FDA tobacco regulation - unintended consequences..

June 16, 2009 - Sometimes when you get what you want, you also get some unintended consequences.

The Family Smoking Prevention and Tobacco Control Act once signed by the president would give the Food and Drug Administration (FDA) far more control over the cigarette industry—to curb advertisements, require stronger warning labels, and potentially even outlaw sales of tobacco products in certain locations and in vending machines.

But the bill is not without its consequences—and one of them is a likely hit to the budgets of many states, which count on tobacco tax revenue to fund their budgets. In fact, after a huge tobacco Master Settlement Agreement in 1998, the tobacco companies agreed to pay more than $200 billion to the states to cover health care costs. Many states actually sold bonds on which interest would be paid out of anticipated tobacco tax revenues.

Because these states have essentially borrowed against future payments from the tobacco industry, they are now dependent on the continued vitality of cigarette sales. If Big Tobacco stumbles, as a result of the FDA restricting sales states will be on the hook for these massive, billion-dollar loans. (Cigarette tax increase cut smoking less payment to states, harm bond repayment..)

And the bill may have a few other unintended consequences that may be good for Big Tobacco. Shares of tobacco companies Altria Group (NYSE: MO), Reynolds American (NYSE: RAI), and Lorillard (NYSE: LO) moved slightly higher when the bill passed. Why? With limited new advertising, their more established brands will benefit.

And since the FDA is unlikely to ever approve new cigarettes, existing brands will benefit. Plus, the government will have the power to crack down on counterfeit cigarette sales, driving buyers into the hands of the big companies.

Tobacco companies have long been known as recession-proof. People who are hooked are unlikely to give up their smokes in hard times. A Merrill Lynch research report says tobacco companies have outperformed the Standard & Poor’s 500 index by an average 12 percentage points during the last six recessions!

So, here’s the irony: Restrict advertising, limit new smoking opportunities, and states have less money for health care, while tobacco dividends are perpetuated, making the stocks more attractive.

Reference: Unintended Consequences Can Sting, Terry Savage Money Blog, 6/15/2009.