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Philip Morris wants to put $11 billion surplus in Kraft

Looking ever toward the future, Philip Morris Companies, the nation's largest cigarette manufacturer, has put $11 billion on the table to buy Kraft Inc., one of the biggest US food manufacturers. Aside from its blockbuster status as the second-largest merger attempt ever (behind the $13.3 billion takeover of Gulf Oil by Chevron Corporation in 1984), the Philip Morris bid is only the most recent major diversification within the United States tobacco industry.

``Tobacco companies are companies whose basic business is deteriorating,'' says George Thompson, a tobacco analyst with Prudential Bache Securities in New York. ``If they want to remain large business entities, they have got to do this. It's just one step along that road.''

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With billions in tobacco profits gushing into corporate coffers, industry analysts have been speculating for months that Philip Morris would be using its surplus cash for a major new acquisition.

In November 1985, Philip Morris purchased General Foods, the makers of Kool-Aid, Jell-O, Bird's Eye frozen foods, Entenmann's, and other brand names. If successful in capturing Kraft, PM will also provide a stable for household names like Velveeta, Cheez Whiz, Miracle Whip, Parkay, and Breyers ice cream.

In some ways, industry analysts say PM executives may be looking to follow the formula for success used by RJR Nabisco Inc. The nation's second-largest cigarette manufacturer, RJR has in recent years become one of the largest diversified consumer products companies, with $15.7 billion in sales last year. In 1985, RJR purchased Nabisco, and immediately became a major food-industry player with Oreo, Ritz, Chips Ahoy!, Planters, Baby Ruth, Blue Bonnet, and other major food brand names.

``Philip Morris has been observing a winning strategy at RJR,'' says Robert Miles, a professor of management at Emory Business School in Atlanta. ``It took them a little longer, but PM is simply realizing they have to move forward, given stagnant tobacco demand. They have to increase expertise in the food business.''

Diversification of the US tobacco industry began in earnest after the first surgeon general's warning in 1964 about the potential health consequences of smoking. In the past quarter century, R.J. Reynolds, Philip Morris, Liggett & Meyers, and others have, with greater or lesser vigor, sought to diversify.

Cigarette sales declined 1.5 percent last year, the sixth year in a row of flat or declining sales. Industry analysts expect drops as large as 2 or possibly 3 percent in coming years.

Philip Morris has, however, to some degree lagged other industry leaders such as R.J. Reynolds (now RJR) in diversification efforts. The commitment of PM to cigarette products that are much more profitable than food products was apparently a ``deliberate'' strategy during the '60s and '70s, according to Mr. Miles.

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In his book, ``Coffin Nails and Corporate Strategies,'' chronicling the tobacco industry's diversification, Miles describes PM as the ``most committed'' to tobacco because of its highly successful innovation into filtered cigarettes. This allowed PM to grow from the bottom of the domestic industry to compete head to head with RJR for sales, but also caused PM to rely on tobacco profits for high growth.

Recognition of declining cigarette sales is only part of the story. Tobacco companies are generating much more cash than they can reinvest in a declining industry. Analysts say Philip Morris alone is expected to generate $2 billion in surplus cash beyond hefty dividends and reinvestment. That money has to find a home.

PM has offered $90 a share for Kraft, enough to stun food-industry analysts. Kraft's shares closed at $60.125 a share on Monday. By midday Tuesday, Kraft's stock had jumped more than $28 a share.

Major food companies like Kraft have been doing well as acquisition and divestitures in recent years have left them more focused, says Stephen Grant, a food-industry analyst with Value Line Investment Survey in New York. Mr. Grant cites Kraft's sale of its Duracell battery division and progress in grabbing market share from regional companies.

Miles says tobacco company executives are learning a lot about the consumer products business from food-company managers. In recent years, food-industry executives have migrated into the parent companies' tobacco operations, lending new savvy.

``I predict,'' says Miles, ``that in coming years, tobacco-industry executives will be looking a little bit less like the Marlboro man and more like the Pillsbury doughboy.''

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