Copyright 1997 The New York Times Company
The New York Times
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May 4, 1997, Sunday, Late Edition - Final
SECTION: Section 3; Page 3; Column 3; Money and Business/Financial Desk
LENGTH: 1597 words
BYLINE: By DAVID BARBOZA

HEADLINE: INVESTING IT;
Asking a Lawyer to Lift Tobacco's Haze

LAWSUITS are Calvert D. Crary's bread and butter. A managing director of the securities firm of Auerbach, Pollak & Richardson in Stamford, Conn., Mr. Crary, a 53-year-old lawyer, is what is known as a litigation analyst: he helps investors figure out how court actions might affect them.
Of course, few industries face the complex legal actions that Big Tobacco does. There are suits brought by smokers and nonsmokers, by states and cities seeking payment for smokers' Medicaid costs, even by tobacco shareholders who say the industry's failure to reveal information about smoking's harms has cost them money. Indeed, top tobacco executives have begun negotiating with their legal opponents over a global settlement, one in which the industry might pay hundreds of billions of dollars and submit to stricter regulation in return for immunity from all or most of this avalanche of lawsuits.
So The New York Times asked Mr. Crary what all this means for the investor. Here are his answers, from his belief that regulation, not litigation, is the industry's biggest problem, to his explanation of why investing in tobacco is much like investing in a huge, but gradually depleting, oilfield in the Gulf of Mexico:

Q. How important are the civil lawsuits against the tobacco industry?

A. The significance of litigation is not its financial threat to the tobacco companies. They are so big that one damage award, 100 damage awards, 1,000 damage awards, just don't add up to an awful lot of money. The financial risk to investors is that the litigation might drive a change in public and regulatory attitudes toward the tobacco industry in general. And those are attitudes that the industry has spent many, many years building up, and as a result it can have a product which kills off hundreds of thousands of people and still maintain public acceptance.
And in fact, the litigation has invigorated the political will. We now have the state attorneys general, the President and the Food and Drug Administration all having made up their minds that they're going to do something about this.

Q. Some 20-odd states have filed suits for Medicaid reimbursement, and thousands of people are seeking damages. Wouldn't losses in those cases be enough to threaten the survival of any industry?

A. Well, I think that you can tell the answer from the positive reaction of investors to the news that the tobacco industry might enter into a global settlement for $300 billion paid over 25 years, or $12 billion a year.
I think the industry sells roughly 30 billion packages of cigarettes a year in the United States. If you raise the price 50 cents, that generates an additional $15 billion of revenue in one year. Now, they can easily raise the price 50 cents; they're still going to be relatively inexpensive cigarettes. A package of cigarettes costs less than $3. And in the rest of the world they cost more like $5. In Europe it's $5.

Q. Is the issue coming to a head now? Is there such a serious threat to tobacco that people investing in these companies ought to think twice?

A. I believe there are three possible scenarios for the industry. One, everybody just forgets the whole thing, and tobacco companies can go back to business as usual. Second, they can continue their program of strenuous resistance, fighting every case to the bitter end. Or, third, they can negotiate a settlement that makes a meaningful concession but gives them a license to continue.
I think the industry has recognized that it's never going to go back to the old days. Between total devastation and a negotiated settlement, I think they've concluded that a settlement is the one to do. And that's why they have been willing to make such a generous settlement offer.
If they do succeed in putting the litigation behind them, that would open up a lot of opportunities for the tobacco industry to begin to engage in a rational dialogue about the health risks associated with smoking and the measures that could be taken to reduce those health risks. I think that's the favorable scenario that warrants continued investor interest.
However, if they do make a very substantial payment, such as the $300 billion that has been talked about, the risk is that the overseas markets are going to say: 'Gee, we want some of that money, too. We've also got indigents that the government has to pay for. How much are you going to pay us?' "
As a matter of fact, I was reading about a meeting the other day between the health minister from Ukraine and representatives of the major American tobacco companies where the minister posed exactly that question. And the foreign markets are what the tobacco companies are interested in; that's where all the money is for the future.

Q. So there might be a ripple effect to an American settlement?

A. Well, it's complicated. Many foreign governments own the domestic tobacco industry or at least have a major participation in it. So they don't want to put it out of business; it's a revenue source. Cynically speaking, many a foreign government looks at cigarettes as combining two benefits: increasing the tax on individuals and insuring that those buyers don't live too long past their productive age of 65. Q. So how do you advise investors?

A. I believe that tobacco investments make a great trading vehicle. There are times when the market is blissfully indifferent to what's going on, and they bid the price of tobacco companies up substantially. There are other times when the market is in a state of sheer panic, and they sell the shares off. If you buy at the height of panic and if you sell at the height of complacency, you can do well.
And you never really have to worry about unpleasant financial surprises because these companies are already so deeply discounted. They carry low multiples compared with other consumer products industries.
But you can very easily get bagged if you buy the stock at the height of complacency.
In the long term, tobacco is not a one-decision stock. You have to keep monitoring them and try to come to a decision whether at some point the game is over.
As far as what's happening now, I think there is something very important. And that's the decision of the District Court judge in Greensboro, N.C., Judge William S. Osteen Sr., that the F.D.A. does indeed have jurisdiction to regulate cigarettes. I believe that if there was ever going to be a judge who would rule against the F.D.A. on precisely that point, it would be a judge in Greensboro, N.C. And, therefore, I would not be looking for a reversal of that conclusion on appeal. In fact, if he had ruled in favor of the industry on F.D.A. jurisdiction, I was pretty satisfied that he would have been reversed.
So the tobacco industry is now a regulated industry. That is a clock that will never be turned back. And the regulatory agenda of the F.D.A., as far as tobacco is concerned, is to regulate a decrease in consumption to whatever extent it can. They're going to do that by requiring the tobacco company to tell the truth about their products and to get them to develop safer products.

Q. Why shouldn't something like this case, which seems like a major step, say to investors, "Sell your tobacco stock before the end comes," or to diversify? Is that an alarmist view?

A. The example that I like is that of an oilfield in the Gulf of Mexico. If you own shares of the companies whose sole asset is that oilfield, you know that eventually that field is going to be exhausted. But in the meantime there is going to be tremendous cash flow generated by that field. And you also know that, with the expenditure of some of those funds on secondary and tertiary recovery techniques, you can extend the life of the field, for perhaps a very long time.
That's what the tobacco industry is doing now. They are spending some of their huge cash flow on secondary and tertiary recovery techniques to extend the life of the cigarette industry. A lot of those expenditures are for lawyers; a lot are on public relations. Q. In summary, you think regulation poses a much bigger threat to tobacco than do lawsuits?

A. Yeah. I believe that. However, it's also possible for the litigation to go very badly for the tobacco companies. It could happen that they never settle anything and that they lose cases on a regular basis. That would be a constant drain.
Other things could happen, too. There is a potential for criminal liability. Under both state and Federal laws there are said to be several criminal investigations pending against the industry.
So I see lots of threats. But I believe that the odds are that a global settlement will be negotiated. And I believe further that the odds are that the tobacco industry will attain immunity in this settlement, at least from past torts. I think the negotiators on behalf of public health will recognize that that's the whole reason for entering into a settlement, so that you can put litigation behind you.
And that's when we're going to have to start to watch what kind of impact the U.S. settlement has on the rest of the world.

Q. Suppose I bought a Big Tobacco stock and decided to hold it for 20 years. Would that be a good strategy?

A. I don't think I would do that. Because an industry whose product kills off 450,000 American citizens every year, I think you have to assume that over time there's going to be some rather substantial evolution in that industry. And it's not entirely clear what it's going to turn itself into. GRAPHIC: Photo: Calvert D. Crary, posing with a borrowed cigarette, says regulation is a major threat to tobacco companies. He is a former smoker. (Chris Maynard for The New York Times)
LOAD-DATE: May 4, 1997