Moody's Investors Service Inc. has cut R.J. Reynolds Tobacco Holdings Inc.'s debt-rating outlook to negative from stable partly because the U.S. company could be stuck with a $1.36-billion Quebec tax bill for cigarettes exported by its former Canadian unit and brought back across the border by smugglers in the 1990s.
The New York rating agency cited “an increased possibility that RJR might have to make a substantial payment” under a 1999 deal in which it sold RJR-Macdonald Corp. (now JTI-Macdonald Corp.) to Japan Tobacco Inc.
The Canadian company, best known for its Export A brand, this week got temporary court protection from creditors and tax collectors under the Companies' Creditors Arrangement Act.
The five-year-old purchase deal includes indemnity clauses making RJR responsible for certain possible costs relating to taxes and smuggling. The terms have not been made public and the companies disagree on their meaning. Japan Tobacco has said it will seek compensation from RJR if the Quebec taxes must be paid. RJR said it does not think it will have to pay.
Moody's did not downgrade RJR's debt ratings, already at speculative-grade (junk) levels, but darkened the outlook because of the Quebec situation and an impending trial in which the U.S. Justice Department seeks to seize hundreds of billions of dollars in allegedly ill-gotten gains from tobacco companies under the Racketeer Influenced and Corrupt Organizations Act.
“These negative developments occur at a time when RJR's operating performance is improving, and the company stands to reap substantial benefits from its merger with [Brown & Williamson Tobacco].... Nonetheless, Moody's considers that the net positive effect on operating metrics expected from the merger is currently more than offset by the increased potential liability stemming from RJR's indemnity agreement with JT and from the Department of Justice case.”
The Quebec tax claim is part of an effort to hold tobacco companies responsible for a circular trade in which cigarettes were shipped to the United States and spirited back across the border to be sold tax free. Separately, Ottawa is suing JTI-Macdonald for $1.5-billion.
Although the Canadian companies disclaim ties to the illicit traffic, a U.S.-based RJR subsidiary admitted channelling cigarettes to smugglers and paid penalties of $15-million (U.S.) after pleading guilty in U.S. federal court in 1998.
RJR, formerly part of the RJR Nabisco empire, is now a unit of publicly traded Reynolds American Inc., 42-per-cent owned by British American Tobacco PLC of London, which also owns Montreal-based Imperial Tobacco Canada Ltd.
Moody's puts RJR's senior secured debt at Ba2, two notches below investment grade, and its senior unsecured debt at B2, five below investment grade. Standard & Poor's Corp. rates the debt classes double-b-plus and double-B, respectively, similarly in junk territory with a “negative” outlook.
© The Globe and Mail
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