Smoking Gun

Monday was the first day in nearly two decades that Kraft Foods traded as an independent company. In 1988, tobacco giant Philip Morris, which has since changed its name to Altria, acquired the packaged foods and beverages manufacturer in a conglomerate merger. One likely explanation for the merger is that Philip Morris wished to reduce the risk inherent in the cigarette industry by acquiring a stable and well-regarded company. Industry risk is large and rising as anti-tobacco groups gain clout, further litigation and federal regulation loom in the future, and hundreds of thousands of consumers die from product usage each year.

This past Friday, Altria completed a spin-off of Kraft Foods by distributing its 88.9% stake in the company to its shareholders. Why is the spinoff taking place? Some would conjecture that Kraft’s association with Philip Morris is dragging down sales, as consumers boycott Kraft’s products due to its ties to cigarette money. The stock market, however, supplies a different answer.

Typically, a spin-off increases the value of the shares of the spun-off company, but in our case the opposite is true. After the announcement of the spinoff this January, Kraft shares have dropped 11% as Altria shareholders have bet against Kraft Foods. By the end of the trading day on Monday, the first trading day after the completion of the spin-off, Kraft Food stocks (KFT) fell $0.81, or 2.6%, to $30.85 while the shares Altria (MO) rose $2.32, or 3.5%, to $68.22.

It seems investors favor Altria to Kraft. Even though it is plagued by charges of unethical behavior, deadly products, and threats of increased regulation and litigation, the cigarette industry’s strongly inelastic demand curve guarantees market stability and industry power.

It remains to be seen how Kraft and Altria’s share prices will respond to the merger in the long run. Perhaps the spin-off signals an end to the merger-happy 1990s. We will have to stay tuned to the situation to find out.

-Pam, Jung In, Helen, and Katie