McCain's Bill Remains On Death Bed -- Narrow Youth Smoking Bill Most Likely Outcome


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

June 5, 1998

TOBACCO

"I think the President feels that the Republican leadership of Congress would have a very difficult time explaining to the American people why this badly needed legislation that has bipartisan support could not advance on their watch." White House Press Secretary Michael McCurry 6/1/98

HIGHLIGHTS

  1. Yesterday’s passage of the Durbin amendment, which strengthened youth lookback penalties, and the angry partisan split over elimination of the marriage penalty in the tax code, and the broader issue of how to allocate proceeds of an excise tax hike, has shifted momentum back in favor of a much narrower youth smoking bill tied to teen drug use. This would be bullish for stocks.

  2. While the Administration has threatened to make tobacco a political issue if nothing passes, Republicans now appear to have cover to pass a narrow tobacco/drug bill similar to that being contemplated by the House. With a narrow bill, Republicans can argue they addressed the problem of teen smoking; but were opposed to raising cigarette prices by $2.75/pack or more, which would have been paid by the poor, and caused a massive black market. The industry’s $50M ad campaign also provides cover.

  3. Key vote now is Daschle’s motion for cloture, which is scheduled for Tuesday, and would preempt filing of new amendments, limit future debate to 30 hours, and force a vote on the overall McCain bill. While voting against McCain’s bill could be a political liability, voting to continue discussion on the bill is not. We expect Daschle’s motion for cloture to fail.

  4. Dr. Kessler’s speech before our Strategic Decisions Conference yesterday left little doubt in our minds that the public health community would prefer to keep tobacco alive as a political issue than secure a narrow drug/tobacco bill in 1998. Dr. Kessler indicated he did not care if one or more players in the industry went bankrupt as a result of the McCain bill, and expressed his preference to continue the battle into next year and beyond if McCain’s bill died, rather than move back to the June 20 accord.

  5. We believe investors are not paying attention to the fact that absent the McCain bill, we are back to a pre-settlement exogenous environment, but with the most onerous state Medicaid suits -- MS, FL, and MN -- settled for essentially a $.20/pack price hike, which also funded a 25% increase in industry marketing spending to build brand momentum for the post-settlement environment. This marketing spend could fall sharply next year -- without too adverse a consumption effect -- with a narrow tobacco/drug bill.

  6. The biggest obstacle to getting comprehensive tobacco legislation is now the clock. After today, there are just 12 weeks left in the current session of Congress (adjourns October 9). Most of our sources say that if the Senate fails to pass a bill by June 26 (July 4th recess June 26 - July 12), or the House fails to pass its bill by August 7 (August recess Aug. 7 - Sept. 9) there will be no tobacco legislation this year. With McCain now likely opposed to his own bill, McCain himself can help run out the clock.

  7. We reiterate outperform ratings on Philip Morris, RJR, and UST. A return to historic multiples adjusted for changes in secular growth rates (80% relative on MO, 60% on RN, and 70% on UST), translates to price targets of $60, $40, and $40 respectively.

ADDITIONAL DETAILS

  • 1. McCain’s bill close to death. Yesterday, prospects of the McCain bill passing moved from bad to worse, as Senator Phil Gramm’s amendment to eliminate the marriage penalty caused endless partisan debate on the floor and then an ultimate break down in discussions. In what is being perceived as an act of desperation likely suggested by the White House, Senate Minority Leader Tom Daschle called for cloture to end debate and proceed to a vote next week on McCain’s overall bill -- even though many of the major issues have not been touched. We expect Democrats to keep filing motions for cloture until one passes. Last night, the Durbin amendment to strengthen lookback penalties was passed, as many conservatives and moderates, trying to weaken the overall McCain bill or not wishing to be perceived as protecting tobacco, joined with liberals to make the lookback penalties company specific. As written, we are fairly certain the lookback penalties are unconstitutional. We can find no legislative precedent for a manufacturer being held responsible for the illegal actions of a retailer (selling cigarettes to minors), unless there was direct intervention by the manufacturer. As we have said many times, Anheuser-Busch could not be fined if the owner of a liquor store sold a six-pack of Budweiser to a 17-year old.

    • Our sources close to McCain suggest that even McCain may not support his own bill when the bill returns to the Senate floor next week. Senate Majority Leader Lott’s conclusion yesterday was: "Things look pretty dismal right now." Today, Senator Lott took to the Senate floor and declared the McCain bill "dead" unless the Democrats stopped playing politics.

  • 2. Resurrection of skinny tobacco/drug bill. One plausible scenario is that the entire McCain bill falls under its own weight, the White House and health community get nothing, and the industry goes on with its life, fighting case by case. We would expect Senator Orrin Hatch to try to introduce a June 20-type bill if the McCain bill falls apart, but we doubt Hatch has the votes needed to get his bill passed. Increasingly, Democrats and the Administration appear to prefer that nothing passes rather than something small, so that Democrats can cite the lack of progress on tobacco as a campaign issue. The House will wait for the Senate to act before it takes up its youth access bill; the House version will have no excise tax hike, a tough youth access program, and limited advertising restrictions. Our view remains that if the McCain bill unravels next week, we could see Senator McCain and Assistant Senate Majority Leader Nickles team up to try to pass a narrow drug/tobacco bill -- with a small ($.25-$.50/pack) or even no excise tax increase, limited FDA authority, tough retail access restrictions, and narrowly tailored advertising restrictions. Republicans could then say they passed a bill that directly deals with the teen smoking issue, after partisan politics caused the original bill -- proposed by Senator McCain, a Republican -- fell apart. We seriously doubt that the Administration would make good on its threat to veto a skinny bill that was "not comprehensive enough;" since such a claim would not pass the public laugh test, and open up Clinton to claims the Administration is pro-drugs. If President Clinton did veto a skinny drug/tobacco bill, Republicans could come back and say they wanted to do something about teen smoking, but did not want to raise taxes, cause a massive black market, or bankrupt the tobacco industry -- all which the McCain bill as amended could do.

Current McCain bill:

McCain II

June 20

Comments

Base payments

$21.0

$15.0

1999 inflation adjusted $

Lookback penalties

9.0

2.0

June 20 $2.0b cap; McCain II $4.0b cap, $1,000/kid not tax-deductible

Tort fund

8.0

1.0

Excess costs to eliminate liability: June 20 - 20% of $5b = $1b.

Total payments and penalties

$38.0

$18.0

  

Cigarette payments only

36.6

18.0

McCain II - 96.8% of payments by cigarette makers

Industry volumes

14.1

23.5

Volume adjusted after 2002 off base year = 80% of 1997 volume

Per pack increase - mfr’s list

$2.60

$.77

$ per pack increase in list prices

Per pack increase - retail

$2.72

$.80

$ per pack increase at the shelf -- assumes 4.7% avg. sales tax multiplier
       

Average retail price - 1998 $

$4.77

$2.85

Avereage retail following recent $.05//pack price hike now $2.05/pack