Investors Are Swearing Off Tobacco Firms
Fed up with seemingly endless cigarette litigation, investors are kicking the habit in droves.
Tobacco shares have long suffered from litigation fears but now appear to be tanking as never before. An adverse court ruling in Florida pummeled tobacco stocks to multiyear lows Thursday, although they recovered slightly Friday.
Realistically or not, Wall Street is acting as though the value of the entire U.S. tobacco industry, with retail sales of $50 billion last year, is less than zero--in fact, many billions of dollars less.
The stock slump doesn’t directly affect the companies’ operations--they still rake in their profits--but it increases the pressure on the firms to reach some legal solution to the morass, either through settlements or outright victory.
And because Big Tobacco stocks are so widely held in mutual and pension funds, millions of Americans share the pain, regardless of how they feel about smoking.
The huge settlement last year between the industry and the states led many investors to hope it was putting its problems in the past. Instead, investors are now worried that there will never be an end to the litigation and that future increases in the price of cigarettes will go to litigants rather than shareholders.
From a peak of $58.25 a share last November, the stock of market leader Philip Morris Cos., maker of Marlboro, has plunged to $24.75, losing nearly 60% of its value--more than $80 billion in all.
“The market is saying this company is going bankrupt,” said Robert Sanborn, whose Oakmark Fund owns 10 million shares. He hastened to add that he holds the opposite view.
Philip Morris, remember, also owns Kraft Foods and Miller Brewing Co., which by themselves ought to be worth $24 a share, said industry analyst Martin Feldman of Salomon Smith Barney. He estimated the overseas tobacco operations--not subject to U.S. litigation--at an additional $33 a share.
Therefore, at Philip Morris’ current share price, and with 2.4 billion shares in the market, investors are valuing its U.S. tobacco business at negative $70 billion, Feldman said.
Shares of other cigarette makers, including R.J. Reynolds Tobacco Holdings (Winston and Camel); British American Tobacco, parent of Brown & Williamson Tobacco Co. (Kool); and Loews Corp., parent of Lorillard Tobacco Co. (Kent and Newport), also have fallen.
Feldman and other analysts insist that this represents a huge overreaction to the Florida case and to tobacco’s legal problems in general.
Yet many investors apparently have decided that, regardless of how profitable the business is, sticking with tobacco just isn’t worth the headaches.
“There’s no such thing as peace for tobacco investors,” declared Matt Myers, vice president and general counsel of the anti-smoking group National Center for Tobacco Free Kids. “Every time they get a court decision or a settlement that they think helps, they turn around and face a new risk.”
In the Florida case, a bitter defeat for the cigarette companies, an appeals court Wednesday said a jury that has already found the industry guilty of fraud and misrepresentation may now decide whether to impose a single, and potentially huge, punitive-damages award for all injured smokers in the state, without even determining first how many smokers actually deserve compensation.
“It’s clear that the current law is being stretched to accommodate an issue that really does not fit the legal and political system we have,” said James Gipson, manager of the $1.2-billion Clipper Fund, which still has extensive tobacco stock holdings.
The Florida ruling was the latest legal setback since a $246-billion settlement between the industry and 46 states last November that tobacco officials and investors hoped would bring a semblance of peace in the immense legal war over smoking.
Since then, juries in San Francisco and Portland, Ore., have imposed heavy damage awards against Philip Morris in the cases of two Marlboro smokers who contracted lung cancer. Both cases are on appeal, but the industry faces hundreds of other claims in courts across the country on behalf of individual smokers. Other legal challenges facing the industry include a pair of class-action lawsuits by Blue Cross/Blue Shield plans and a suit by the U.S. Department of Justice that seeks recovery of government costs of treating sick smokers.
But is Wall Street’s extreme reaction warranted?
“That’s what we’re discussing now,” Gipson said.
Richard Daynard, a Northeastern University law professor and head of the anti-industry Tobacco Products Liability Project, believes there is “a very substantial likelihood that these companies are going to be at the mercy of a bankruptcy judge in a few months. . . . That means they’ll be in business not for the benefit of the shareholders but for the benefit of their victims.”
The tobacco industry, however, has frustrated similar predictions from Daynard and others over many years. Many analysts predict that the Florida case ultimately will be decertified as a class action, reflecting increased skepticism by the courts that claims involving toxic injuries should be lumped together.
In the meantime, Philip Morris is making its own bet on whether the stock market has overreacted.
According to a recent filing with the Securities and Exchange Commission, the company in recent months has repurchased 21 million shares of its own stock, a sign that the company believes the shares are undervalued by investors.
