An Offer Big Tobacco Can't Refuse?

A tough new compromise may be the best the industry can get

Judging by the howls coming from Tobacco Road, compromise legislation unveiled by Senate Commerce Committee Chairman John McCain (R-Ariz.) on Mar. 30 will bankrupt the tobacco industry and spawn a black market in smuggled cigarettes. McCain's plan toughens last year's settlement between tobacco lawyers and states by requiring a $506 billion payment by cigarette makers while denying them much of the legal shield from class actions that they want. "The extreme positions in the McCain outline are very disappointing," says industry negotiator J. Phil Carlton.

So will Big Tobacco's opposition snuff out legislation? Not likely. The industry may be forced to accept the McCain proposal as the best vehicle--still being offered--to rid itself of a growing backlog of civil suits. Tobacco's erstwhile GOP allies, worried that their industry ties will hurt them in this fall's elections, are in no mood to be generous. And lawmakers from both parties are eager for a deal now that they've made plans to spend the settlement windfall. "This is the best deal tobacco's ever going to see," concedes a tobacco-industry source.

"BEST EFFORT." McCain's consensus bill is a watershed in the yearlong debate over a possible settlement of legal claims against tobacco companies. And on Apr. 1 it was overwhelmingly approved by the Commerce Committee with the bipartisan support it needed to reach the Senate floor. "This is our last, best effort to get the tobacco settlement done," says Mississippi Attorney General Mike Moore, who helped craft the June, 1997, proposed settlement between tobacco lawyers and 40 state attorneys general.

McCain's compromise would cap at $6.5 billion the amount the industry could be forced to pay annually in legal damages--$1.5 billion higher than the '97 deal. It would permit class actions and punitive damages barred by the June accord. And it would give the Food & Drug Administration power to regulate tobacco products. Wall Street reacted quickly: Tobacco stocks plunged, and bond ratings were downgraded.

Tobacco executives and Wall Street analysts are now scrambling to decide whether the industry is better off accepting McCain's plan or abandoning the deal in order to fight legal battles on a state-by-state basis, with all the uncertainty that brings. Sanford C. Bernstein & Co. analyst Gary Black says industry earnings would fall 20% the first year after the McCain legislation would take effect, and 36% by the fifth year. Still, analysts say Big Tobacco desperately wants a cap on liabilities to bolster share prices. Even industry-friendly Hill staffers are urging the companies to sign on. "Tobacco has missed out on the stock market boom of the '90s," one staffer says. "It's time for them to get on board."

But many in the industry are not ready to buy those arguments. The companies plan to attack McCain with a media blitz, a lobbying offensive, and tobacco CEO appearances before editorial boards and on morning television shows. It's an all-or-nothing strategy that could prove counterproductive if executives walk away and lawmakers make the bill even tougher.

Already, many Republicans are dashing for cover as Democrats bash them for taking millions in tobacco contributions. Indeed, McCain's proposal is clear evidence that the industry's $30 million in donations since 1987 can no longer buy happiness on Capitol Hill. "I can't and will never be subject to a veto by the tobacco industry," says McCain. And if McCain's tough stance wasn't convincing, certainly the Senate's overwhelming approval on Mar. 31 of a resolution declaring that cigarette companies should not be immune from lawsuits ought to be a wake-up call.

Some of Big Tobacco's wounds are self-inflicted. For one thing, the industry misjudged the political climate. "I underestimated the pure hatred for the industry that is out there," says Carlton. On Capitol Hill, Republican leaders and pro-tobacco Democrats remain furious that the industry excluded them from last year's settlement talks. And House Speaker Newt Gingrich has told his leadership team that he won't allow Democrats to outflank him on the issue.

Tobacco negotiators are realizing some legislation is likely with or without their support. That's quite a comedown for what was once the toughest industry lobby in town. Now, Big Tobacco has a choice: Keep fuming or start dealing.

Before it's here, it's on the Bloomberg Terminal.