The Management Team of Ust

To: The Management Team of UST

From: Group 6 (Tu Le, Lior Scheinbach, Benjamin Chua, Shupei Tao, Rafael Jiménez Padrón)

Subject: Recommendations for Debt Policy at UST

Q1. Attributes and Risks of UST

Attributes: Historically, UST is one of the most profitably companies in the US, beating Coca-Cola and Microsoft to attain the title of most profitable company from Forbes in 1998. Plus, UST is highly cash generative while it achieves high returns (54% ROA, 103% ROE) with low financial leverage (17.6% debt-to-capital). However, since UST is an active and large player in the tobacco industry, it faces litigation and lawsuits on daily basis. It also has advertising restrictions to reduce youth exposure to tobacco, yet still manages to sustain continued growth rate.

Risks: One of the most prevalent risks for UST is litigation and regulation risks, owing to daily lawsuits from individuals for health issues due to tobacco usage, and from competitors for violating antitrust and advertising laws, and for participating in anti-competitive conduct. For UST’s market share is partially value segment, that UST has been aggressive with its price increases leads to its eroding market share and decreasing brand value to smaller competitors willing to cut prices, eventually hurts UST with missed earnings and lowered Wall Street expectations. UST also reduced innovation and responded tardily to introduce new products and product line extensions. Because of such strategic direction while being pressured by investors for more promptly product and market response, key executives of the company resigned, leading to management risk.

Q2. Leveraged Capitalization

UST’s stock repurchase program was interrupted in 1997 due to regulatory and litigation issues, but was resumed in 1998 after UST negotiated and signed  the Smokeless Tobacco Master Settlement Agreement to settle Medicaid disputes, along with favorable victory in class-action lawsuits and federal court’s ruling on FDA’s invalid regulations of tobacco products. Because of such settlements, UST was possibly more confident on expanding its product line and introducing new products to the market, while aggressively implementing promotions, that the firm deemed its current stocks were then undervalued, and expected promising boost in its stock value after the court’s ruling on FDA regulations, Congressional failure to pass broad-based tobacco legislation, and UST’s Medicaid settlement.

UST was not that successful with its operation on wine and premium cigars compared to its moist smokeless tobacco products, yet UST’s executives might use this fund to over-invest in under-performing businesses in addition to finance the stock repurchase program.

However, this decision might potentially lead to the reduction of UST’s S&P credit rating and mixed views from Wall Street investors for its future. Because UST has already had continued threat from price-value competitors, softening smokeless tobacco market, investors worried that leveraged capitalization would only hurt UST’s financial state.