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We believe odds remain high that the final bill out of the Senate will be $1.10/pack tax hike over 5 years;however, too many changes to the left of McCain's manager's amendment could cause Republicans to balk on the vote to pass the overall bill, since Republicans are still counting on the industry to ultimately embrace the Senate bill so that the bill doesn't become a tax increase.

Two big amendments to be offered today and tomorrow are:1) Conrad/Kennedy's amendment to change the $1.10/pack increase over five years in McCain's amendment to a $1.50/pack increase over three years (vote likely until tonight);2) Judd Gregg's amendment to strip the $8 billion liability cap from the McCain bill. The vote is too close to call on the $1.10 vs. $1.50 issue.

We expect Gregg's amendment to strip the liability cap from the bill to pass, since no Senator wants to be perceived as giving legal protections to the industry. Paradoxically, if both the Conrad and Gregg amendments pass, the tobacco bill becomes less appealing to most Republicans, since there would be no incentive for the industry to return to the table, and the bill becomes a giant tax hike, rather than a price increase by the industry. That is why Clinton/McCain are pushing to keep the bill where it is.

Complicating the tobacco legislation is that the $200 billion transportation bill, now moving through House-Senate conference, appears to have blown up. Senate Majority Leader Lott is trying to resuscitate that bill, which Republicans want to use in November, since the bill funds new bridge, tunnel, and highway projects that Republicans can wave in front of constituents.

The House Republican tobacco bill being formulated appears to be much narrower than the McCain bill, and will likely take the form of a combination drug/tobacco bill, and include a $.50/pack tax increase over five years. This bill may be unveiled late this week. A scaled-down House tobacco bill should give investors some confidence a House-Senate conference will be needed to resolve two very different bills, with the most likely outcome a Clinton-led brokered deal that is closer to the June 20 settlement.

We reiterate outperform ratings on MO, RN, and UST.

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