Philip Morris’ Tactic: FDA Regulation

Is Philip Morris turning over a new leaf? The world’s largest maker of cigarettes is asking Congress to give the Food and Drug Administration regulatory authority over tobacco products.

The company is serious, although it doesn’t want tobacco regulated as a drug or medicine--because that would lead to a ban on cigarettes. In order to be marketed as a drug under FDA rules, a product must be “safe and effective.” And as the company itself admits in a white paper explaining its stance on FDA regulation, “cigarettes simply cannot be found to be ‘safe and effective.’ ”

Philip Morris wants the government to regulate cigarettes without putting too many restrictions on them. Government, the company advises, “should continue to inform the public about the dangers of cigarettes but should not restrict an adult’s ability to make a decision about smoking.”

Simply put, the company--which now sells $49 billion of cigarettes annually worldwide--wants the government’s tacit approval of smoking.

Is that a pipe dream? Maybe, but it also looks like a shrewd marketing strategy.

Sure, the tobacco industry is denounced regularly by politicians. But viewed from another angle, the industry has become a sort of public utility.

Tobacco companies have long collected cigarette taxes for governments nationwide and worldwide. Last year, Philip Morris accounted for $4.3 billion in federal excise taxes, $12.7 billion in taxes to foreign governments and undoubtedly a comparable amount in taxes to U.S. state governments.

The industry now has become a silent partner in state medical programs. In 1997 and 1998, the tobacco companies reached settlements with state attorneys general to pay $246 billion over 25 years to offset costs of treating smoking-related illnesses in Medicaid programs.

This year, the tobacco companies will pay $9.9 billion. Philip Morris will shoulder at least $5 billion of that load because its share of the U.S. cigarette market is more than 50%.

The settlements have had an effect. “You hear less rhetoric and criticism of tobacco from the statehouses now,” notes analysts David Adelman of Morgan Stanley Dean Witter.

Similarly, Adelman believes, FDA regulation would tone down criticism from federal officials and Congress. That would help Philip Morris because “criticism from federal officials can hurt if you’re facing jury trials,” Adelman says.

Philip Morris, along with other domestic cigarette producers such as R.J. Reynolds Tobacco Holdings and the Brown & Williamson division of British American Tobacco, faced thousands of smoking and health cases filed in U.S. courts as of the end of last year.

Also, a decision in a landmark class-action suit in Florida in November brought a $74-billion damage award against Philip Morris. That case is being appealed.

Tobacco company prospects appear to be like those of asbestos companies, which were pushed into bankruptcy years ago by massive damage payments.

Yet Geoffrey Bible, Philip Morris’ chief executive, displayed no fears last month in an address to institutional investors in Washington. After dismissing the lawsuits as the latest editions in a long line of court actions that the tobacco industry has defeated or dealt with, Bible said Philip Morris is embracing a new approach to selling risky products “in response to changes in society’s view of tobacco use.”

“We believe the industry should be regulated to a much greater extent than it is now,” Bible said. He avowed the company’s support for programs aimed at reducing teenage smoking--which most reports show to be on the rise despite numerous such programs.

There is method to Bible’s seeming madness, competitors conclude. Executives of rival R.J. Reynolds, producers of Camel and other cigarettes, see Philip Morris’ calls for regulation as a ploy to lock in the leadership position of the company and its Marlboro brands. Regulation typically raises barriers to entry of new companies and restricts competition within an industry.

There’s another reason, analysts say. Philip Morris is close to producing a “safer” cigarette with, in its words, “fewer carcinogens.” Some form of FDA regulation, which would measure carcinogens, could allow Philip Morris to gain a competitive edge with such a cigarette.

The firm, in short, is making a shrewd marketing move to emphasize relative safety in a dangerous product, as cigarette companies five decades ago moved to put filter tips on cigarettes. No coincidence that filter tips sparked the rise of Philip Morris’ Marlboro brand, now the world’s largest seller.

Of course, filters didn’t really end the risks of lung cancer, heart disease and emphysema that cigarette packages warn of in blunt terms. And cigarettes with “fewer carcinogens” won’t either.

But smoking will undoubtedly go on. With 40 million smokers in the U.S. alone and hundreds of millions more worldwide, attempts at prohibition would only breed a massive underground industry.

As for the future of Philip Morris, Bible, who has led the firm for 14 years, professed that the firm will go on even if smoking doesn’t. “If smoking declines significantly, so be it,” he told investors. “We are a consumer products company.”

He was referring to Philip Morris’ other businesses, notably the Kraft Foods division, which is a global giant with more than 80 brands--ranging from Kraft cheese to Oreo cookies--and $26.5 billion in annual sales.

Philip Morris is about to demonstrate the value of that big franchise. In May or June it will sell less than 20% of Kraft in a public stock offering. Analysts think it will bring a notable price.

Bonnie Herzog of Credit Suisse First Boston estimates that Kraft and Philip Morris’ Miller beer division would be worth $47 a share if traded today as a separate company.

That’s quite a judgment. The whole of Philip Morris, with tobacco delivering 61% of the sales and 65% of the profit, sells for $47.19 a share as of Friday’s close.

Of course, the company’s stock is kept down by the threat that all those lawsuits will send it into bankruptcy. That’s why it remains a perilous stock for average investors.

But sophisticated investing institutions, which have pushed Philip Morris stock up 130% in the last year, obviously think shrewd marketing and dogged lawyers will keep the company going forward.

Their judgment clearly is that investors face fewer risks than users of the company’s tobacco products.

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Still Smokin’

As lawsuits and government actions against tobacco have multiplied over more than a decade, Philip Morris has diversified into food and beverage businesses. Yet the company’s cigarette business continues to provide more than 60% of its sales and operating profit.

Source: Company reports

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James Flanigan can be reached at jim.flanigan@latimes.com.