Ratings Outlook Lowered for Philip Morris, Kraft

S&P says the move reflects increased financial uncertainty associated with the outcome of recent and prior substantial punitive damage awards

On Oct. 8, 2002, Standard & Poor's affirmed its 'A' corporate credit rating as well as its other ratings on Philip Morris Cos. (MO ) (and related entities) and on its Kraft Foods (KFT ) subsidiary. At the same time, the ratings outlook for both Philip Morris and Kraft was changed to negative from stable.

The actions reflect the increased financial uncertainty associated with the outcome of recent and prior substantial punitive damage awards against the company, the most recent of which was the Oct. 7 award by a Los Angeles, Calif., jury of $28 billion in punitive damages to plaintiff Betty Bullock in an individual-smoker lawsuit against Philip Morris USA, the domestic tobacco subsidiary. The substantial punitive damages award followed a previous award to the plaintiff totaling $850,000 in compensatory damages.

New York, N.Y.-based Philip Morris had about $22.3 billion of total debt outstanding, including about $15.6 billion of total debt outstanding at Kraft, at June 30, 2002.

The outlook changes follow Standard & Poor's assessment of the increased uncertainty with respect to litigation trends. This is partially reflected in the Bullock award, the cumulative effect of previous sizable punitive damage awards and uncertainty about their final resolution, and the magnitude and financial impact of potential future litigation losses.

The outlook change for Kraft reflects its ratings link to Philip Morris. The ratings on Kraft Foods reflect the creditworthiness of its parent company. The corporate credit rating for Kraft includes Standard & Poor's expectation that Philip Morris will maintain more than an 80% ownership of Kraft and, therefore, does not anticipate a spin-off of Kraft. Accordingly, any rating changes at Philip Morris will result in a rating change for Kraft.

Philip Morris intends to request first that the Bullock verdict be set aside; in the event that this request is denied and that a new trial is not granted, the company will request that the amount of damages be reduced. Because the amount of the punitive damages award is about 33,000 times the amount of the compensatory damages, Standard & Poor's believes it is highly likely the punitive damages award will be significantly reduced.

While California does not have any bonding limitations, Standard & Poor's expects Philip Morris to be able to manage the potential bonding requirements for the Bullock case. However, potential bonding requirements could reduce the company's financial flexibility for investments and other potential uses of cash. Standard & Poor's estimates that Philip Morris USA already has $300 million-$350 million of total damages under appeal, excluding its $74 billion portion of the industry's total $145 billion punitive damages award in the Engle class action lawsuit, currently under appeal.

In the past, the industry and the company have been successful both in requesting a reduction in damages and in having cases overturned on appeal and have not yet suffered any material financial impact as a result of these awards. Philip Morris USA has not paid any damages to plaintiffs to date. However, Standard & Poor's remains concerned that, in addition to changing jury sentiment, the Bullock case may also indicate a further negative change in the future direction of jury decisions, particularly on the West Coast, where juries are already perceived to be somewhat hostile toward tobacco companies. (Philip Morris faces two more trials on the West Coast before year-end, one in Sacramento and one in San Francisco.)

Standard & Poor's will continue to closely monitor the impact on the company's financial condition of the near-term resolution of the course of events in the Bullock case, other appeals, and future cases, as well as the momentum and number of future cases, including those awaiting trial. Standard & Poor's will assess the rating impact, if any, of any further bonding requirements as they occur.

Philip Morris Cos. Inc.'s ratings reflect the company's exceptional free-cash flow (derived from leading domestic and worldwide tobacco market shares), as well as its position as one of the world's largest food companies and its 36% economic ownership interest in SABMiller plc, the second-largest global brewer.

The ratings outlook for both Philip Morris Cos. and Kraft Foods Inc. is negative. The outlook reflects the increased financial uncertainty associated with the outcome of recent and prior substantial punitive damage awards against the company.

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