Conclusive Evidence That Tobacco Causes Revenue

After hearings in which members of Congress last week vilified top executives of tobacco companies as engaging in “an enterprise that is sure to kill some of our children,” the stocks of most cigarette companies rose--including that of industry leader Philip Morris by $2 a share.

Thus, the paradox continues: Thirty years after the Surgeon General said that smoking causes lung cancer, cigarettes are still a strong worldwide industry, in which U.S. companies alone have sales of $50 billion.

And cigarettes won’t be banned now, although last week’s hearings by a Congressional subcommittee on health were part of a long-term process that will increase regulation and ultimately cause the cigarette business to diminish.

In the meantime, the Food and Drug Administration may not even get jurisdiction over cigarettes. The paradox there is that if FDA declared nicotine to be a drug, it would be forced to approve cigarettes as safe and effective or ban them altogether. And nobody wants a total prohibition of smoking.

Why not? Because banning cigarettes would create an illegal market approaching $100 billion a year in the United States alone. That’s no exaggeration.

Figure it this way: There are 50 million U.S. smokers today and half of them would quit rather than smoke illegally. But that would leave 25 million two-pack-a-day smokers at, say, $5 a pack because contraband costs more. That would add up to $91.3 billion a year, an illegal industry far bigger than cocaine is today.

So cigarettes will remain a legal business, but with more regulation. “Addicted smokers can continue to smoke but not harm their fellow citizens, so smoking should be kept out of all public places; and we can do more to keep them away from kids by enforcing prohibitions on sales to minors,” says Rep. Henry Waxman, (D-Los Angeles) who chaired last week’s hearings.

Wall Street still finds tobacco stocks attractive, but for other reasons. “They’re undervalued given the strength of their food businesses and their potential in international markets,” says analyst Sally Schaadt of Fourteen Research, an adviser to institutional investors.

She’s referring to the fact that Philip Morris and RJR Nabisco, which together control 75% of the U.S. cigarette market, also own valuable food companies. But because RJR’s Nabisco (Oreos, Life Savers) and Philip Morris’ General Foods and Kraft divisions (Post cereals, Jell-O, Kraft cheeses, Oscar Mayer meats) are overshadowed by fears about tobacco, the stock market doesn’t give their owners the premium it accords other food companies, such as H.J. Heinz.

That’s one reason both tobacco companies are considering setting up their food divisions with a separately trading stock. Based on the ratio of price to earnings that the stock market accords other food companies, such separate firms theoretically could add 40% to 60% to the total value of RJR and Philip Morris.

Vast international markets are just opening up in Russia, Eastern Europe, China and India. But U.S. operations, thanks partly to the tobacco companies’ highly efficient manufacturing and distribution, have always returned three to four times the profit of international operations.

And the domestic business faces a future of increasing restrictions. Professor Mark Kleiman of Harvard University, an expert in drug regulation, puts cigarettes in context: “We regulate lots of drugs on different levels, from total prohibition for heroin, to morphine for medicinal use, to prescriptions for Valium, down to aspirin, alcohol, nicotine and caffeine.

“We can increase the restrictions on nicotine,” Kleiman adds.

New legal troubles will arise for tobacco companies. Congress last week demanded that the companies provide reports of research they’ve conducted on smoking’s injurious effects. Reluctantly, the executives promised to comply.

Such information will arouse class action lawsuits alleging that the companies failed to disclose product dangers--even though cigarette packs for decades have stated that smoking causes lung cancer and heart disease.

The tobacco companies have faced and won “364 lawsuits since 1954,” observes veteran analyst John Maxwell of Wheat First Butcher & Singer in Richmond, Va. “More won’t bother them,” he says.

But this time it’s different. Regulation develops slowly but inexorably as medical knowledge grows and attitudes change. The American people used to spit in the street and tolerate occasional cholera in the drinking water. Now they don’t.

Similarly with cigarettes, the accumulation of lawsuits and pressures from insurers, smoking bans at work and anti-smoking ad campaigns will erode the industry.

“There was a long build-up before the ban on asbestos,” observes Professor Lawrence Fischer of Michigan State University’s Toxicology Institute. But ultimately it was found to be a danger to the public health and banned.

But cigarettes are not proven guilty, tobacco executives protested last week. They even denied that nicotine is addictive because people quit smoking. But that’s disingenuous. “So what,” retorts drug expert Kleiman, “17 million people have kicked cocaine, but it’s still addictive.”

Executive denial sparked anger among Congressmen, who questioned how the business people could live with themselves. The answer is that money leads to convenient rationalization, but there’s no need to make scapegoats of executives on that score. Thousands of pension and mutual and trust funds have invested billions of dollars in tobacco stocks; the $25-billion buyout of RJR was a zenith of the 1980s bull market. Many ordinary people have benefited from tobacco profits.

Also, many states and now President Clinton and Congress want to tax cigarettes to pay for schools and health care and other good things. We scorn smokers but want to live off them at the same time; there’s hypocrisy enough to go round.

But now we’re moving on. A political decision has been made that the cost to the public health of cigarette smoking outweighs the protests of the industry. The coming of regulation will be inexorable. And, raucous as they seemed, last week’s hearings were an important part of that process.