1. 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 Tobacco Buyout: Impacts on Manufacturers 42 nd Tobacco Workers Conference Charleston, South Carolina January 17, 2006 Kelly Tiller Agricultural Policy Analysis Center The University of Tennessee

2. APCA Impacts on Manufacturers TTPP assessments Future Phase II obligations Domestic leaf cost savings Imported leaf cost savings Responsiveness to future market changes

3. 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

4. Assessments Assessments authorized up to $10.14 billion FY2005 through FY2014 Based on share of sales volume for 6 major tobacco product classes 158 product manufacturers and 666 product importers –Required to submit data regularly to enable CCC to determine respective quarterly shares of product classes CCC to send quarterly assessment notices the 1 st of March, June, September, and December –Assessments due in 30 daysAPCA

5. AssessmentsAPCA Class FY2005 Proportional Share FY2005 Assessment (mil $) Cigarettes96.331%$975.0 Cigars2.783%$28.2 Snuff0.539%$5.5 Roll-your-own0.171%$1.7 Chewing0.111%$1.1 Pipe0.066%$0.7

6. 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 authorityAPCA

7. 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

8. Methodology P i,t = current price (value) d i,t+k = expected future cash flow to firm i at time t+k r = discount rateAPCA

9. Methodology R i,t = stock returns Compare stock returns to a measure of “normal returns” Select event dates –Corresponding to tobacco buyout legislation progress –Lack of information about expected outcome Select firms –Tobacco product manufacturers with complete data available on CRSPAPCA

10. Methodology R m,t = value-weighted return on a portfolio of all marketable securities at time t e i,t = error term for firm i at time t; expected value of zero; variance = σ 2 ei Estimated over the period 200 trading days before the event to 11 days before the eventAPCA

11. Methodology AR i,t = abnormal return for firm i at time t, equal to e i,tAPCA

12. Companies IncludedAPCA 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

13. 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

14. Cumulative Abnormal ReturnsAPCA 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

15. Summary & Conclusions No evidence that the buyout negatively affected tobacco product manufacturers Cumulative impact on expected returns was positive, 0.0006%, not statistically significant –Passage of conference report had a negative impact, -0.02%, significant at 10% –Phase II ruling was statistically significant, positive impact, 1.01% Weak evidence that non-market benefits of terminating the tobacco program outweighed net economic costs to manufacturersAPCA

16. Summary & Conclusions Hypothesized that individual firms may be affected differently across event dates –No statistical evidence found The overall legislation (corporate tax overhaul) affects some multinational firms simultaneously in multiple ways May consider alternative event sets –Excluding signing bill into law –Pulling out Phase II ruling and doing a separate event study on Phase II impactsAPCA