Ust Case

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|Applied Corporate Finance |

|UST |

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Gianluca BARCA

Lorenzo FANTINI

Steven KOOLEN

Johan NORD

|Understand the world. Expand your world |

Question 1

The smokeless tobacco industry generated $2 billion of retail revenue in 1998. The industry appears to be a very mature market, which could turn to be declining over the next 10-15 years: smokeless tobacco volumes increased by a moderate 3,7% over the last 17 years, partially substituting the traditional cigarettes (whose volume decreased by 2% over the same period), more expensive and with higher health risk.

In this setting, UST was the dominant producer controlling 77% of the market. Historically, the company drove the expansion of the overall market through product innovation, price increases and heavy marketing and promotion. It achieved a strong brand recognition and historically faced low competition due to advertising restrictions. However, analysts criticized UST for its recent reduction in innovation and late reply to new competitors’ moves, which were growing their market shares. As an additional concern, UST invested in wine and premium cigars obtaining returns far below these of its core industry, raising doubt of the management use of its remarkable excess cash.

From an operational point of view, UST performance had been spectacular: in 1997 and 1998 it had been appointed by Forbes as the top company in terms of profitability; from 1988 to 1998 sales, earning and cash flow grew by 9%, 11% and 12%...