There is a popular adage in the tobacco industry: whenever Bill Clinton needs money, he calls on Philip Morris. The consumer brand giant that also owns Kraft foods and Miller beer operates the largest international tobacco business and was Clinton’s highest taxpayer last year. Philip Morris had the second-highest budget for lobbying ($23 mn, compared to Brown & Williamson’s $24.9 mn), and courted congress with $2.3 mn in political donations – to no avail. Soon after November’s Masters Settlement Agreement burned the US tobacco industry with $206 bn in Medicaid costs, Clinton added insult to injury by announcing plans for a new wave of suits to dwarf all previous numbers. At the Philip Morris investor conference in June the message was crystal clear: no more Mr Nice Guy.
Amid the controversy, one thing is certain: the tobacco industry is in flux. While Philip Morris, RJ Reynolds and British American Tobacco subsidiary Brown & Williamson enrich their public image by emphasizing positive aspects of their business, they face higher social pressures, increasing regulatory uncertainties and continued ambivalence from Wall Street. All this has driven stocks down despite strong performances. Morris’s stock hit record lows (falling 24 percent in the first six months of 1999) and was added to the Dow’s list of best bargains for value buyers. Other players – like number three global cigarette marketer Japan Tobacco and the UK’s Gallaher Group – have opted to stay out of the controversial US market altogether. Never has an industry, so strong for so long, appeared so vulnerable.
Riding out the storm
As the tobacco industry pitches and heaves, IROs scramble to get their footing and anchor their shareholders. ‘Our job is to provide accurate and timely information to the investment community, especially when it comes to legal and regulatory issues affecting the company,’ summarizes Nick Rolli, vice president of IR and financial communications at Philip Morris. ‘The media may not get it right, and if that adversely affects investor perception, then we need to respond quickly.’
Indeed, investor relations in the tobacco industry is largely an attempt to describe the dance between public issues and business practice. While shareholders are undoubtedly influenced by public perception, investor relations officers help to manage the issues and dispel perceived threats. This means steering them back to fundamentals, as Rolli always does. ‘Our message to the community is that the fundamentals of the business are good, the brands are strong, we can grow this business going forward and we believe we can manage the litigation and regulatory environment.’
Litigation is manageable – that’s the single most important message, the premise which allows business to proceed. It’s the basis on which the tobacco companies build their operations and handle shareholders’ concern. At the Philip Morris conference, Murray Bring, vice chairman and general counsel, summarized his view on litigation: ‘We are in a much better position today than we were a year ago.’ He encouraged investors to see the light at the end of the litigation tunnel. ‘My guess is that [the US Department of Justice] will file the suit,’ Bring said, ‘and we will seek to have it immediately thrown out of court.’
Tobacco executives say Clinton’s claims will not stick, and that the big battles have already been fought. The Masters Settlement Agreement concluded one level of debate; and tobacco won a significant coup when the federal appeals court rejected the Food and Drug Administration’s bid to regulate it as a drug. Should the federal suits go through, the industry plans to launch an all-out counter attack. Philip Morris’s strategy to sharpen its public image and respond aggressively to critics is appropriately called ‘no more bunkers’.
Shooting straight
The tobacco industry has learned something important from the last round of court battles: it cannot afford to be silent. Philip Morris’s June conference was its first big investor meeting in more than four years. Other companies, too, had opted for a low profile until the court battles were resolved. Having realized that such battles could drag out for years, however, tobacco companies have taken a more active role in counseling shareholders. IROs have realized they need an intimate understanding of the law and of court cases past, present and future. Often they must translate the mercurial minutiae of legal language. ‘We’ve tried to be very straightforward with investors and tell them about the litigation environment. We also talk about our track record, which has been very strong,’ says RJR Tobacco’s vice president of IR, Dianne Neal. ‘The more people understand about the litigation environment, the better off the industry is.’
Mark Cohen, tobacco analyst at Goldman Sachs, adds another spin: ‘Everybody in the world has very emotional feelings about cigarette smoking.’ IROs may have to come to the rescue like paramedics to an accident, putting out emotional fires and consoling hysterical victims. They have to be the voice of reason, keep a level head, downplay the drama and instill a confidence that smothers all doubt.
Conceptual art
With all the pending issues that keep tobacco shareholders skittish, investor relations officers are left wondering how they can handle the tasks at hand. After all, how does one speak authoritatively about uncertainty?
Part of the solution is knowing what the Wall Street audience expects. Uncertainties in the industry are no secret, least of all to analysts and investors, and they need to feel that the IR department stays out in front of pertinent issues. Shareholders need to be kept informed when developments arise and when nothing new has happened, paradoxically, they need to know that too. ‘You don’t want the answer to how much a company is going to make, because even they don’t know what they’re going to make a lot of the time,’ admits Manny Goldman, Merrill Lynch’s global coordinator for beverages and tobacco. ‘But you want them to be able to talk about what goes into creating earnings – the different factors, what’s more certain and what’s less certain. The good IR person will talk conceptually.’
Sometimes shareholders just need to feel that they’re not the only ones in the dark. They need to know that communication lines are open and that the process of sorting out details includes them. ‘When there are issues that have uncertainty you discuss the different possibilities, even if no-one knows how it is going to come out,’ Goldman continues. ‘As you talk about it, things get clearer and some outcomes may be more likely than others or more significant in terms of impacting earnings.’
One advantage IROs have is their audience. Speaking exclusively to the financial community, they are not on the front lines of tobacco’s ethical debates. Gallaher Group IR manager Claire Jenkins explains: ‘I don’t have to communicate with people who are vehemently anti-tobacco. I do have to communicate to my specific audience about what is happening regarding these issues, but I’m not the one who’s having to respond to hostile questioning.’
While her PR department handles the ‘demonization’ from anti-smoking forces and the popular media, her shareholders are not themselves part of the witch hunt. The IRO’s job is to explain how the witch hunt affects business.
There is a fundamental difference in the way tobacco companies operate around the world. European companies face a different legal structure and a different tort system, notably lacking punitive damages. The practice of speculative litigation and class-action lawsuits, while common in the US, are new to Europe. Plaintiffs have filed such suits against the European tobacco companies, such as the UK’s Leigh Day case, but they lack momentum. British American Tobacco’s head of IR, Ralph Edmondson, describes the difference: ‘You can’t sue someone without having to pick up the financial risk if you lose that case, and that’s the difference between the US and other legal systems. So what you had with Leigh Day was a fairly speculative action that failed and was going to become very expensive to take further to the next stage.’ The courts dismissed the Leigh Day case and most other plaintiffs subsequently dropped their charges.
Blue skies over Europe
While the dark cloud of litigation still looms, the magnitude of proceedings in the US has in certain ways benefitted European tobacco companies. Many non-US investors, lured by tall tales of ambulance-chasing lawyers, began investigating the tobacco debate and educating themselves about litigation. Subsequently the knowledge base among investors has risen.
‘In the UK the investment community is becoming more knowledgeable about the industry,’ confides Gallaher’s Claire Jenkins. ‘Two years ago investors were very wary about smoking and health litigation because they just read the stories about what was happening in the States.’ The sensational stories drew attention to the issues in the tobacco industry and also to the fundamental differences in legal practice on either side of the Atlantic. The result has been an increased appetite for non-US tobacco stocks. ‘Those same long-term investors are now looking particularly at the European tobacco stocks because they can get the same brand equity, cash generation, strong management and so on without the risk of the US litigation overhang.’
The US also differs from the rest of the world in its social attitude toward smoking. Social activism in many countries can be just as hostile, although there is a widespread belief that smoking is a matter of personal choice and responsibility. In Europe, the tobacco debate has put the focus more on legislation than litigation. And cigarette packs in Japan read like a haiku: ‘Be careful not to smoke excessively for your health.’
While the dwindling US smoker population caused local companies to diversify (Philip Morris acquired General Foods and Kraft, RJR bought Nabisco, and Sara Lee got out of the tobacco business altogether), companies abroad have begun to consolidate. Japan Tobacco recently financed the largest foreign acquisition by a Japanese company on record when it picked up RJR Nabisco’s international tobacco operations for a smoking $7.8 bn. British American Tobacco (BAT) merged with Rothmans to focus on the UK market, and Germany’s Reemtsma, one of Europe’s largest tobacco companies, has made many non-German acquisitions.
Meanwhile emerging markets like Singapore, Hong Kong and eastern Europe show the most promise for industry growth. BAT has been the traditional leader in emerging markets although Philip Morris’ Marlboro Man, representing the world’s most popular cigarette brand, has galloped out to increase international sales by 80 percent in the last five years.
Perhaps the industry’s greatest change hinges on the issue of responsibility. Smoking has health repercussions, and while everyone must be aware of them, the onus of education falls on the companies themselves. They are assuming a more visible profile.
Brown & Williamson’s new web site, for example, is remarkable not only for the scope of its information, but also for its frank acknowledgment of tobacco’s health risks. B&W is calling itself ‘a responsible company in a controversial industry’ and attempting to polish its tarnished public image. Likewise, Philip Morris launched a $75 mn ad campaign to discourage youth smoking. Although the subtlety of this campaign has been widely criticized by anti-smoking activists (who prefer more direct imagery like the woman smoking through a hole in her throat), Steven Parrish, senior vice president of corporate affairs at Philip Morris, has vowed to turn the other cheek and build bridges to the activist community. Equally important, the corporate giant is emphasizing its many non-tobacco businesses (‘We’re much more than a tobacco company’ is the new angle) as well as its charitable donations.
In the pregnant pause between last year’s MSA settlement and Clinton’s promised lawsuits, tobacco stocks have maintained shareholder interest with strong performances, sound defenses and the promise of good dividends. Despite the ethical debates, tobacco is big business. In the end, the industry has a trump card that rarely gets played: it knows that congress would not support a full ban. Just as the public is addicted to cigarettes, congress is addicted to cigarette money.
