Altria's Perfect Storm Hit by cut-rate competitors, taxes, and most of all, litigation, the company that owns Philip Morris faces its worst crisis in years.
By Patricia Sellers Reporter Associates Julia Boorstin and Christopher Tkaczyk

(FORTUNE Magazine) – When Illinois state judge Nicholas Byron issued his March ruling on a class action against Philip Morris, Louis Camilleri was 945 miles away in New York City, bracing for bad news. The chairman and CEO of Altria, as Philip Morris's parent company is now known, expected "the worst from that court," he says, because the Illinois jurisdiction seated in Madison County has a reputation for socking it to corporate defendants.

Camilleri got what he expected. The judge's $10.1 billion verdict hurt, but the real killer was that before Philip Morris appeals, it would have to pony up a $12 billion bond. Philip Morris is plenty big, but not big enough, Camilleri says, to write a check of that size. The ruling left the 48-year-old CEO threatening a once-unthinkable option for its U.S. tobacco business: Chapter 11 bankruptcy. What does Camilleri say of Judge Byron's decision? "It's just another gust of wind in the perfect storm."

The talk of bankruptcy may well be old-fashioned posturing--a trump card to lower the court's tobacco bond. And, the posturing, if that's what it is, may have worked. At presstime Judge Byron was suggesting that he would consider alternatives. Camilleri says, "I have confidence in the judicial system." But even if this gust passes, the captain of Altria's ship is still caught in a terrible gale. At its stern, the company's Philip Morris USA unit is being slapped by state governments, which increased excise taxes on cigarettes 48% last year. New discount competitors offering cheap cigarettes are prying apart its bow. And then there's the rogue wave: unending lawsuits. Over the past couple of years, Philip Morris has lost a string of multimillion-dollar personal-injury cases on the West Coast. Then, on March 21, came Judge Byron's ruling that Philip Morris had deceived smokers into believing its light cigarettes were less hazardous than regular ones. The company was given until April 21 to pay the $12 billion bond; meanwhile rating agencies downgraded Altria's debt. Investors have jumped ship. Since Camilleri took over the helm Altria has lost 48% of its market value, or $57 billion.

To add insult to injury, the new chief can't even light up in his office. New York City recently banned smoking in restaurants, bars, and public buildings--including Altria's Park Avenue headquarters. "It's draconian," grouses Camilleri. He gets his fix by stepping onto the terrace off his 22nd-floor office to smoke. It's a hard habit to break, particularly these days. He's up to two packs a day. "It helps me concentrate," he says.

Just a year ago, when Camilleri became CEO of the world's largest consumer products company, he surveyed a very different scene. With its momentous decision in 1998 to settle Medicaid-reimbursement lawsuits brought by state attorneys general, the company seemed to have put the worst of its potentially crippling litigation behind it. (Philip Morris agreed to pay half of the tobacco industry's $254 billion bill over 25 years.) That decision buoyed the stock, which stood at $55, not far from its all-time high of $58. The company had turned a corner, and Camilleri was planning a new corporate identity--one that would be more inclusive of the company's huge food business, while diminishing its association with tobacco. The new name, Altria, was intended to convey both altitude and altruism "because we're always reaching higher," Camilleri says, "and we have a commitment to social responsibility."

Apart from the crisis in its domestic tobacco business, Philip Morris (which officially became Altria on Jan. 27) does have enviable assets. Kraft Foods (Altria owns 84%) has some of the world's best-known brands, including Oreo, Jell-O, Maxwell House, and Oscar Mayer. Its profits have grown 15% annually over the past five years--among the best results in the industry--though tumult in Latin American economies, among other problems, have crimped growth recently. Altria's international tobacco division, the biggest revenue driver for the $80-billion-a-year behemoth, shows no signs of slowing down. That division's profits in 2002 totaled $5.7 billion on $28.7 billion in revenue and are expected to grow 11% this year. Philip Morris International chief Andre Calantzopoulos may be the luckiest tobacco executive at Altria. Outside of the United States, he says, "You don't have the sticker on you that says 'bastard.' "

Camilleri's plan is to build on these strengths by making acquisitions in the food industry and the tobacco business overseas. Candidates include snackmaker United Biscuits and tobacco businesses in Turkey, Morocco, and Serbia. The debt downgrades will make financing purchases harder, but Camilleri bets the crisis won't last long. "Those downgrades are short term," he says. "As soon as you get relief, the downgrades disappear." In fact, as Moody's was lowering Altria's debt rating and all hell was breaking loose in New York in early April, Camilleri was traveling in China, meeting with government officials to gain entree into the world's largest cigarette market.

Born in Egypt to Maltese parents and raised in Europe, Camilleri came to Philip Morris as a financial planner at age 23. He went on to run various international tobacco and food businesses, rising to the post of chief financial officer. The new CEO is as cool and dispassionate as his Aussie predecessor, Geoff Bible, was fiery and inspirational. "You're born with two eyes and two ears and one mouth. You should use them proportionally," Camilleri says, by way of explaining his leadership philosophy. Nancy De Lisi, his senior vice president of mergers and acquisitions, says, "Louis isn't one of those guys who comes in saying, 'This is my vision for the company.' " Rather he keeps his ideas--and his calculator--close to the vest, scrutinizing details and always sticking to the facts. "If you mix emotion with business decisions, you're not going to go very far," Camilleri says. He pauses, then adds, "I don't want to come across as a cold fish."

Camilleri has reason to worry about this: He is reserved to the point of shyness, and that can be a weakness. He was clearly the top candidate inside Philip Morris for the CEO job: He's done it all at the company, and as CFO he was a key player in crafting the settlement with the states as well as engineering the $8.4 billion IPO of 16% of Kraft, the second-largest initial public offering ever. Yet his reserved demeanor prompted Altria's board of directors to consider recruiting an outsider. (Richard Parsons, now chief executive of AOL Time Warner, FORTUNE's owner, was the board's leading outside contender.) Camilleri's experience and skill won out in the end. But he has to prove that he is enough of a leader to steer the company out of its current troubles.

The source of all those troubles is Altria's domestic tobacco business. Try as Camilleri might to convince people that Philip Morris--excuse us, Altria--is not just about cigarettes, the company's fortunes are still very much tied to Philip Morris USA. For many years that was a good thing. Philip Morris USA could raise Marlboro prices and--presto!--the parent's earnings per share would leap 15%.

But that giant domestic tobacco business is now broken. Philip Morris USA, with sales of $18.9 billion last year, saw profits fall 13%, to $5 billion. They will likely decline 23% in 2003, says Martin Feldman, Merrill Lynch's tobacco analyst. The primary reason is that cigarettes are just too expensive. On top of big industry hikes, state governments, facing their largest deficits in decades, tacked an average of 21 cents in taxes onto the price of a cigarette pack last year. Feldman calculates that the average price of a pack of high-margin cigarettes in the U.S. rose 90%, to $3.58, between 1997 and mid-2002. In New York City, a pack of Marlboros sold for $7.68. Those prices are tough to take for the typical smoker, whose household income is about $35,000.

High prices have created an opportunity for new competitors. Bargain-basement cigarettes have popped up, selling under names like USA Gold and Roger. These deep-discount brands now account for about 10% of the U.S. market, up from 2% in 1997. Smokers get even better bargains by buying via Internet sites such as esmokes.com. and dirtcheapcigs.com. Philip Morris counts 536 such sites, including many based offshore or on Indian reservations, which are exempt from state and federal taxes. Also, in the past year a counterfeit business--mainly fake Marlboros imported from China--has taken just under 1% of industry sales. In effect, that's stealing three billion cigarettes a year from the world's biggest tobacco brand.

Like gnats nipping at an elephant, the myriad deep discounters have turned into a real nuisance. By last summer Philip Morris USA's volume had slipped 14%. In July the company responded. It hiked promotional spending by an additional $850 million last year--taking a big bite out of profits. The money has funded buy-two-get-one-free offers and other enticements to buy its premium brands. "We could have let share erode and maxed out profits. But we're not short-term oriented," Camilleri says.

Sounds sensible. The problem is that he's fighting a perpetual battle. Excise taxes are rising again this year, forcing Philip Morris to spend even more--probably an additional $1.2 billion--to keep consumers from switching to the cheaper alternatives. It's a new game for Philip Morris. "I'm not worried about our conventional competitors," says Camilleri. "The issue is these competitors who play on a different playing field."

If the deep discounters are biting at Philip Morris's ankles, plaintiffs lawyers are giving it a hard right across the jaw. A new threat--so-called individual smoker cases--has emerged. Since 1999 seven plaintiffs claiming cigarettes caused cancer or other illness have prevailed against the company. The damages include one mind-boggling $28 billion judgment. (It was later reduced to $28 million.) Philip Morris has appealed this and every other unfavorable verdict, but the frequency and size of the awards put the company on notice. Says Altria's general counsel, Chuck Wall: "The fact that these awards are in the millions and billions of dollars has everyone concerned, and rightly so."

Altria's top executives admit that Philip Morris is now paying for its history of arrogance and denial. Camilleri goes so far as to say the company has to get beyond "40 years of mistrust." Top executives staunchly denied that cigarettes caused cancer until 1999. "It would be a different world today if we had talked earlier about causation and addiction," says Wall. "We stayed too long in the ring." While Camilleri can't erase the past, he still needs to protect the company's assets in the future. Lately Philip Morris has been interviewing jurors more carefully, presenting more evidence, and calling more witnesses at trial. Also, the company is trying to move cases out of Los Angeles and San Francisco, antismoking hotbeds. "Over time we will prevail," says Camilleri.

So he thinks. But there are many ways to choke Big Tobacco in the courts. The Madison County case marked a new kind of class action. The plaintiffs--a class of 1.1 million Marlboro Lights and Cambridge Lights smokers--claimed that Philip Morris had defrauded them by not specifically stating that light cigarettes are just as hazardous as regular strength. Not surprisingly, Philip Morris objects to Judge Byron's verdict.

At presstime, the company was negotiating with the plaintiff and the judge over the $12 billion bond, as well as lobbying the Illinois legislature. Its hardball tactic is to insist that it can't pay. No one outside the company can be sure of that, since Philip Morris USA's financials are not public. It could pay the plaintiffs a nonrefundable fee in exchange for a bond reduction, as it did once in a Florida personal-injury class action. But Wall calls this "extortion money."

Then there's the bankruptcy card: Philip Morris USA could file for Chapter 11 protection. In that event a bankruptcy court would oversee Philip Morris's cash flows, which, indirectly, would constrain Altria, since tobacco cash feeds the dividend and stock buyback programs. There would also be a ripple effect: In bankruptcy Philip Morris possibly would cut off its annual multibillion-dollar payments to the states. The possibility of that happening caused rating agencies to lower the ratings of state bonds backed by future tobacco revenues and prompted a broad selloff of those bonds. The upside of a Chapter 11 filing? It would put a stay, or hold, on litigation--unless the bankruptcy court ruled otherwise.

However Philip Morris resolves its Madison County problem, there are plenty more fights to come. Two more consumer fraud class actions have been certified in Massachusetts and Florida. Two additional personal injury cases are slated for trial in California this year. And there are ten plaintiffs' verdicts that Philip Morris is appealing. One is the Engle case, which awarded $145 billion in damages to Florida smokers three years ago; Philip Morris is on the hook for $74 billion. Every Wednesday at 10:30 A.M., the folks on Altria's 22nd floor wait in hope that a Florida appellate court has reversed the verdict or sent the case back to trial court.

Through hell and high water, Camilleri has remained even-keeled. "To be calm when there's a storm around is pretty useful," says the CEO. Useful, too, when it comes to placating investors, for there is no going back to the magnificent growth of the past. For four decades Philip Morris was the only firm among 150 large companies to post consistent 15% annual earnings increases. Today, says Camilleri, that is "an exceedingly difficult, if not impossible, task." Management used to aim for growth in the low teens, he notes, "but clearly since then we've had issues."

So how much does Altria expect to grow? The new CEO declines to get specific. "We aim to do better than our consumer-products peers. That's all I want to do," Camilleri says curtly. That's not such a tall ambition for a company named Altria. Yes, this is a new Philip Morris.