Agricultural Policy Analysis Center - University of Tennessee Morgan Hall - Knoxville, TN phone: (865) fax: (865) Tobacco Farmers, Markets, & Industry: Buyout Impacts ERS & Farm Foundation Tobacco Buyout Impacts Workshop Washington, D.C. September 20, 2005 Kelly Tiller Agricultural Policy Analysis Center The University of Tennessee

APCA Impacts Addressed Impacts on manufacturers Impacts on/of Phase II Impacts on state/regional economies Post-buyout contract evolution Other impacts and observations

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

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

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

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

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

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

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 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

Cumulative Abnormal ReturnsAPCA Event Dates Average Cumulative Abnormal Return Z-Statistic House Passage (6/14/04) Senate Passage (7/15/04) Conference Report (10/6/04) Signed into Law (10/22/04) Phase II Ruling (12/2304) Cumulative Across All Dates

Phase II Payments Because the buyout funded by manufacturer and importer assessments, future Phase II payments will be terminated Total Phase II payments expected to be about $2.13 billion Not specifically addressed in the buyout, triggered by an offset condition in the Phase II agreement Legally untested, but many believed that taxpayer (Treasury) funding of a buyout would not trigger the legal Phase II offset languageAPCA

Phase II Legal Issues Shortly after buyout passed, participants withheld Q4 payments ($106 m) and requested refund of Q1-Q3 payments for 2004 ($318 m) –Major legal question was the start of the buyout Decision issued by NC federal business court December 23 –2003 Phase II payments were essentially the “last” Phase II obligations Decision appealed to NC Supreme Court Decision issued August 19 reversing lower court –Ordered participants to make 2004 Phase II paymentsAPCA

Phase II Impacts Widespread lack of anticipation that 2004 Phase II payments may not be forthcoming Phase II payments tied to cash flow Misperception about basis for Phase II payments Influencing quota owners and growers to choose discounted lump sum over 10 annual payments –Perception of risk of early termination and significant payment delays Promoted grower distrust of manufacturers In reality, Phase II and buyout are apples and orangesAPCA

Buyout Payments by StateAPCA (million $) Owner Payments Grower Payments Total Payments North Carolina$2,752$1,191$3,943 Kentucky$1,736$733$2,469 Tennessee$528$240$767 South Carolina$508$216$725 Virginia$458$208$667 Georgia$429$183$612

Buyout Payments by KindAPCA

Community Economic Impacts Input-Output analysis using the IMPLAN model State level analysis for 11 states –Congressional district level analysis for NC, KY, TN Estimate regional impacts and statewide impacts –Sum over regions does not equal state impacts Estimate impacts (2003 vs. 2005) due to –Infusion of buyout payments (with tax consequences) –Changes (reduction) in acreage –Changes in yields and prices –Phase II paymentsAPCA

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

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) Total Value Added Impacts –The dollar value of wages and salaries, including benefits, self-employment income, interest, rents, profits, taxesAPCA

IMPLAN ScenariosAPCA Scenario A Scenario B Scenario C Scenario D 1/10 of paymentsX 1/10 of payments + 30% of remaining payments at 78¢/$1 X 1/10 of payments + 40% of remaining payments at 78¢/$1 X 6/100 of payments (1/10 * 60%)X (-) 2005 Phase II, (+) 2004 Phase IIXXX 2005 state acreage declines according to 8/31 NASS report, no change in yields XXX 2006 state acreage increases 10% over 2005, yields increase 10% over 2003 X Burley/Flue avg prices at $1.50/$1.40XXX Burley/Flue avg prices at $1.60/$1.50X

Post-Buyout Contract Evolution Since 1999, most contracts offered generally marketing contracts with some production guidelines –Grower still bears most production risk, reduces price risk Post-buyout incentives to move toward production contracts –Contractor has significantly more control over the production process 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

Other Impacts Impacts on locations and staffing of USDA Service Centers in tobacco states Impacts of §1031 like kind exchanges on land sales and land values Financial decision for contract holders are very individualized –Many at or above retirement age, many without internet access –Lack of information among tax preparers and financial planners in many rural areasAPCA

www. T obacco B uyout I nfo.comAPCA