- The Washington Times - Wednesday, June 1, 2005

KEYSVILLE, Va. - Three years ago, Steven Bailey’s small tobacco company was growing so fast that he could have retired early. Now, he’s fighting for every sale.

On July 1, a new Virginia law will force his company, S&M; Brands Inc., to raise prices on its cigarettes. That’s on top of a $2-per-carton increase last year, after other states passed similar laws at the urging of large tobacco companies.

“You’re kind of fighting the world,” said Mr. Bailey, whose family has been in the tobacco business for more than a century.

Few would shed tears for a cigarette maker. But Mr. Bailey’s reversing fortunes show how the states’ $206 billion settlement with major tobacco companies over smoking-related Medicaid costs is altering the industry.

Critics say the 1998 Master Settlement Agreement has not turned out as expected as big players accused of wrongdoing wound up with market protections while small businesses were forced to pay up.

But few think the deal will vanish soon.

“It’s 46 state attorneys general, the 200 or so wealthiest trial lawyers in the world and the six largest tobacco companies against a bunch of very small businesses who are losing money,” said Jeremy Bulow, a Stanford University economics professor.

Under the deal, the big cigarette companies agreed to restrict their marketing, fund stop-smoking efforts and make annual payments to the states for 25 years.

But attorneys on both sides knew the large companies would raise cigarette prices to make their payments, so they built in protections to prevent companies outside the agreement from taking too much market share.

They also invited other manufacturers to join the agreement by offering favorable deals. Those who did not join had to pay about $4 per carton into escrow accounts, which would be refunded in 25 years if the states didn’t sue them over health-care costs.

But S&M;’s owners learned that outsider companies that sold cigarettes in fewer states could get refunds of much of their escrow payments. They also found a bank that provided short-term loans, allowing them to keep prices low while awaiting refunds.

“We outsmarted them,” Mr. Bailey said.

Once the news got out, the nonparticipating manufacturers’ share of the market rose from a fraction of a percent in 1997 to almost 8 percent in 2003, according to PricewaterhouseCoopers, which audits the tobacco agreement.

S&M;’s sales soared from $25 million in 1997 to $141 million last year.

An alarmed National Association of Attorneys General warned states to expect a large decrease in settlement money, and more than 40 states passed legislation locking up escrow payments for the entire 25 years.

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