UK: THE GOOD, THE BAD AND THE UGLY - 'UGLY' BUSINESSES. - Wealth creation of any kind may be ugly to some but companies that are involved with products seen as morally repugnant or dangerous bear an extra burden.

by Jonathan Gregson.
Last Updated: 31 Aug 2010

Wealth creation of any kind may be ugly to some but companies that are involved with products seen as morally repugnant or dangerous bear an extra burden.

What do the following companies have in common: Allied-Lyons, BAT, Brent Walker, British Aerospace, GrandMet, Guinness, Hanson, Ladbroke, Paul Raymond Organisation, Rothmans, Sport Newspapers and Tomkins? The answer is that they are all engaged - either principally or through subsidiaries - in 'ugly' businesses. That is, they are involved with products or services - tobacco, hard liquor, gambling, firearms, pornography - that are widely regarded as morally repugnant or physically dangerous, or both.

Now, let's be clear about this. We are not taking up a sternly puritanical position. There are different types and intensities of ugliness and wealth creation of any and every kind is considered ugly by some. Yet the plain fact is that, because of the nature of their activities, the companies listed above must contend with a certain degree of public disapproval which, although in some cases fairly muted, is usually vocal and is always there.

Moreover, a faint whiff of this disapprobation can be detected throughout Western society. Gambling and drinking may no longer be 'vices', but they are still perceived as potentially dangerous or corrupting, which is why they are not legally available to children. In Britain, off-course betting has been legally available - even to adults - for little more than 30 years. And public attitudes are reflected in government policies, so that ugly products are subject to censorship or licensing laws or advertising restrictions or more or less punitive taxation. These factors are what set ugly companies apart from the rest. They also dictate, to a considerable extent, how the companies operate.

Of course, most managers employed by ugly companies see their industries as no different from any other. As a BAT executive says: 'You just get on with it'. Tobacco company managers soon learn to cope with the social situation in which some fervent anti-smoker demands 'How can you?' And asked whether an ugly reputation poses any specific challenges in the workplace, nine out of 10 managers will say 'No'. They think of themselves as being in consumer goods or publishing or precision engineering - not in fags or porn or lethal weapons. 'It's like working in any other business,' insists a director of Paul Raymond's 'adult entertainment' empire.

Which is true, up to a point. Cigarettes, for example, are archetypal fast-moving consumer goods. Indeed, cigarette manufacture has the highest volume production of any consumer business in the world. The concerns of tobacco company managers centre on their state-of-the-art production technologies and equally sophisticated distribution and marketing operations - not on the intrinsic nature of the product. Volumes among the big drinks companies aren't in quite the same league. But the distillers share with cigarette-makers - and with other major FMCG producers - all the problems of positioning, maintaining and managing international brands.

However, it's also in the area of marketing that differences between the ugly and the non-ugly begin to appear. The marketers of ugly products have to be especially alert to any possible build-up of public censure. Hence the tremendous importance attached by most (though not by all) of these companies to the 'three Rs': public relations, government relations and investor relations. Campaigns by 'anti' lobbies must be monitored, and their arguments met by counter-arguments. Any threat of inimical legislation must be detected at the first whisper, and its course diverted if at all practicable. Thus trade federations, such as the Tobacco Manufacturers Association and the Scotch Whisky Association, play unusually active roles. And specialist firms of political lobbyists are retained to track developments in Whitehall (or on Capitol Hill), and to feed information to the right quarter.

In the UK, it's the tobacco industry which faces the toughest problems. The fact that its advertising is banned from television screens, and is elsewhere undermined by government health warnings, has done nothing to diminish the vehemence of the industry's opponents. Besides calling repeatedly for a total ban on cigarette advertising, they now threaten moves to prevent the televising of sports sponsored by tobacco companies. And the pressure mounts with each new item of medical evidence. In the face of this onslaught, the industry assumes a defiant insouciance. Michael Prideaux of BAT dismisses the anti-smoking lobby's 'neo-prohibitionist stand' as a temporary phase. 'They'll probably find another target to charge at in a year or two.' Or maybe not. Meanwhile, in Washington the tobacco industry is caught in a pincer movement. The Clinton administration's health reforms imply a quadrupling of the tax on a packet of cigarettes. At the same time, congressional committees are investigating a number of issues that augur no good for the industry: was there an industry-wide cover-up about smoking's danger to health during the '60s?; why were programmes aimed at developing a 'safer cigarette' abandoned? And in law courts throughout the US there is a rising tide of suits against the tobacco companies, seeking damages for the ill-health or death of relatives.

Washington is also at the centre of the current row over firearms. Here, despite constitutional endorsement of the right to bear arms - and use them in self-defence and for the protection of property - the anti-gun lobby has lately seized the initiative. This represents a potential threat to the profit and prestige of the leading US handgun manufacturer Smith and Wesson, a subsidiary of Britain's Tomkins group. Anthony Spiro, Tomkins's director of corporate affairs, points out that 'There are over 200 million handguns in the US, and 75% of our annual sales goes to the general public with the balance going to law enforcement and government'. So far, he claims, 'The perception of resistance to handguns is much greater than the reality.' Tomkins leaves any lobbying on US gun laws to the local subsidiary and pressure groups like the National Rifle Association. On this side of the Atlantic, the issue of firearms has scarcely arisen, for the obvious reason that such weapons are banned (except for licensed use by sportsmen and clubs) in Britain as in most other Western countries. Sober advertisements for handguns appear in a few police and other trade journals, but there are no parallels to the frighteningly graphic ads in US publications such as Guns and Ammo. Even so, with the rise in violent crime, public attitudes towards gun makers could harden, and throw the industry (which includes Hegler and Koch, part of Royal Ordnance which is in turn part of British Aerospace) on to the defensive. Tomkins is evidently sensitive to the danger that guns pose to its image. The reference to Smith and Wesson in the company's latest annual report was illustrated by two little girls chatting to a policeman, revolver inconspicuously clipped to his belt.

For the time being, however, guns figure fairly low on any British league table of relative ugliness. To most people, the risk of getting shot at still seems slight - and infinitely slighter than in America. Besides, the fact that Smith and Wesson is tucked into a foods-to-industrial products conglomerate effectively removes it from the public gaze. Other businesses have similarly discovered that, if you are ugly, it helps to be inconspicuous. The big bookmakers are all buried within larger diversified groups. So Ladbroke's betting shops sit alongside its hotels and property interests without unduly tarnishing the parent's corporate image. And Imperial Tobacco lies half-hidden within the vast Hanson conglomerate. Although it contributes nearly a third of Hanson's profits, tobacco has only a minor influence on how the group is perceived.

If ugliness is best concealed within a bigger and more varied group, the strategic implications are obvious. Happily for the tobacco companies, the huge cash-generating capability of cigarettes made diversification easy: less fortunately, it also attracted predators. Imperial Group was busily diversifying when waylaid by Hanson. So was BAT until the Goldsmith-led break-up bid caused management to retrench into two core businesses, tobacco and financial services. In the US, Philip Morris and RJR Nabisco both have important non-tobacco interests, including foods and brewing.

Latterly, however, the tobacco companies have seemed reconciled to making the best of a poor job, to accepting their ugly status and milking the cash cow for all they are worth until it dries up - if it ever does. Rothmans, its luxury goods arm having been demerged 18 months ago, is once again a 'pure' tobacco stock - the purest in Britain or the US. RJR Nabisco is thinking about unbundling its food and tobacco businesses. Philip Morris has already thought about it and decided against. But BAT's $1 billion bid for American Brands, which remains on the table, offers to concentrate the industry further, and tilt the group so that it rests still more firmly on a foundation of tobacco leaf.

Down the years, the distillers have shown a steadier faith in the long-term future of their product. True, GrandMet opted for diversification when it bought the US foods group Pillsbury, but it nevertheless remains dedicated to drink. Guinness's strategy is entirely drinks-oriented, and Allied-Lyons shifted in that direction when it joined forces with Domecq. Worldwide, four of the five biggest international liquor groups have now declared their intention of concentrating on drinks.

The distillers' greater confidence is well grounded, in spite of superficial similarities between drinks and tobacco. Both are ex-growth. Cigarette smoking has been declining in the West by 2-3% a year, and is expected to maintain this downward trend. Spirits consumption is broadly static, although brown spirits are likewise in gradual decline in major markets such as the US. Both industries are heavily taxed in their traditional markets, and are looking to open up new ones in the Far East, Latin America and Eastern Europe. However, in most Western markets, increases in tobacco duty have lately outstripped inflation, and surged ahead of alcohol.

These days, while the tobacco lobby can only complain of 'the predictability of the excise regime', the drinks lobby is calling for a reduction in duties to bring the UK more closely into line with other EU member states. Buoyed up by medical studies suggesting that moderate drinking may be beneficial to health, the liquor industry has also become more proactive in its dealings with the public. A few years ago, executives of the country's eight biggest drinks producers came together to form The Portman Group (named after the hotel where they met) to promote a 'socially responsible approach' to alcohol consumption. Its director, Dr John Rae, aims to 'explore ways of dealing with alcohol-related problems (like drink-driving) without recourse to control measures such as raising taxes or banning advertisements'. The industry is at pains to point up the distinction between moderate - or 'sociable' - drinkers and the 5% who 'abuse' its product.

The more aggressive posture is inspired by a conviction that the industry is winning, that the old moral objections to drink are fading away. If this is so, the implications for the companies are considerable. They carry little weight in the City however. Evidence that degrees of ugliness have a bearing on how a company is valued, or on its access to capital, is comparatively slight. It's true that some fund managers refuse to invest in certain ugly businesses. A medical charity, for example, may blacklist both tobacco and alcohol. So-called 'ethical funds', and institutions such as the Co-operative Bank, will not buy shares in, or lend to, businesses that fail to match up to their guidelines. However ugliness is just one consideration among many for the fastidious investor. An imperfect environmental record, or a tendency to trade with 'unacceptable' regimes, serves to disqualify many more potential users of capital. The Co-op blacklists 85% of the FTSE 100, which leaves 'mostly medium-sized companies trading in the domestic market'. In any case, ethical investors are so far a tiny minority.

One measure of the status granted to ugly companies in financial circles is provided by Moody's, the debt-rating agency. Moody's rates Guinness corporate debt AA2, Hanson is A1, BAT and GrandMet are both A2, so is Philip Morris - all these are above average. Only RJR Nabisco lets the ugly side down, with the lowest grade before the ratings descend to junk bonds (and that says more about the group's financial structure than its interest in tobacco). All are big, stable, cash-generative businesses with ample asset-backing, which is what the bond markets like. None has had much difficulty into tapping into capital markets to finance acquisitions.

If ugliness has any commercial consequences, it's on the stock market that they appear. If taxation and regulation look likely to impact upon future sales and profitability, then investors naturally sit up and take notice. The share price of the tobacco majors is unquestionably influenced by external factors, like the Clinton administration's health programme and the adverse medical reports. But even so, events like the price war in tobacco, which broke out on 'Marlboro Friday' and slashed margins in the US by more than a quarter last year, are far more dramatic in their effect.

In the UK, too, the tobacco companies are relatively low-rated, on a p/e well below the market average. Part of the equation is that 'there's not much good news to come', as Nyren Scott-Malden, tobacco analyst at BZW, puts it. The unpredictability of tax hikes or advertising bans - all factors outside management's control - 'obviously have an effect on the quality of earnings,' he says. However, 'it's not a quantifiable one'.

At least the porn kings do not have to worry about their share price. In Britain the adult entertainment (or sex) industry remains almost entirely in private ownership, yet there is no sign that it has ever been starved of capital. Since liberalisation in the 1960s and '70s, pornography has grown into a multi-million pound industry. The big players, Paul Raymond (of Revue Bar fame) and David Sullivan (proprietor of Sport Newspapers) are not surprisingly secretive about their companies' fortunes. Raymond has pursued a form of 'vertical integration', investing in magazines, clubs and properties in Soho. Sullivan is best known for making mild titillation the main selling-point of a national tabloid, although he, too, owns a stable of 'men's magazines' such as Parade. But 'top shelf' magazines no longer enjoy the rapid growth of previous decades. Porn is increasingly available via other media. Nevertheless it remains very much a private niche business, an industry that has failed to make it out of the ghetto.

And there it is likely to remain for the time being. One or two adult magazines are part of wider publishing groups: Northern and Shell, the UK publishers of Penthouse, owns a portfolio of consumer magazines. But, as a rule, the ugly duckling in the nest tends to drive off major public companies, even if - like EMAP or Reed Elsevier - they have a visible hunger for general interest titles. 'We would not get involved in publishing that,' says John Lowe, director of IPC Magazines, disapprovingly indicating a mildly pornographic publication. 'It would dilute the quality of our portfolio.' On the scale of relative ugliness, pornography goes too far. It is a no-go area for publishers with a wide readership, or for companies with institutional shareholders.

But it would be unwise to assume that things will always be so. Attitudes are changing, to ugly business as to so much else. What was once ugly because morally suspect is now acceptable - thus the old moral objections to drink and gambling are on the wane. What was once wholly acceptable, like smoking, is now acquiring the status of a pariah. A New Puritanism is in the ascendant, and it is built around the sanctity of human life. It asserts the right of an individual to a long and healthy life, however much this impinges on the liberties of others.

If the shift in public concern about health and environmental issues continues so far as to override personal liberties, then 50 years hence the list of ugly businesses will look rather different. Out will have gone betting (a generally condoned leisure activity) and maybe pornography (the ultimate safe sex). Firearms and tobacco will also have disappeared, but for other reasons. Both will be banned. In will come dairy and meat products, private motor vehicles and a broad swathe of environmentally degrading products. And the status of drink? That will depend largely on future medical reports. Not inconceivably, it could find itself in competition with cannabis and other 'social relaxants'. For ugliness, like beauty, is in the eye of the beholder.

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