Is Big Tobacco Ready To Deal?

RJR's Goldstone hopes to lead the industry toward a compromise

For the head of a major U.S. tobacco company, they were revolutionary words. Cigarette makers "can't continue in public as kind of an outlaw industry," declared RJR Nabisco CEO Steven F. Goldstone in a Dec. 5 speech to executives in Boston. More than that, he continued, "a lot of forces are at work" favoring some broad settlement with industry adversaries. "In 1997," Goldstone proclaimed, "the most meaningful thing I can do is come to some solution on this problem."

Goldstone's remarks were the strongest that any major tobacco company executive has ever made in favor of making peace with the industry's enemies. In one bold stroke, the 50-year-old attorney stepped forward as the industry's leading proponent of compromise, raising the possibility that Big Tobacco will offer to make a historic deal: accepting Food & Drug Administration regulation of tobacco in exchange for legal protection against future courtroom attacks.

The conciliatory stance helped push shares of RJR Nabisco Inc. and arch-competitor Philip Morris Cos. to new 52-week highs. No wonder. The tobacco industry has been mired for years in a Byzantine tangle of increased regulation and hundreds of liability suits from individuals and state governments. In August, investors were shocked when Brown & Williamson Tobacco Corp. suffered a landmark $750,000 judgement in a personal-injury case in Florida. The threat of an asbestos-like courtroom meltdown, analysts say, has depressed share prices by 50% or more.

A broad settlement, then, "is what needs to be done. It's what the companies need to get back on track," says Jeffrey A. Altman, a vice-president at Franklin Mutual Advisors Inc. in Short Hills, N.J., a major tobacco shareholder. Despite makers' consistently superior profitability, courtroom battles are siphoning both management's attention and hundreds of millions in legal fees.

Resolution of future litigation also could help Goldstone fend off financiers Carl C. Icahn and Bennett LeBow, who are pressing for a spin-off of Nabisco. Some investors and analysts suspect that Goldstone may be initiating settlement maneuvers in part to counter the raiders' charges that he hasn't taken sufficient steps to boost share price. In fact, RJR Nabisco's stock has underperformed the market, in spite of improvements that Goldman, Sachs & Co. analyst Marc I. Cohen estimates will lift profits 14% this year, to $860 million.

BALANCING ACT. Goldstone clearly is gambling. By holding out an olive branch, he risks appearing weak--inviting a new round of lawsuits or tempting adversaries to make harsher demands. But if there's one thing the experienced trial lawyer knows, it's how to float a peace offering while maintaining a show of strength. To keep the litigation dam from breaking, Goldstone is managing his public statements skillfully.

He first indicated his openness to a settlement in an interview with the London-based Financial Times in March, then backpeddled when news of his statements broke in the States. This time, he spoke at an out-of-the-way breakfast gathering of CEOs at Northeastern University--but in a subsequent interview with BUSINESS WEEK, he refused to offer any details. With such cautious communications, Goldstone has put the issue of a compromise in play without stoking fears of industry vulnerability--a perception that caused tobacco shares to plummet after Liggett Group Inc. announced its settlement of addiction suits in March.

According to sources inside and outside the company, as an opening offer, Goldstone is willing to agree to most, if not all, of the FDA's recent advertising and promotion restrictions aimed at reducing teen smoking. The FDA regs go into effect in August, but the industry is challenging them in a North Carolina federal court. Analysts think the industry will prevail--and then dangle its willingness to accept the regulations as a bargaining chip in later negotiations. If necessary, Goldstone is thought to be willing to accept permanent, but limited, oversight by the agency--a prospect the industry has fought for years.

In exchange, he hopes for a congressional guarantee that tobacco makers will be protected against future injury lawsuits--a shield potentially worth billions in saved litigation and settlement costs. According to several analysts who have spoken to sources inside the company, such immunity would not apply to pending cases, but it would protect manufacturers from suits filed after some selected date in the future.

Why isn't Goldstone interested in settling any of the pending suits filed against RJR by plaintiffs' attorneys and state attorneys general? Because he thinks it will be cheaper to continue fighting these opponents, according to Martin Feldman, a Smith Barney Inc. tobacco analyst. Given the industry's almost flawless courtroom record, Feldman says, Goldstone sees no reason to shell out the billions of dollars annually that plaintiffs' attorneys have indicated they are seeking from tobacco makers--especially if he can get some form of legal protection from Congress without doing so.

Philip Morris, with United States Tobacco Co.'s support, brought forth a more modest FDA peace treaty last May but failed to win any political backing. Now, says Gary D. Black, a tobacco analyst at Sanford C. Bernstein & Co., which holds large chunks of Philip Morris and RJR stock, executives at Philip Morris and United States Tobacco are more interested in a settlement than ever. "We continue to be amazed at the 180-degree turn within the industry, embracing the concept of a legislative settlement," Black wrote in a Dec. 11 report. Philip Morris wouldn't comment.

There still is widespread disagreement in the industry about how a deal should be structured and pursued. For example, some execs at Philip Morris and other tobacco companies fear it will be politically impossible for the industry to win congressionally guaranteed immunity from lawsuits. According to David J. Adelman, a tobacco analyst at Dean Witter Reynolds Inc., some members of this group are willing to accept the proposed FDA rules in exchange for a promise that the FDA won't take permanent jurisdiction over tobacco. Instead, they would be willing to submit to the oversight of the Federal Trade Commission, which is authorized to review some advertising issues. These execs note that the FTC doesn't concern itself with health issues and is considered friendlier to business than the FDA.

UNDER WRAPS. Details of the status of settlement negotiations are sketchy. Because of the sensitivity and complexity of the discussions, the parties are certain to try to keep any talks under wraps. Goldstone told BUSINESS WEEK that while he "is going to do things" to bring about a resolution, it would not "help the result come about" by discussing it publicly. Key players in the health community and Congress deny they have been contacted by the industry.

Black thinks the industry will attempt to cook up a deal behind closed doors, then try to get a friendly member of Congress, such as Trent Lott or House Commerce Committee Chair Thomas J. Bliley Jr., to sponsor it. But on Dec. 9, Bliley was pessimistic about a legislative resolution. "You are not going to be able to move legislation unless the Administration signs on," he says.

There are, indeed, plenty of reasons to be skeptical that a deal will succeed. For starters, it's not clear that rivals such as Philip Morris and RJR will be able to agree on a plan. RJR failed to join Philip Morris' earlier compromise proposal, though, in a sign of conciliation, Goldstone now goes out of his way to praise the Philip Morris plan.

Even if manufacturers can reach agreement on terms, they will have a hard time stiff-arming the politically powerful plaintiffs' attorneys, who fear that any legal protection for manufacturers will limit their ability to win money in current suits. Most industry experts expect plaintiffs' lawyers to succeed in forcing the industry to settle current cases as part of the broader resolution--creating a mammoth challenge for the companies in determining how much money to fork over. The next hurdle: the health community, which also has the clout to block a deal.

But for RJR Nabisco, the alternative may be worse: the bloodiest litigation war in history and years of continued pariah status. Given such a prospect, it's hardly surprising that Goldstone wants to strike a deal now.

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