British American Tobacco is seeking to appease its critics

It was difficult to part the smoke. The chairman was lighting up; the chief executive was already drawing on a cigarette. Not only was smoking not forbidden; it was positively encouraged. Free cigarettes were on offer throughout the room. And this was at the announcement of annual results for Eagle Star, a large insurance company. Its parent, British American Tobacco (BAT), eventually sold Eagle Star, but a blue hazed memory of the event remains.

Most companies are at pains to proclaim the social value of their activities. Reputation is regarded as one of their most valuable assets. But in the eyes of the health conscious, tobacco companies cannot take that stance. The UK's Action on Smoking and Health (ASH) describes tobacco as 'one of the most despicable industries in history.'

Nevertheless, at 100 years old, BAT is a testament to the enduring appeal of tobacco. A constituent of the FTSE 100, its market capitalisation was around £14bn at the end of September 2002. In the previous 12 months, the shares outperformed the FTSE 100 by nearly 40%.

In the wake of the collapse of the new technology bubble, the stock market rediscovered the established, cash-generating, profit-making and dividend-paying tobacco companies that it had punished harshly during the dot com infatuation.

As Deborah Pretty of Oxford Metrica, a consultancy that specialises in shareholder value issues, points out, there are different aspects of corporate reputation. She comments, "The stock has delivered strong returns recently, so its management team has generated a positive reputation with investors as regards financial performance. And reputation and value can produce a virtuous cycle."

Concern about litigation was an element in BAT's previously dire stock market performance in the nine months to March 2000, when the price reached a low of around 235p compared to a high of about 780p in early September 2002. The issue has not gone away.

In December 2001, BAT disclosed among its contingent liabilities more than 4,000 product liability cases in the US against group companies, including 28 class actions and 15 by asbestos companies. There are active claims in 17 other countries, but BAT's main exposure is through its subsidiary, Brown & Williamson, which is the third largest tobacco company in the US. To date, BAT has no provision in its balance sheet for the result of any pending litigation, and the directors have stated that they do not believe the ultimate outcome of the litigation would significantly impair the financial condition of the group.

Leading on CSR?
Within the limits set by its business, BAT is hoping to stand out by taking a leading position in corporate social responsibility. One of its defences is to stress its intention to market only to adults and to work to reduce smoking among young people. The company states its position thus: 'At British American Tobacco, we have long accepted that smoking is risky. Our business is not about persuading people to smoke; it is about offering quality brands to adults who have already taken the decision to smoke. We strongly believe that smoking should only be for adults who are aware of the risks.'

In its social reporting process, BAT looked first for expert external guidance from EQ Management, a social reporting consultancy, and then appointed Bureau Veritas to verify the process and the accuracy of the results against an international standard, AA 1000, using agreed reporting guidelines.

The first social report was published in June 2002. In his foreword, BAT executive chairman Martin Broughton states, 'Tobacco products pose real risks to health, and our industry can be seen as controversial. We therefore believe it is all the more important that our business is managed responsibly and in line with the reasonable expectations of our stakeholders.'

The issues covered fall under two headings: social, which includes the workplace, suppliers, products and services and human rights, and environmental, which deals with energy, materials and water consumption, emissions, land use and biodiversity, and compliance.

So far, not surprisingly, BAT has failed to impress ASH with its campaign to show itself a good corporate citizen. Director Clive Bates said, "It's like the Mafia godfather going to church on Sunday and putting a thousand dollars in the collection plate - it's what they do during the week that matters."

However, in September 2002, BAT became the only tobacco company to have its shares included in the Dow Jones sustainability indexes. According to Sustainable Asset Management (SAM), a Swiss based asset manager that compiles the Dow Jones indexes, BAT was included because of 'an excellent overall sustainability performance compared to the industry average.' The company has 'strong capabilities' in dealing with corporate sustainability in all the three dimensions measured by SAM.

The company also donated £3.8m to create the International Centre for Corporate Social Responsibility at the University of Nottingham. To accept the money, the university referred to a protocol covering donations by tobacco companies, drawn up by the organisations that are now Universities UK and Cancer Research UK. There were objections - the editor of the British Medical Journal, Richard Smith, resigned a part time post at the university in protest - but the deal went ahead. Philip Dalling, director of public affairs for the university, said there had been no strings attached to the donation. "Their demands were minimal."

Although BAT's annual report deals with financial risk, the company is well diversified geographically. The biggest risk is litigation, confirms tobacco analyst Andrew Darke at Williams de Broe in London. The market does seem to accept a certain level of background noise in terms of litigation, and when BAT's interim results were announced in July 2002, Martin Broughton said he thought the litigation climate was "getting distinctly better". He fired a shot at his competitors, suggesting that they ought to look at how they conducted some of their cases, especially on the US west coast.

All tobacco stocks suffered in the wake of of an award of $28bn in punitive damages by a California jury against Philip Morris, at the beginning of October 2002. BAT was more affected than its UK competitors, because of its exposure to the US through Brown & Williamson. Merrill Lynch downgraded its view to neutral from buy, but Andrew Darke retained his buy recommendation.

Philip Morris immediately said it would appeal. On the basis of previous cases, it is likely to see the punitive damages substantially reduced, even if the verdict is confirmed. The compensatory damages awarded by the jury to the 64 year old woman suffering from terminal cancer were only $850,000.

Despite the views of some stakeholders consulted during the corporate social responsibility exercise, who said simply that BAT should cease manufacturing toxic products or diversify into other areas, the company does not intend to do either. As it comments forcefully in the 2001 annual report: 'The simple reality is that the demand for tobacco products is not going to disappear. Governments and regulators therefore need to consider who they would really prefer to be running the tobacco industry." The message is clearly that not everyone selling tobacco deserves the same reputation. FROM MEDICAL HERB TO CANCER STICKS
Tobacco grows naturally in North and South America, and native Americans have been using it in many ways, including medicinal and religious purposes, for more than 2,000 years. Sailors who came to America with Christopher Columbus took plants back to Europe, where tobacco soon became popular for its claimed healing properties.

Early tobacco was generally chewed, or smoked as cigars. Mass production of cigarettes only became possible in the 1880s, and cigarette smoking increased gradually. In 1913, R J Reynolds began to market a brand called Camel, often considered the birth of the modern cigarette. British American Tobacco (BAT) had been formed in 1902. The two world wars saw an explosion in cigarette smoking.

Lung cancer rates rose in tandem with increased cigarette consumption, but it took years before there was general acceptance of causation. Two seminal scientific papers were published in 1950, one in the US and one in the UK, but public awareness developed slowly. The tobacco companies, naturally, put up great resistance.

The first US lawsuit against a tobacco company was filed in 1954, a year after the Readers Digest published the article 'Cancer by the Carton'. It failed. For years, the tobacco companies outspent and outlasted their opponents in court. Outside the courts, they fought tooth and nail against the growing anti-smoking movement, but the momentum against them was building.

Despite the initial failure of individual lawsuits, plaintiffs wore away at the industry. Advertising, marketing and public use restrictions loomed. Tobacco companies diversified. Philip Morris bought into General Foods Corporation and Kraft in 1985. R J Reynolds acquired Nabisco and became RJR/Nabisco. BAT became a major player in UK financial services.

In 1992, the US Supreme Court ruled that warning labels on packs of cigarettes did not shield tobacco companies from lawsuits. US states took up the fight, claiming compensation from tobacco companies for their spending on health care through Medicaid. The first settlement was in 1996. In 1997, tobacco companies and state attorneys general reached a $368.5bn settlement, and the following year US tobacco companies settled civil cases for $206bn. The breach in the tobacco companies' defence created, US juries are prepared to find against them and award punitive damages.

In October 2002, a Los Angeles jury awarded $850,000 in compensatory damages to a 64 year old woman suffering from terminal cancer - and $28bn in punitive damages against US tobacco giant Philip Morris. The jury found that the tobacco company had deliberately concealed information about the dangers of smoking. Philip Morris immediately said it would challenge the verdict and, if that failed, the amount.

Lee Coppack is a freelance writer and analyst specialising in insurance and risk management issues. Email: