Kraft's Philip Morris Connection

June 13, 2001 -- When you think of Kraft, you probably think more about Velveeta than Marlboros. But what many people may not realize is that embattled tobacco producer Philip Morris is the food maker's parent company.

Philip Morris purchased Kraft in 1988, combining the company a year later with its other food unit, General Foods Corp. to form Kraft General Foods. The company was later reorganized to form Kraft Foods Inc. in 1995.

Although Philip Morris sold off 16 percent of Kraft in Tuesday's initial public offering, the tobacco maker still controls almost 98 percent of the voting rights of the company through its 49.5 percent stake of Kraft's Class A shares and its 100 percent ownership of its Class B shares. This is a factor that analysts say makes some investors uncomfortable.

Others worry that Philip Morris might have to sell some of its Kraft shares to pay off tobacco litigation, which would depress Kraft's share price.

Though these fears are certainly valid, some analysts say it is unlikely that Philip Morris would actually have to sell off Kraft shares in the event of a massive windfall against the company. With a 51 percent share of the U.S. tobacco market, the company is a cash cow. Philip Morris had $80 billion in revenue and $11 billion in cash at the end of last year.

"For one thing, Philip Morris has a lot of money and generates a lot of cash, so it can pay them," says Morningstar stock analyst David Kathman.

Although recent events such as last week's ruling ordering the tobacco company to pay $3 billion in damages to a California man with lung cancer are major legal set backs for Philip Morris, the company's stock has remained steady, rising 7.5 percent since the beginning of the year.

Kathman says perception plays a big role in how Philip Morris' stock performs in the market. The recent court rulings, while a legal set back for the tobacco company, also remove uncertainty about the company's legal issues, which is positive from a shareholder's point of view. Kathman adds that he expects Philip Morris to ultimately be able to get the amount of damages it has been ordered to pay reduced.

"The judgment may be upheld, but I don't think it's going to be upheld to anywhere near $3 billion," predicts Kathman.

Further, with a Bush administration in the White House, Kathman argues that the climate toward big tobacco companies like Philip Morris is much more favorable than in the Clinton era, a factor that further supports the company's shares.