Tobacco.org

"I’ll get my gun." Assistant Senate Majority Leader Don Nickles, after being asked last week whether the tobacco bill was going to live or die.

1. In the Senate, neither side appears to have the 60 votes needed to either proceed to a vote, or remove the tobacco bill permanently. With key votes on farm provisions, deductibility of advertising expenses, liability cap, and Hatch’s substitute bill all scheduled for this week, final action in the Senate is likely to be delayed again, pushing the bill right up against the July 4th recess (begins 6/26).
2. Most likely scenario remains negotiated House-Senate conference in August, where President Clinton agrees to limited legal protections (unlimited liability cap, parent’s assets protected) in return for industry consent on advertising restrictions and a straight $1.10/pack payment scheme over 5-10 years. Catalyst for stocks: House passes narrow bill with no excise tax increase.
3. Senate Majority Leader Lott’s comments over the weekend ("We are going to have to find a way to go to a much smaller bill, or I don’t think it’s going to be brought to conclusion"), combined with House Speaker Gingrich’s comments Friday ("It’s dead because we won’t take it up. There is no chance -- none") should give investors confidence that any tobacco bill enacted will be much narrower in scope than McCain’s -- or be a brokered deal between the industry, Congress, and President Clinton.
4. Of the $69 billion in net revenues to be raised by the McCain bill over the first five years, we calculate there is now no money left for public health or cancer research, which were to get $15 billion each. In the past two weeks, marriage penalty relief ($16 billion), drug interdiction ($15 billion), and veteran’s funds ($3 billion) have been added to spending that already included state settlements ($28 billion) and farmers’ protections ($11 billion). The Administration says this will be changed in conference.
5. President Clinton and Democrats may be operating under different agendas: We believe Clinton may come to any House-Senate conference anxious to strike a deal to bolster his job approval ratings to cushion the expected nose-dive once Ken Starr starts showing his Lewinsky cards. Democrats appear more apt to want an issue to run on in Fall elections. The tobacco industry’s $50 million ad campaign, portraying the bill as tax-and-spend liberalism at its worst, is perceived to be giving Republicans cover.
6. We point out that for $28 billion per year -- the base payments and lookback penalties paid by the industry under McCain -- the country could hire 4 guards round the clock to monitor each and every cigarette rack at each one of the 330,000 distribution points at which cigarettes are sold in America. Alternatively for $28 billion per year, we could pay each one of the 4 million teens who reach majority each year $7,000 if they reach their 18th birthday without ever having become a smoker (confirm via blood tests).
7. Key event on litigation front remains Engle class action trial, set to begin in West Palm Beach, FL on July 6. The common issues trial will last about four weeks. If the jury finds common liability, the same jury will determine "a basis or ratio of punitive damages" to be applied if compensatory damages are awarded to any of the six representative class members in Phase II. In Phase III, separate trials would be held for all class members, which could number 300,000. Industry could appeal after a Phase II loss.

We reiterate outperform ratings on Philip Morris, RJR, and UST. With every day the Senate fails to end the debate on tobacco legislation, odds increase there will either be a very narrowly-tailored youth access bill with little or no excise tax increase, or a bona fide settlement agreement between the Administration, Congress, and the industry that gives the industry the legal protections needed (parent assets protected, unconditional cap) to separate domestic tobacco from other operations, and allow restoration of normal relative multiples (MO 80%, RN 60%, UST 70%) or sum-of-the-parts valuations. Price targets remain MO $60, RN $40, UST $40.

1. Revisiting the Republican script. Senate Majority Leader Trent Lott again hinted at a change in direction over the weekend, suggesting on ABC’s This Week that the McCain bill had to be made "much smaller" or "would not be brought to conclusion." Lott’s statement, following on the heels of House Speaker Newt Gingrich’s comments on Friday that there was "no chance -- none" that the House would take up a bill that even resembled McCain’s, effectively puts President Clinton and Senate Democrats on notice that the strategy that Republicans appeared to embrace at the end of last week was a mirage. As of late-Friday, the conventional wisdom in Washington was that Republicans would hold their noses, and pass a big-government, big tax, big bureaucracy bill, that would effectively remove the bill from the Senate floor, and allow it to be rewritten by perhaps a dozen lawmakers behind closed doors in House-Senate conference, with President Clinton and the industry both at the table. Lott’s comments clearly convey the impression that the Democrats still do not have the 60 votes needed to enact cloture, which would limit future debate to 30 hours, permit votes only on amendments now on the floor, and push the overall McCain bill to a vote. This seems to be true whether Lott, as Senate Majority Leader, files the motion for cloture or Democratic Minority Leader resumes his one-per-day cloture motions -- three of which failed last week, with votes strictly along party lines. From what we can tell, Lott appears to be embracing a run-out-the-clock-strategy, but with a tantalizing end-game twist: Rather than kill the tobacco deal, Lott appears to be pushing Democrats to either scale back the existing McCain bill as amended (currently $516 billion in base payments, plus $154 billion in non-deductible lookback penalties; total pretax equivalent cost $773 billion, with no liability protections) -- or embrace an alternative bill in waiting, which we presume is the Hatch bill, which was introduced on Friday as a substitute bill, and could be voted on either this week or next. Hatch’s bill is similar to the June 20 agreement, requires $428.5 billion in payments (adjusted for volumes and inflation), includes $175 billion in potential lookback penalties ($95 billion not tax-deductible), and includes all legal protections found in the June 20 agreement. The Hatch bill is 40% more expensive than June 20, but is infinitely superior to the McCain bill, which we believe would lead to industry collapse if enacted:

2. Christmas in June implies conference in August. The McCain bill was expected to generate some $92.5 billion in gross revenues over the first five years. Net of the standard 25% income tax offset, this would produce net revenue of $69 billion over five years. The amended McCain bill that went to the Senate floor was to allocate this $69 billion as follows: $28 billion (40%) for the state settlements; $15 billion (22%) for public health initiatives such as smoking cessation, education and prevention, FDA activities, and enforcement of retail access and licensing provisions; $15 billion (22%) for cancer research and grants to institutions such as NIH and the Centers for Disease Control; and $11 billion (16%) for farmers’ price supports and crop buyouts.