Altria's (NYSE:MO) 2003 fourth-quarter results marked a positive ending to what had been a rather difficult year, with increased price competition from low-cost tobacco producers and troubles at Kraft Foods (NYSE:KFT) putting a damper on earnings. But the story few people are talking about could prove to be the most important (and risky) decision in the company's history.
The seemingly endless parade of tobacco litigation against Altria has overshadowed its operations for some time now. The second half of the year, however, saw positive legal developments, with a number of suits against Philip Morris USA decertified as class actions. At the same time, Altria's taken on considerable debt to cover settlement costs and appeal bonds related to all this litigation. At $19 billion, its long-term debt is 50% greater than it was just four years ago. The debt-to-equity ratio peaked at 1.9 in 2000, but has since fallen to 0.98, thanks to a reduction in share buybacks.
Into this mix of endless litigation and rising debt load rides a potential white knight. Altria has thrown its support behind legislation that would allow the Food and Drug Administration to regulate tobacco as a drug. The government would then take responsibility for policing the health effects of tobacco and establishing guidelines for production and sales, shielding Altria from further health-related lawsuits. Management seems to believe this is the best way to preserve shareholder value under current conditions.
Understandably, regulation looks like a saving grace to many investors, especially after the tobacco industry recently lost another round in court to the government (a U.S. district judge rejected a request to throw out the Justice Department's $289 billion suit against Altria and others). Yet by supporting FDA regulation, Altria takes one step closer to the eventual outlawing of tobacco.
With a strengthening balance sheet, several successes in the courts this past year, and a turnaround in operations, is now the time to make this deal? Regulation may stave off the lawsuits, but like Faust's bargain with the devil, it may be at the expense of the company's soul.
Chris Mallon owns shares of Altria through his private investment partnership.
