By Bill Barker (TMF Max)

I remember well the last time that Philip Morris was considered in the Dueling Fools space, a little over two years ago. Dale Wettlaufer put forth a solid well-researched Bull argument ostensibly proving that on a discounted cash flow basis, the company should correctly be valued at somewhere between $63 and $74 a share. At the time, the stock traded for only $39 a share and, if memory serves, Dale received the highest percentage of votes ever recorded in the Dueling Fools space for his argument. Of course today, two years later, while the market has skyrocketed higher, Philip Morris has managed to shed about 25% of its value.

Mind you, Philip Morris has continued its strong performance as a business in those intervening two years. No question about it -- this is a company that executes well. (No pun intended.) So why the stock drop, from low to even lower? As everybody knows, the market finally caught on to the fact of the enormous litigation risk that this company possesses. Did I say enormous? Excuse me -- make that incalculable, infinite, or simply "beyond all reasonable measurement."

I'll try to keep this simple. The bear argument for Philip Morris may begin, continue, and end with the litigation risk inherent in owning this company, but that one simple argument should be much more than enough to dissuade any thinking investor from owning this company.

Mind you, I don't feel it's necessary to make any arguments regarding "ethical investing" to support the bear side here. I think that the issue was best covered in Christopher Buckley's brilliant, hilarious and highly recommended 1994 satire Thank You For Smoking, which treated the sanctimoniousness of the anti-smoking movement and the perfidiousness of the tobacco lobby with more or less equal contempt. Let's not get into a morality play here, even if we're talking about what is frequently termed "America's most reviled company."

Philip Morris, simply put, is the biggest litigation liability in the history of mankind. Brush aside, for the moment, the record-setting $100 billion that Philip Morris will be shelling out for years as a consequence of the 1998 settlement with 46 states to recoup smoking-related health costs. What Philip Morris shareholders really have to worry about is the upcoming lawsuits.

Let's start with the most recent piece of private litigation -- the $145 billion judgment against Big Tobacco handed down in a class action case by a Florida jury in July. Philip Morris is responsible for approximately $74 billion of that amount. True, the verdict and award will be appealed, and it is a surety that the award will be lessened and possible that the verdict itself will be overturned, but don't focus on that one case. Remember, that $74 billion is only the Florida class of plaintiffs.

It doesn't really matter all that much whether the total award is upheld, though on its own the award would entirely wipe out Philip Morris, a $65 billion company by market cap. The deeper problem is that this stuff will never stop, and it's only going to get a lot worse. There are 49 other states (plus the District of Columbia) that also could have class action cases against Tobacco. Did I say "could?" How likely do you think it is that aggressive lawyers won't keep pursuing Tobacco with potential awards like that in store? Oh, and there's nothing to stop every other country in the world from similarly pursuing settlements against Tobacco along the same lines as the 46 states did. A number of nations are looking into it already.

Given enough time, enough motivated lawyers (the potential for hundreds of billions of dollars will motivate a couple I guess), and enough different fact patterns, there will be some pretty big judgments that stand up. That's a given. Because even if you don't think that Tobacco should be liable for its behavior ("To my knowledge, it's not been proven that cigarette smoking causes cancer." -- William Campbell, president and CEO, Philip Morris, The New York Times, December 7, 1993) that's a matter as to which reasonable minds can differ. And there are a lot of different reasonable minds that will be on juries addressing this matter over the next decade. Or two. Or three.

With 50 states worth of trial and error, some of those juries will make awards against Philip Morris, and some of those awards will be for tens of billions of dollars, and some of those awards will stand up on appeal. That's what you're investing in with this company -- the virtual certainty that enormous chunks of its cash and future cash flow will never go into building the business, but into recompensing the victims of its business.

And speaking of the victims of its business, smokers are on a prolonged steady decline in this country. That decline will continue not only as education continues to spread about the unarguable risks of smoking, but also because Philip Morris is no longer able to advertise as much as it once could. Recently, bowing to pressure, Philip Morris announced that it would no longer advertise in magazines with heavy teen readership. (We wrote a Top 5 list about that one.)

I just can't see how you could calculate that the future prospects for this business are attractive. I'm sure Mike has given the old Kraft/Miller/cash flow yadda-yadda-yadda, but don't be fooled: it's no more accurate a gauge of what you're buying than it was two years ago. Investing in Philip Morris is consciously buying into incalculable legal liability, and for the life of me, I don't see how that can make for an intelligent investment.

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