Politics Giveth, Politics Taketh -- How Gingrich and Lott Teamed Up To Knock Out McCains Bill
Politics Giveth, Politics Taketh -- How Gingrich and Lott Teamed Up To Knock Out McCain's Bill
Jon Rooney (212)
April 21,1998
HIGHLIGHTS
1. Speaker Gingrich's comments that Senator McCain's tobacco bill was too liberal, too big government, and too bureaucratic, combined with Senate Majority Leader Lott's lukewarm comments yesterday ("As I travel around the state, nobody asks about [tobacco]"} effectively eliminates any chance of the McCain tax bill passing. In its place, we expect the House to propose, and the Senate to endorse, a combination youth drug/tobacco bill that raises excise taxes by $.60-$.75/pack over 10 years.
2. Gingrich's plan to fold tobacco into comprehensive legislation to combat teen drug use could relegate tobacco to a minor role. While still work-in-process, our sources within the House suggest that the tobacco bill could include:
3. The Administration appears to have underestimated the political firepower of the diverse groups that joined forces over the past week to kill McCain's tobacco bill -- the ACLU, National Association of Convenience Stores, the Beer Institute, farmers, Food Distributors International, U.S. Chamber of Commerce, Americans for Tax Reform, National Restaurant Association.
4. To detonate the escalating rhetoric from the White House, we expect the industry to voluntarily withdraw advertising that can be construed as marketing to youths. The industry will move away from talking about bankruptcy risks (which, ironically, only investors believed) and focus discussion on issues dear to Republicans -- that bigger taxes, bigger government, and bigger payoffs for lawyers are bad . Industry's two most potent weapons: a) Evidence showing that higher prices have little impact on teen smoking rates; and b) Parents perceive that teen drug use (which has also escalated since Clinton took office) is a far bigger threat.
5. Senator McCain again appeared to attribute his last-minute decision to strike the liability provisions from the Senate Commerce tobacco bill, to Newt Gingrich's now infamous comment, quoted in the Washington Post, that Gingrich would "not let Clinton get to the left of him on tobacco." We continue to believe that McCain, who like Gingrich, is seeking the Republican nomination for President in 2000, wanted to ensure that candidate McCain, too, would be positioned as being to the left of Clinton on tobacco.
6. Key events:
INVESTMENT CONCLUSIONS
We reiterate outperform ratings on Philip Morris, RJR, and UST. We expect relative valuations to stabilize as tobacco legislation is merged into a comprehensive program to reduce teenage drug use, which will relegate tobacco to a minor role, and as investors realize that current valuations are already discounting domestic tobacco bankruptcies. :We continue to believe that the industry could settle with most or all of 50 states at some fraction of the $516 billion cost in the McCain bill, and agree voluntarily to a series of youth anti-smoking provisions that eliminates the need for national legislation. Biggest risks: Continuing DOJ investigation into criminal fraud, Minnesota documents, multi-billion dollar Minnesota verdict. We believe that there will be a settlement in the Minnesota Medicaid case for $4-$5 billion, and be viewed as a modest positive, particularly for RJR, which has the most precarious financial position if there is a multi-billion dollar verdict. Tobacco valuations remain at all-time low relative multiples -- Philip Morris 50% relative, RJR at 40% relative, and UST at 48% relative, despite near- and long-term earnings growth that should exceed earnings growth of the S&P 500. Our price targets: MO $60 (75% relative), RN $40 (.65 NA = $32, 0.8 RI x 15 P/E x $.75 EPS = $8), UST $40 (70% relative).
ADDITIONAL DETAILS
1. Republicans move back to the right on tobacco. We believe that House Speaker Gingrich's unflattering comments toward Senator McCain's tobacco bill over the weekend ("That bill is a very liberal, big government, big bureaucracy bill ...Those people that say that's not a Republican bill, they're right."), and Senate Majority Leader Lott's lukewarm responses to questions about prospects for tobacco legislation yesterday have killed any chance that the McCain bill will be passed by the House or Senate:
Q: Are you confident you will pass a tobacco bill this year?
Lott: I don't think we know yet. It takes a lot of effort by the Senate and the House.
Later, in response to another question about prospects for tobacco legislation, Lott offered this telling dialogue:
Lott: You know, I'm from a state that obviously has been involved in all this tobacco settlement issue. But as I travel around the state, nobody asks about that.
Q: Nobody asks?
Lott: Naw! The people are concerned about safety in their schools, safety in their homes; they're concerned about drugs and crimes -- crime in their district. They're concerned about the deteriorating quality of education, they're concerned about taxes -- this is the type of thing that they really do ask about. I'm not saying -- I'm not trying to diminish it. I think we should try to do something. But that's not, you know, number one, two, three, four, five on the list of things that people ask about."
2. Tobacco legislation likely to be folded into overall youth anti-drug legislation. President Clinton reacted as one might expect a President to react as he sees his major legislative initiative for the year going up in smoke -- along with $65 billion in new spending initiatives. Likely at the urging of his advisers, who have always appeared to be more to the left of Clinton on tobacco, the President turned up the political rhetoric and attacked the industry head-on at a special midday rose garden press conference -- attacks, which in the past, had been delegated to VP Gore, Domestic Policy Adviser Reed, or Chief of Staff Erskine Bowles:
President Clinton: "For decades, we know from their own documents, the tobacco companies targeted children. And for decades, the tobacco industry, once again, seeks to put its bottom line above what should be our bottom line, the health of our children. In today's newspaper, the lead lobbyist for the tobacco industry says, and I quote, " We are fighting for our life." Well let me be clear; we are fighting for the lives of our children. We are fighting for the public health, and we are fighting the predatory practices by tobacco companies that have targeted our children."
Unfortunately for the President, and something that both House Speaker Gingrich and Senate Majority leader Lott have picked up on, Americans, while eager to do something about teen smoking, are far more concerned about escalating drug use among teens, which parallels the rise in teen smoking incidence. That fact, combined with the industry's new public relations campaign that the McCain's bill will do nothing to reduce teen smoking, but will lead to bigger taxes, bigger government, and bigger payoffs to plaintiffs' lawyers, has clearly struck a chord among mainstream Republicans -- hence, Gingrich's move back to the right.
It seems clear to us that Republicans, having established public positions that are just as tough on tobacco as Clinton, will now try to draft tobacco legislation that Republicans can actually take credit for, rather than Clinton. This strongly suggests that tobacco will be embedded in a Republican led initiative to reduce overall youth drug and tobacco use, which will effectively relegate tobacco to a minor role, since teen drug use is a far more potent issue politically than teen tobacco use. Without the industry's brute force and money pushing to make tobacco legislation happen, Clinton may have no choice but to call a tobacco summit to try to resurrect standalone tobacco legislation -- at which he would have to give Republicans political cover on liability provisions to get the tobacco industry back at the table. Perhaps that is what Speaker Gingrich had in mind all along.
3. Can the tobacco deal be resurrected? While odds that the tobacco settlement will somehow be resurrected in a form acceptable to the industry remain very low, they are not zero -- particularly if President Clinton perceives that Republicans have found a way to beat back a huge tobacco excise tax increase while still doing something to combat teen smoking. The American public is clearly not obsessed with punishing the tobacco industry -- otherwise juries wouldn't keep ruling in the industry's favor at trials. The American public would, however, like Congress to do something that would get Johnny not to smoke.
We have suggested in the past that the industry can afford a $550 - $600 billion tobacco deal, assuming it can put to rest the tens of thousands of potential lawsuits that would result from any tobacco settlement, given the multi-billion liability fund a settlement would create. The civil liability protections found in the June 20 agreement -- bans on class actions, consolidations, and punitive damages for past behavior, and liability caps limiting individual payments -- accompanied by a true $1.10/pack price increase to fund industry payments and penalties -- would likely have been acceptable to the industry. As we and other analysts have pointed out, the McCain tax bill is not a $1.10 tax hike -- it is at minimum a $1.43/pack tax hike with reasonable assumptions about volume declines during the first five years. The McCain bill is a $1.80/pack tax hike when lookback penalties are factored in.
Our suggestions for the House, as it contemplates legislation that could bring the industry back to the table, and still be actionable:
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