U.S. tobacco companies, awash in cash from cigarette production and sales, will become even more aggressive in the mergers and acquisitions that already have made them competitors in several major businesses besides tobacco, industry analysts predict.
Billions of dollars from cash-rich tobacco companies have filtered into significantly large segments of the national economy -- from the manufacture of consumer products to delivery of health-care services to the operation of major department stores.
The blockbuster acquisition of General Foods Corp. last week by Philip Morris Inc. and the purchase of Nabisco Brands Inc. by R. J. Reynolds Industries Inc. earlier this year are among the most notable of the industry's diversification moves to date. But they represent a well-established trend that began in the tobacco industry more than 20 years ago, analysts point out. Long before the merger binges of the 1970s and '80s, the tobacco industry began snapping up companies such as Pacific Hawaiian Products Co. (Hawaiian Punch) and Allen Products Co., makers of Alpo dog food.
Still, Philip Morris' $5.6 billion acquisition of General Foods -- the biggest merger outside the oil industry -- coming so soon after RJR's takeover of Nabisco, has fueled speculation that tobacco companies may be positioning safety nets for a big fall by their basic business. More specifically, some observers suggest, an acceleration in diversification may have been prompted by the industry's concern over a welter of pending product-liability suits.
Industry officials emphatically deny any such motivation, pointing to a long skein of acquisitions that were undertaken as hedges against possible slumps in the industry's growth. But while they deny that they are diversifying because they think the cigarette industry is endangered, they are also quick to say that they want to change the image of their firms from cigarette companies to diversified consumer products corporations.
Asked if the acquisition of Nabisco was a direct response to potential product-liability suits, J. Tylee Wilson, Reynolds' chairman and chief executive officer, said the two are not related.
"We have long said that RJR would be interested in a merger candidate that offered the right fit with our existing lines of business," Wilson said.
RJR's acquisition of Nabisco and the divestiture in 1984 of its shipping business, Sea-Land Services, and its energy operations, Aminoil Inc., were logical steps in the company's long-range plans to refocus on consumer products, Wilson said.
"We believe that offering a broad range of consumer products is in the best interest of RJR shareholders," he continued. "That is the company's primary mission: to achieve above-average, orderly growth of shareholder value over time."
The threat of product-liability suits "played no specific role" in Philip Morris' decision to acquire General Foods, according to Hamish Maxwell, Philip Morris' chairman and chief executive officer.
"We're obviously concerned about product liability , but we're not worried about it," Maxwell continued.
Many analysts agree with tobacco company officials that an apparent acceleration in diversification has little to do with the specter of product-liability suits against the industry. But some say litigation is a major concern among tobacco companies.
"The companies won't admit it, but I think it would be naive to believe that diversification is not related to product-liability," said David A. Goldman, tobacco industry analyst at Dean Witter Reynolds.
Goldman said that the tobacco industry could suffer serious damage if any of several product liability suits are successful. By diversifying, he suggested, a company might declare bankruptcy of its cigarette business under Chapter 11 and still operate its other subsidiaries. "Let's assume a suit is successful. Clearly, if you diversify, you have one more safety net before you go belly-up," Goldman said.
Under Chapter 11 of the federal bankruptcy law, a company may seek protection from creditors while reorganizing its business.
Saul Steinberg, chairman of Reliance Insurance Co., a major property and casualty insurance underwriter, expressed his concern about the pending lawsuits in a private breakfast meeting in New York last week with graduates of The Wharton School.
"There has not yet been a single case that has linked the product cigarettes to cancer," Steinberg said. "Such a case will be decided, and that will have unbelievable ramifications. Once the first case is lost, and I'm told it will be lost, thousands of cases will be brought. It is a problem of incalculable cost. If it gets to be something like asbestos, the winners will be the lawyers and the losers will be industry and the public. If the case goes this way with tobacco, you're going to see a bloodbath."
The tobacco industry managed to snuff out a series of lawsuits that were brought between 1950 and 1970 by smokers who blamed cigarettes for lung cancer. But a new brace of lawsuits -- at least 30, according to recent estimates -- have been filed against the industry, which has failed thus far to block their litigation.
"I think there is no correlation" between diversification and the threat of product-liability suits, said John C. Maxwell, tobacco analyst at Furman Selz. Tobacco companies find themselves in a position where it's necessary to "throw off excess cash" and it is "just a good policy to use that cash for the good of your stockholders rather than put it in CDs certificates of deposit ," analyst Maxwell said.
Even though there is little apparent growth left in the cigarette industry, tobacco companies continue to reap handsome profits from their basic product even though the Surgeon General considers it dangerous to one's health. "Those little white tubes are money-makers," Maxwell noted.
Nonetheless, "There is that need to diversify, not so much from a psychological basis, but because the tobacco industry has not grown very fast," observed John Baugh, the tobacco analyst at Wheat First Securities Inc.
Baugh acknowledged there is greater movement toward diversification but, he emphasized, "I would argue that it's not because these suits have come up. You're not going to insulate yourself against those lawsuits by diversifying."
Widespread diversification, notwithstanding, the tobacco business stands out as a cash cow among other businesses controlled by the industry. The tobacco business is the source of 90 percent of the industry's operating income, according to David A. Goldman of Dean Witter Reynolds.
Profits remain high but further growth in the industry "is going to be extremely modest, if it is there at all," said Maxwell of Philip Morris. Although it is the largest of the major tobacco companies, with a 35 percent share of the market, Philip Morris is generally considered the least diversified.
Hence, Philip Morris saw in General Foods "an opportunity to continue to keep the company in an accelerated growth level by using some of the excess cash for acquisitions," the company's chairman noted in an interview.
A similar explanation for diversification is offered by most analysts who maintain that even though tobacco companies are profitable, there is little growth left in the market, which is controlled essentially by six companies.
With substantially lower consumption in this country, "The cigarette industry is just not an industry that will grow at 20 percent a year," said Neal Kaplan, an analyst at Interstate Securities.
Although growth in the tobacco industry has been relatively flat in recent years, profits have continued to climb because of pricing programs, higher productivity and lower production costs, analysts point out.
Since 1964, the Surgeon General and the Secretary of Health and Human Services have issued several reports that link cigarette smoking with a number of health hazards. According to government estimates, smoking kills 350,000 Americans annually, mainly through lung cancer, chronic lung ailments and coronary heart disease.
Ironically, the death claims attributed to cigarette smoking continue to increase despite the mandatory warning that is carried on the labels of cigarette packages: "Warning: The Surgeon General has determined that cigarette smoking is dangerous to your health."
Congress has ordered the tobacco industry to begin placing new, more specific health safety warnings on packages of cigarettes and in cigarette advertisements and to change the messages every three months.
The presence of those warnings, both on cigarette packages and in print advertising, render product-liability suits virtually moot, according to the industry as well as some analysts. "When you've got on the label for 20 years that cigarettes can kill you, how can you sue?" asked Maxwell of Furman Selz.
Anne Browder, the assistant to the president of The Tobacco Institute, said the industry is genuinely concerned about the health of consumers. She added, however, that smokers are "intelligent enough to make their own decisions."
Browder noted that anti-smoking campaigns and statements associating cigarettes with health hazards have had a negative impact on sales.
Cigarette companies reported higher sales and profits in 1984, nevertheless. U.S. expenditures for tobacco products in 1984 were a record $28.7 billion, according to estimates provided by The Tobacco Institute. U.S. consumers, including armed forces personnel overseas, last year consumed 600 billion cigarettes.
The stock market continues to react negatively to the pending lawsuits and other problems surrounding the cigarette industry, however. Analysts have pointed to Philip Morris's stock price as an example. Given the company's track record, its stock should be selling at a higher price than the current range of $75 to $76, they said. Tobacco companies have been buying back significant amounts of their stock but that hasn't proved to be the right solution to the excess cash problem or to the industry's performance on Wall Street.
Indeed, the product-liability issue has been a major psychological factor among investors, according to Arthur Kirsch, financial analyst at Drexel Burnam Lambert. "Investors are unwilling to take the risk of staying with the tobacco stocks with the uncertainty of the litigation and the prospects that the companies may lose some of the cases and have to pay money."
Diversification into other areas "makes Wall Street a little more comfortable with tobacco companies stocks," said Kaplan of Interstate Securities.
Diversification hasn't always panned out according to expectations, however. Philip Morris' acquisitions of Miller Brewing Co. and The Seven-Up Co. haven't been success stories, Kirsch points out. An industry report by Kidder, Peabody earlier this year cited a need for "significant repair" at Miller and Seven-Up.
Philip Morris was forced to take a $280.4 million pre-tax earning write-down of a Trenton, Ohio, Miller Brewing plant "with the best technology in the world" that the firm spent more than three years to build but has no plans to open at this time because the industry is flat, according to a company spokesman. The plant cost more than $400 million.
No. 2 Reynolds, meanwhile, is moving into "more mainstream consumer goods," after venturing into the energy and shipping businesses, Kaplan noted.
The tobacco industry's evolution -- from the basic business of manufacturing cigarettes and other tobacco products to becoming heavily involved with a wider array of consumer products -- has been marked also by the transformation of some cigarette manufacturers into subsidiaries of larger corporations. At least two of those subsidiaries -- the Liggett & Meyers Tobacco Co. and Brown & Williamson Tobacco Corp. -- are controlled by London corporations.
Will the diversification trend continue?
"Absolutely," says Roy Burry of Kidder Peabody. "Obviously, Philip Morris and Reynolds will not make any more acquisitions soon, but I think you will see more by the other companies."