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Rating Action:

Moody's downgrades British American Tobacco's ratings to Baa2; stable outlook

17 Jan 2017

Confirms P-2 ratings

London, 17 January 2017 -- Moody's Investors Service ("Moody's") today downgraded the long term ratings of British American Tobacco plc ("BAT") and its subsidiaries from A3 to Baa2. Today's action follows the announcement that BAT reached an agreement to acquire the outstanding 57.8% of the shares in Reynolds American Inc ("RAI") for approximately USD 25 billion in cash (including about USD 500 million fees) and USD 25 billion in BAT's shares for a total enterprise value of approximately USD 97 billion, including USD 13 billion net debt assumed. This concludes Moody's ratings review that began on 21 October 2016, when BAT initially approached the board of RAI. Moody's also confirmed the P-2 short term ratings. The rating outlook is stable.

"BAT's two-notch downgrade to Baa2 reflects the significant debt and resulting high leverage that it will incur to fund the RAI deal," says Ernesto Bisagno, a Moody's Vice President - Senior Analyst and lead analyst for BAT. "We expect BAT's leverage pro forma for the acquisition to increase to approximately 4.6x at December 2017, versus 3.1x we expected for BAT on a standalone basis in December 2016", adds Mr Bisagno.

A full list of affected ratings can be found at the end of this Press Release.

RATINGS RATIONALE

Today's action reflects Moody's expectations that BAT's leverage pro forma for the RAI acquisition will increase to 4.6x at December 2017, versus 3.1x we expected for BAT on a standalone basis in December 2016. The increase in leverage will be mainly driven by the new debt raised to fund the acquisition and to a lesser extent RAI's newly acquired debt.

The acquisition is subject to final approval from BAT and RAI shareholders; obtaining certain regulatory approvals including the registration of BAT shares with the Securities and Exchange Committee and the anti-trust approvals in the US and Japan; approval of the BAT shares for listing on the London Stock Exchange and the BAT American depositary receipts on the New York Stock Exchange; and other customary conditions. BAT expects the transaction to close in Q3 2017.

Moody's expects that BAT's higher leverage will be mitigated by its improved business profile. This will be a result of a stronger geographical footprint and improved margins due to the contribution from the more profitable US operations. Following the acquisition, BAT will become the largest tobacco company worldwide, with pro forma EBITDA of USD12.5 billion as of December 2016 (excluding synergies), versus peer Philip Morrison International's USD11.5 billion for the same period.

Moody's assessment also reflects the expectation that, following the full consolidation of RAI, which Moody's assumes will happen after July 2017, BAT's operating cash flow will improve significantly, allowing room for deleveraging. That will be driven by the contribution from RAI, combined with BAT's mid-single-digit range annual organic growth. As a result, Moody's expects that total EBITDA in 2019 will be almost double BAT's current level. Stronger EBITDA, combined with some expected moderation of its dividend payout, will drive leverage down towards 3.9x by 2019.

Litigation risk for BAT will increase as a result of the acquisition of RAI. RAI continues to face ongoing tobacco litigation and remains exposed to new litigation given the still high number of Engle-related individual cases and the potential for new class action cases to be certified. Despite potential for further action, US litigation risk has moderated because a number of large class-action lawsuits have been settled or dismissed in the last decade. As such, Moody's does not consider the risk to be significant enough to affect BAT's credit quality.

As a result of the acquisition, the rating agency expects around 20% of the combined entities' total debt to be at RAI's level at the end of 2017. However, we expect the structural subordination for BAT's bondholder to be offset by an upstream guarantee from the US operations. We also expect BAT to provide a guarantee to RAI's existing bondholders, meaning that RAI and BAT debt will rank pari passu.

BAT will fund the acquisition through a combination of existing cash resources, new bank credit lines and the issuance of new bonds. The credit lines comprises USD 15 billion and USD 5 billion bridge loans with 1 and 2-year maturities respectively, each with two six month extensions available at BAT's option. In addition, the facility includes two USD 2.5 billion term loans with maturities of 3 and 5 years. Moody's assumes the refinancing risk to be manageable and expects that BAT will take out most of the refinancing needs related to the new banking facilities through the capital markets.

RATIONALE FOR STABLE OUTLOOK

Despite the weakened metrics, the stable outlook also reflects Moody's view that credit metrics after the acquisition will progressively improve. In particular, Moody's expects that leverage will decline towards 3.9x by 2019. Moody's also assumes that the litigation environment will remain manageable for the group and that any potential payment associated with court rulings will be diluted over time.

WHAT COULD CHANGE THE RATING UP/DOWN

An upgrade is unlikely in the near term considering the high leverage post-acquisition. However, provided there are no adverse litigation trends and that BAT preserves its current operating performance and brand recognition, positive rating pressure could result from improving credit and a debt/EBITDA ratio trending below 3.5x.

Negative pressure on BAT's ratings could result (1) from a combination of debt/EBITDA not returning below 4.0x by 2019 (with further progression towards 3.5x thereafter); (2) if a fundamental erosion of the company's business position were to result in operating profit declining (excluding FX); (3) from a significant deterioration in the litigation environment; and/or (4) from less favourable operating conditions with, for example, higher taxes or further restrictions on smoking weighing heavily on volumes in the company's key geographies.

LIST OF AFFECTED RATINGS

Downgrades:

..Issuer: British American Tobacco plc

....LT Issuer Rating, Downgraded to Baa2 from A3

..Issuer: B.A.T Capital Corporation

....Backed LT Issuer Rating, Downgraded to Baa2 from A3

....Backed Senior Unsecured Medium-Term Note Program, Downgraded to (P)Baa2 from (P)A3

..Issuer: B.A.T Industries plc

....LT Issuer Rating, Downgraded to Baa2 from A3

..Issuer: B.A.T. International Finance plc

....LT Issuer Rating, Downgraded to Baa2 from A3

....Backed Senior Unsecured Medium-Term Note Program, Downgraded to (P)Baa2 from (P)A3

....Backed Senior Unsecured Regular Bond/Debenture, Downgraded to Baa2 from A3

..Issuer: B.A.T. Netherlands Finance B.V.

....Backed Senior Unsecured Medium-Term Note Program, Downgraded to (P)Baa2 from (P)A3

..Issuer: British American Tobacco Hldgs (Netherlands)

....Backed Senior Unsecured Medium-Term Note Program, Downgraded to (P)Baa2 from (P)A3

Confirmations:

..Issuer: B.A.T. International Finance plc

....Backed Commercial Paper, Confirmed at P-2

Outlook Actions:

..Issuer: British American Tobacco plc

....Outlook, Changed To Stable From Rating Under Review

..Issuer: B.A.T Capital Corporation

....Outlook, Changed To Stable From Rating Under Review

..Issuer: B.A.T Industries plc

....Outlook, Changed To Stable From Rating Under Review

..Issuer: B.A.T. International Finance plc

....Outlook, Changed To Stable From Rating Under Review

..Issuer: B.A.T. Netherlands Finance B.V.

....Outlook, Changed To Stable From Rating Under Review

..Issuer: British American Tobacco Hldgs (Netherlands)

....Outlook, Changed To Stable From Rating Under Review

The principal methodology used in these ratings was Tobacco Industry published in November 2014. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Ernesto Bisagno
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Marina Albo
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

No Related Data.
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