Debt Policy in Ust

Executive Summary

UST is a strong leader of US tobacco industry. The company maintains an advantage position in the market and develops to an untouchable target to its rivals. However, due to more and more litigation against the industry and the company happens, UST is facing a severer market environment and more financial burdens on its legal issues. An extremely strong profitability brings the company a huge cash balance, which makes the company shareholders feel more tax burdens on shoulders. To release the tax burden and enjoy the benefit from the restructuring of the company's finance, the management decided to launch a new stock buyback program by acquiring $1 billion debt. The following research and analysis will give us a clear look on the whole situation and justify the motivation of this new debt acquiring program of UST.

The Industry Overview

The US smokeless tobacco industry generated $2 billion of retail revenue in 1998 with approximately 5 million consumers of moist smokeless tobacco and 7 million consumers of chewing tobacco. Moist smokeless tobacco consumption approximated 50% of the total. According to USDA, the moist smokeless tobacco has been the fastest growing segment of the tobacco industry because a number of factors contributed to the continued growth. Among these factors, a stronger consumer perception on smokeless tobacco as a healthier alternative to traditional smoke tobacco plays an important role.

A Real Market Driver

US Tobacco is a dominant player in US tobacco industry and market, especially in moist smokeless tobacco segment, controlling 77% of the market in 1998 .

8-yr Market Share of UST

1991 1992 1993 1994 1995 1996 1997 1998

Industry

Premium Market Share % 99.0% 97.9% 97.2% 96.3% 94.9% 92.7% 90.9% 89.2%

Price Value Market Share % 1.0% 2.1% 2.8% 3.7% 5.1% 7.3% 9.1% 10.8%

UST

Total Market Share % 86.2% 84.6% 85.1% 83.8% 81.7% 79.5% 78.2% 77.2%

Increase/(Decrease)% -1.9% 0.6% -1.5% -2.5% -2.7% -1.6% -1.3%

Premium Market Share % 86.2% 84.6% 85.1% 83.8% 81.7% 79.5% 78.2% 76.6%

Price Value Market Share % 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.6%

From the above table, although there is a downturn trend of the company's market share, we can easily find out that from 91 to 98, the average market share of UST is 88%, which means this market is still dominant by UST. Not only had the market share, the company's compound annual growth of sales (5% of 5yr CAGR, 9% of 10yr CAGR), EBIT (6% of 5yr CAGR, 11% of 10yr CAGR), gross profit margin (79% of 5yr Avg, 73% of 10yr Avg), net margin (32.7% of 5yr Avg, 31.3% of 10yr Avg) and ROE (122.8% of 5yr Avg, 89.1% of 10yr Avg) also showed a beautiful record showing that the company is one of the most profitable companies in America.

UST has maintain its solid boost to earnings and the company's stock price by an aggressive pricing strategy. The financial statements shows that a very positive and stable situation of the company and the cash flow it generated guaranteed UST to precede its 86 years uninterrupted cash dividends payout since 1912.

Potential Business Risk

However, some signs or the signals reflect the potential business risk of UST should not be neglected. One thing is that during the last five years, company's market share has been eroded by its smaller competitors. UST has been a dominant player of the market for a long time so the current advantage position gives him too much confidence to underestimate its potential competitors. For the last 7 years, the market share of the tobacco giant has been shrinking for 1.7% and its competitors' has grown substantially. The company had been criticized for a conservative innovative and new product introduction plan and tardiness towards to the value segment which is a new spotlight and growing point of the US tobacco industry. UST launched its new value products in 1996 and competed with some other already well-established value products. By the end of 1998, UST had only taken 0.6% market share of value market, which was far behind its competitors. UST tried to extend its business line by operating wine and other businesses, but the turnover of those back-ups is not very desirable. A Wall Street Journal article in 1997 noted "the company's management, pleased with their dominant market share and keenly aware of the company's strong heritage, turned their noses at the smaller upstarts."

Litigation and Legislative Environment

Besides the business risk caused by UST's competitors, legal issue is a more stringent matter that the company should seriously deal with. Although in 1998, UST had only seven pending health related lawsuits (compared to cases numbering in hundreds filed against cigarette companies), the company still signed an agreement with the governments of 46 states, which will pay $100 to $200 million each next 10 years to a Smokeless Tobacco Master Settlement Agreement to settle its Medicaid disputes. This continuous payment for the next 10 years since 1999 will no doubt largely offset the company's profitability because it already taken 21% to 43% of its current net income.

Financial Information of UST

UST has historically been one of the most profitable companies, not only in the tobacco sector, but also in corporate America. In 1997 and 1998, UST received accolades from Forbes which named the company as the top company in terms of profitability. UST's five-year return on capital of 92.1% was nearly 20% higher than the second ranked firm.

UST posted continuous increases in sales, earnings and cash flow over the entire period. Sales, earnings and cash flow have grown at 10-yeare compound annual growth rates of 9%, 11% and 12%, respectively. UST also maintained enviable margins with average gross profit, EBITDA,EBIT and net margins of 77%, 53%, 50% and 31%, respectively. Annual return on equity averaged 89% and return on assets averaged 48%. All the financial structure ratio of UST is much better and healthier than its competitors in the tobacco industry.

Due to the stable financial standing, UST provided a generous return of capital to investors, paying $2.2