Case Study:

Our recent rapid expansion into the USA is a good example of our ability to create value through targeted investment.

We have sold rolling papers and tubes in the USA since our acquisition of the Rizla business in 1997 but made a strategic decision not to enter the tobacco market due to the uncertain litigation environment.

Over the years, however, this has eased considerably reflecting the fact that the vast majority of individual and class action claims in the USA have been decided in favour of the tobacco industry.

These improvements prompted us to re-evaluate our strategy. We originally intended to enter the USA tobacco market organically but in 2007 had the opportunity to acquire Commonwealth Brands, the fourth largest tobacco company in the USA.

The company, based in Bowling Green, Kentucky, had a 3.7 per cent cigarette market share from a portfolio of discount brands, a sizeable sales force, and a modern factory in Reidsville, North Carolina.

The company was also the exclusive distributor of the Bali Shag and McClintock fine cut tobacco brands.

Commonwealth Brands was one of the first tobacco companies to voluntarily sign the Master Settlement Agreement (MSA) and, like Imperial Tobacco, has never lost or settled any product liability claim.

The MSA is an agreement between tobacco manufacturers and the National Association of Attorneys General.

In return for annual payments based on market share and compliance with restrictions on advertising and marketing, each MSA member is protected from State healthcare cost actions.

Membership of the MSA is important in managing litigation risk in the USA and was always a pre-requisite for our entry into the tobacco market.

The acquisition of Commonwealth Brands provided a strong platform for growth which we have optimised through a number of initiatives.

Imperial Tobacco secured MSA membership in November 2007 in order to be able to sell our own tobacco brands in the USA. We have subsequently launched Davidoff in key cities across the USA and Fortuna in both Florida and Texas.

We also focused on driving the growth of Commonwealth Brands’ portfolio of discount brands, which include USA Gold and Sonoma, and our cigarette share has now increased to 4.3 per cent.

Fine cut tobacco is a growth area in the USA and as world leader in this sector we were quick to capitalise on this opportunity, acquiring the Bali Shag and McClintock brands in the USA, and launching our own brand, Premier.

We further enhanced our fine cut tobacco portfolio with the Rave brand following the acquisition of the company, Lignum 2, in May 2008. These initiatives have significantly developed our fine cut tobacco share which had grown to around 8 per cent in September 2008 compared to 1 per cent in the previous year.

Completing our multi-product portfolio is our market-leading position in cigars, in terms of net sales, which we inherited through the Altadis acquisition. We offer the broadest range of cigar products in the USA, from premium to mass market.

Although our cigar sales have been generally affected by smoking restrictions and the economic downturn, particularly in the premium category, this is being offset by the good performance of our brands in the natural wrapper segment and growth in cigarillos.

Altadis had a 51 per cent stake in JR Cigars, a nationwide retailer of cigars and related products, and in October 2008 we purchased the remaining shares to further strengthen our position in the market.

Outlook

In a relatively short period of time we have developed a strong and growing presence in the USA tobacco market and remain very well positioned to continue to improve our market shares and profitability.

Through our strong portfolio we have a presence in cigarette, fine cut tobacco, cigar and rolling papers and tubes. This broad representation provides significant potential for future growth.

Sales excellence is key to our success and we are currently in the process of expanding our sales force. This will improve our national distribution capabilities and ensure that we continue to maximise the opportunities that our versatile multi-product portfolio offers.