
5.8%
6.1%
5.9%
7.5%
8.0%
% Earned Total Cap'l
11.0%
Common Stock 273.574 mill. shs.
19.5%
23.9%
NMF
NMF
4.4%
9.3%
NMF
7.0%
7.4%
8.1%
9.5%
10.0%
% Earned Net Worth
12.0%
(326.502 mill. primary shs.)
(47% of Cap'1)
12.2%
15.4%
NMF
NMF
2.0%
7.0%
NMF
3.9%
2.4%
1.9%
3.0%
3.5%
% Retained to Com Eq
5.0%
CURRENT POSITION
1994
1995
12/31/96
39%
35%
56%
28%
NMF
(SMILL)
52%
72%
80%
70%
70%
% All Div' to Net Prof
70%
Cash Assets
423 234 252
Receivables
934
1334
1418
BUSINESS: RJR Nabisco Holdings Corp. is a major tobacco and
Milk-Bone, Planters, Life Savers, Snack Well's, and Parkay. Has
Inventory (LIFO)
2580
2489
2636
food concern. R.J. Reynolds Tobacco is the second largest domes-
about 79,700 employees. FMR Corp.: owns 10.6% of common;
Other
426
503
445
tic producer (about 25% market share) of cigarettes. Brands include
Sanford C. Bernstein, 7.4%; Off. & Dir., less than 1% (3/97 proxy)
Current Assets
4363
4560
4751
Winston, Salem, Camel, Doral, Vantage, & More. Nabisco is the
Chairman President & C.E.O. Steven Goldstone Inc DE
Accts Payable
548
755
691
largest U.S. maker of cookies (Orea, Chips Ahoyl) and crackers
Add 1301 Avenue of the Americas, New York, NY 10019 Tel
Debt Due
2266
418
672
Other
2780
2951
2943
(Ritz, Wheat Thins). Other products lines include Fleischmann's,
212-258-5600. Web site: http://www.rjmabisco.com.
Current Liab
5594
4124
4306
RJR Nabisco shares have been more RJR first-quarter operating results
L
RATES
Past
Past
Est'd
'94-'96
volatile than usual as of late. In the included some potential concerns
or change (per sh)
Yrs.
Yrs.
to '00-'02
past month, RJR and Philip Morris began The domestic and international tobacco
Sales
14.0%
14.5%
7.0%
discussing a sweeping litigation settlement units registered 5% and 11% volume
"Cash Flow"
13.0%
12.0%
Earnings
18.0%
15.0%
with anti-tobacco forces, a federal judge declines, respectively, compared to the
Dividends
17.0%
15.0%
ruled that the FDA may regulate tobacco year-earlier period And the Nabisco
Book Value
-9.5%-
6.5%
3.0%
as! drug, and RJR won a controversial Holdings food division's year-over year
Cal-
"QUARTERLY SALES mill.) AVE
Full
lawsuit in which the jury found that the sales fell by 4%
endar
Mar.31 Sep.30 Dec.31
Year
company was not responsible for the death but 1997 share net should still rise
1994
3572
3784
3966
4044
15366
of a smoker who died of lung cancer. It is by about 15%, to $3.00 thanks to a lower
3540 4063 4324
16008
clearly impossible to know or quantify the tax grate, further cost-reduction measures,
3886 4203 4349 4625
17063
eventual ramifications of these develop- and continuing share repurchases (RJR
3779 4400 4821 5000
18000
ments, although it seems likely: that an recently raised its dividend and announced
4000 4500 5000 5500
19000
industrywide tobacco settlement would that it is doubling its buyback program to
Cal-
EARNINGS PER SHARE BE
Full
help the stocks
$200 million:) Domestic tobacco profits will
ander
Mar.31 Jun.30 Sep 30 Dec.31
Year
We expect neutrally ranked RJR likely be flattish, marked by higher sales
311.600
5/400
2.10
stock to continue trading erratically and lower volumes; international tobacco
.60
2.30
over the short term. Indeed, speculation earnings, which were hurt by a temporary
64
.68
73
2.62
regarding an ultimate settlement between importing problem in the former Soviet
62
70
88
3.00
Big Tobacco and its foes, as well as a busy Union-in the first quarter, should rebound
1998
75
80
1.00
3.50
litigation calendar through August will nicely for the balance of the year; and food
Cal-
QUARTERLY DIVIDENDS PAID c
Full
probably increase tobacco stocks volatility profits will probably trend higher as the
ander
Mar.31, Jun 30 Sep.30 Dec.31
Year
going forward Accordingly, risk-averse unit's current reorganization progresses
investors should avoid these shares. For additional information on Nabisco
1994
However, aggressive accounts may want to Holdings, refer to our report on page 1488.
375
375
375
1:13
consider a commitment here, given that Earnings growth through 2002 should
375
4625
4625
4625
1.76
RJR stock's total-return prospects through also approximate 15% per year.
4625
5125
2000-2002 are above average
Nick Primavera
May 16, 1997
(A) Excludes exclse taxes
(C) Dividend reinstated 2/95: Next dividend
(D) Includes intangibles. In '96, $20.3 billion,
Company's Financial Strength
8
(B) Primary earnings. Excludes net n/r items:
meeting early August: Next ex date June 11th:
$74.20/sh
2
Stock's Price Stability
35
96, (86c); 95, (77c); '94, (80c); 93, (50c);
Payment dates about the 1st of January, April,
(E) in millions, adjusted for stock split:
Price Growth Persistence
92, (1.60c). Next earnings report late July
July, and October.
Earnings Predictability
Factual material is obtained from sources believed to be reliable, but the publisher is not responsible for any
or omissions contained herein. For the con-
fidential use of subscribers: Reprinting, copying, and distribution by permission only. Copyright 1997 by Value Line Publishing, Inc. © Reg. TM-Value Line, Inc.
To subscribe call 1-800-833-0046.
580
UST INC.
RECENT
28
PET
11.6(
Trailing: 11.5
RELATIVE
NYSE-UST
PRICE
RATIO
0.70
DIV'D
Median: 15.0
P/E RATIO
YLD.
5.7%
VALUE
LINE
1581
lange
2002
TIMELINESS
Below
High:
5.7
8.1
10.5
15.4
18,3
34.0
35.4
32.8
31.5
36.0
35.9
34.1
Target Price Range
Relative Price Perform-
Average
Low:
3.8
4.9
6.1
9.8
12.4
16.4
25.4
24.4
23.6
26.6
28.3
25.5
2000
2001
2002
100
ance Next 12 Mos.
80
Above
100
SAFETY
Average
GL60)
64
(Scale: Highest to 5 Lowest)
Cash
Flow'p ch
split
13.0 x
AT841
48
BETA .95
(1.00 Market)
40
48
2000-02 PROJECTIONS
32
40
Ann'l Total
32
24
Price
Gain
Return
20
High
45
(+60%)
17%
24
2-for-
spin
201
I
16
Low
35
(+25%)
11%
20
Insider Decisions
12
2-for
split
A
JASONDJF
Relative
Price
Strength
12
LUD
0.0
8
to Buy
000000100
006
Shine
0
main
Options
100022010
Boild
6
to Sell
300032000
Shaded area
Indicates
files
Institutional Decisions
recession
20'M
20TH
40'M
Percent 9.0
Buy
124
113
139
shares
6.0
144
148
139
traded
3.0
Options CBOE
(mm/yyyy)
2
Hk's(000) 112867 112876 113061
1998
© VALUE LINE PUB.: INC.
00-02
00
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
50
1.28
1.44
in
1.70
2.00
2.16
2.32
2.61
2.81
3.13
3.59
4.30
4:95
5:42
6.24
7.01
7.60
8.05
8.70
Sales per sh
10.95
M
00
23
.29
38
44
.48
54
67
.82
95
1.14
1.37
1.60
1.82
2.12
2.43
2.68
2.60
2.70
"Cash Flow" per sh
3.25
50
20
25
30
36
40
46
56
71
.82
.98
1.18
1.41
1.61
1.87
2.16
2.42
2.40
2.50
Earnings per sh A
3.00
A
00
10
12
15
18
22
25
30
37
46
55
.66
80
.96
1.12
1.30
1.48
1.62
1.50
Div'ds Decl' per B
*1.80
'0
13
24
13
17
14
07
12
10
11:
19
14
16
28
14
19
24
30
DO
.30
Cap'l Spending per sh
00:40
0
85
.99
1.18
1.27
1,46
1,66
1.82
2.06
2.21
2.23
2.29
2.45
2.26
1.84
1.55
1.53
1.80
2.05
Book Value per sh
280
183.86
180.00
175.00
Common Shs Outst'g c
10
0
219.57
221.87
225.12
221.41
222.21
223.25
220.37
219.96
218.20
212.98
210.98
211.04
204.76
196.11
189.19
15
8.9
8.5
12.7
12.6
10.9
10.5
11.7
11.4
15.7
15.2
19.8
21.6
17.7
14.9
13.8
13.4
Bold figures
are
Avg Ann'l P/E Ratio
13.0
71
1.19
1.13
1.26
DE
1.08
94
1.07
1.17
89
78
.95
1.31
1.05
.98
28
.84
Value
Line
Relative P/E Ratio
.95
5.7%
5.5%
3.8%
4.0%
4.9%
5,1%
4.6%
4.6%
3.6%
3.7%
2.8%
2.6%
4.6%
estimates
3.4%
4.0%
4.5%
Avg Ann'l Div'd Yield
3.6%
0
CAPITAL STRUCTURE as of 12/31/96
576.1
618.5
682.5
764.7
907.3
1044.4
1110.4
1223.0
1325.4
1396.8
1450
1520
Sales ($mil)
1750
0
Total Debt $250.0 Due In 5 yrs. $250.0 mill.
44.0%
44.9%
46.2%
48.2%
49.2%
50.3%
53.3%
54.7%
55.6%
55.8%
51.5%
50.0%
Operating Margin
48.5%
LT Debt $100.0 mill.
LT Interest $5.8 mill
16.2
17.7
16.5
19.6
22.6
24.5
26.7
28.2
29.1
28.3
30.0
32.0
Depreciation ($mill)
40.0
(26% of Cap'l)
130.9
162.2
190.5
223.3
265.9
312.6
346.9
387.5
429.8
464.0
435
440
Net Profit ($mill)
480
44.2%
37.9%
36.8%
36.6%
37.6%
37.8%
38.8%
39.5%
39.0%
37.7%
39.0%
39.0%
Income Tax Rate
40.0%
Pension Liability $39 mill. in '96 Vs. $37 mill. in
22.7%
26.2%
27.9%
29.2%
29.3%
29.9%
31.2%
31.7%
32.4%
33.2%
30.0%
28.9%
Net Profit Margin
27.4%
'95
197.3
221.1
187.5
197.2
209.9
249.0
228.4
221.1
144.9
137.6
125
150
Working Cap'l ($mill)
200
Pfd Stock None
37.1
21.8
6.8
3.1
40.0
125.0
100.0
100.0
150
150
Long-Term Debt ($mill)
200
401.1
453.3
482.3
473.9
482.9
516.6
463.0
361.7
293.6
282.0
325
365
Net Worth ($mill)
12450
Common Stock 183,855,7433 shs (74% of Cap'l)
30.4%
34.5%
39.1%
46.9%
55.1%
60.5%
69.0%
79.9%
109.6%
122.2%
92.0%
86.0%
% Earned Total Cap'l
74.5%
(Options Exercisable 7.5%)
32.6%
35.8%
39.5%
47.1%
55.1%
60.5%
74.9%
107.2%
146.4%
164.5%
134.0%
120.5%
% Earned Net Worth
106.5%
16.0%
17.8%
18.5%
22.2%
26.1%
28.0%
31.8%
44.7%
60.4%
66.2%
44.0%
37.0%
% Retained to Com Eq
34.0%
CURRENT POSITION
1994
1995
12/31/96
51%
50%
53%
53%
53%
54%
58%
58%
59%
60%
67%
60%
% All Div'ds to Net Prof
60%
(SMILL)
Cash Assets
50.7
69.4
54.5
BUSINESS: UST Inc. Is the leading U.S. producer and marketer of
Michelle, Conn Creek, Columbia Crest Villa Mt. Eden wines. Sold
Receivables
65.9
69.6
77.9
Inventory (LIFO)
237.7
256.1
271.4
smokeless tobacco with approximately an 80% share of the moist
broadcasting stations; 12/85; cigarette paper (distribution rights,
Other
27.6
30.5
40.4
smokeless segment. Smokeless tobacco products accounted for
3/93. Has about 4,465 employees, 11,907 stockholders. Officers
Current Assets
381.9
425.6
444.2
about 86% of 1996 sales, 97% of operating profits. Significant
and directors own about 2.5% of stock (3/97 proxy). Chimn., Pres.
Accts Payable
20.5
24.9
27.9
brands: Copenhagen, Skoal, Skoal Long Cut, Skoal Bandits moist
and C.E.O.: Vincent A. Gierer, Jr. Incorp, DE. Address 100 West
Debt Due
100.0
150.0
snuff Borkum Riff, Don Tomas pipe tobacco; Chateau Ste
Putnam Avenue, Greenwich, CT-06830. Telephone: 203-661 1100
Other
140.3
155.8
128.7
Current Liab.
160.8
280.7
306.6
USTs earnings may retreat somewhat
Despite stepped up marketing initiati
Past Est'd '94-'96
in 1997. The company continues to lose
and new product rollouts, UST has not
ANNUAL RATES Past
of change (per sh)
10 Yrs.
Yrs.
to 00-02
market share to lower-priced private label
been able to expand usage of smokeless to
Sales
12.5%
13.5%
8.0%
brands, and little has been done to reverse
bacco beyond its core demographics: young
"Cash Flow'
17.5%
16.0%
5.0%
this unfavorable trend Two of USTs top
single males, residing primarily in the
Earnings
18.0% 16.5% 5.5%
Dividends
20.0%
19.0%
5.5%
officers resigned abruptly in February, dis-
South or Midwest Moreover, increased
Book Value
1:0%
-6.0%
9.5%
pleased with its strategic direction.
awareness of health risks continues to thin
QUARTERLY SALES mill)
Volumes for moist smokeless tobacco prod-
the ranks of this constituency. The compa-
Cal-
Full
endar
Mar.31 Jun 30, Sep.30 Dec.31
Year
ucts declined by roughly 4% in the first
ny attempted to court the regular tobacco
quarter. This follows a 3% decline in the
smoker through the introduction of Skoal
1994
280.4 310.2 310.4 322.0
1223.0
306.1; 340.2 334.3 344.8
1325.4
final period of 1996. The average selling
Flavor Packs in late 1995, but consu
1995
1996
327.8 350.5 366.0 352.5
1396.8
price for a can of UST's moist smokeless
response has not been too promising UST
1997
340.5 369.5 370 370
1450
tobacco is now slightly more than $1.90,
is hoping for a better reception for its new
1998
360
385
385
390
1520
nearly double that of the discount brands.
Copenhagen Long Cut brand, released last
EARNINGS PER SHARE A
The company is extremely reluctant to month. The company valso instituted
Cal-
Full
endar
Mar.31 Jun 30 Sep.30 Dec.31
Year
engage in pricing wars, but may soon have "free gear for (lids" promotion last year,
1994
42
48
48
49
1.87
little choice. Should the wide price dis- similar to Philip Morris popular mer
1995
49
55
55
57
2.16
parity between UST and its competitors chandise giveaway program. Still, UST
1996
54
62
65
61
2.42
remain cin effect, the company's share of will be hard-pressed torachieve significant
1997
55
60
65
60
2.40
the moist snuff market could drop below earnings gains over the next two years
1998
57
63
68
62
2.50
75% by the end of the year, down from Investors should avoid this equity.
Cal-
QUARTERLY DIVIDENDS PAID B
Full
80% in 1996 At its recent annual meeting, These shares are not timely. Furthermore,
endar
Mar.31 Jun.30 Sep.30 Dec.31
Year
management stated that a new marketing the stock's 8 to 5-year appreciation pc
1993
24
24
24
24
96
plan would be unveiled during the second tial is below average Although its legal
1994
28
28
28
28
1.12
half of this year, possibly involving price risks appear smaller than those of the tra-
1995
325
325
325
325
1.30
cuts
ditional cigarette companies, they may
1996
37
37
37
37
1.48
Overall growth for smokeless tobacco still prove to be quite costly down the road
1997
405
products has leveled off considerably. Perry H. Roth
May 16, 1997
(A) Primary earnings. Incl. (loss) from discon-
standing. Next earnings report due mid-July
cember: . Div'd reinvestment plan available
Company's Financial Strength
tinued operations: 81, (3c). Excl. net nonrecur
(B) Next div'd meeting about June 12th. Next
(C) In millions, adjusted for splits (D) Partly
Stock's Price Stability
70
ring gains: '85, 1c; '93; 1c. Quarterly figures
ex date about June 1st. Approximate payment
FIFO.
Price Growth Persistence
60
may not sum due to changes in
out
dates: 15th of March, June, September, De-
Earnings Predictability
100
Factual material is obtained from sources believed to be reliable, but the publisher is not responsible for any errors or omissions CO
For the con-
To subscribe call 0046
fidential use of subscribers. Reprinting. copying. and distribution by permission only. Copyright 1997 by Value Line Publishing. Inc. R Heg. IM-value Line, Inc.
07/17/97 THU 15:03 FAX 202 6222633
001
Office of Economic Policy
Department of the Treasurv Washington. D. C. 20220
FAX
Date:
7/17/97
Number of pages including cover sheet: 2
Name
FAX Number
Phone Number
To:
Mark Mazur
395-6809
395-5147
From:
Jon Gruber
202.622.2633
622-0563
REMARKS:
Urgent
For your review
Reply ASAP
Please comment
07/17/97 THU 15:03 FAX 202 6222633
4.
002
Question:
Does deductibility reduce net revenue to the government from tobacco
companies?
Answer:
Yes. Revenue would be greater if the tobacco payment were not deductible.
Nonetheless, focusing on the tobacco industry alone, the revenue loss to the
government from deductibility is likely to be offset by a revenue gain from higher
corporate receipts. To the extent that the settlement amount is fully reflected in
increased spending on tobacco products (e.g., through an increase in the price of
cigarettes), receipts will rise by the full amount of the settlement payment, and
there will be no change in tobacco company's taxable income. The increase in
reccipts offsets the effect of the deductibility of the settlement payment by tobacco
companies. In essence, deductibility allows the tobacco companies to serve as a
"pass through" for collecting the settlement payment from consumers, without
affecting their net tax liability.
Question:
Since allowing tobacco settlement payments to be deductible reduces net revenues
to governments from the agreement, should the payments be deductible?
Answer:
Under present tax law, businesses are allowed to deduct in computing net income
ordinary and necessary business expenses paid or incurred in carrying on a trade
or business. Deductible amounts include amounts paid as compensatory or
punitive damages if they arise in the ordinary course of a taxpayer's business.
Absent a deduction for ordinary and necessary business expenses, income (and tax
liability) would be overstated. On tax policy grounds, allowing a deduction for the
settlement payments is appropriate.
7/18/97
Tobacco Settlement
Economic analysis group
Inclined to believe that excise tax would
lead to price morease slightly higher
than excise tax
Gr uber./Gotbavm will work on putting these
Figures in normal budget terms (by fiscal year)
mear por ating
Options for raising more money
(1) $1 per pack excise tax
x$15 B /yr
(2) get rid of volume edjistment (lower volume
of tobacco sales
lewer sayment by ¥ 1/4)
doing this shifts some of the briden
From smokers to shereholders
(3) auction questity licenses for cigarette celes
Lerry policy makes analyzy to climate change
Bruce: God of this exercise are
(1) reduce smoking
(2) not allow compenies to avoid oblystions
to reduce smoking
Lerry: Industry gets insurance efemist being put
into benerapty from Demage curds;
2
Industry gets to administer its own excise tex
as a wey to fund payments for damages
Issue is what else Admin can get From this
did (blc industry seems to be deing OK, besed on
the economics)
Lookbeck mechenism
Lerry think it should not be Formed like an
excise tax
Cold be done on Company. by company besis
to make sure that each company makes serious
efforts to (w Free rider)
Gruben: Should size of lookback penalty
(probably devble) and also should eliminate the
75% obetement of senalty baced on "good/efforts"
to reduce Smoking
Faith
That material is the secret Treasury
stuff designed to make lerry leck good.
From Treasury
(Gruber)
July 18, 1997
ON THE LOOK-BACK SURCHARGE
The settlement contains a "look-back" provision that attempts to provide economic incentives to
tobacco firms to achieve "dramatic and immediate reductions in the number of underage
consumers of tobacco products." Manufacturers would face a surcharge if tobacco-use reduction
targets for underage users are not met. The surcharge would be imposed on the basis of a
comparison between actual underage teen tobacco use percentages and specific youth smoking
targets. The stated goal of the lookback surcharge was to "approximate the present value of the
profit that the cigarette industry would earn over the life of underage smokers". Manufacturers
could petition the FDA for partial abatement of the surcharge if they have acted in good faith and
in full compliance with the Act.
PROBLEMS WITH THE CURRENT STRUCTURE OF THE LOOK-BACK
A number of problems exist with the current structure of the look-back surcharge:
The lookback penalty $80 million per percentage point of underage use in excess of the
reduction target -- was determined as part of the negotiations between the Attorneys General
and the industry. But our estimates indicate that the present value to firms of the profit
stream from the underage smokers in excess of the reduction target is about twice as large as
the cost of the surcharge as specified in the agreement. As a result, this surcharge amount
offers little incentive for tobacco companies to reduce teen smoking, beyond the natural
reductions that will occur due to
Underage Daily Tobacco Use Percentages and Targets
higher cigarette prices. The
Michigan Survey Data and Settlement Look Back Targets
accompanying figure compares
Percent
20
projected teen smoking reductions
History
Projected path from
due to price changes alone with
100% price markup
the specified lookback targets¹
15
Base = 15.2%
If the specified surcharge is too
low, so that youth smoking falls
10
With 125%
through the price effect only, our
price markup
estimates suggest that the
surcharge payments would begin
5
at roughly $100 million per year,
Use reduction targets
and rise to roughly $250 million
per year after the final step down
0
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
in the reduction targets.
The % price markup is relative to the per pack penalty payment; estimates include 15%
reduction in use from sales and marketing restrictions.
I The reductions shown in the chart are from price effects alone and do not account for the possible
reduction in youth smoking that could result from the marketing restrictions and other components of the agreement
intended to help reduce underage smoking.
2
The partial abatement -- under which firms could receive up to 75% abatement of the
surcharge -- would significantly erode the economic incentive of the surcharge. Many
believe that it would be very easy for firms to qualify for the abatement. If firms did qualify
for this abatement, then the lookback surcharge would only be one-eighth as large as the
profit stream from increasing youth smoking.
An additional difficulty is the "free rider" problem. Because the targets are specified for use
of non-brand-specific tobacco, individual firms have the incentive to keep their sales to teens
while others would bear the surcharge cost from that use. As each firm has these same
incentives, in practice it is less likely that the reduction targets would be met.
A stronger approach would advocate that the goal should be to eliminate underage tobacco
use, not merely reach the targets specified in the agreement. Six percent of high school teens
would continue to smoke cigarettes on a daily basis even if the ultimate teen reduction target
(60% reduction in 10 years) was fully met.
OPTIONS THAT MORE EFFECTIVELY REDUCE YOUTH SMOKING
While maintaining the broad structure of the deal, adjustments could be made to attempt to make
the look-back actually work to provide the incentive to reduce underage tobacco use.
Eliminate the surcharge abatement: As a first principle, the partial abatement of the
surcharge should be eliminated.
-
The industry likely would strongly oppose any effort to eliminate the abatement -- the
industry claims that it does not have direct control over whether teens smoke or not and
therefore should not be held directly accountable for all of their use.
-
The Attorneys General accepted the abatement provision in part because they viewed it as
a vehicle to assure that firms would actually pay the surcharge without first challenging it
in court and thereby delaying their payment and also because the hearing process would
provide the opportunity for an annual public relations campaign against smoking.
Option 1: Increase the size of the surcharge
As noted above, our calculations indicate that the base surcharge amount should be increased to
at least $160 million per percentage point. An amount above this level would truly penalize the
industry for not reducing youth smoking, and would as a result increase their incentives to do so.
If youth smoking only falls through the price effect (that is, if even the increased penalty
level does not impact youth smoking) the level of payments with a $160 million base
3
surcharge would run in the range of about $200 million initially, and roughly $450 million
when the steps down in the reduction targets occur.²
-
If other settlement provisions or firm efforts succeed in reducing teen smoking below the
levels shown in the chart, the level of surcharge payments would be lowered accordingly.
Option 2: Eliminate the double counting provision
Under the agreement as negotiated, the surcharge is reduced to account for underage smokers
on whom a surcharge was paid in earlier years.
We see little justification for not repeatedly penalizing the companies for youths that do not
quit. Under this so called "double counting" provision, once a youth has begun smoking (and
the company has been fined), there is no remaining incentive for the industry to discourage
continued smoking.
Furthermore, given existing data constraints, the double counting provision is
administratively unworkable. Without data that follows teens over time to assess whether
they continue to smoke, the double counting adjustment will simply be a rough
approximation based on the share of cohorts that do smoke.
Our estimates indicate that by eliminating the double-counting provision, the current level of
the surcharge ($80 million) would provide an effective incentive to firms to reduce underage
smoking.
-
Initially, there is no change in effectiveness because the double counting provision would
not be in effect. In succeeding years, however, the present value of profits generally
would be about ½ the size of the surcharge payment (rather than twice the size, as we
estimate for the current settlement parameters).
Once again, if even this increased penalty has no effect, the estimated levels of annual
surcharge payments would begin at roughly $250 million, and grow to $500 to $600 million
annually.
-
But, as noted above, the level of payments would be lowered if there were greater success
in reducing teen smoking.
2 These amounts would be the equivalent of about I or 2 cents per pack.
4
Option 3: Look-back penalty based on all underage smoking
An alternative approach is to have a goal of eliminating underage smoking, not merely
reaching the reduction targets specified in the agreement. With such a goal, the level of
industry payments under the look-back could be determined relative to total underage
tobacco use. 3
In this option, the look-back penalty would operate in a fashion similar to that of the
agreement, except the reduction targets would be respecified for the ultimate goal of
eliminating underage smoking; also, there would be no double-counting provision and no
abatement. The ultimate target would be for a weighted survey response of 1 percent or less
-- the 1 percent to allow for possible survey error.
Because it may be unreasonable to expect to get current teens who smoke to stop, the
reduction targets would be reduced on an annual basis to account for the turnover in the 13 to
17 year-old age group of the survey. Current estimates show a weighted average of 18
percent of underage daily smokers. A path with immediate reduction targets would therefore
be as follows4:
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6 and after
16%
13%
10%
7%
4%
1%
As in the no double-counting option presented above, a base surcharge level of about $40
million per percentage point would be required to make the look-back effective. Based on
the currently projected use levels without further reduction efforts, the level of payments
would start out at zero in the first year and then rise steadily until the payments continued at
about $520 million each year.
-
Once again, the level of payments would be lowered if there were greater success in
reducing teen smoking.
Tobacco firms likely would strongly oppose this approach as being unnecessarily punishing
and that they don't have that much control over underage users.
³The settlement's targets were based on the earlier FDA rule analysis that had a generally stated goal of
cutting teen smoking in half.
A path with a delayed or more gradual decline -- as in the settlement -- could be used, but the stated goal
is "dramatic and immediate" reductions.
5
THREE REMAINING ISSUES
1. Free Rider Problem: As noted above, there is a significant free rider problem.
One option would be to expand the Michigan Survey to ask the underage tobacco users about
their brand preferences and use. Additional funding -- albeit small relative to the size of the
agreement -- might be required to make changes to the survey and perhaps increase the
survey size. 5
If firm- or brand-specific reduction targets were to be specified, however, the problem of the
double counting would become even more severe and all the more difficult to calculate.
2. Reliance on Michigan Survey data: The use of the University of Michigan's High School
Drug Use survey as the basis for determining actual teen use and the surcharge payment presents
a number of problems:
To our knowledge, no Federal expenditure or tax policy is based on private survey data. This
deal, depending on how it is ultimately implemented, could establish such a precedent and
that may be undesirable. One option would be to have the Federal government take over the
survey.
Errors in measurement in the survey could have profound effects on the amounts paid by
tobacco firms.
High school teens may end up having the incentive to misrepresent their true use status and
lie on the survey -- if it became known that the cost of cigarettes and other tobacco products
were affected by responses to the survey, teen smokers may recognize that admitting use on
the survey would lead to higher prices for their habit. Careful attention would have to be
paid to the design of the survey to deal with this issue.
3. How should the target be defined? It isn't clear what the best measure of underage use is.
Health care professionals argue that the daily users are already "hooked" and that the better
measure for attempted reduction is to target the 30-day user numbers. However, the current
reduction targets wouldn't be effective until the fifth year, meaning an entirely new cohort of
teens would be in place. Also, it likely would be more difficult to get reductions in the
number of daily users -- thereby establishing a more difficult and more meaningful target to
hit.
5 At the current level of use, the survey would have to be about 5 times larger in order to be confident that
the reported percentage use of a particular brand would be accurate to within plus or minus 1 percentage point.
6
Another issue is whether the target measure should be in terms of the number of users -- as in
the survey -- or in terms of number (volume) of cigarettes smoked by teens. The industry
reportedly advocated using the volume rather than the number of smokers. The Attorneys
General advocated the number of users under the pretext that they wanted to reduce the
number of smokers and not just have the possibility of the same number of smokers but at,
say, 1/4 a pack rather than ½ a pack a day.
From Treesury (Gruber)
July 18, 1997
OTHER ALTERNATIVES
Moving beyond the structure of the settlement, several other alternatives exist that could be used
and that would boost government receipts:
1. Higher excise tax
One way to boost prices, reduce use, and capture additional government revenues is to impose a
higher excise tax on cigarettes. It is widely accepted that teen smoking (and overall smoking as
well) declines as the price increases -- yet total revenues would actually increase.
Rough estimates indicate that a $1 increase in the excise tax on cigarettes would generate
about $15 billion in additional tax revenue each year -- and at the same time generating a
38% decline in overall cigarette sales, and a 38% decline in the number of teen smokers.
2. No volume adjustment
- Josh Gotberm says that going to d
deller revenue adjustment would be
The current settlement uses a volume adjustment to adjust the size of the annual penalties an
paid by firms -- ultimately $25 billion per year before the volume adjustment. The intermediate
volume adjustment would reduce the size of the penalty because of the decline in sales -- god
roughly 22% over ten years -- that will occur under current trends and with the price
increases associated with the penalty payments.
Eliminating the volume adjustment would guarantee a higher stream of payments that
would not be eroded in the event that firms raise prices and the quantity of sales declines.
In fact, under the current agreement, firms may have the incentive to boost prices in the
effort to capture greater profits. This would occur because the penalty payments would
decline with volume but firms would only have to pay 25% of any excess profits.
While the existing structure of the settlement would raise $197 billion over 25 years, with
no volume adjustment, $252 billion would be raised.
3. Auction quantity licences
A final alternative would be to target overall tobacco use and establish quantity restrictions (with
reduced quantity over time) for tobacco sales. Such an approach could be implemented by
auctioning the rights to sell a given quantity of tobacco products (perhaps defined in terms of tar
and nicotine in the product).
This approach has the desirable feature that it would guarantee the decline in tobacco use
over time.
The auction approach would rely on the private market to solve the rationing problem that
accompanied the declining quantity.
From Treesury
04:28 PM
PRELIMINARY
07/16/97
Table 1
Net Payments to all Governments from the Tobacco Settlement
Payment Reflected in Price of All Products
100% Pass Through
(1996 $'s Millions)
PDV
Base Payment
368,500
231,910
Gross Volume Adjusted Payment
293,566
187,547
Federal Excise Tax Leakage
(13,397)
(9,025)
State Excise Tax Leakage
(18,151)
(12,227)
Total Gross Excise Tax Leakage
(31,548)
(21,252)
Net Volume Adjusted Payment
262,018
166,296
(Pre-offset)
Fixed
GDP
[
Income Tax Offset
(65,504)
(41,574)
Individual
(55,679)
(35,338)
assumption
Corporate
(9,826)
(6,236)
Net Volume Adjusted Payment
196,513
124,722
(including offset)
Department of the Treasury
Office of Tax Analysis
04:30 PM
PRELIMINARY
07/16/97
Table 2
Sources of Net Yearly Payments to all Governments from the Tobacco Settlement
Payment Reflected in Price of All Products
100% Pass Through
(1996 $'s Millions)
Year
Base Payment
Gross Volume
Net Volume
Net Payment
Adjusted Payment
Adjusted Payment
Fixed GDP
1998
10,000
10,000
8,665
6,498
1999
8,500
7,601
6,497
4,873
2000
9,500
8,365
7,179
5,384
2001
11,500
9,867
8,495
6,372
2002
14,000
11,656
10,062
7,547
2003
15,000
12,298
10,657
7,993
2004
15,000
12,247
10,661
7,995
2005
15,000
12,198
10,664
7,998
2006
15,000
12,137
10,655
7,991
2007
15,000
12,072
10,641
7,981
2008
2009
mmmm
15,000
12,012
10,629
7,972
15,000
11,951
10,616
7,962
2010
15,000
11,891
10,601
7,951
2011
15,000
11,832
10,586
7,939
2012
15,000
11,772
10,569
7,926
2013
15,000
11,713
10,550
7,913
2014
15,000
11,655
10,531
7,898
2015
15,000
11,596
10,511
7,883
2016
15,000
11,538
10,490
7,867
2017
15,000
11,480
10,468
7,851
2018
15,000
11,423
10,444
7,833
2019
15,000
11,365
10,421
7,815
2020
15,000
11,309
10,396
7,797
2021
15,000
11,252
10,370
7,778
2022
15,000
11,196
10,344
7,758
2023
15,000
11,140
10,317
7,738
Total
368,500
293,566
262,018
196,513
Department of the Treasury
Office of Tax Analysis
04:30 PM
PRELIMINARY
07/16/97
Table 3
PDV of Sources of Net Yearly Payments to all Governments from the Tobacco Settlement
Payment Reflected in Price of All Products
100% Pass Through
(1996 $'s Millions)
PDV
PDV
PDV
PDV
Year
Base Payment
Gross Volume
Net Volume
Net Payment
Adjusted Payment
Adjusted Payment
Fixed GDP
1998
10,000
10,000
8,665
6,498
1999
8,182
7,317
6,254
4,691
2000
8,803
7,751
6,652
4,989
2001
10,258
8,801
7,578
5,683
2002
12,021
10,008
8,640
6,480
2003
12,398
10,165
8,809
6,607
2004
11,935
9,744
8,482
6,362
2005
11,489
9,342
8,167
6,126
2006
11,059
8,948
7,855
5,892
2007
10,646
8,568
7,552
5,664
2008
10,248
8,206
7,262
5,446
2009
9,865
7,860
6,981
5,236
2010
9,496
7,528
6,711
5,033
2011
9,141
7,210
6,451
4,838
2012
8,799
6,906
6,200
4,650
2013
8,470
6,614
5,958
4,468
2014
8,154
6,335
5,724
4,293
2015
7,849
6,068
5,500
4,125
2016
7,555
5,812
5,284
3,963
2017
7,273
5,566
5,075
3,806
2018
7,001
5,331
4,875
3,656
2019
6,739
5,106
4,682
3,511
2020
6,487
4,891
4,496
3,372
2021
6,245
4,684
4,317
3,238
2022
6,011
4,487
4,145
3,109
2023
5,787
4,297
3,980
2,985
Total
231,910
187,547
166,296
124,722
Department of the Treasury
Office of Tax Analysis
Tobacco briefing for Bruce Reed
7/11/97
Dealis probably positive For tobacco industry
One concern raised is the language providing &
sent -of entitrust immunity allowing understry to
"colude" on enti-smoking activities, including
making sure that price increases 8 through to
consumers *stick
granted is vigned call be sweeping
Justice Dept is worsed b/c the entitrest immunity
Treasury estimates that revenues raised over 25
years world not be $368B but only $189B or
Reesons:
(1) lenner smoking estimates in the future
- responsetaprice T ( lewer dened) I
($84B) over 25yrs also secular decline overtime ($44B) (1.6% peryear
(2) current excise tax revenue
(3) excise tax offset ($60B)
Goverz5 yrs
Treasury estimates that "youth smoking" penelty is only
about helf as large as the present volue of 95%of
getting another young person to be e Smoker. Also, the
penalty gets rebated it the company can sher it mide
p
"food feith" effort to reduce youth Smoking So the
penelty imposed wold be only 1/5 to 1/2 co large co the
PV oF profits from getting P new smoker,
Single year revenue numbers when fully phesed- in
is probably 7-10B (not 110B, I edvertised)
Bruce wents grap to focuson her to modify "lookback
provisions "..(-yevth smoking) that are perceived
inadequate
Also think about recepturing profits, edvertising
restricture, & incentines to develop sefer cigarettes.
From
CEA/Treasury
Economic Effects of the Tobacco Settlement
Discussion Agenda
July 11, 1997
I. Impact of the Settlement on the Tobacco Manufacturing Industry
Overall the industry is in very good shape and could be made better by the settlement.
A critical issue here is whether the settlement facilitates collusion that could lead to even
higher prices than are implicit in the payment and higher industry profits; both FTC and DOJ
expressed serious concern about the antitrust immunity.
Wall Street analysts see tobacco stocks as a good buy if the settlement goes through.
Uncertainy about whether it will go through probably explains the timid response in the
market so far. In large part, the analysts' positive assessment reflects a negative view of
tobacco company stocks in the absence of a settlement.
The tobacco manufacturing industry represents a tiny piece of the labor market. It employs
about 41,000 people, or only 0.03 percent of the 119.5 million workers on non-farm payrolls.
By comparison, the economy generates between 100,000 and 200,000 new jobs every month.
The companies with a large domestic market share and a strong overseas presence should do
fine; Liggett was marginal to begin with and might be tipped over the edge by the settlement.
II. Impact on prices and smoking
The industry payment will operate like an excise tax equivalent to about 62 cents per pack
once the base value reaches $15 billion per year.
Other aspects of the settlement may increase the degree of non-competitive pricing so that
the price rises by more than the amount of the implicit excise tax and industry profits
increase. This could be especially serious with antitrust immunity.
To the extent that the price goes up by more than the implicit excise tax, the discouraging
effect on smoking will be larger.
Large price increases will discourage smoking but increase the burden on continuing smokers
(which would disproportionately affect those below the median income).
The price increase should have an important impact on youth smoking because youth
smoking is more responsive to price changes than adult smoking.
The reduction in smoking would produce substantial positive health effects.
III. Impact on other sectors
One study estimates job losses in tobacco and downstream industries might total about 6,500
after 8 years from an annual price increase of 2.1 percent, with most concentrated in the
Southeast tobacco region. The price increase resulting from the settlement would probably
be twice as large, so job losses could be larger as well.
The overall impact on other sectors should be small.
Although over 140,000 farms engage in tobacco farming, many engage in other activities as
well (The average impact of reductions in demand due to a 62 cent rise in cigarette prices
would be about $885 a farm on a tobacco crop worth $18,000 a farm)
IV. Budgetary Effects
If the pass-through of the excise tax is only about 1-for-1, the actual amount of money
collected will be less than the base value due to secular decline in demand and price-induced
reductions. Reduced volume will also result in less other revenue, such as excise taxes, for
the Federal government. Preliminary estimates suggest the actual payments could be half to
two-thirds the full value of the base payments.
A valuation of the settlement payments should be expressed on a present value basis, not
simply as a cumulative sum over an arbitrary 25 years. This can take another third off the
expressed value of the settlement (over and above the adjustment for reduced volume).
The settlement will result in higher Federal budget outlays over time, primarily in Social
Security because less smoking means people live longer.
Treasury estimates that ≈2%π
V. The "look-back" and youth smoking
Suc Security costs m75
The look back penalty for failing to meet targets for youth smoking reduction was meant to
years
approximate the expected lifetime profits to the industry of hooking a young smoker.
The penalty may be only half expected profits. But even if the penalty were about equal to
expected profits, that would merely make the industry indifferent about attracting a youth
smoker. To penalize them would require something like treble damages.
The industry is likely to demonstrate "good faith" efforts to reduce smoking which gives
them a rebate of much of the penalty even if they do not achieve their target.
75%
VI. Important incentive effects
vil pridby industry
The industry has little incentive to fight individual suits, which will largely be paid out of the
settlement fund subject to a cap. As residual claimants to the settlement fund, States and the
Federal government may not want to see successful lawsuits.
The advertising ban does not cover important methods of advertising, creating an incentive
to shift advertising into those areas.
L₂ about 1/2 of advertising
but get all of the benefit when they attract an extra youth smoker because the penalty is based
A free-rider problem exists for the look-back (individual companies pay only part of the cost dollars cover
is
on industry performance).
Consumers may have incentives to switch to higher tar cigarettes or smoke more intensively by beni
Substitution of cross-licensing for patent and trademark protection reduces incentive to
develop new safer products.
Efreement
DRAFT,
July 10, 1997
FACT SHEET
ON THE U.S. TOBACCO INDUSTRY
Production
The United States was the world's second largest producer of leaf tobacco
in 1995, accounting for about 9 percent of the estimated 14.0 billion pounds that
were produced worldwide.
Top 10 Leaf Tobacco Producers - 1995
Million
Share of
Pounds
Total (Pct.)
1.
China
5,180
37
2.
United States
1,323
9
3.
India
1,156
8
4.
Brazil
877
6
5.
Turkey
464
3
6.
Zimbabwe
463
3
7.
Indonesia
375
3
8.
Italy
292
2
9.
Greece
291
2
10.
Malawi
240
2
Some 124,000 farms in 16 states grow tobacco. About three-quarters of
these are actually classified as tobacco farms, meaning that tobacco comprises
at least 50 percent of sales.
Six states account for 91 percent of production: North Carolina and
Kentucky originate 65 percent; Tennessee, Virginia, South Carolina, and
Georgia produce another 26 percent.
The U.S. tobacco crop in 1996 was worth $2.5 billion, representing
approximately 2.4 percent of the total for all cash crops and farm commodities.
The manufacture of tobacco products accounted for $16.6 billion or
0.2 percent of gross domestic product in 1994, down from 0.6 percent in the
early 1960's.
2
Tobacco manufacturing makes up 1.2 percent of U.S. industrial output.
--
Production slid from early 1991 through most of 1993, but by mid-
1994 returned to levels that prevailed in the late 1980's.
TOBACCO PRODUCTION
Relative to All Manufacturing
Index Jan. 1987 = 100
140
Recession
130
Manufacturing
120
110
Tobacco
100
90
80
70
87
88
89
90
91
92
93
94
95
96
97
Trade
Exports of tobacco products totaled $6.6 billion in 1996, $5.2 billion of which
was in manufactured tobacco products and $1.4 billion in unmanufactured (leaf)
tobacco. The value of tobacco imports was $1.3 billion last year, $1.1 billion of
which was in unmanufactured products.
--
Exports rose rapidly from the mid-1980's through 1990 but have since
been little changed and the trade balance has shown similar patterns.
TOBACCO IMPORTS AND EXPORTS TOBACCO TRADE BALANCE
Billion Dollars
Billion Dollars
7
7
$6.6
6
$5.3
Exports
5
5
4
4
3
3
2
2
$1.3
Imports
1
1
0
0
1970
1975
1980
1985
1990
1995
1970
1975
1980
1985
1990
1995
3
U.S. factories produced an estimated record of 760 billion cigarettes in 1996,
of which about 36 percent were shipped abroad for foreign consumption.
Consumption
U.S. consumers spent an estimated $50.3 billion on tobacco products in 1996,
or 1.0 percent of all consumer expenditures.
Tobacco Expenditures by Type - 1996 (est.)
Billions
Percent of Total
Total
$50.3
100
Cigarettes
47.2
94
Cigars
1.0
2
Other (smoking tobacco, chewing
2.1
4
tobacco, and snuff)
The average household spent $269 in 1995 on tobacco products and smoking
supplies, with households in the lowest income quintiles spending more of
their budget on tobacco.
Tobacco Expenditures by Income Quintile in 1995
Lowest 20%
Second 20%
Third 20%
Fourth 20%
Highest 20%
Tobacco
$204
$242
$327
$307
$278
Share of total
1.4%
1.1%
1.1%
0.8%
0.4%
expenditures
Per-capita cigarette consumption has been on a long-term decline in the
United States from a record high of 4,345 in 1963 (based on the population 18
years and over) to 2,482 in 1996 -- a drop of 43 percent.
PER CAPITA U.S. CIGARETTE CONSUMPTION
(Persons 18 years and older)
Number of Cigarettes
5,000
1963
4,500
4,345
4,000
3,500
3,000
1996
2,482
2,500
2,000
45
50
55
60
65
70
75
80
85
90
95
4
Cigar consumption, while a tiny part of the total, rose 19 percent last
year, to 32.7 per male 18 years and over, but was only about 3 percent
above the 1987 level.
More than offsetting the decline in the United States has been a rise in foreign
consumption of tobacco, which has resulted in an increase in worldwide
consumption of 1.2 to 1.5 percent annually.
Foreign sales, however, are said to be much less profitable that
domestic sales.
China is the leading world cigarette market, consuming 1.7 trillion cigarettes
annually, or about 3-1/2 times as many as the 470 billion of the United States.
(China's population is about 4-1/2 times that of the United States.)
U.S. tobacco consumption is less than 10 percent of the world total.
WORLDWIDE CIGARETTE CONSUMPTION
Total = 5.3 trillion cigarettes in 1996
China 32%
Japan 6%
U.S. 9%
Other Asian 13%
Other 28%
Europe 12%
Profile of Domestic Consumption
There are estimated to be about 50.5 million adult smokers (18 years and
older) in the United States, or about 25 percent of the adult population. (See
table on the next page.) These smokers consume an 18.2 cigarettes a day
(almost a full pack) on average.
5
Adult Smoking Rates
Adult Quit
Rates*
Current
Former
Never
Adults 18+
25.7
24.1
50.2
48.5
18-24
22.9
7.7
69.3
25.2
25-44
30.4
19.4
50.2
38.9
45-64
26.9
32.9
40.2
55.1
65+
13.3
36.4
50.3
73.3
* Percent of eversmokers who are former smokers
There are about 3.1 million underage smokers (younger than 18 years old).
Their average consumption is about one-half a pack a day.
-
The FDA estimates that there are 1 million new underage smokers a year,
which would roughly offset the number of 17-year-old smokers who turn
18 each year.
--
Youth smoking rates are shown below. (Note: "Daily" is used for the
Lookback provisions.)
Youth Smoking Rates
Have smoked in
Have smoked 1/2
Age
past 30-days
Daily
pack or more a day
Daily users
(
Percent
)
(Number)
8th graders
21.0
10.4
4.3
395,000
10th graders
30.4
18.3
9.4
695,000
12th graders
34.0
22.3
13.0
847,000
Demand>Elasticities: A consensus estimate for overall demand elasticity is
-0.4, signifying that for every 1.0 percentage increase in price, demand would
fall by 0.4 percent. The Surgeon General's report provides the following
elasticities by age:
6
Demand Elasticities
Age Group
Total
Participation
Quantity per Smoker
12-17
-1.40
-1.20
-0.25
20-25
-0.89
-0.74
-0.20
26-35
-0.47
-0.44
-0.04
36-74
-0.45
-0.15
-0.15
All Adults (20-74)
-0.42
-0.26
-0.10
All Ages (12-74)
-0.47
-0.31
-0.11
Employment and Wages
Tobacco manufacturing's contribution to payroll employment is minuscule.
In 1996, 41,400 workers were employed in the tobacco manufacturing industry
(which includes processing of tobacco, as well as production of cigarettes,
cigars, etc.), or only 0.03 percent of the 119.5 million workers on nonfarm
payrolls. More than 100,000 workers (0.23 percent of nonfarm employment) had
been employed in the industry in the early 1950's.
--
Five states and Puerto Rico account for nearly 85 percent of the jobs
in tobacco manufacturing. (Note: These are the only states that report
employment separately for tobacco manufacturing and are presumably
the most important for the industry.)
Jobs in Tobacco Manufacturing
Number of Jobs
Share of State's Payroll Jobs
(percent)
North Carolina
16,830
0.47
Virginia
9,550
0.31
Kentucky
4,210
0.25
Florida
1,480
0.02
Tennessee
1,180
0.05
Puerto Rico
1,040
0.11
7
Production workers in the tobacco industry earned $19.44 an hour last year,
52 percent more than the average worker in manufacturing. Tobacco industry
wages have climbed steadily from less than 75 percent of the average factory
wage in the early 1950's. Few other industries can boast comparable wages
(coal mining, steel, petroleum and coal product manufacturing also have
earnings that top $19 an hour).
Average Hourly Earnings in 1996
Private nonfarm
$11.81
Manufacturing
12.77
Tobacco
19.44
Prices
Tobacco products have a weight of only 1.6 percent in the CPI. Since
cigarettes make up 94 percent of tobacco consumption, their weight would be
1.5 percent.
--
Current estimates of the impact of the tobacco settlement range suggest a
$0.35 a pack increase in cigarette prices for 1998 and $0.62 by 2002.
This amounts to a price hike between roughly 20 and 35 percent. The
impact on the CPI could be in the range of 0.3 to 0.5 percent
Over the past decade, tobacco prices have risen at a 6.3 percent annual
rate, compared to 3.7 percent for "core" consumer prices (excluding food
and energy). Faster growth was mainly the result of a sharp uptrend prior to
1993. (See chart on the next page.)
In 1993, there was a steep downward adjustment in prices as
manufacturers of premium brands reduced prices to meet competition
from the discount brands. Since 1993, tobacco prices grew at about the
same pace as the core.
This year, tobacco prices have sped up again, increasing at nearly an
8 percent annual rate through May in part reflecting higher state taxes.
8
CONSUMER TOBACCO PRICES
Relative to the "Core" CPI
Index 1982-84 = 100
280
Percent Change, Annual Rate
Tobacco
Core
CPI
Dec.86-Apr.93
10.2
4.4
240
Tobacco
Apr.93-Nov.93
-15.8
2.8
Nov.93-Dec.96
3.0
2.8
Dec.96-May 97
7.9
2.6
200
"Core" CPI
160
120
80
87
88
89
90
91
92
93
94
95
96
97
Industry Composition
The cigarette market is dominated by Philip Morris, which accounts for half of
cigarette sales in the United States.
The Cigarette Market in 1997 (est.)
Sales
Market
(Bil.Cigarettes)
Share (%)
Philip Morris
233.4
49.2
RJR Nabisco
114.5
24.2
BAT
76.8
16.2
Lorillard
39.9
8.4
Liggitt
8.0
1.7
TOTAL
474.1
100.0
Philip Morris has the widest profit margins (45 percent of revenues per pack),
followed by Lorillard (40 percent). Liggitt is estimated to have a margin of only
about 3 percent this year. (See table on the next page.)
--
Domestic producers devote 33 percent of revenues to marketing
(advertising, promotion, selling).
10
Advertising and Promotional Expenditures
U.S. domestic cigarette advertising and promotional expenditures averaged
$4.9 billion annually over the five years ended 1994.
---
Conventional advertising (point-of-sale, print media and outdoor and
transit) accounted for only about $1 billion, or 21 percent of the total.
The biggest advertising expenditures were point-of-sale
($352 million). Outdoor and magazine advertising followed at
$306 million and $266 million, respectively.
Coupons, buy-one-get-one free promotions, etc accounted for
$1.8 billion, or 37 percent of spending. Promotional allowances
(volume discounts and incentives for priority shelf space) made up
$1.4 billion or 28 percent of spending.
Domestic Cigarette Advertising and Promotional Spending,
1990-94 Averages
Billion Dollars
Percent
TOTAL
$4.929
100.0
Advertising
1.015
20.6
Newspapers
0.043
0.9
Magazines
0.266
5.4
Outdoor
0.306
6.2
Transit
0.048
1.0
Point-of-sale
0.352
7.1
Other promotional
3.915
79.4
Promotional allowances
1.386
28.1
Coupons and retail value added
1.810
36.7
Other
0.719
14.6
Prepared by
Treas./Econ.Policy/K.Hendershot
The Economics of the Proposed Tobacco Settlement
How does it work?
The proposed tobacco settlement has three provisions which could have economic
impacts: 1) industry payments to the settlement fund, 2) restrictions on advertising, and 3)
guidelines for FDA regulation of tobacco. Of these, the payments to the settlement fund are likely
to have the most significant effects.
The Settlement Payments acts like an excise tax on tobacco. The Settlement language has
the effect of making the annual industry Payment proportional to cigarette sales volume or a per-
pack charge.¹ From the tobacco industry perspective, the Payments required by the settlement are
equivalent to an excise tax of about 35 cents in the first couple years, rising to about 65 cents by
the xth year, and remaining at that level thereafter. In fact, the effects of the Settlement Payment
provisions could be replicated with an excise tax at the appropriate level and divided among
States, the Federal government, and individuals (and allocated to particular uses, like smoking
cessation, in some cases) in the manner set forth in the Agreement.
The economics of the Settlement Payments and an excise tax are similar; however, there
are some important practical differences. Most important, an excise tax is straightforward: We
know exactly what it is and have a lot of experience administering and enforcing excise taxes on
tobacco. The Settlement would make the tobacco companies their own tax collectors, and some
mechanism for oversight would need to be established, whereas, an additional excise tax could be
easily administered Treasury Department. Additionally, the Settlement Payments are made to a
Fund that is to be divides among States and individuals. The bulk of the payments to States are
for damages to the Medicaid system. Under Medicaid statute, each State should give the Federal
government a share of the Medicaid payments based on its Medicaid matching rate (after
subtracting reasonable costs of bringing the suits). Of course, a Federal excise tax would go
directly to the Federal government.
The settlement also provides for an "excess profits tax" of 25 percent. Because the
tobacco industry is not competitive and the Settlement would provide some anti-trust exemptions,
industry could restrict output and raise prices, increasing profits. (The economics of the industry
is discussed more fully below.) This provision requires the tobacco industry to pay 25 percent of
any profits above 1997 profits to the Settlement Fund. (It is not clear how these would be
allocated among States, individuals, and the Federal government because these payments are not
specifically for Medicaid damages.) Some worry that industry could find ways of "hiding" its
profits to avoid this excess profits penalty. More specific rules and oversight are could help
¹If cigarette sales fall, the industry's Payment to the Settlement Fund is reduced by the
ratio of that year's sales to 1996 sales; if sales rise, the Payment is increased by percent increase in
sales to adults. The Settlement does not make clear how "adult volume" will be measured, but
estimates indicate that adults consume more than 95 percent of cigarettes produced. Thus, the
use of "adult volume" for an increase instead of "total volume" as for declines is of little
consequence.
prevent this. Alternatively, the penalty could be related to a measure less prone to gaming, like
revenues.
The advertising restrictions attempt to eliminate advertising targeted to children. These
requirements are similar to those proposed (accepted?) in a recent FDA rule. The industry spends
an estimate $xx billion on advertising every year. These restrictions could save the industry
billions of dollars, increasing profits (which would be subject to the excess profits provision if
profits rise above 1997 levels). On the other hand, the industry could intensify advertising efforts
not banned by the Agreement (advertising to adults) or look for new, creative marketing
techniques such that their overall advertising budget is little affected by the Agreement. Because
advertising expenses are fixed costs, these provisions are not expected to effect the per-pack price
of cigarettes.
The provisions for FDA regulation limit the FDA's authority to regulate tobacco
products compared to the status quo. Problems with these provisions have been widely
discussed, particularly by Koop/Kessler.
How will the Settlement Effect Particular Objectives/Outcomes?
Effect on Youth Smoking and Current Smokers
Youth Smoking. Most of the "work" in reducing youth smoking is likely to happen
through price increases for cigarettes. Among young people, the "participation rate" of smoking
is very sensitive to price. The Settlement will increase the price of cigarettes considerably, by
between X an X percent. This suggests that smoking rates for young people are expected to fall by
x to X percent, or about XX to XX million 8th, 10th, and 12th graders. The number of packs that a
young smoker consumes is also fairly sensitive to price, and the price increase is-expected to
reduce consumption for young people who do continue to smoke by about XX to XX percent.
Advertising and access restrictions, as well as public health advertising, may also reduce youth
smoking over the long term, although fewer studies address these issues. Some evidence suggests
that access restrictions (enforcing age requirements and requiring face-to-face purchase) are
effective in reducing youth smoking. Recent FDA regulations have already done a lot to
strengthen access restrictions. (Is this true??) [Insert assessment of advertising restrictions and
public health ads.]
The "lookback" provision does not give the tobacco industry an incentive to reduce
youth smoking. The Settlement requires industry to pay a penalty if targets for the reduction in
youth smoking are not met, capped at $2 billion. If the industry can show the FDA that they have
made a "good faith" effort, 75 percent of the penalty would be refunded. The amount of the
penalty was selected to equal the present discounted value of profits for a new smoker. In other
words, the penalty is by design financially neutral from the tobacco industry perspective. (Our
calculations are consistent with this.) Depending on how "a good faith effort" is interpreted, the
penalty could be significantly less than the expected profits from a new smoker. Furthermore,
once the $2 billion cap is met, there is no marginal penalty for addicting new smokers. If the
lookback provision is really meant to punish the industry for failing to reduce youth smoking,
triple damages (or more) would be a more appropriate penalty. However, most of the work in
reducing youth smoking is likely to be done by other aspects of the settlement: price increases,
advertising and access restriction, and FDA regulation.
Adult Smokers. Adults smokers are significantly less sensitive to increases in the price of
cigarettes, so the reductions in adult smoking will be smaller. The evidence suggests that the
number of adult smokers could fall by between XX and XX percent, and the packs smoker per
smoker could fall by about XX to XX percent. Smokers are disproportionally lower-income, so as
with a tax on cigarettes, the Settlement will be regressive. Analyses of recent cigarette tax
proposals suggest that
[insert
table].
The estimates of the number of adults who quit smoking could be understated if smoking
cessation techniques become better and/or cheaper. The Settlement provides some funding to
subsidize smoking cessation programs. The Settlement also creates an incentive for the
development of alternative nicotine delivery systems. There is essentially no evidence on the
potential for this type of substitution: Any estimation of its scope would be highly speculative.
The settlement also attempts to encourage the development of safer, lower-nicotine cigarettes,
which would provide alternative for current adult smokers (although this may be undermined by
other provisions discussed below). There is some evidence, however, that when lower-tar
cigarettes were introduced, smokers often consumed more of these cigarettes. This might also be
the case for lower-nicotine cigarettes.
Impact on the Tobacco and Related Industries
Does the Settlement "Punish" the Tobacco Industry? While putting the tobacco industry out of
business is not the goal of this Settlement, the damages are, in part, punitive. The tobacco
industry can clearly absorb the payments required by this settlement. (In fact, it is required that
they be largely passed along to consumers in the form of higher prices.) [Checking into possibility
that one or more smaller co's could be put out of business.]
[Insert Christian's industry paragraph.]
The impact on employment and farmers is likely to be small. [Insert Chad paragraph.]
Effects on related industries are likely to be small and temporary. [Insert Chad summary of FDA
analysis.]
Potential for-Side Effects and "Red Flags"
The incentive to develop safer cigarettes is greatly curtailed. The Agreement essentially
eliminates intellectual property rights for tobacco-related innovations by requiring companies to
notify FDA of any risk-reducing technologies that they develop or acquire and cross-licence them
for a "reasonable" fee. In addition, the advertising restrictions could make it difficult to introduce
a new product onto the market.
The Settlement limits industry's incentive to fight lawsuits and could encourage the government
to limit lawsuits even more than the Settlement. The Agreement would eliminate class-action
suits and punitive damages for past harm. Individuals could still sue for damages (just not
punitive damages), and 80 percent of any awards in these suits would be paid from the Settlement
Fund (subject to an annual limit, excess claims are carried over to the next year). This means that
the industry has little incentive to fight these cases and that the States and the Federal government
-- who are the residual claimants to the Settlement Fund -- might like to discourage lawsuits.
What this lawyers would get form the settlement is not specified in the Agreement. We do not
know specifically what agreements attorney's have with States for payment, but many may have
contingency agreements which could give them up to a third of the settlement. (How this would
work in practice is not clear.) Similarly, under Medicaid statute, the States are allowed to deduct
reasonable costs of litigation up to 50 percent of the settlement before splitting it with the Federal
government. These issues should be explicitly worked out in the Settlement to ensure that
payments to lawyers are not excessive.
Draft - Not for Distribution
Impact of Proposed Resolution on Cigarette Prices and Industry Profits
Can the Settlement be thought of as an excise tax?
Yes. The key to understanding the payments as effectively being an excise tax on cigarettes is the
volume adjustment provision found in Title VI, B.5 of the settlement, entitled "Adjustment for
Volume Decrease (Adult Volume Only) or Total Volume Increase."
For any given year, let X₀ denote the scheduled payment. Let q represent the actual unit volume
of cigarette sales, and q* denote the base volume in 1996. Then the volume adjusted payment
would be X₀(q/q*), which can be rewritten as (X√q*)q. This is the same as writing the volume
adjusted payment as tq, where the "tax" t = (X/q*). This is just like an equivalent unit tax on
cigarettes. As an example consider year 10 in which the base payment X₀ = $15 billion. Since the
actual number of cigarettes sold in 1996 was q* = 24.4 billion, the effective tax per pack is equal
to t = (X√q*) = / 24.4 = 61.5 cents.
What will be the impact of the effective excise tax on prices of cigarettes?
According to the economic literature and historical evidence, the price of a pack of cigarettes will
probably go up by at least as much as the tax, and probably more. Prominent analysts of the
cigarette industry conclude that previous excise tax increases may have served as a focal point for
coordinating oligopoly price increases by sellers. As a result we expect there to be two effects, 1)
a direct price response to the increase in costs due to the effective excise tax, and 2) a further
price increase as a result of opportune coordination on the part of sellers. The combined effect
would raise prices by more than the increase in the excise tax. The range of the price increase
expected starts from a conservative 100 percent of the tax to a high of 200 percent of the tax.
Will the advertising restrictions result in windfall profits for the industry?
The restrictions on advertising and marketing imposed by the settlement (Title I, A and Appendix
VII), will not increase profits very much because of the expected substitution into non-restricted
forms of advertising. Moreover, marketing innovations are expected as a result of the restrictions
further increasing costs. Because the most important components of current cigartte advertising
and marketing, promotional allowances (28% of total advertising expenditures) and coupons and
retail value added (37%), are not barred by the Proposed Resolution, we expect these to increase
in intensity. Furthermore, we expect there to be an increase in conventional media advertising.
The bottom line then is that advertising expenditures may fall by about $ 500 million to $1 billion.
This is equivalent to savings of less than 5 cent per pack (compared to the 62 cent effective
excise tax starting in year 5).
What is the impact of increased prices on the tobacco industry's profits?
Corporate profits are expected to go up as part of the settlement. There are three components to
the change in corporate profits:
Fixed cost savings of at most 5 cents per pack due to decreased advertising expenditures
Lost revenues of 33 cents per pack on those not sold due to the reduction in cigarette
sales (on the order of 2 - 6 billion)
Increased revenues of 10 to 16 cents per pack on remaining cigarettes due to new higher
price (on the order of 18 - 22 billion)
It is clear that the combination of all three components would lead to higher industry profits.
1.
...
07/10/97 THU 19:27 FAX 202 6222633
002
Real Net Revenue From Tobacco Settlement
Attached are preliminary estimates of the net revenue from the tobacco settlement. They include
revenue effects at federal, state and local levels. One set of calculations assumes that the
payments are reflected in the price of all tobacco products, while the other assumes that the
payments are reflected only in the price of cigarettes. These estimates are in real terms, measured
in 1996 dollars.
We find that, considering all tobacco products, the real net revenue from the tobacco settlement is
likely to be about $189 billion in total, if summed over the first 25 years of the agreement. We
obtain essentially the same estimate in our cigarette only calculation.
Two reasons explain why our $189 billion net revenue estimate is substantially lower than the
$368.5 billion figure cited in the report. First, the $368.5 billion figure in the report ignores the
sales adjustment feature of the settlement. As sales fall, whether as a result of the long-term
secular trend which has historically characterized the tobacco market, or as a result of the features
of this agreement, the size of the payment falls proportionately. Adjusting for the fall in sales
reduces the net revenue estimate by about 19%, to $298 billion.
Second, the $368.5 billion figure does not adjust for the reduction in revenue from existing excise,
income, and employment taxes. Considering federal income and employment taxes, and federal,
state and local excise taxes, this adjustment can reduce net revenue by an additional $109 billion,
or by 32% of the $368.5 billion cited in the report. In total, then, we estimate that the actual
increase in net government receipts will be about $189 billion, or 51%, of the $368.5 billion
payment cited in the report.
The $368.5 billion figure also is misleading because it is a simple sum of (real inflation adjusted)
payments which flow in over time. Proper measurement of the value of the payment flow would
discount to reflect the (real) time value of money. As shown in the table, discounting the payment
stream by a 3.7% real discount rate will reduce its sum from $189 billion to $123 billion, or by
about 18% of the original $368.5 billion dollar figure cited in the report. A higher (lower)
discount rate would lower (raise) the discounted present value of the payment stream, relative to
our $123 billion figure.
Our modeling focuses on the basics of the payment plan outlined in the agreement. We do not
include the effects of the special penalty imposed if profits increase, nor do we model the look-
back provisions that impose a penalty if sales to minors fail to fall to specified target levels. By
way of justification, we note that is seems unlikely that domestic profits will increase as a result of
this agreement, so neglecting the profits tax seems reasonable in this preliminary estimate. For
two reasons, the look-back also seems unlikely to have a major revenue effect. First, it seems
likely that the agreement will be effective in significantly reducing under-age smoking, and so any
penalty would likely be much lower than the $2 billion annual maximum. Second, any assessed
penalty can be reduced by 75% as along as the manufactures can show that they made a "good-
faith" effort to comply with the agreement.
07/10/97 THU 19:28 FAX 202 6222633
4.
003
One detail that we do incorporate is the inflation indexation of the payments. Without such
indexing, the real value of the annual proscribed payments would fall below their published level,
thereby reducing the real net-revenue to the government. Our approach implicitly assumes that
inflation indexing is complete, so that the real value of each year's annual payment is completely
unaffected by inflation.
While this is not an official revenue estimate, our modeling approach does rely on some standard
revenue estimating conventions. In particular, our estimate is based on a fixed GDP assumption,
which has a number of important implications. First is an income and employment tax offset,
reflecting the fact that the tobacco payments are "taken-off the top", and so reduce the base of the
income and employment taxes by lowering national income. These offsets capture reductions in
personal income, corporate income, and employment taxes at the federal level.
Second, some features of the agreement, which may have important effects for particular firms, or
for the tobacco industry as a whole, have no effect at all in our model. In particular, the fixed
GDP assumption means that the settlement's restrictions on advertising, even if effective, would
have no direct effect on revenue; all else constant, the tobacco industry's reduced spending on
advertising leads to a reduction in taxable income in the rest of the economy (e.g., in the
advertising sector) which approximately offsets the tobacco industry's increase in taxable income.
The advertising restrictions, if effective, also might reduce net revenue indirectly by reducing
tobacco sales. We have ignored this for two reasons. First, it is likely that much tobacco
advertising is spent in intra-industry fights over the distribution of a fixed pool of smokers, rather
than in an attempt to increase the number of smokers in the pool. Mandated reductions in this
type of advertising would have no effect on industry wide sales. Second, the advertising
restriction's bark may be worse than its bite because they are loosely worded, and because they
do not apply to some major categories of promotional expenses.
An alternative to holding GDP fixed would be to let it rise by the full amount of the increase in the
price of tobacco products. In that case, income tax receipts would not fall, so that net revenue to
the government would be $252 billion over 25 years. While net revenue seemingly is higher than
in the fixed GDP case, in purchasing power terms it really is the same, as the rise in GDP reduces
the purchasing power of government tax revenue.
David Richardson and James Mackie
U.S. Treasury, Office of Tax Analysis
OTA
7/10/97
07/10/97 THU 19:28 FAX 202 6222633
004
05:59 PM
PRELIMINARY
07/10/97
Net Payments to all Governments from the Tobacco Settlement
Payment Reflected in All Products
100% Passthrough
($'s Millions)
PDV
Base Payment
368,500
231,910
Gross Payment
284,399
182,735
Federal Excise Tax Leakage
(18,537)
(11,836)
State Excise Tax Leakage
(25,113)
(16,077)
Total Gross Excise Tax Leakage
(43,650)
(27,913)
Net Payment (Pre-Offset)
240,749
154,822
Income Tax Offset
(60,187)
(38,705)
Individual
(51,159)
(32,900)
Corporate
(9,028)
(5,806)
Net Payment including offset
180,561
116,116
Department of the Treasury
Office of Tax Analysis
07/10/97 THU 19:28 FAX 202 6222633
005
05:59 PM
PRELIMINARY
07/10/97
Net Yearly Payments to all Governments from the Tobacco Settlement
Payment Reflected in All Products
100% Passthrough
($'s Millions)
Year
Volume Adjusted
PDV
Volume Adjusted
PDV
Fixed GDP
Fixed GDP
1998
8,677
8,677
6,508
6,507
1999
6,404
6,163
4,803
4,623
2000
7,039
6,522
5,279
4,891
2001
8,288
7,392
6,216
5,544
2002
9,766
8,384
7,324
6,288
2003
10,295
8,508
7,721
6,381
2004
10,249
8,154
7,687
6,115
2005
10,207
7,817
7,655
5,863
2006
10,158
7,488
7,618
5,616
2007
10,104
7,170
7,578
5,378
2008
10,019
6,844
7,514
5,133
2009
9,925
6,526
7,444
4,895
2010
9,833
6,224
7,375
4,668
2011
9,741
5,935
7,306
4,451
2012
9,650
5,660
7,237
4,245
2013
9,560
5,397
7,170
4,048
2014
9,471
5,147
7,103
3,860
2015
9,382
4,909
7,037
3,681
2016
9,295
4,681
6,971
3,511
2017
9,208
4,464
6,906
3,348
2018
9,122
4,257
6,842
3,193
2019
9,037
4,060
6,778
3,045
2020
8,953
3,872
6,715
2,904
2021
8,870
3,692
6,652
2,769
2022
8,787
3,521
6,591
2,641
2023
8,706
3,358
6,529
2,518
Total
240,749
154,822
180,561
116,116
Department of the Treasury
Office of Tax Analysis
07/10/97 THU 19:29 FAX 202 6222633
006
05:46 PM
PRELIMINARY
07/10/97
Net Payments to all Governments from the Tobacco Settlement
Payment Reflected in All Products
125% Passthrough
($'s Millions)
PDV
Base Payment
368,500
231,910
Gross Payment
274,466
176,584
Federal Exclse Tax Leakage
(22,760)
(14,545)
State Excise Tax Leakage
(30,835)
(19,747)
Total Gross Excise Tax Leakage
(53,594)
(34,292)
Net Payment (Pre-Offset)
220,872
142,292
Income Tax Offset
(55,218)
(35,573)
Individual
(46,935)
(30,237)
Corporate
(8,283)
(5,336)
Net Payment including offset
165,654
106,719
Department of the Treasury
Office of Tax Analysis
07/10/97 THU 19:29 FAX 202 6222633
007
05:47 PM
PRELIMINARY
07/10/97
Net Yearly Payments to all Governments from the Tobacco Settlement
Payment Reflected in All Products
125% Passthrough
($'s Millions)
Year
Volume Adjusted
PDV
Volume Adjusted
PDV
Fixed GDP
Fixed GDP
1998
8,367
8,367
6,275
6,275
1999
5,976
5,752
4,482
4,314
2000
6,548
6,067
4,911
4,550
2001
7,662
6,833
5,746
5,125
2002
8,956
7,689
6,717
5,767
2003
9,411
7,778
7,059
5,833
2004
9,370
7,454
7,027
5,590
2005
9,331
7,146
6,998
5,359
2006
9,286
6,845
6,965
5,134
2007
9,237
6,555
6,928
4,916
2008
9,159
6,257
6,869
4,692
2009
9,074
5,966
6,805
4,475
2010
8,989
5,690
6,742
4,267
2011
8,905
5,426
6,679
4,069
2012
8,822
5,174
6,616
3,881
2013
8,740
4,934
6,555
3,701
2014
8,658
4,706
6,494
3,529
2015
8,577
4,487
6,433
3,366
2016
8,497
4,279
6,373
3,210
2017
8,418
4,081
6,314
3,061
2018
8,340
3,892
6,255
2,919
2019
8,262
3,711
6,197
2,784
2020
8,185
3,539
6,139
2,655
2021
8,109
3,375
6,082
2,532
2022
8,034
3,219
6,025
2,414
2023
7,959
3,070
5,969
2,302
Total
220,872
142,292
165,654
106,719
Department of the Treasury
Office of Tax Analysis