Interview with Bennett S. LeBow

Interview with Bennett S. LeBow

APS Financial Corporation

October 23, 1998
Joel D. Luton

Credit Update

(Previous Credit Update: August 28, 1998, Initial Report: March 14, 1997)

Brooke Group Ltd./Liggett Group Inc.

Interview with Bennett S. LeBow

Recommendation: Speculative BUY on Liggett Senior Secured Notes

We recently attended the Brooke Group shareholders annual meeting held in Miami. After the meeting, we had an interview with the controversial Bennett S. LeBow ~ the Chairman, President, and CEO of Brooke Group. We discussed a variety of topics with Mr. LeBow and, during our visit, also had conversations with some of Brooke’s other senior officers. Below is a summary of our conversations and some of our own impressions:

  • The Tobacco Industry’s Negotiations with the States

Mr. LeBow, while not privy to any details of the negotiations, believes that a settlement will be reached between the states and the tobacco industry regarding the Medicaid-related litigation. He believes that an announcement of an agreement will come after the November 3rd elections. The Attorneys General are likely to be reluctant to release an announcement before the elections, given the possible political criticism of settling with the tobacco industry. With the agreement, LeBow believes that there will be a price increase for cigarettes to pay for the settlement, but he is uncertain on the amount of the initial price increase and also the ramp-up time for further price increases. (Note: We believe that there could be an initial price increase of $0.15/per pack to $0.35/per pack.)

  • Liggett’s Agreement with the States

Mr. LeBow believes that the Brooke/Liggett agreement with 41 states is "solid and airtight", and that the possible agreement between the states and the tobacco industry will not interfere with his own agreement. Mr. LeBow does not view Liggett as a "renegade" tobacco company, since it has its own settlement with the states. (Note: Renegade tobacco companies are smaller tobacco companies that are not in the negotiations with the states. We believe, with the state/tobacco industry settlement, the renegade companies could be required to pay a significant state licensing fee, if they do not participate in the settlement.) In addition, Mr. LeBow believes that a state/tobacco industry settlement could actually be more beneficial to Liggett than the impact from the failed federal settlement of this summer (i.e., the McCain bill). With the state/tobacco settlement, Liggett would not have any limits on its market share. (Note: In the McCain bill, Liggett’s market share was limited to 3.0% of the market. Presently, Liggett has an estimated 1.3% market share. We estimate that Liggett is currently operating at only 28% of capacity.) Mr. LeBow estimates that Liggett currently has about an $0.11/per pack pricing advantage over the other major tobacco companies. (Note: The tobacco industry has already settled with four states and has raised cigarette prices accordingly to pay for the settlement. Assuming a settlement with the remaining states, we estimate that Liggett could have approximately a $0.25 to $0.50/per pack pricing advantage over the rest of the industry.)

  • Refinancing the Liggett Senior Secured Notes

Mr. LeBow believes that, with a state/tobacco industry settlement, Liggett will be able to refinance the Senior Secured Notes that are due February 1, 1999. Mr. LeBow believes that Brooke/Liggett will not have to enter into negotiations with the bondholders to extend the maturity of the Notes, despite the current turmoil in the high yield market. With respect to Liggett’s $40 million revolving credit facility that expires March 8, 1999, Mr. LeBow believes that facility is well collaterized and the ability to extend the facility is not an issue. (Note: Given the current situation in the high yield market, we are not as certain of Liggett’s ability to refinance the Senior Secured Notes. The Company, however, may be able to take out a portion of the Notes and extend the maturity of the remaining amount ~ with an appropriate consent fee and other incentives. With an improvement in the high yield market, we believe that refinancing the Notes should not be a problem, assuming a state/tobacco industry settlement. We believe an extension of the revolving credit facility is contingent upon the ability of the Company to refinance or successfully extend the maturity of the Senior Subordinated Notes.)

  • Liggett’s Outlook for 1998

Mr. LeBow said that Liggett’s business is doing well and is performing in line with internal corporate projections. Also, Mr. LeBow said that Liggett’s distribution contract with Speedway SuperAmerica LLC, which expired June 30, 1998, has been renegotiated and renewed. (Note: For 1998, we are estimating a slight increase in revenues for Liggett, $323.0 million versus $312.3 million for 1997. We are estimating a strong increase in EBITDA for the year ~ over a 40% increase to $40.8 million versus $28.8 million in 1997 (refer to Financial Summary, page 5). Our estimate assumes no additional price increases for the remainder of the year. We believe our 1998 EBITDA estimate is on the conservative side. Regarding SuperAmerica, Mr. LeBow would not comment on the details of the new contract. SuperAmerica is Liggett’s largest distributor and sales to them represented approximately 19.4% of 1997 revenues. We believe, with a state/tobacco industry settlement, the contract could include financial incentives to SuperAmerica to distribute a greater amount of Liggett cigarettes ~ which thus could aid Liggett in increasing its market share.)

  • The Turmoil in Russia and the Impact on Brooke

Mr. LeBow discussed the current situation in Russia and the impact of Brooke’s Russian related investments. With respect to Liggett-Ducat (Ducat), the Russian cigarette manufacturer, Ducat is actually having strong volume growth and, in fact, the month of September was a record for Ducat. Mr. LeBow attributed this strong volume growth to trading down by consumers for the cheaper, Russian branded cigarettes (which Ducat currently makes) instead of the more expensive American style cigarettes. While Mr. LeBow expects strong volume growth for the third quarter (ended September 30, 1998), Ducat’s revenues are harder to gauge given the devaluation of the ruble ~ although Ducat has increased cigarette prices substantially since the devaluation. With respect to the new Ducat cigarette plant, it is not scheduled to open until April or May of 1999. Mr. LeBow said that the plant is 80% to 90% complete and the scheduled opening has been delayed by approximately a month due to the recent economic turmoil. The plant’s capacity is 30 billion cigarettes a year and, upon completion, the facility will be the second largest cigarette plant in Russia. (Note: Russia is the third largest cigarette market in the world.) RJR currently has the largest with production capacity of 36 billion cigarettes per year and Phillip Morris has plans for the largest facility, but it is not scheduled to open for a couple of years. Mr. LeBow and other Brooke officers spoke very highly of Ronald Bernstein (President of Liggett-Ducat) and his capabilities (refer to our May 21, 1997 Credit Update ~ Interview with the President of Liggett-Ducat).

Mr. LeBow briefly discussed New Valley’s Russian real estate investments (in partnership with Apollo Group). He said the developed properties are almost fully leased, primarily to "blue-chip" American companies and rent payments are in U.S. dollars. Additional development of new properties has been put on hold, pending improvement in the Russian economic environment.

  • The Recent Performance of Brooke’s Common Stock

Brooke common stock (NYSE: BGL) has been under recent pressure ~ currently at $6 _ per share and down from its earlier year high of $17 _. However, Mr. LeBow believes that there are a variety of positive factors that could impact the Company and are not fully reflected in the stock price (i.e., the competitive advantage which Liggett may have from a state/tobacco industry settlement, the possible refinancing of the Liggett Senior Notes, the strong volume trends of Liggett-Ducat, and the potential of the new Ducat factory). Mr. LeBow urged shareholders to be "patient" with their investment, and believed better performance from the stock was ahead, especially after a state/tobacco industry settlement falls into place. (Note: We attribute the weakness in the common stock primarily to the following factors: the failure of a federal tobacco settlement by Congress; the overall weakness in the equity market, especially smaller cap stocks; inaccurate information on Brooke’s situation reported by a prominent TV and internet investment commentator; the economic turmoil in Russia; and a large holder selling his position ~ which we believe has been completed.)

Mr. LeBow also commented on the recent amendment (which was approved by shareholders at the annual meeting) to increase the number of authorized shares of Brooke common stock from 40 million to 100 million. Mr. LeBow said that this was to give him "flexibility" and did not have anything currently planned with the additional shares. (Note: We have heard some recent speculation over the meaning of this increase in the authorized shares outstanding, the recent, although small, increase in Carl Icahn’s position in Brooke’s common stock, and Mr. Icahn’s recent renewed position in RJR’s common stock. We currently do not have an opinion on whether these actions are related and, if so, are tied to some "grander scheme".)

  • Investment Opinion

We continue to believe that the Liggett Senior Secured Notes are attractive from a risk/return standpoint for speculative investors. We believe that there is a high probability that a large percentage of the states (if not all) will reach a settlement with the tobacco industry. With a settlement, we believe Liggett will have a significant cost advantage over its competitors. Also, with the settlement, it is possible that Liggett can refinance its debt. If Liggett is unable to refinance, we believe the Company has a strong incentive to constructively work with Noteholders to extend the maturity (or get a high percentage to extend) and to continue to make the interest payments (which we believe Liggett will easily have the capability to do). Also, we advise Noteholders (who received 3.33 shares of BGL common stock per $1000 principal amount from the extension of the February 1, 1988 sinking fund payment) to hold the Brooke common stock. We believe the Brooke common stock (current yield: 4.7%) could significantly strengthen in reaction to several possible positive events (i.e. the state/industry settlement, refinancing of the Liggett Notes, strong volume growth at Ducat, etc.).


The securities discussed in this report are speculative in nature and may not be appropriate for all investors. No investor should purchase these securities unless such investor understands and is able to bear the yield, liquidity, interest, event and other risks associated with such securities. These risks could adversely affect expected returns and/or result in substantial loss. Information herein has been obtained from public sources believed to be accurate and reliable. However APS Financial Corporation cannot guarantee the accuracy of completeness of any information or results obtained from the use of such information. Any opinions expressed herein reflect our judgment at this date and are subject to change. We do not undertake to advise you as to any order to buy/sell. APS Financial, our affiliates, employees and their families, thereof may have positions in securities referred to in this review and any make purchases or sales thereof while this report is in circulation. If you have any questions about the information provided, please contact your investment representative prior to making any investment in the security. Since some investments in securities have unique tax implications and consequences, such` as original issue discount, you should consult your tax advisor, as necessary, prior to making this investment.