When The Smoke Clears...

Why Big Tobacco would settle for a $200 billion states' deal

After months of talks, negotiators were working overtime to complete a proposed $200 billion deal to settle lawsuits between cigarette makers and 36 states. Their goal: to announce a deal on Friday, the 13th of November.

Could it be Big Tobacco's lucky day? With "the most material threat against the industry" removed, predicts Salomon Smith Barney analyst Martin Feldman, shares of Philip Morris Cos. and RJR Nabisco Holdings Corp. could climb 30% over the next year. Analysts predict a flurry of financial maneuvers to boost tobacco stocks. Philip Morris is expected to restart its $3 billion-a-year share buyback, and perhaps spin off its Miller Brewing or Kraft divisions. Wall Street is counting on RJR Nabisco to divest international operations and its 80.5% stake in Nabisco. RJR execs might want to delay the Nabisco spin-off, but a confidant of financier Carl Icahn tells BUSINESS WEEK that Icahn will force RJR's hand in a proxy battle if it stalls.

But the spin-offs could run into other problems. Even if the state suits are settled, there are still more than 850 pending actions by insurers, smokers, and labor unions--many of whom may try to block deals that shift assets to other entities.

And the states' deal will make the cigarette business a lot less attractive. Philip Morris and RJR may need to raise prices by 35 cents a pack to fund their share of payments, hikes that could accelerate the 4% annual decline in consumption.

Meanwhile, new taxes aimed at curbing sales are coming. In California, they're still tallying Proposition 10, a 50 cents-a-pack tax that is expected to pass. And there's talk of a federal tax as high as $1.10 per pack. The White House is reluctant to impose new taxes, but insiders say the Administration might consider a levy on cigarettes as part of a tax-cut package or a tobacco bill.

Finally, if holdouts such as Connecticut Attorney General Richard Blumenthal get their way, the state deal will impose curbs beyond limits to billboard advertising, product placement in movies, and use of branded merchandise. Even with all that, cigarette makers will breathe a sigh of relief.

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