Acquisitive Philip Morris may be on the prowl


New York -- In a generation that has witnessed flights to the moon, the splitting of the atom and the invention of the microchip, the most lucrative invention of all could be the Marlboro cowboy.

Wall Street's decade-long infatuation with Philip Morris' tobacco-driven profits has pushed the company's total market value past that of General Electric Co. and IBM, two

standard-bearers of U.S. industry. At $68 billion in market capitalization, Philip Morris ranks, behind only Exxon's $74 billion.

Fueled by expanding sales of image-driven Marlboro, Philip Morris is not only the largest tobacco company in the world, but also the second-largest brewer (behind Anheuser Busch) and the second-largest package food producer (behind Nestle).

Meanwhile, Philip Morris has used tobacco profits to wean itself from tobacco dependency. The share of operating earnings from tobacco earnings has declined from 91 percent in 1984 to an estimated 64 percent this year.

And there are widespread expectations that percentage will drop further because of another non-tobacco acquisition.

In March, Michael A. Miles, a non-smoker who is a former president of Kraft (acquired by Philip Morris in 1988), became the company's first chief executive not to have worked in tobacco operations. And recently, hurried arrangements were made for $15 billion in standby bank credit -- a sum hardly necessary for ongoing operation given the company's consistent ability to produce billions of dollars in surplus cash.

"They are in a position to make their next acquisition of size," said Gilbert Alexandre, an analyst at Darphil Associates in Connecticut who has closely tracked the company for years. "But they have to find something good and available."

At various moments during the past two months, almost every major food company has been thought to be a likely target, including H. J. Heinz, Quaker Oats, General Mills, PepsiCo and ++ CPC International. Even Kellog Co., which has a controlling shareholder (the Kellog foundation) perceived to be anti-tobacco, was considered a target.

In the lackluster current environment for acquisitions, such rTC whispers had a galvanizing impact on some share prices. Heinz's stock shot up from just under $40 a share to $47, only to slide back when no takeover bid emerged. The wait continues.

"Where there's smoke, there's fire. Take it at face value, something is imminent," said Richard Church, an analyst at Smith Barney.

That deal might not be for a major U.S. company, though.

Philip Morris is so large that a domestic merger in the most likely area, packaged consumer goods, could reawaken even the Republican administration's slumbering antitrust department.

Philip Morris controls about 45 percent of the domestic cigarette market. No other company comes close. And it has a fat share of supermarket sales. In cereal, it owns Post; in cold cuts, Oscar Mayer; in dairy products, Kraft; in coffee, Maxwell House; in frozen food, Birds Eye; in bagels, Lender's; in ice cream, Sealtest and Breyers; in jello, well Jell-O; and so on.

Most analysts believe that the deal will be overseas, where the company's presence is far smaller, though lucrative and

growing. "What they really want to do is flush out Europe or the Pacific rim," said John Maxwell Jr., an analyst with Wheat First Butcher & Singer in Virginia.

On the London Exchange, Cadbury-Schweppes, United Biscuits, Allied Lyons all have seen share prices affected by rumors of Philip Morris' looming presence. A $1 billion to $2 billion acquisition in continental Europe would come as no surprise.

Philip Morris' perceived willingness to expand comes as the rest of corporate America is moving in the opposite direction.

Divesting and reducing debt are probably the two most common business strategies at the moment. Even RJR Nabisco, Philip Morris' longtime adversary, has begun to eliminate the massive debt assumed in a 1988 leveraged buyout.

Despite a consistent ability to generate billions of dollars a year .. in surplus cash, Philip Morris has only modestly paid down the billions of dollars in loans assumed in prior acquisitions. Its capital structure remains almost 60 percent debt. Large dividend increases come in annual increments, and as much of the improvement in its capital structure has come from increased shareholder equity as from reduced borrowing.

Despite health concerns, Philip Morris' core business of tobacco remains a growth market. In 1990, the company produced 368 billion cigarettes, up 15.5 percent from the year before and 50 percent over the past decade. In the United States, the company continues to expand by gaining market share in a slowly shrinking market; elsewhere, it expands by gaining market share in a growing market.

The outlook for the immediate future remains strong. Within its vast market share, Philip Morris' strength is among young smokers, said Mr. Alexandre. So over time, it's likely to grow.

A critical event for the cigarette industry will come this fall when the Supreme Court hears an appeal of the Cipollone case. It will determine whether the warnings on cigarette packages exempt manufacturers from additional liability -- a decision with profound consequences. A number of Wall Street analysts expect the tobacco industry to prevail. Still, suspicions linger in some quarters about the ongoing viability of a business based on a product whose success almost defies rational explanation.

"I just feel it can't last," said Carey E. Tharp Jr., an analyst at H. G. Wellington & Co. "If tobacco kills people, demand is going to decline."

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