Should British American Tobacco plc And Imperial Tobacco Group PLC Shareholders Be Worried By A $24bn Damages Award?

No grounds for complacency at British American Tobacco plc (LON:BATS) and Imperial Tobacco Group PLC (LON:IMT)

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british american tobacco / imperial tobaccoNews that a Florida court has awarded $23.6bn to the widow of a smoker who died of lung cancer might have caused some spluttering in the boardrooms of both BAT (LSE: BATS) and Imperial Tobacco (LSE: IMT) . The award — mainly punitive damages — was made against US tobacco giant Reynolds America.

BAT is directly affected: it owns 42% of Reynolds, and is about to pump another $5bn of cash into the company to maintain its shareholding after Reynolds acquires rival Lorillard. Meanwhile, Imperial is spending $7bn to acquire brands being shed as a result of the deal. Those assets come with indemnities against health-related litigation, but being propelled from number 5 to number 3 in the market will surely put Imperial more in the firing line of future litigation. BP and the banks are testimony that US courts are unsympathetic to foreign firms.

Whatever the boardroom reaction, investors seem to have shrugged it off with the shares of both BAT and Imperial just down a percent or two. The expectation is that such a massive award will be slashed on appeal. Its constitutional basis is suspect, and the tobacco industry has seen this before: in 2002 a Los Angeles court imposed a fine of $28bn on Philip Morris, subsequently reduced by a factor of 1,000 to $28m.

Complacent

I wonder if investors are being unduly complacent. I don’t doubt the massive award will be cut. But it rested on an earlier ruling that litigants need only prove that a smoker was addicted to tobacco and that tobacco caused his or her death: it’s not necessary to establish any wrongdoing. That’s symptomatic of the tide of public opinion, which is turning fast against Big Tobacco.

Though there are still some areas of growth, the tobacco industry faces a structurally declining market. Thus consolidation, to maintain profits and cash flow, is the name of the game. It should drive dividend payments and M&A activity for some years yet.

E-cigarettes

Meanwhile the saviour of the industry could be e-cigarettes. However, they could also turn out to be the disruptive technology that accelerates the industry’s decline. With plain packing legislation reducing the value of brands and uncertainty over government and medical attitudes to e-cigarettes, it’s not certain that the new industry needs Big Tobacco. Why saddle yourself with those unquantifiable litigation liabilities?

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Tony Reading has no position in any shares mentioned. The Motley Fool has no position in any of the shares mentioned.

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