Post of the Day
August 18, 1998

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Subject: Fork in the road -- settle or fight?
Author: Fozziebare

Tobacco is building on an impressive string of victories in recent months, culminating with what many consider tobacco's biggest victory: Friday's verdict overturning the FDA's power to regulate tobacco products as a drug. Though an appeal will follow from the Department of Justice, tobacco has definitely increased bargaining power in any comprehensive settlement's going forward.

It's time to look in the mirror at MO, and see where we are today, and figure out where we are going.

With Friday's ruling, new worries are bound to come. There have been speculations that the federal government, faced with an uphill legal battle against tobacco and a Congress hostile to comprehensive tobacco legislation, will file a landmark lawsuit seeking reimbursement for Federal Medicaid payments for treating sick smokers. Some have estimated the price tag of such a suit at $1 Trillion, with a "T". However, such a suit is purely speculation at this time, as no motions have been filed.

On the state-front, tobacco and AGs resume meeting in upcoming weeks on a comprehensive settlement for the state Medicaid suits. Investors argue on the issue of settling at all at this point, what with tobacco's recent string of courtroom victories. But let's look at both sides:

1) No comprehensive settlement -- tobacco settles on a state-by-state basis. This is how tobacco is currently working, until a comprehensive settlement is announced and agreed to. Legal victory after legal victory have added up and seemingly stacked the deck in tobacco's favor. Settling on a state-by-state level allows the industry to focus on one state's case at a time, instead of all at once. Settling one at a time also allows the industry to try and have each case thrown out before even going to trial or reaching a settlement stage (as evidenced in Indiana where the state's Medicaid suit was thrown out in its entirety).

2) Comprehensive settlement with the states. This is what the tobacco industry is in talks to do. Unlike its state-by-state brother, this settlement would effectively end all the states' suits at once upon ratification by each state. Tobacco no longer needs to challenge each state to a legal duel to determine an outcome. A comprehensive settlement will give investors a much clearer picture of tobacco's financial future than if tobacco went state-by-state. The certainty of the settlement would allow valuation models to become more firmly established which would benefit shareholders.

With that said, it is not clear what choice would be the best. It can be argued that it is far more likely that stock buyback programs and dividend increases will resume with such a settlement, while there is no such anticipation if things remain at status quo. But, with the "one fell swoop" approach, it may end up costing tobacco more than it would have had to pay out if it fought it out with each state. I doubt that anyone will argue that the state-by-state approach would provide the certainty needed to properly assess the value of the tobacco sector. The threat of losing any of such cases seems greatly diminished with the recent pro-tobacco verdicts, however, a loss could end up snowballing and lead to unfavorable financial terms on subsequent cases. Each investor must decide which method they prefer on their own.

Tobacco's victory against the FDA showed that tobacco is far from dead, as the press had proclaimed with the emergence of McCain's bill early in the year. Tobacco's mounting victories may end up forcing the federal government, whose own obesity got in the way of what was heralded as "an historic event" in the great tobacco wars. Since then, MO et al have been stuck in a trading range, which has typically remained at the lower end of the range. MO has traded between 35 and 48, but the mid to upper forties are a distant memory to many. Congress' "overreaching" and the demands of Kessler, Koop and others in the public health community destroyed any chance that the country would be able to capitalize on tobacco's "turning over a new leaf" and remove this debate from the national agenda. Over a year later, the issue is as contentious as ever, with more and more federal judges claiming that any resolution of the tobacco debate should come from Congress, not the courts.

Well, to one and all, I applaud tobacco's fight. With a lion's share of tobacco proceeds going to "sin" taxes, it makes me wonder where all of those tax dollars from tobacco products is being spent. Oh wait, I think I just drove over it on highway marker 38 on Interstate 75. Instead of using tobacco taxes to pay for smoking medicare costs, the government is attempting to take even more money from tobacco. Then they want to curb its advertising. Then they want to regulate it. And all under the claim of public health, and "saving our children." Take a look at this article, Tobacco Article posted by another Fool, and see if you think the government has gone too far.

And do me a favor, let me worry about "saving my kids" and you worry about running the country.

Long on MO, Short on the government's (federal and states') case.


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