Gary Black:Closing The Renegade Rift -- Why RJR and B&W Came Back To The Table. Outperforms MO, RN

Gary Black (212) 756-4197
Jon Rooney (212) 756-4504

October 6, 1998

HIGHLIGHTS

1. Sources indicate that RJR and B&W returned to the settlement talks after Philip Morris agreed to their demands that renegade credits be allocated on the basis of actual share lost, rather than average share as Philip Morris had proposed. Philip Morris apparently believes that renegade credits will never become an issue, given incentives that strongly encourage states to pass licensing fees, combined with an innovative proposal that should convince even the smallest manufacturers to embrace the deal.
2. Specifically, would-be renegades are likely to be offered a carve-out that allows them to join the deal, and make no payments unless their share rises above 1998 levels. Share above the 1998 level would be subject to the same per pack payment as incurred by the majors. Renegades who don't sign up would be subject to state licensing fees on all share, rather than just marginal share.
3. We now understand why it has taken so long for this deal to surface: The parties are trying to assemble a critical mass of 30-35 AGs in a position to embrace the deal when it is announced, to send a clear message to AGs who might be on the fence or hostile to the deal that the settlement offer is final, and that it would be futile to attack the deal as not strong or expensive enough. We believe the opt-in period will be relatively short (7-14 days); the longer the opt-in period, the more time open for criticism.
4. Some on the AG side also believe it may be helpful to hold off announcing any deal until after Congress adjourns for the year -- likely this Friday, but could be delayed until Monday, October 12. With prospects for the income tax cut (already passed by the House) now dead in the Senate, any risk of an excise tax increase on cigarettes (to help fund the income tax cut) is also dead.
5. The terms of the deal are largely what we have outlined before: $196.5 billion pro-rated for 46 states over 25 years ($.35/pack price hike); includes $10 billion in up-front payments, spread over 3-4 years; marketing restrictions similar to Minnesota (bans on billboards, branded merchandise, product placements in movies, plus ban on most sponsorships; no FDA or lookback provisions).
6. The renegade multiplier is set at 3x (any share lost to non-signatories would be multiplied by 3x and credited to the industry against the annual payments). Sources suggest that renegade credits would only be "paid" by those states who do not pass licensing fee statutes -- which effectively forces all states to adopt licensing plans or become one of a dwindling number of states who would share the burden of the renegade credits. Any settlement payments would be credited toward licensing payments.