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 Farmers, Tobacco Farmers, Markets, & Industry: Markets, & Industry:

Buyout ImpactsBuyout Impacts

ERS & Farm FoundationTobacco Buyout Impacts

Workshop

Washington, D.C.

September 20, 2005

AAPPAAPPCCAACCAA

Kelly TillerAgricultural Policy Analysis Center

The University of Tennessee

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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 pack

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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 1st of March, June, September, and December– Assessments due in 30 days AAPP CCAA

Assessments

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ClassFY2005

Proportional Share

FY2005 Assessment

(mil $)

Cigarettes 96.331% $975.0

Cigars 2.783% $28.2

Snuff 0.539% $5.5

Roll-your-own 0.171% $1.7

Chewing 0.111% $1.1

Pipe 0.066% $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 authority

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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 returns AAPP CCAA

Companies Included

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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. 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 questionAAPP CCAA

Cumulative Abnormal Returns

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Event Dates

Average Cumulative Abnormal

Return

Z-Statistic

House Passage (6/14/04) 0.0083 0.5864

Senate Passage (7/15/04) 0.0036 0.2655

Conference Report (10/6/04) -0.0176 -1.3993

Signed into Law (10/22/04) 1.0019 0.1478

Phase II Ruling (12/2304) 1.0071 1.5717

Cumulative Across All Dates 0.000634 0.1085

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 2005-2010

• 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 language AAPP CCAA

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

payments AAPP CCAA

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 oranges AAPP CCAA

Buyout Payments by State

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(million $)Owner

Payments

Grower Paymen

ts

Total Paymen

ts

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 Kind

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Type(s) / Kind (million $)Owner

PaymentGrower

PaymentTotal

Payments

11-14 Flue-Cured $4,073 $1,734 $5,807

31 Burley $2,266 $1,048 $3,314

22-23 Dark Fire-Cured $23.6 $68.2 $306.8

35-36 Dark Air-Cured $78.6 $33.7 $112.3

21 Virginia Fire-Cured $10.1 $4.4 $14.4

37 Virginia Sun-Cured $0.9 $0.4 $1.3

41-55 Cigar Filler & Binder $47.9 $20.5 $68.4

ALL TOBACCOS $6,500 $2,909 $9,624

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 payments AAPP CCAA

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 spendingAAPP CCAA

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, taxes AAPP CCAA

IMPLAN Scenarios

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Scenario A

Scenario B

Scenario C

Scenario D

1/10 of payments X

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 II X X X

2005 state acreage declines according to 8/31 NASS report, no change in yields

X X X

2006 state acreage increases 10% over 2005, yields increase 10% over 2003

X

Burley/Flue avg prices at $1.50/$1.40 X X X

Burley/Flue avg prices at $1.60/$1.50 X

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 supplies

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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 areas

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www.TobaccoBuyoutInfo.com

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