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Molson Coors: Not Quite So Bubbly

In the face of challenging business conditions and increased debt leverage, Standard & Poor's Ratings Services on Mar. 1 lowered to BBB its long-term corporate credit and other long-term ratings on beer producer Molson Coors Brewing (TAP

, replacing the BBB+ former rating of Adolph Coors. S&P also affirmed its A-2 short-term corporate and commercial paper ratings on the company.

In addition, S&P's lowered its senior unsecured debt ratings on subsidiary Coors Brewing (guaranteed by Molson Coors Brewing) to BBB from BBB+. At the same time, S&P lowered its corporate credit and senior unsecured debt ratings on Molson and Molson Canada to BBB from BBB+. As Molson and Molson Canada recently called virtually all outstanding debt, S&P will withdraw the corporate-credit and senior unsecured-debt ratings on these entities upon repayment.

HEADY COMPETITION. All ratings have been removed from CreditWatch, where they were placed Nov. 5, 2004. The original placement followed the announcement by Coors and Molson regarding a pact to pay a special dividend of about $316 million to Molson shareholders the day before their proposed merger closed. This dividend, subsequently increased to $532 million, has resulted in greater-than-expected debt levels and a high degree of leverage at the combined entity. The CreditWatch listing also reflected S&P's concerns about weak operating trends at both entities. The ratings outlook is stable. Pro forma for the merged entity, about $2.5 billion of total debt was outstanding at Molson Coors Brewing at Dec. 31, 2004.

The downgrade reflects the ongoing soft volume trends and operating performance at certain of Molson Coors Brewing's businesses. S&P's believes that the company will continue to be challenged in its efforts to reverse the declines in volume because of intense competition in the Canadian, U.S., and Brazilian marketplaces. Additionally, higher-than-anticipated debt levels at the combined entity will result in weaker credit measures at Molson Coors over the near term.

On Feb. 9, 2005, Montreal-based Molson and Adolph Coors, headquartered in Golden, Colo., completed their merger of equals to form Molson Coors Brewing. The ratings reflect Molson Coors' position as the fifth-largest global brewer, with pro forma revenues of more than $6 billion and EBITDA (earnings before interest, taxes, depreciation, and amortization) of close to $1 billion. Molson Coors' business profile will benefit from its larger scale, more diversified product portfolio, and broader geographic penetration.

SHRINKING GLASS. But these strengths are somewhat offset by the significant competition within the mature and low-growth Canadian and U.S. beer markets, and volume declines in certain of its key markets, as well as increased debt leverage following the merger.

Some of Molson Coors' brands have strong market positions, including Molson's standing as the no. 1 brand in Canada, Carling as the top lager in the U.K., and Coors Light as the No. 4 brand in the U.S. Molson Coors remains a distant third place overall in the U.S., with an 11% market share, far behind No. 1 and financially stronger beer producer Anheuser-Busch (BUD

;corporate credit rating, A+), with a 50% share.

Although Molson Coors has plans to expand and upgrade its Shenandoah, Va., facility and close its Memphis brewery, U.S. production remains heavily reliant on its Golden, Colo., brewery, thereby resulting in higher U.S. transportation costs. Molson Coors also lacks the pricing flexibility and marketing economies of scale enjoyed by its key U.S. competitors.

Despite some fourth-quarter improvement, Molson Coors' U.S. volume continued to shrink in 2004, reflecting ongoing declines in core brand Coors Light. S&P estimates that Coors Light will account for close to 30% of the combined entity's total shipment volume, although less than 20% of cash flow.

BLAME IT ON RIO. In Canada, Molson Coors has the lead overall share of about 43% in a duopoly market, yet is only slightly ahead of its key competitor Labatt Canada (100%-owned by Ambev-Companhia de Bebidas das Americas) with an estimated 42% share. Molson Coors has lost volume and share in Canada in recent years and will be challenged to reverse this trend. S&P's estimates that Canada will account for a significant portion of the merged entity's cash flow.

Operating performance for the U.K. business was strong in 2004, partly aided by favorable currency exchange rates. Yet volume continued to grow, and Coors Brewers Limited retained its overall 21% share of the U.K. market. Brazil was a drain on cash for Molson last year, and the future strategy of these operations is unclear in light of the difficulties Molson has experienced in this marketplace. S&P's expects management will have a focused strategy for its Brazilian business over the next several months.

Although pro forma margins are weaker than some of its international beer competitors, Molson Coors expects to realize cost savings and synergies of about $175 million over the next three years, which should contribute to improved margins. S&P's expects Molson Coors to continue to invest in its brands in order to reverse current volume trends in the U.S. and Canada.

SHEDDING DEBT. Liquidity is expected to be adequate at the combined entity. Financial flexibility at the new Molson Coors will be provided by a 364-day, $1.3 billion revolving credit facility, which will be available for working-capital needs and refinancing of existing Molson debt. (Molson Coors used about $532 million of this facility to support the payment of the special merger-related dividend at Molson, Inc.) The company's existing $500 million credit facility is available to support any commercial paper outstanding. Molson Coors expects to put a longer-term credit facility in place over the near term.

Coors generated about $270 million of free cash flow in the 12 months ended Sept. 26, 2004, most of which was applied to debt reduction, and management intends to continue applying free cash flow to debt reduction in the near term. S&P's estimates that Molson generated about C$71 million (approximately US$59 million) of free cash flow for the 12 months ended December, 2004. As Molson called virtually all of its outstanding debt on Feb. 8, 2005, this debt is expected to be refinanced through Molson Coors.

Outlook: S&P's expects Molson Coors to stabilize its volume and market share trends in both Canada and the U.S. while turning around its Brazilian operations in the medium term. S&P's also expects Molson Coors to repay the special dividend debt over the next 24 months and reduce leverage. From S&P's Ratings Services

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