Some wonder if cigarette makers can afford another huge payout

Stephanie Stoughton

Friday, Oct. 15, 2004 | 9:32 a.m.

RICHMOND, Va. -- Big tobacco companies have already agreed to pay $246 billion to settle states' suits against them. Now, at a civil racketeering trial in Washington, D.C., the Justice Department is seeking $280 billion from cigarette makers, charging them with defrauding the public about the health risks of smoking.

What if the government wins its case?

Tobacco executives and their lawyers, who believe the government has overstepped its bounds, predict U.S. District Judge Gladys Kessler won't hobble the firms by ordering another huge payout in the nonjury trial she's presiding over and that's expected to last well into 2005.

As the industry is quick to note, it has undergone significant change in the past decade, adding youth smoking prevention programs and operating under stricter rules. In the late 1990s, it agreed to the $246 billion payment to settle suits filed by multiple states over health care costs. The agreements also forced the companies to alter their practices.

"Those are irreversible changes that are the best indication of how we'll do business in the future," said Peggy Roberts, a spokeswoman for industry leader Philip Morris, the subsidiary of Altria Group Inc. that relocated from New York to Richmond.

To hear the industry tell it, the result of an adverse court decision would be simple. "If we lose, we all go bankrupt and the federal government will own all the tobacco companies," said Seth Moskowitz, a spokesman for Reynolds American Inc., created through the merger this summer of R.J. Reynolds Tobacco Co. and Brown & Williamson Tobacco Co., and second in size only to Philip Morris USA.

Critics and legal experts, however, say such a drastic outcome is unlikely. They contend the defendant companies -- R.J. Reynolds, Brown & Williamson, British American Tobacco Ltd., Lorillard Tobacco Co., Liggett Group Inc. and Philip Morris USA and its parent Altria Group -- are likely to settle if they sense defeat. And if they do, the landmark Master Settlement Agreement with states six years ago provides a road map for their survival, according to these experts.

"If this settlement is structured like the MSA, it's highly likely it will be passed on to smokers through higher prices, which means the industry won't suffer as much," said Jonathan Gruber, an MIT professor of public finance who plans to testify for the federal government at the Washington trial.

The master settlement limited the financial damage by allowing the companies to make annual, volume-based payments over 25 years. The industry passed on most of the costs through wholesale price increases that contributed to a rise in the retail price of a pack of cigarettes by more than $1.50 a pack.

There's also plenty of money that could be tapped for another payout, anti-smoking advocates say. Last year, the net worth of Altria, R.J. Reynolds, British American Tobacco and Lorillard owner Loews Corp., topped $45 billion. And their assets were above $200 billion. The industry's top two players, Philip Morris and R.J. Reynolds, had $22 billion in U.S. sales in 2003.

"They use this strategy of crying bankruptcy all the time," said Eric Lindblom, policy research manager for the Campaign for Tobacco-Free Kids. "It's a PR strategy and a legal strategy."

Tobacco companies say they're already under pressure. As higher state and local taxes and the 1998 agreement have helped boost the price of cigarettes, tobacco sales and profits have been sinking.

Philip Morris' revenue dropped 10 percent to $17 billion last year, while its operating income declined 22 percent to $3.9 billion in 2003. R.J. Reynolds said its sales fell 15 percent to $5.3 billion, and it reported an operating loss of $3.8 billion last year, compared to operating income of $779 million the prior year.

But there's hope for the industry. Wall Street analysts have been openly dismissive of the Justice Department's case. As a result, tobacco stocks have been largely untouched by news coverage of the racketeering trial.

Robert T. Campagnino, an analyst with Prudential Equity Group, said the Justice Department will have a difficult time proving a key element of its case -- that there is a reasonable likelihood that the tobacco companies will commit wrongdoing in the future.

"If the tobacco industry has one thing going for it, it's that it has done a complete 180 over the past several year," Campagnino wrote.

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