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Big Tobacco Companies Winning in Buyout

CHICAGO -- Analysts believe a U.S. tax bill featuring a $10.1 billion buyout for tobacco farmers could narrow the price gap between cigarettes sold by Big Tobacco and its lower-priced competitors, according to Reuters.

As part of a much wider corporate tax bill passed by the Senate on Monday, U.S. tobacco companies will pay $10.1 billion over 10 years to tobacco farmers that own quotas, or the right to grow a certain amount of tobacco. The quotas are determined under a government price support system.

Manufacturers ranging from the largest players -- including Altria Group Inc.'s Philip Morris USA and Reynolds American Inc. -- to smaller sellers of deep-discount cigarettes will all pay for the buyout, with payments based on market share. This is a contrast with the 1998 tobacco settlement agreement with the states, which did not include most smaller manufacturers.

Judy Hong, tobacco industry analyst at Goldman Sachs, estimated that major tobacco companies will have to raise prices by only a penny per pack to fund their portion of the buyout, while deep discounters will have to hike prices five cents. "The buyout could actually benefit the major cigarette companies, as the deep discounters will need to raise prices at a higher rate than the major companies," Hong wrote in a research report.

Philip Morris, which makes Marlboro cigarettes, and Reynolds American, with Camel and Kool, have had to sharply increase marketing expenses in recent years to fight off market share gains by the deep discounters. Deep discounters do not typically spend the massive amounts on marketing that the major players do, and some also have not had the additional cost of payments from the earlier tobacco settlement.

"Although the costs of the buyout will be based on market share, it is likely that the costs to smaller tobacco manufacturers will be more onerous relative to the big manufacturers due to their lack of economies of scale," Bonnie Herzog, analyst at Smith Barney, said in a research note.

The cost of the buyout will be mitigated for cigarette makers that are part of the 1998 anti-smoking settlement with the states, as they will no longer have to make payments to a trust for tobacco growers, analysts said.
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