1. CAAP Agricultural Policy Analysis Center - University of Tennessee - 310 Morgan Hall - Knoxville, TN 37996-4519 www.agpolicy.org - phone: (865) 974-7407 - fax: (865) 974-7298 The Tobacco Buyout: Farmer, Industry & Market Impacts Lessons from the Tobacco Buyout Organized Symposium Southern Agricultural Economics Association Annual Meeting Orlando, Florida February 6, 2006 Kelly Tiller

2. CAAP Impacts Addressed Farmers and quota holders Regional and community economies Manufacturers and industry

3. CAAP APCA Impacts on Farmers Differs by category –Owns quota, not an active grower –Active grower, owns little/no quota –Owns and grows quota Structural change in tobacco marketing post-buyout

4. CAAP Characteristics: Quota Holder / Not A Grower More likely to be an absentee landlord Less likely to earn household income from agriculture More likely to be at or above retirement age Majority hold relatively small amounts of quota Less likely to desire to remain in tobacco (agriculture) post-buyout

5. CAAP Buyout Impacts: Quota Holder / Not A Grower Receive $7/lb based on quota owned in 2004 Future quota lease income eliminated –Phase II payments 2005-2012 eliminated Mixed reactions to the buyout –Depends on expectations about the longevity of the program

6. CAAP Characteristics: Active Grower / No Quota More likely to produce larger acreage More likely to have significant crop-specific investments (barns/curing, machinery, market- prep) More likely to be a younger grower More likely to have a higher debt load More likely to desire to remain in tobacco (agriculture) post-buyout

7. CAAP Buyout Impacts: Active Grower / No Quota Receive $3/lb based on quota grown/marketed in 2002, 2003, 2004 Most likely to benefit from the buyout Costs of production down 25%+ without quota lease requirement –Transaction costs associated with leasing also eliminated More likely to remain in tobacco (agriculture) –May expand tobacco acreage to take advantage of scale economies Good relationships with contracting companies critical to success

8. CAAP Characteristics: Quota Holder & Grower More likely to be a small to medium size operator Production likely down 50%+ over last 5 years Likely have a lower debt load Mixed age range, more likely to be closer to retirement age

9. CAAP Buyout Impacts: Quota Holder & Grower Receive $7/lb for quota owned in 2004 plus $3/lb for quota grown marketed in 2002, 2003, 2004 Mixed reactions to the buyout, depends on: –Expectations about program longevity –Desire to remain in tobacco production Some will exit tobacco (agriculture) Some will continue to produce tobacco –Depends on expectations for yield potential –May expand production, at least up to historical levels –Likely to need new investments in barns, equipment

10. CAAP Post-Buyout Contract & Marketing Rapid rise in direct contracting since 1999, warehouse auction sales/markets declining To date, most contracts generally marketing contracts with some production guidelines Post-buyout incentives to move toward production contracts? Changes in contract length: (+) and (-) –Shorter term contracts May reduce long-term purchase commitments Gain flexibility in meeting market changes and demands –Longer term contracts Ensure longer-term leaf supply security With sufficient competition, ensure quality and stability in suppliesAPCA

11. CAAPAPCA Payment-Related Impacts Complex and highly individualized tax and financial considerations –Default is 10 equal annual payments –Option to receive discounted lump sum For payments 2-10, payments 3-10 Good year to be an accountant, tax preparer, banker, financial planner/ adviser, lawyer, real estate appraiser … Impacts on locations and staffing of USDA Service Centers in tobacco states Impacts on land sales and land values –Some §1031 like kind exchanges

12. CAAPAPCA Community Economic Impacts Input-Output analysis using the IMPLAN model State level analysis for 11 states –Focus on 6 major tobacco states (95% of payments) Estimate impacts (2003 vs. 2005) due to –Infusion of buyout payments (with tax consequences) –Changes (reduction) in acreage Based on 8/31 NASS acreage reports, state level –Changes in yields and prices No change in yield, burley/flue prices $1.55/$1.45 per pound –Loss of 2005 expected Phase II paymentsAPCA

13. CAAPAPCA IMPLAN Impacts Direct Impacts –Impacts that result from changes in the tobacco sector’s economic activity Indirect Impacts –Impacts that result from changes in inter- industry purchases Induced Impacts –Impacts that result from changes in household income and spendingAPCA

14. CAAPAPCA IMPLAN Impacts, cont’d Total Industry Output Impacts –The annual dollar value of the goods and services that the tobacco production sector produces Employment Impacts –The number of total wage and salary employees (full-time, part-time, self-employed) Tax Impacts –The dollar value of federal taxes and state/local taxesAPCA

15. CAAPAPCA Economic Impacts APCA 6 Major Tobacco States2005 Total Buyout Payments (mil. $) $918.3 Quota Owner Payments (mil. $)$641.2 Active Grower Payments (mil. $)$277.1 Additional Economic Activity (mil. $)+ $737.7 Jobs Added+ 7,225 Tax Revenue Added (mil. $)+ $129.0 Federal Tax Impact$100.9 State/Local Tax Impact $28.1

16. CAAPAPCA Economic Activity Impact, Year 1 $337m $164m $67m $58m $57m $55m

17. CAAPAPCA Employment Impact, Year 1 3,253 1,661 664 600 540 508

18. CAAPAPCA State/Local Tax Impact, Year 1 $12.6m $6.5m $8.8m $7.5m $8.1m $7.5m

19. CAAP Impacts on Manufacturers Tobacco manufacturer and importer assessments (-$10b) Domestic leaf cost savings (+$3.1b to $6.5b) Imported leaf cost savings (+?) –Savings for domestic leaf purchases for use in international manufacturing operations (+?) Phase II payment savings (+$2.1b) Responsiveness to future market changes (+?) Net financial burden: 1.3¢ to 2.7¢ per packAPCA

20. CAAP Market Responsiveness Absent the federal tobacco program, U.S. tobacco industry can exert more control over the tobacco production sector –Mere existence of former program influenced the incentive structure surrounding contracting –Growers now have a much stronger incentive to quickly adjust production, curing, and market prep practices to meet customer demands Highly beneficial in the event of future FDA authority over manufactured tobacco products

21. CAAP Measuring Mfgr Impacts Event study methodology –Predicated upon the efficient markets hypothesis –All available information is impounded in current stock prices –The value of a firm changes as the result of unexpected events that cause investors to revise estimates of future cash flows and/or risk Calculate a measure of “normal” returns Calculate “actual” returns around event dates Estimate abnormal returns, the difference between actual and normal returnsAPCA

22. CAAP Companies Included APCA Company Total Assets (mil $) Sales (mil $) Net Income (mil $) EPS (diluted) Altria / Philip Morris$101,648$63,963$9,416$4.57 British American Tobacco$33,867$65,633$387$1.45 RJR / Reynolds American$14,428$6,437$688$5.62 Imperial Tobacco Group$11,630$5,485$805$2.21 Gallaher Group$7,867$4,886$556$3.40 Loew’s CP$2,778$3,348$546$3.15 U.S. Smokeless Tobacco$1,659$1,789$531$3.23 Vector Group$536$323$7$0.10 Star Scientific$70$31-$17-$0.28

23. CAAP Event Dates June 14, 2004 –Buyout added to H.R.4520, vote in House W&M Committee –No FDA, funded by part of tobacco excise tax (public $) July 15, 2004 –JOBS bill passed Senate vote with a buyout intact –Included FDA, funded by tobacco manufacturers October 6, 2004 –H.R. 4520 reported out of conference committee WITH the buyout October 22, 2004 –President signs JOBS bill, prior to election December 23, 2004 –Judge rules in favor of cigarette manufacturers on 2004 Phase II payment questionAPCA

24. CAAP Cumulative Abnormal Returns APCA Event Dates Average Cumulative Abnormal Return Z-Statistic House Passage (6/14/04)0.00830.5864 Senate Passage (7/15/04)0.00360.2655 Conference Report (10/6/04)-0.0176-1.3993 Signed into Law (10/22/04)1.00190.1478 Phase II Ruling (12/2304)1.00711.5717 Cumulative Across All Dates0.0006340.1085

25. CAAP Manufacturer Impacts No evidence that the buyout negatively affected tobacco product manufacturers Cumulative impact on expected returns was positive, 0.0006%, not statistically significant Weak evidence that non-market benefits of terminating the tobacco program outweighed net economic costs to manufacturers Hypothesized that individual firms may be affected differently across event dates –No statistical evidence foundAPCA

26. CAAP Post-Buyout Outlook Who will produce? Where? How much? At what price? Demand response? 2006 and beyond? Expand Wait & See Get Out