Philip Morris Bear's Rebuttal
by Paul Larson [email protected]

While my associate Dale has thrown down a valiant attempt at doing a bottom-up analysis of Philip Morris, I think he is clearly missing the forest for the trees. His argument not only misses the big picture, but it also makes some extremely unrealistic valuation assumptions. Mixing a case of myopia with outlandish presumptions is a recipe for capital losses.

Dale's point that Philip Morris is more than just a tobacco company is valid. What he fails to point out, though, is that only a third of its profits come from its other businesses. The vast majority of the company's bottom line is entirely attributable to the business of tobacco. Surely, there is some value to these "purer" food businesses, but their portion of Philip Morris should be heavily discounted as long as they are packaged with the very "dirty" business of smoking.

I'd also like to ask Dale where he got his 32 times earnings for the food business as a fair value, especially when there is little to no growth in these sectors. I wonder if he knows that historically the S&P 500 has traded at roughly 15 times earnings? I've also got to wonder why he would pay 20 times earnings on the beer business. What hat is he pulling these numbers from?

Of course, the most laughable assumption in Dale's whole argument is when he says he'll be "conservative" and value the tobacco business at 30-35 times earnings. Even with the S&P trading at all-time high multiples of earnings, his "conservative" assumption still tops the average blue chip in this frothy market. This assumption for a business that is "ethically challenged" and clearly sells products that are harmful not only to users but also to those who are around them? Sorry, I ain't buyin' it.

Sure, the free cash flow and the return on capital of the tobacco business is quite high, but how much of this cash flow is going to be earmarked for lawyer fees and compensatory damages? Or punitive damages, for that matter? The cost of selling cigarettes goes far beyond just paying for the paper and tobacco leaves.

These "other" costs and liabilities are the white elephants Dale has consciously sidestepped, and it is these elephants that are going to water down Philip Morris' prospects for the foreseeable future.

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