More leaks from Gary Black (fwd)

[Robert Weissman <rob@essential.org>]

The following is from Gary Black, a Wall Street tobacco analyst who
effectively functions as a tobacco industry spokesperson. In this update,
he discusses industry negotiations with U.S. state attorneys general to
settle the state cases against the industry -- a very important matter for
those concerned with U.S. domestic tobacco legislation.

At the bottom of the update, Black hypothesizes a future in which RJR
either spins off its international tobacco subsidiary, or merges it into
BAT. These are critical industry strategic issues for those working on
international tobacco control. 

Robert Weissman
Essential Information			|   Internet:	rob@essential.org


Gary Black: Plan B -- Follow-Up Comments. Outperforms MO, RN, UST.

TOBACCO
Plan B -- Follow-Up Comments. Outperforms MO, RN, UST.

Gary Black (212) 756-4197
Jon Rooney (212) 756-4504

July 10, 1998

HIGHLIGHTS

Here are responses to questions clients asked us yesterday about the
state-only settlement, otherwise known as "Plan B."

Money: The state-only settlement would resolve all remaining state claims
(37), and provide funding for those 9 states that have not yet sued (there
may be different participation tiers). All told, the package being
discussed for the 46 states would be $180 - $200 billion (the original
state portion of the June 20 accord was $196.5 billion), with some $10
billion up front (same as June 20 accord). The attorneys general obviously
want as much of these funds as possible upfront, and point to the Minnesota
settlement, which would imply some $40 billion spread over the first five
years. The compromise may be to give $15 billion up front, but spread it
over 5 years ($7-$8 in first year). Keep in mind that four states -- MS,
FL, TX, and MN -- have already settled their claims for $36 billion. We
estimate the industry will have to kick back some $6 billion in total to
FL/TX/MS under those states? MFN (most favored nations) clauses because of
the more favorable terms given to Minnesota. The total cost of all 50
states? claims, then, would be $220 - $240 billion ($180-$200, plus $42
billion). If some states don?t take the money, the amount would go down.
However, the industry will say that unless there is unanimous participation
by all states, they xould void the deal.

Legal protections: The state-only settlement would put an end to the
Medicaid actions brought by the states forever. It would also effectively
protect the industry if a local municipality within the state successfully
brought suit and won, since the industry would get a credit against
judgments or settlements if a municipality received awards. One additional
idea under consideration would be to gross up the total funds to the 50
states by some $60 billion -- the amount agreed to by the attorneys general
to settle all punitive damage claims in the June 20 national accord -- and
give the industry a credit for any punitive damages won by individuals in
that state. This would effectively give the industry legal protection from
punitive damages as well. The industry would not get class action
protections in a state-only settlement, and would instead hope that the
state courts would at some point follow the federal precedent established
over the past two years effectively banning class actions in tobacco cases.

FDA regulation over nicotine: The new agreement would cut the FDA and the
federal government out from any aspect of the settlement. Hence, the FDA
would not get regulation over nicotine as a drug, nor be able to control
advertising. Some Attorneys general want the industry to concede to the FDA
jurisdiction over nicotine (i.e., some are insisting that the industry drop
its lawsuit to block the FDA from asserting jurisdiction). We believe this
effort will fail; the four states that have settled to date have not
insisted on this provision; more importantly, one objective by both sides
in announcing this deal is likely to give Washington one last shot at
enacting national legislation similar to the June 20 accord (which the AGs
would presumably go for). Not having FDA jurisdiction in the state-only
deal may help convince Washington to try to revive the June 20 accord ($368
billion) or the Hatch-Feinstein proposal ($600 billion including penalties,
but contains all legal protections from June 20).

Efforts to reduce teen smoking: The new plan contains no youth smoking
reduction targets or lookback penalties. None of the four states that have
settled to date have been able to negotiate industry penalties for failure
to meet youth reduction targets. The industry would voluntarily withdraw
its billboards, branded merchandise, and sponsorships, and marketing near
schools in any state that takes the deal. Importantly, all trademarks (e.g.
Marlboro Man), magazine ads, and continuity programs would remain.

Washington?s response: Republican staffers we talked with yesterday liked
the plan, since, as we expected, it would provide cover for Republicans to
not pass an onerous tobacco bill this year (since teen smoking problem
would be taken care of at the state level). Democrats, of course, seemed
more anguished, and are today calling for Congress to pass the
Hansen-Meehan bill in the House ($1.50/pack price increase over three
years; full FDA authority) rather than the "focused" Pryce bill (focus on
youth access, no excise tax increase, no FDA regulation) when the House
takes the issue up the week of July 20. The wild card here, and one key
reason the industry and attorneys general may have decided to move forward
now, is to perhaps convince the Administration The incentives for the
Administration and the health community to take one last stab at enacting
comprehensive national legislation as embodied by the June 20 accord or
Hatch-Feinstein are: a) The $200 billion in settlement funds for federal
programs in the June 20 accord (on top of the $180 - $200 billion that goes
to the states); b) FDA jurisdiction over nicotine as a drug; and c) youth
"lookback" targets and penalties if youth smoking rates don?t fall (not in
the state-only deal). Our bet is that Congress has blown its chance at
getting comprehensive legislation passed, since there are just 35 working
days left in the waning days of this Congress. President Clinton would have
to take an active role and explicitly grant the industry the legal
protections found in June 20 and Hatch-Feinstein to revive a national deal.

Timing: There is a national attorneys general meeting next week in
Colorado. We expect there to be a flurry of negotiations over the weekend
to come up with at least a tentative tobacco plan to present to the
attorneys general next week. We expect final details of the state-only
settlement to be resolved by mid-August. We expect the House to pass the
focused Pryce bill at the end of July, and for the Senate to hold the House
bill "at the desk" until it returns from its August recess (September 1).
The Senate is expected to at least bring up the Hatch-Feinstein bill for
debate just before it adjourns August 1. We have fairly high confidence
that any bill out of Congress this year will dovetail with a state-only
bill (no FDA jurisdiction, tough youth access restrictions executed at the
state level, no federal excise tax increase).

INVESTMENT CONCLUSIONS

We reiterate outperform ratings on Philip Morris ($60 price target), RJR
($40), and UST ($40). We believe tobacco stocks will continue to run --
particularly RJR, which has lost 1/3 its value this year, and continues to
trade with negative implied tobacco value (Nabisco position worth $24/per
RN share). We urge investors to think about RJR the way Carl Icahn (who
announced yesterday that he holds 10 million shares, or 3 of RJR) or any
other would-be acquirer would -- $4.05 in 1998 cash earnings (adjusted for
goodwill charges), and $4.25 in 1999 cash earnings. Viewed from a cash
standpoint, RJR is selling for just 5.9x earnings, or at a slightly
ridiculous 23 relative multiple. We believe the Icahn position increases
the odds that RJR will restructure its assets in some way (IPO of RJR
International, combined international operations with BAT) and gives the
company cover with lenders and credit rating agencies to maintain its $2.05
dividend (51 dividend payout ratio). By comparison, Philip Morris, which we
expect will show cash earnings of $3.42 in 1998, and $3.75 in 1999, trades
at an 11.4x 1998 cash multiple, and has a 47 cash dividend payout ratio
($1.60/$3.42). UST has no goodwill; hence reported earnings and cash
earnings are the same.