Philip Morris Bull's Rebuttal
by Dale Wettlaufer ([email protected])

Good thing we're not talking ethical standards here, being that you're the guy who covers the gaming industry for the Fool. Why think about ethics, though, when we have such enlightened leaders who want to do the thinking for us? One day we'll look back on the Clinton and Gore administrations and thank our lucky stars such intelligent, clean-living politicians were able to break us of our harmful ways with lots of regulations and new taxes.

As for socially responsible investing, I'd like those who feel uncomfortable about owning Philip Morris to get the heck off the bandwagon. Write your mutual fund manager and your other fiduciaries and tell them to sell. It would get so cheap that current owners could buy back the company in far less time. That's pretty much what's happening now, as the company has repurchased (net of issuance) $4.74 billion worth of common stock in the last three years. On top of that, the company has paid out $10.29 billion in dividends over that period.

Those are pretty big numbers for a company with a $106.1 billion enterprise value. With government pressure stepping up, the company has not been able to continue its share buybacks at the pace that it would like -- since the government may come after the company for assigning assets that may have to be paid to plaintiffs in lawsuits against the company. That's one reason why the food division can't be spun off to shareholders right now.

By the way, the company doesn't trade at a discount because it "deserves" it and because people like you don't buy it. It trades at a discount because of the threat to its cash flows. If there were not a legal/regulatory threat, other investors would more than pick up the slack for those who don't care to invest in the company.

I keep scanning down your case and all I see is the continuation of a fuzzy logic stating that the company's debt to society is large, it has to pay, yadda, yadda, yadda. How about quantifying some of this? A stock's value is not what people are willing to pay for it. That's ridiculous. Sure, there's a market mechanism to setting the price for stock, but it doesn't set the value of a company. A stock's value is equal to the net present value of the cash that can be taken out of the business over its lifetime.

If you don't want to own this company, then that's fine. I see it as fairly valued using very conservative assumptions as to the value of the various operating units and as to the damage to the cash flows a tobacco settlement could cause. Using valuations that reflect this company's ability to generate returns on capital far and away higher than its cost of capital, the shares are worth in the neighborhood of $150.

The company pays a 4% dividend, which last year increased 13.8%, and it continues to generate huge amounts of cash that it can either return to shareholders or use to make acquisitions. Further, the company can choose to do a number of things to protect the owners' interests, such as moving offshore or eventually spinning off the food units when there is less governmental threat to that course of action. If you don't want to own the resurgent Miller Brewing Company, if you don't like Marlboro, Post cereal, Oscar Mayer, Kraft, Altoids mints, Toblerone, Jell-O, Kool-Aid, and all the other great Philip Morris brands, fine. You don't have to.

However, I don't think that Americans need to be saved from themselves by political lynch mobs, and I think it's absurd that the current political debate does not consider the fact that excise taxes on cigarettes pay a great deal of, if not all of, the costs of smokers' illnesses. Philip Morris' international growth, excellent management, investment opportunities, and sheer cash generating possibilities are very attractive to me as an investor. I think the danger has been discounted properly by the market here. I'm glad to participate in the growth of the intrinsic value of this company and have no problems sleeping at night.

Next: The Bear Responds