Lawyers' Poker

Avid skier Luc Jobin knows what it's like to hurtle down slopes not knowing what lies ahead. The recently appointed CFO of Imperial Tobacco Ltd. certainly can use this experience in his new job--managing the finances of a company whose terrain is fraught with hidden dangers.

Jobin actually is better off than most other tobacco CFOs. He works for a company that manufactures and sells cigarettes in Canada, where at least the legal climate is more temperate than in the United States. "My concerns, while large, are extremely benign compared to the CFOs of RJR Nabisco or Philip Morris," says Jobin from the Montreal headquarters of $3 billion (Canadian) Imperial, the 85-year-old manufacturer of Player's and du Maurier cigarettes.

"The level of litigation here is nowhere near what it is in the United States," he continues. "Canadians are typically a lot less litigious, and our punitive damages are very different in magnitude. We're also not facing the U.S. Congress." Jobin is referring to the now-defunct Senate bill sponsored by Sen. John McCain (R­Ariz.) that would have increased the price of cigarettes by $1.10 a pack, required the industry to pay $516 billion over 25 years, and increased the authority of the Food and Drug Administration to regulate nicotine products. (At press time, the Senate sent the bill back to its Commerce Committee-- effectively killing it--in the wake of a $40 million advertising blitz by the tobacco industry. Meanwhile, the House of Representatives was preparing its own, narrower version of tobacco legislation.) "These are unbelievable numbers," Jobin says.

He's right. Between the tax hikes and the lawsuits--cigarette manufacturers are currently the target of numerous class-action suits as well as an array of suits brought by 36 state attorneys general--the U.S. tobacco industry is facing some very negative numbers. Last year, for example, Philip Morris Co. took charges of almost $1.5 billion for tobacco settlements in Mississippi, Florida, and Texas. In June, Brown & Williamson Tobacco was hit with a $1 million settlement in a Florida case that included $450,000 in punitive damages--the first time a jury in a tobacco case has awarded such a penalty. And if the McCain bill had passed intact, according to some analysts, industry earnings would have declined 20 percent one year after the legislation took effect and 35 percent by the fifth year.

The CFOs, however, have been relatively silent. The finance chiefs at each of the five major tobacco companies--Philip Morris, RJR Nabisco Holdings, Brown & Williamson, Lorillard Tobacco, and Liggett Group--refused to be interviewed on the matter. "My management does not want any reference to our company in the press at this time," says Jeff Kushner, who was CFO at Lorillard Tobacco Co. until last month. "I wish you got me in my last job as the CFO of a hardware company. I'm in an industry now that has more lawyers than I'm used to."

Steven F. Marascia, a tobacco analyst at Richmond, Virginia-based Branch Cabell & Co., is not surprised at the finance executives' reticence. "It's like asking Eisenhower how he's going to fight World War II and the war has only just begun," he says. "CFOs can't spell out a contingency plan when there are so many battles to be fought. We're talking unprecedented uncertainty at a sustained high level. This is not your average CFO dilemma."

Burning Up
In fact, there is nothing average about the current situation. "Maybe if you go back to what the liquor and beer companies experienced prior to Prohibition, you might find some similarities," suggests Marascia. But, he adds, "In recent history, we haven't seen anything of this nature."

For finance chiefs, this environment is distinguished by two major characteristics: the uncertainty of future costs and the legal handcuffs on any financial engineering. "Part of the problem facing these CFOs is that the lawyers won't let them extract any value," says analyst Gary Black of Sanford C. Bernstein & Co. In addition, the level of uncertainty regarding the final tally for legal damages makes effective strategic planning almost impossible. "There's no telling what that amount will be," says Marascia.

Tobacco finance chiefs did have a brief flirtation with certainty in June 1997. At that time, a landmark $368.5 billion deal was struck with several states that gave manufacturers sweeping legal protections in exchange for marketing and regulatory concessions. Economists concluded that cigarette makers would need to raise the price of a pack by only 62 cents on average to cover the settlement's costs. Moreover, no one could file a class action against the industry or seek punitive damages. And the firms would never be required to pay more than $5 billion in damages in a given year. Public outrage, however, squelched that agreement and led to the more restrictive McCain bill with its much higher $6.5 billion liability cap and absence of protection against class-action suits.

Without a Federal law, however, tobacco companies find themselves without a settlement and with renewed uncertainty. States and individuals are expected to press ahead with their lawsuits buttressed by the numerous damaging documents that companies previously disclosed as part of the settlement process. And President Clinton has promised to make the failed tobacco legislation a campaign issue this fall--a move that could eliminate some of the legislative allies the industry still has.

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