Fitch Affirms R.J. Reynolds' Ratings; Outlook Revised to Stable.

CHICAGO -- Fitch Ratings has affirmed R.J. Reynolds Tobacco Holdings, Inc. (RJR) ratings and revised the Outlook to Stable from Negative following the company's announcement that the U.S. Federal Trade Commission has closed its investigation and will not challenge the companies' plan to combine R.J. Reynolds Tobacco Company (RJRT) and the U.S. business of Brown & Williamson Tobacco Corp. (B&W). In addition, on June 22, 2004, the companies received favorable private-letter rulings from the IRS, establishing that the transaction will be tax-free to RJR shareholders and B&W's parent company, British American Tobacco p.l.c. (BAT). The transaction, subject to shareholders and Securities and Exchange Commission approval, is expected to close in July. BAT senior unsecured debt is rated 'A-' by Fitch. The Outlook is Negative. Fitch rates RJR's guaranteed senior notes and bank credit facility 'BB+' and senior notes 'BB'. Rated debt is approximately $1.7 billion.

RJR and B&W signed a definitive agreement on Oct. 27, 2003, to combine the assets and operations of their U.S. businesses to form Reynolds American Inc. (RAI), which will be a new publicly traded holding company. RJR shareholders will own 58% of the equity and BAT will own the remaining 42%. Furthermore, RJR is expected to pay BAT $400 million in cash to acquire the stock of Lane Limited, a subsidiary that manufactures and distributes tobacco products. The combination will result in a larger number two U.S. tobacco company, with over $8 billion in annualized revenues, approximately $1.2 billion of operating earnings, and more than a 30% share of U.S. cigarette sales. B&W will transfer to RJRT cash equal to B&W's accrued Master Settlement Agreement liability, which fluctuates during the year but on average is $750 million, at closing. In addition, B&W will be indemnified by RJRT for historical and prospective litigation relating to its U.S. business. No incremental debt is involved in B&W's asset transfer, resulting in substantially lower leverage for RAI. Reynolds American's annual dividend is expected to be approximately 75% of net income, which is higher than RJR's 50% payout and could constrain financial flexibility. Share repurchases are not expected to be substantial.

RAI has a high degree of liquidity, with pro forma cash and short-term investments of $2 billion at March 31, 2004 and $1.7 billion total debt. While the company has ample liquidity, the ratings also take into consideration the company's substantial litigation risk and the execution risk of implementing RJR's current restructuring plan along with this business combination. Prior to the combination, both companies experienced steep volume and market share declines. Fitch is looking for sustainable improvement in operating earnings and stabilization of volume and market share before upgrading the ratings.

Overall, the transaction is viewed positively by Fitch. The combined companies should be better able to minimize or compensate for industry issues in the highly promotional and competitive U.S. tobacco industry. RAI, with greater scale and cost efficiencies, also is expected to compete more effectively with the market leader. A primary driver of the lower cost structure for RAI is the estimated $500 million of annual synergies within two years of the closing. These cost savings are beyond the $1 billion RJR plans to achieve by year-end 2005. Successful execution of the business combination and the realization of the cost savings through production, selling, general, and administrative expenses should result in RAI having a substantially stronger credit profile.

For more in depth analysis of RJR see Fitch's credit update, 'Credit Update: R.J. Reynolds Tobacco Holdings, Inc.,' dated May 27, 2004, and for more in depth analysis of the domestic tobacco industry, see Fitch's special report 'U.S. Tobacco Industry,' dated April 16, 2004, available on the Fitch Ratings web site 'www.fitchratings.com'.