Pressure Mounts on RJR to Split Up Its Food and Tobacco Businesses

[Robert Weissman <rob@essential.org>]

                        October 23, 1998

Earnings Focus

Pressure Mounts on RJR to Split Up
Its Food and Tobacco Businesses

By SUEIN L. HWANG 
Staff Reporter of THE WALL STREET JOURNAL

RJR Nabisco Holdings Corp., faced with renewed pressure from investors to
split up its food and tobacco businesses, may find a catalyst for action
in troubled Russia. 

Investors have been after the company, which Thursday reported a nearly
30% increase in quarterly earnings, to do some kind of split-up for years,
arguing that the value of its 81%-owned, publicly traded food business is
hobbled by the tobacco ball and chain. 

Now, the clamor for action is growing louder as the chaos in Russia drives
down RJR's stock price. On Aug. 17 -- the very day that Chief Executive
Officer Steven Goldstone cut the ribbon on the company's new cigarette
factory in St.  Petersburg and celebrated in a palace once used by Peter
the Great -- the ruble's value plunged, hurtling Russia into economic
crisis. 

The effects were painfully evident in the release of RJR's earnings. While
Thursday's results were in line with expectations, RJR had warned analysts
last month that its overseas profit would be cut in half because of
Russia. 

The company reported net income of $158 million, or 45 cents a diluted
share, up from $122 million, or 34 cents a diluted share, a year earlier.
But excluding $133 million for the settlement of lawsuits in the 1997
quarter, as well as a $7 million charge in the current quarter for a
restructuring of the Nabisco food business, earnings fell 36% to $164
million. Revenue declined 1.8% to $4.33 billion from $4.41 billion. 

International Sales Drop of 19%

Overseas, R.J. Reynolds International reported a 17% volume decline and a
19% sales plunge. Operating profit slid 52% to $95 million after a $15
million blow from negative currency exchange rates. "Conditions in these
markets [Russia and the Commonwealth of Independent States] won't recover
overnight," Mr. Goldstone warned Thursday. 

The turmoil in Russia has taken a huge toll on RJR's stock: It finished
Thursday at $24.625, up 12.5 cents, in New York Stock Exchange composite
trading, down from a 52-week high of $38.0625. And it commands roughly a
quarter of the price Kohlberg Kravis Roberts & Co. paid for the company 10
years ago in the biggest leveraged buyout in history. 

Certainly, it isn't just Russia that is weighing on RJR. Competitive
pressures haunt both its food and its tobacco businesses. Nabisco
Holdings, once RJR's star performer, is struggling to revive its sales of
cookies and crackers. RJR's aging cigarette brands such as Winston
performed "satisfactorily" in the third quarter, according to the company;
but analysts say its U.S. market share, now around 25%, resumed falling in
recent weeks as America's No. 2 tobacco company gave ground to Philip
Morris Cos. Third-quarter tobacco sales in the U.S. rose 15% to $1.5
billion, but volume declined 7%. 

But it's the Russia factor that is putting a big spotlight on the company
to act. 

"Investors have lost confidence in management," says Gary Black, an
analyst at Sanford C. Bernstein. "If they don't do a restructuring,
management will be in trouble." Analysts figure that only about $1 of the
company's current stock price reflects tobacco. If the units were cleaved,
some believe RJR's shares could shoot up by more than 50%. 

Split-Up vs. Overseas Divestiture

Mr. Black is arguing for a tobacco/food split. But some others figure that
in the short run the company might do well to shed its foreign tobacco
business and husband its resources for U.S. tobacco. The company won't
speak for the record about any split-up ideas. 

There is speculation on Wall Street that RJR's international tobacco
business will be sold, perhaps to a rival such as British American Tobacco
PLC. In London, a British American spokesman declined to comment, but
people familiar with the situation say executives there fear tax
implications might be too onerous for any deal to proceed. 

The idea of a food/tobacco split-up goes back several years. It was just
such a rationale that helped inspire corporate raider Carl Icahn to join
forces with Bennett Lebow to stage a proxy fight for control of RJR two
years ago.  Although the investors ultimately failed, they did win the
support of a number of angry shareholders, and RJR reaffirmed its
commitment to split its operations as soon as it possibly could. 

But the cigarette company has always cautioned that it was hamstrung by
the cloud of tobacco-liability lawsuits. If RJR tried to initiate a split,
plaintiffs' lawyers could persuade a judge to block it, arguing that the
split is an illegal way for RJR to hide assets from a tobacco judgment. 

A recent string of court decisions have gone in the industry's favor,
however, and brightening prospects for an industrywide settlement of
remaining state Medicaid lawsuits just might give RJR legal room to
restructure. 

"Certainly, when you make peace with the states, a huge piece of liability
is gone," says one person familiar with RJR's thinking. A state settlement
"would certainly prompt the company to take an extremely close look at its
options,"  says an RJR executive. Still, many well-heeled plaintiffs'
lawyers are vowing to stop any spinoff dead in its tracks. 

At the very least, some investors hope the company finds a buyer for its
international tobacco business, stunted by a late start and years of
skimpy investing in the post-LBO era. Unlike Philip Morris, which
generates nearly 60% of its international tobacco profit from
long-established markets in Western Europe and Japan, RJR is far more
dependent on the highly volatile Eastern European and Russian markets. 

Last year, RJR had operating profit of $70 million in Russia, representing
9% of the $759 million its international tobacco unit earned last year.
Analysts estimate that all Eastern European markets including Russia make
up at least 25% of its operating profit. "The businesses are really
struggling," says David Adelman, an analyst at Morgan Stanley Dean Witter,
who estimates RJR's Russian profits will nose-dive to somewhere between
$10 million and $20 million this year. 

Strategy in Russia

When RJR began investing in Russia in the early 1990s, analysts and
executives say the company made a conscious decision to focus its limited
resources on markets that weren't yet dominated by its bigger rivals.
"Russia was a very big bet for RJR," says Martin Feldman, an analyst at
Salomon Smith Barney. 

The strategy paid off handsomely last year, when the company successfully
launched Peter the First, a midpriced, locally produced cigarette that
appealed to Russians' pride in their heritage. The company quickly sold 15
billion Peter the First cigarettes, Mr. Feldman estimates, or 5% of the
total Russian market. 

But according to RJR's rivals, the company's problems began to surface
months before Russia's economy was making headlines. Flush with its
initial success, tobacco executives based in Russia say, Reynolds
overescalated production of Peter the First. 

By early this year, they say, Russian distributors were loaded down with
too much Peter the First, sparking a backlash. By the time the ruble was
devalued, rivals say Reynolds was sitting on more than six billion
cigarettes of Peter the First in excess inventory. Last month, the company
disclosed that it temporarily halted cigarette production in Russia for
about two weeks. 

An RJR spokesman concedes the company had difficulties with its
distributors, but says those problems are resolved and the company is
working hard to strengthen its distribution network. "If anything, the
distributors wanted more Peter the First and less of other brands," he
says. Sales volumes, while not at the pre-devaluation levels, are perking
up, he says. 


-- Vanessa O'Connell contributed to this article. 

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