Tauron. In PLN mn e 2011e 2012e

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1 June 16, 2010 Utilities/Poland Tauron Not Rated pre IPO IPO Factsheet Maximum price for retail PLN 0.7 Maximum price for institutions Individual investors Final price Institutional investors n.a. 9 June 18 June 22 June 22 June 24 June 1:9 reverse split 25 June First listing Shares being sold 30 June 7.4 bn Par value per share PLN 1.0 Maximum price leaves little upside potential The State Treasury of Poland is about to sell its 53%-stake in Tauron one of the largest utility groups in Poland. The maximum price to retail investors has been set at PLN 0.7 per share. We reckon that the maximum price already discounts quite some of the future value creation potential. Company Description: Tauron is one of the largest electricity utility companies in Poland, leading in terms of the distribution of electricity and being the second largest producer. The Group is fully vertically integrated and operates in the following areas: mining (4.9 mn tons of output of hard coal), generation (5.6 GW of installed capacity), distribution (27% market share, no. 1 in Poland), sales (30.4 TWh of electricity sold). We like the company: because it operates in the most industrialized and densely populated parts of Poland, being alone the most dynamic market in the EU. Tauron has its own hard coal mines providing 30% of its needed fuel, an ambitious investment program, and strong balance sheet and a potential to become a heavyweight in WIG20 and MSCI indices. We don t like the following issues: old capacities, overemployment, State-ownership, heavy dependence on polluting hard coal, short position in power generation, no capital increase during the IPO, significant share overhang from the employees and low margins. Valuation: Any DCF on Tauron can only be back-end loaded. Also a comparison to its Polish peers PGE and Enea leaves a wide valuation range given the differences in operational structure. Still, we see Tauron trading closer to Enea due to its low efficiency and short position in generation, which finds its support in our DCF. On the other hand, we see a small premium to Enea justified with its coal mines. However, the maximum IPO price leaves only some upside potential vs. our model. Analyst: Bartlomiej Kubicki, CAIA, CFA Tel.: kubicki@rcb.at Published by: Raiffeisen Centrobank, A-1015 Vienna, Tegetthoffstrasse 1 Disclosures: Supervisory authority: Financial Market Authority Key ratios In PLN mn e 2011e 2012e Sales 12,449 13,634 13,795 15,200 16,279 Gross profit 1,182 2,112 1,875 2,352 2,853 EBITDA 1,616 2,581 2,402 2,893 3,457 EBIT 347 1,260 1,038 1,484 1,990 EPS At PLN 0.7 per share PE reported Price cash flow Price book value Dividend yield 2.0% 2.9% 3.9% Free cash flow yield -0.8% 4.4% 7.0% 7.0% 4.6% Source: Tauron, Raiffeisen Centrobank estimates

2 Poland is one of the largest electricity markets in Europe The Polish energy market Increasing demand, tightening supply and obsolete generation capacities According to Eurostat, Poland is the seventh- or eight-largest electricity market in Europe (in terms of power station generation and installed capacity of electricity generation, respectively), however stays far below its peers in terms of electricity consumption, with per-capita consumption of electricity at 3 MWh per annum. Installed capacity (GW) Electricity consumption per capita (MWh) Germany France Italy Source: Eurostat Spain U K T urk ey Sweden Poland Netherlands Romania Austria Czech Republi Belgiu m Greece Finland Sweden Belgium Source: Eurostat Austria France Slovenia Netherlands Germany Denmar Ireland Spain EU-27 UK Czech Republic Italy Greece Portugal Slovakia Hungary Poland Turkey Romania Electricity export position deemed to reverse Furthermore, Poland is still a net electricity exporter. However, this is deemed to reverse within a few years as the demand increases (the Ministry of Economy forecasts an increase by 55% until 2030) along with the strong economy (forecasted by our economists to grow 2.7% and 3.2% this and next year, respectively), convergence of electricity consumption to European averages and decommissioning as well as rising service requirements of existing, aged capacities. Most of the power generation capacities operated in Poland were constructed in the 60 s and 70 s, thus their remaining economic useful life is about to end. Age of Polish generation capacity Electric power demand forecast (TWh) 20% years, 6% < 10 years, 10% > 40 years, 23% 15% % years, 13% growth 5% TWh 100 0% % 50-10% years, 48% 5y growth gross demand Source: PGE Source: Ministry of Economy Squeeze on reserve margin likely increasing electricity prices With planned decommission of 15 GW and the anticipated increase in peak load demand by 11 GW, up to 30 GW of capacity will have to be built over the next 20 years. The squeeze of the reserve margin (already declining to 3% at peak demand, whereas 5% is generally considered safe) resulting from the above is expected to 2

3 start reversing only in approximately 4-5 years as new capacities are added to the system. New projects are underway, and already a construction of 21GW has been started (and most of them await the European Commission decision regarding their free CO2 emission credits eligibility). Three projects thereof, with a total capacity of 3.28GW are in the process of construction consortia selection. Due to the economic slowdown, the demand for electricity in Poland decreased by 3% in 2009 compared to the previous year. The situation is deemed to reverse this year, however, as indicated by a 3.5% yoy increase in demand in 1Q Polish market is unbundled and quasi-liberalized Unbundling, consolidation and liberalization 2007 was a year when the Polish energy sector was ultimately unbundled and as a result thereof, a split of the segment into four independent parts was accomplished: generation, transmission, distribution and trade (wholesale and retail). Furthermore, foreign players were allowed to operate in the market (RWE, Vattenfall, CEZ, EDF, GDF Suez), the Energy Regulatory Office (ERO) was created and a transmission system operator PSE Operator S.A. being a state-owned company solely responsible for the transmission part - was established. Following the unbundling exercise with consolidation, four vertically-integrated energy groups came into being: PGE Group, Enea Group, Tauron Group and Energa Group, with PGE being at the leading position in terms of capacity, generation and number of customers. Moreover, only PGE and Tauron have their own mining operations (particularly lignite in case of PGE and hard coal in case of Tauron), giving them an undisputed competitive advantage over their competitors. Main players on the Polish electricity market PGE Tauron Enea Energa others Installed capacity (GW) % of own fuels 68% 30% 0% 0% n/a Market share in net generation 42% 14% 8% 3% 33% Number of end customers 5.0 mn 4.1 mn 2.3 mn 2.8 mn 2.0 mn Market share in distribution 26% 27% 14% 17% 16% 2008 sales in PLN 20.6 bn 12.6 bn 6.2 bn 8.8 bn n/a Source: PGE, Tauron Following the unbundling, the market has been quasi liberalized, where power companies are required to get proposed tariffs approved by ERO for the sale of electricity to households and the distribution of electricity to customers connected to their distribution network. Otherwise, the market is deregulated with the additional introduction of TPA third party network access, allowing end users of electricity to choose their supplier (of limited scope, though, due to formalities and similarity of offers from suppliers). Household prices were already scheduled to be deregulated as of the beginning of 2009, however the development of the economic crisis with fears of imminent electricity price increases and concerns over the effectiveness and understanding of TPA caused that to be postponed. Polish power plants highly dependent on coal Power generation based on coal, however renewable share to increase Poland s electricity generation has been traditionally based on coal, with 58% of the electricity generated from hard coal and 34% from lignite and below 7% comes from renewables, way different than the average in the European Union, where only 29% is generated from coal and as much as 16% comes from renewables. 3

4 Electricity generation in Poland (2009) Electricity generation in the EU (2007) 100% natural gas, 3% 100% others, 4% 80% renewables, 7% lignite, 27% 80% renewables, 16% gas, 23% 60% 60% 40% hard coal, 63% 40% lignite, 34% 20% 20% hard coal, 58% 0% Poland 0% European Union Source: Tauron Source: PGE The production mix is gradually about to change with the government s policy calling for increased generation of electricity from both renewable and co-generation sources. Electricity production mix plan Renewables mix in electricity production 100% 100% 80% 80% 60% 60% 40% 40% 20% 20% 0% 0% 2010e 2015e 2020e 2025e 2030e 2010e 2015e 2020e 2025e 2030e hard coal lignite gas oil nuclear renewables solid biomass biogas wind water Source: Ministry of Economy Source: Ministry of Economy Particular emphasis has been put on an increased share of renewable energy (particularly of wind and biomass in line with the EU s 20% target) and the construction of a first-ever nuclear power plant in Poland. The Government has indicated that PGE will be the power company responsible for the construction of two nuclear plants, each with capacity of 3GW (the first block planned to be finalized by 2020). Additional cost reflected in obligatory certificates The government motivates the power companies to invest in renewable-based power generation units by imposing a law which obliges retail electricity companies to acquire a specific amount of electricity they sell to end users from renewables generation and co-generation sources. The power companies are to present those certificates for redemption (obtained either from their own generation or purchased from third parties) or alternatively pay a substitution fee set each year by ERO. The certificates constitute confirmation that the electricity purchased was generated from the specific renewable or co-generation source. Additionally, all the certificates are subject to trading on the Polish Power Exchange (OTC and on a continuous basis). 4

5 The Energy Law specifies three types of certificates, namely: Green certificates: correspond to electricity generated from renewable resources defined as wind, hydro, solar, biomass, or bio-gas (one MWh generated equals one certificate). Furthermore, ERO sets a minimal share of electricity coming from renewable sources in the total amount of electricity sold by the retail segment for each year. This share amounted to 8.7% in 2009 and is gradually to rise to 12.9% in The substitution fee for 2010 has been increased to PLN /MWh and generally is adjusted on an annual basis to match inflation. Yellow certificates: correspond to electricity generation from gas co-generation units. Electricity retailers were obliged to sell 2.9% of their total electricity sales from gas co-generation sources in 2009 coming. This share is to gradually increase to 3.5% in The substitution fee is also set by the watchdog, however for yellow certificates the price can be within % range of the average electricity prices in the previous year. For 2010 the price is set at PLN /MWh (82.86% of the average price). Red certificates: are related to electricity generation from co-generation units other than gas. Last year, the retailers were obliged to purchase 20.6% of total energy sold from co-generation (other than gas). This share is set to increase to 23.2% in For 2010, ERO increased the substitution fee to PLN 23.32/MWh, being 15% of the average electricity price from last year (the fee can be set in a 15-40% range). Additionally, so-called white certificates are to be implemented. The rules will be the same as in case of other certificates, namely a minimum amount of those has to be created, purchased or otherwise a substitution fee will have to be paid. The white certificates will be issued on the basis of efficiency improvements in power production; however the details are unknown to us yet. Transmission in state hands, distribution in private both, however, cry for modernization Transmission and distribution The electricity transmission system in Poland is solely operated by state-owned PSE Operator. The company operates 13,053 km of transmission lines of extra high voltage ( kv) throughout Poland. Power transmission refers to transmission of electricity from power generators to power distributors and only sometimes to final users of electricity directly connected to the transmission grid. Furthermore, Poland is quite an isolated place on the electricity transmission map in Europe. The available transfer capacities for market participants are forecast to stand only at 200 MW for export and 700 MW for import. Furthermore, the export of electricity in Poland amounted to 5 GWh and import to 2.8 GWh in We find the limited transfer capacities to be one of the factors that could cause electricity prices to increase after the demand pickups and some of the installed capacities will get decommissioned. Power distribution on the other hand, refers to transmission of the electricity to the final customer. There are currently several so-called Distribution System Operators (DSO) on the Polish market (20) using the high and low voltage network. Electricity distribution involves natural monopolies on the local markets, hence power distribution is highly regulated. Firstly, entities willing to distribute electricity need to obtain a licence from ERO, and secondly distribution tariffs must be approved by the regulatory office. Tariffs are generally approved for a one-year period, based on a formula incorporating the following: 5

6 Allowed operating costs of each DSO Depreciation (regulated by ERO) Network losses Planned capital expenditures Regulatory assets base (RAB) Weighted average cost of capital (WACC) derived from the CAPM Transmission costs Electricity distributors to benefit from revaluation of RAB Distribution fees are likely to increase owing to an expected revision of the regulatory asset base. In normal cases, the RAB only increases to the extent that capital expenditures exceed depreciation. However, in case of Polish utilities the regulatory body allows RAB to gradually increase to IFRS book values. This gradual approach has been implemented to prevent a sudden increase of distribution costs. Therefore, the electricity distributors asset revaluation is capped at 1.5% per annum. The profits of the electricity distributors depend also on the relationship between the actual operating costs and those estimated by ERO (and set for three years at a time). Certainly, the higher the difference in minus (actual < estimated) the higher the potential profit (for one regulatory period, though, as ERO is likely to increase the savings in the next year tariff calculation). The table below presents the main players on the distribution market in Poland: Electricity distributors in Poland Number of customers (mn) Electricity sold (TWh) Market share Coverage (ths sq km) PGE % Tauron % 53.0 Enea Operator % 58.2 Energa Operator % 74.5 Vattenfall Distribution Poland % 4.1 RWE Stoen Opearator % 0.5 Source: PGE, Tauron Grid system needs modernization Retail market deregulated except for household tariffs The grid network in Poland is quite aged and in bad technical condition, as most of its 220 kv lines were built in the years leading to substantial network losses and inefficiencies. Substantial investments are needed to not only modernize the network but to also increase the interconnectedness of Poland with its neighbouring countries. It is estimated that around 20% of medium voltage and 50% of low voltage require modernization costing PLN 60 bn. Tariffs: all regulated for distribution, only household regulated for retail The regulator distinguishes between five groups of tariff customers both for distribution and retail: Tariff group A: high voltage level of 110 kv Tariff group B: medium voltage level between 1 kv and 110 kv Tariff group C: low voltage level of less than 1 kv Tariff group G and R: retail including households and farms and irrespective of voltage level As already mentioned, for electricity distribution tariffs for all groups are regulated based on the cost-plus formula. In terms of retail, the market is almost fully liberalized with the exception of the household segment, where tariffs do still need approval from ERO. Certainly, the highest amount of clients is within the G-group amounting to 90% of the total number of electricity users, however, their usage stands only at 25%, thus the retail sales market is to a large extent considered deregulated. 6

7 Sales of electricity to end users in Poland 100% 9% 80% 25% 60% 19% 40% 32% 20% 14% 0% 2008 group A group B group C group G others Source: PGE The retail market refers to transactions of electricity trading where one of the party is the end user, be it individual clients (households) amounting to 14.7 mn and institutional as well as business clients standing at 1.6 mn. Wholesale: exchange trading to be increased The wholesale market is also very vivid in Poland. Transactions in this segment refer to not only to electricity per se, but also to related products such as green, yellow and red certificates as well as CO2 emission rights. The market connects players generating electricity, distributing electricity as well as specialized wholesale entities. The constraint to fully open the market to foreign competition, however, is the limited interconnectedness with the countries surrounding Poland, thus trading occurs predominantly among local entities. The Polish wholesale electricity market can be divided into three segments: Contract Market: being the result of a rather limited number of market participants, most of the trading is based on short- and mid-term bilateral contracts. Electricity Exchange and trading platforms: - Polish Power Exchange (POLPX) electricity exchange set up in 1999 enabling trading on the Day Ahead Market, Power Derivatives Market, Intraday Market as well as on the Property Rights Market for Renewable Energy Sources and the Co-generation and CO2 Emission Allowance Market - POEE Platform internet based electricity trading platform enabling trading of forward contracts with tenors ranging from week to two years as well as the spot market for particular hours of forthcoming days. The participants can also trade green certificates and CO2 emission rights - Brokerage platforms such as TFS and GFI Group Balancing Market: managed by PSE Operator, more technical in nature where differences between transactions concluded and electricity actually delivered are balanced. As PSE Operator is responsible for the balancing of the power system it acts as counterparty to all trades. In 2009, the balancing market constituted 6.2% of all electricity turnovers. 7

8 Although the role of the electricity exchange is rather marginal it is about to change. From August 9, 2010, power producers are obliged to sell at least 15% of electricity produced via the exchange. Additionally, those producers compensated for stranded costs under the LTC Termination Act must sell the remaining electricity (85%) in a way ensuring fair access of all market participants, i.e. by the means of open auctions, internet trading platform or exchanges. CO2 emission certificates to significantly increase power plant costs post-2012 Emission limits to increase costs Being a member of the European Union forces Poland to comply with its regulations related to environmental protection. One of the areas affecting the operation of a power generator is the emission of CO2. In the years , Poland has been granted mn tons of free CO2 emission each year. This is, however, about to change with the implementation of the third phase of the EU Emission Trading System, CO2 emitters will have to purchase all the CO2 emission rights on auctions. However, Poland managed to obtain an exemption until 2020 arguing on their relative low GDP per capita and the high share of fossil fuels in the energy-mix. The exemption implies that power generators will receive 70% of the emission allowances for free in 2013, with the rest to be purchased on auctions. The proportion of auction-purchased allowances is to gradually increase and reach 100% in 2020 (the exact method is not clear yet, though). Additional limitations are also imposed on SO2 and NOx emissions. Being a new EU member country Poland has been granted extension with respect to upgrade and modernization time for the installations to comply with the regulations. SO2 limits are to be achieved until the end of 2015, whereas NOx by the end of Additionally, the regulations impose maximum levels of SO2 and NOx emissions for power generators during the extended transition time. LTC termination to increase revenues, however the issue is still under dispute Electricity prices to converge to international levels, however there the gap is rather narrow already Potential receivables write-off resulting from the termination of LTCs. Long-Term Contracts (LTC) related to the sale of electricity were concluded between the power producers and the transmission system operator in the 90 s. The purpose thereof was to facilitate the producers financing of investments in modernization and an increase of the capacities (as the electricity price was set at a level to cover production as well as financing costs). LTCs have served as collateral to PLN 30 bn of investments. However, in April 2008 the European Commission declared them as conflicting with the existing regulations and the idea of a liberalized market. Hence, Poland introduced a Termination Act under which electricity generators have to have the investment costs incurred under LTC compensated (so called stranded costs ). Furthermore, these compensation payments are included in revenues and the difference between advance payments already received by the power generators and the revenue recognized resulting from compensation is booked as receivables. There is a major dispute and uncertainty, however, related to the amounts of stranded costs to be covered, leading to potential receivables write-downs. Electricity prices limited convergence potential Electricity prices in Poland have been gradually converging towards Western European ones and remain only a few percentage points below, particularly on the liberalized part of the market (business clients). With respect to household prices, despite the fact that their increase can be only determined by ERO, they have been also increasing in reflection of higher prices on the wholesale market as well as rising distribution costs. 8

9 Wholesale electricity prices (Day-Ahead Market month-end, PLN/MWh) Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 base price peak price Source: Polish Power Exchange, Raiffeisen Centrobank We see the prices to reach Central European (German) levels in the mid-term, however the so-called convergence story is almost completed and not to be considered the most significant driver of Polish electricity utilities in the future. We believe that the main driver for the prices will be the squeeze on the reserve margin resulting from decommissioning of aged capacities and rising demand, while new plants are to be commissioned only in a couple of years, compounded by uncertain timing and amounts. Certainly, increasing costs of fuel, CO2 emission certificate costs and other environmental-protection-related investments as well as costs of certificates are likely to be passed to end clients, moving the electricity prices to the north. 9

10 Tauron is one of the four power conglomerates of Poland Tauron Group Tauron Overview: vertically integrated power company operating in one of the most dynamically developing parts of Poland Tauron Group is one of the largest electricity utilities in Poland, leading in terms of the distribution of electricity and the second largest electricity producer in Poland. Tauron Group is fully vertically integrated and operates in the following areas: Mining Generation Distribution Supply and trading Tauron predominantly operates in the southern parts of Poland, considered highly industrialized, densely populated and developing faster than most of Poland, hence with high current and potential demand for electricity among both households and companies. Additionally, almost all of Poland s hard coal mining activities are located in the region, thus considerably diminishing the transportation costs; also the transmission systems are best developed down there, limiting the system losses and amounts of funds needed for investments. The company is currently state-owned with the State Treasury of Poland holding 87.53%, with the remaining of the shares in the employees hands. The Group employs almost 29,000 people, predominantly (45%) in the distribution segment. Implementation of the strategy to boost fuel security and efficiency Tauron owns 20% of Polish hard coal reserves Group Strategy The company aims to strengthen its position as one of the leading power companies in Central and Eastern Europe supported with: Development of core activities via an increased resources base (coal), new generation capacities, acquisitions and potential participation in nuclear generation in Poland Improvement of operational efficiency aiming at PLN 1 bn in savings by 2012 (more efficient asset utilization, optimization of financing, logistics and procurement activities, lower labor costs) Advanced consolidation of the Group Expansion throughout Poland and abroad Mining The Group s mining activities are run by Poludniowy Koncern Weglowy (PKW). The company owns two hard coal mines (Janina and Sobieski, extracting 44.9% and 55.1% of total production in 2009, respectively), which cover around 20% of Poland s hard coal reserves. 30% of Tauron s fuel needs are covered by deliveries from PKW, which implies stability and a competitive advantage over other power utilities of Poland (but PGE having its own lignite supplies). Additionally, Tauron aims to increase fuel coverage from own resources to 50% by 2012 via investments in existing mines as well as an acquisition of Boleslaw Smialy mine from Kompania Weglowa and therefore to increase the amount of coal extracted from 4.9 mn tons to 7.5 mn tons. The combined proven and probably hard coal reserves of the mines amounts to 56 mn tons, whereas its well-defined resources exceed 1.2 bn tons. 10

11 Coal production Q 2010 Revenues (PLN mn) , , % yoy 33.1% 16.2% EBIT (PLN mn) EBIT margin - 6.3% 12.6% 14.4% EBITDA (PLN mn) EBITDA margin 5.1% 17.2% 21.7% 23.3% Coal production in mn tons Source: Tauron s prospectus In 2009, around 42% of mined coal was sold to external clients and the rest (58%) was delivered to the generation segment of the group overall constituting 6.3% of Poland s total coal sales. Please note, however, that in terms of quantity deliveries external clients amounted only to 31% implying higher prices for coal sold outside the group (actually resulting from higher calorific value). The mining segment has risen at a CAGR of 16% being a consequence of rising output (2008/2007) and rising coal prices (please note that Polish coal prices did not follow international markets in late 2008 / early 2009, when coal prices slumped). Second largest power generator with an installed capacity of 5.6 GW Generation Tauron s share in Poland s total electricity generation capacities amounted to 15.3% in 2009 and its net electricity production was 13.3%, making the Group the second largest generator after PGE. Its current capacities of 5.6 GW combined with an ambitious investment plansare to be increased to 8.5 GW in 2020 (after 1.7 GW scheduled decommissions). The generation segment is operated by four subsidiaries with PKE (Polski Koncern Energetyczny) being the largest, followed by ESW (Elektrownia Stalowa Wola), EC Nowa and EC Tychy. The Group operates seven conventional thermal power plants and four combined heat power plants. 95% of the installed capacity is fuelled by hard coal, while only 158 MW comes from natural gas and 131 MW from renewable sources (predominantly from 35 hydro power plants). Because most of the power plants operate on hard coal, they are placed on the midmerit part of the load curve, thus Tauron manages to achieve higher margins for its electricity than the benchmark unit. Electricity and heat generation Q 2010 Revenues (PLN mn) 3, , , ,447.4 % yoy 2.1% 40.5% EBIT (PLN mn) EBIT margin 3.1% 1.1% 13.4% 13.7% EBITDA (PLN mn) , EBITDA margin 15.9% 14.0% 23.0% 23.6% Installed capacity (GW) Electricity produced (net, TWh) Heat capacity (GW) Heat production (PJ) Source: Tauron s prospectus 11

12 Tauron s generation fleet is relatively obsolete with most of its capacities having been constructed in the 60 s and 70 s, thus they are not only of lower efficiency, but also require higher maintenance expenditures and eventually decommission (1.7 GW is planned to be shut down by 2020). As already mentioned, Tauron s generation segment is to 30% supplied with fuel (coal) by its subsidiary PKW (purchased at arm s length). The predominant supplier, however, remains Kampania Weglowa with a 50% share (KHW 11% and JSW 4%). Overall, fuel costs constitute about 50% of total operating costs within the generation segment and the company is quite exposed to coal price fluctuations as coal-delivery contracts (both long-term and less than one-year) have the price component left variable (or fixed for no longer than one year). Being a heavy CO2 emitter, Tauron is also exposed to CO2 regulations and emission certificate costs. In the years , the company was overallocated the CO2 emission certificates (in total 29.5 mn), however not much of the revenue was generated due to prices drop. For the years , the company had initially been allotted cc mn per annum, which was not sufficient for 2008 CO2 generation (22.8 mn), however exceeded 2009 emission of 21 mn tons. However, as of April 2010, Tauron is entitled to receive additional certificates amounting to 2.2 mn tons of CO2 per annum for the years following a commissioning of new capacities. With the enactment of the Long Term Contracts Termination Act, Tauron (PKE to be more precise) is entitled to receive a cash compensation in a total amount of PLN 1.48 bn, PLN 0.47 bn thereof has been paid. Stranded costs compensation plan PLN mn e 2011e 2012e Compensation to be received Cash advances n.a n.a. n.a. Source: Taruon s prospectus There are ongoing disagreements between ERO and Tauron (as well as other power groups in Poland) related to the interpretation of the legislation. In case of Tauron, ERO claims that PLN mn of the compensation should not have been paid to Tauron, however the recent decision (still invalid) of the Polish Court of Competition and Consumer Protection (from the May 26) is in favour of the power players. Tauron has considerably increased the power generation segment revenues with an associated increase in profitability margins. Apart from being a result of growing electricity prices, please also note that Tauron recognized as much as PLN 484 mn of LTC termination revenues in 2009 in comparison to PLN 192 mn in previous year. The largest electricity distributor in Poland Distribution The distribution segment of Tauron Group is operated by two companies: EnergiaPro with an 11% share in the electricity distribution in Poland and Enion with a 16% share, which are responsible for generating about 18% of the Group s total revenues. In 2009 the Group delivered 30.9 TWh of electricity to more than 4 mn customers. The Group s network consists of a thousand km long grid, covering 17% of Poland. Overall, the Group is the largest (with a small margin though over PGE) electricity distributor in Poland. 12

13 Distribution Q 2010 Revenues (PLN mn) 4, , , ,146.2 % yoy 3.2% -3.5% EBIT (PLN mn) EBIT margin 2.7% 4.6% 2.3% 10.2% EBITDA (PLN mn) EBITDA margin 16.8% 19.5% 17.7% 24.4% Distribution of electricity (TWh) Network (ths km) n.a. Source: Tauron s prospectus The distribution network is also highly obsolete with more than 50% of the grid being aged between years and more than 6% being older than 50 years, implying unreliability and above-average system losses and disruptions which additionally require significant investments in network modernization. The distribution business is and will remain highly regulated, where ERO establishes the distribution tariffs for each distributing company. The distribution revenues are to increase quicker in the next years based on the revaluation of the Regulated Asset Base (RAB). The asset base value should be adjusted to their fair levels (which are higher than their values so far), however the adjustment is to take place gradually (in order to avoid sudden tariff increase) and is capped in a way that the regulated return cannot increase by more than 1.5% of regulated revenues from the previous year after incorporating compensation for investments. At the moment Tauron not only loses on its RAB being lower than their true value but also on the inefficiencies in terms of operating costs being higher than those approved by ERO. In other words, around PLN 200 mn of operating costs of the distribution segment are not compensated for by the regulated revenue (17% in 2009). Regulated and actual operating expenses Tariff split (in brackets number of clients) 35% 30% G (3,614) 24% A (0.2) 27% 25% % % % 100 C (473) 17% 5% 0% B (7.7) 32% actual costs - regulated costs (lhs) % of actual costs (rhs) Source: Tauron s prospectus Source: Tauron s prospectus The revenues from the distribution segment remained rather flat in the years due to the regulated character of the business as well as a falling electricity demand (however, rebounding in 1Q 2010). The segment also remains the worstperforming in terms of EBIT margin oscillating around 2-6%. 13

14 As indicated in the valuation section below, we forecast the RAB to be fully revalued for Energia Pro and Enion in 5 and 7 years, respectively. 30.4TWh of electricity sold last year Supply and trading The conglomerate serves more than 4 mn end customers (both companies and households) and managed to sell 30.4 TWh of electricity making it one of the two largest electricity sellers in Poland, with a market share of about 29.4%. The supply and trading operations are predominantly run by two subsidiaries: Enion Energia and EnergiaPro Gigawat. Tauron is short electricity generation, thus its selling units have to purchase electricity from outside suppliers (which constituted 44.7% of total electricity sold last year). Electricity sales Q 2010 Revenues (PLN mn) 6, , , ,094.4 % yoy 44.9% 15.8% EBIT (PLN mn) EBIT margin 0.3% 0.9% 2.6% 2.7% EBITDA (PLN mn) EBITDA margin 0.3% 0.9% 2.7% 2.8% Number of clients (mn) Electricity sold to retail (TWh) Electricity purchased from outside (TWh) Source: Tauron s prospectus Most of the electricity is sold to the retail market (90%, 10% on the wholesale market), 77% thereof consists of business clients (471 ths) with the remainder being sold to households (3.6 mn clients). The Group is also short all the certificates of origin (green, yellow and red) and is obliged to either purchase them on the market or pay a substitution fee. In 2009, Tauron managed to cover 41.4% of mandatory green certificates from own generation, 28.3% of the red ones and was not entitled to any of the yellow certificates. The segment is the largest revenues contributor growing at a CAGR of 19% driven by electricity demand (however decreasing in 2009) and the price increase. Ambitious investment program to boost power capacities and mining operations Investment program Tauron Group is implementing an extensive investment program amounting to PLN 3.3 bn in the years , PLN 9.0 bn in the years and an impressive PLN 39.8 bn from 2013 to The program is intended to be preliminarily financed with debt, associated with cash generated from operations and potential funding obtained via a capital increase. Within the mining segment, Tauron plans to spend around PLN 2 bn in order to increase its annual hard coal extraction from 4.9 mn tons now to 7.5 mn tonnes by The aforementioned is to be achieved via construction of a new shaft in the Sobieski mine, deepening of the shaft in the Janina mine and purchase of Boleslaw Smialy mine (extracting 1.6 mn tons of coal per annum). Please note, however, that according to the agreement between Tauron and Kompania Weglowa, Boleslaw 14

15 Smialy mine is to be contributed in-kind by Kompania Weglowa in exchange for an issue of new shares of Tauron. Moreover, Tauron Group plans extensive investments within the power generation segment and intends to commence construction of 3 GW of capacities by The total budget on the segments for the years amounts to PLN 29.3 bn, PLN 24.2 bn thereof is to be spent on the erection of new capacities and PLN 5.1 bn on maintenance and modernization of the existing fleet. The company also aims to expand into the renewables energy sector, particularly based on wind, where commissioning of 440 MW of capacities is planned by Tauron estimates to spend PLN 1.1 bn in the years , and thereafter PLN 2.8 bn until The company aims to diversity into cleaner technologies including wind, biomass, CCGT, however its coal share in the fuel mix will only slightly decrease from 95% to 86%. Additionally, the management does not exclude a potential, future participation in nuclear energy projects. Tauron s fuel mix in 2009 Tauron s fuel mix in % 3% 2% 35% 51% 87% modern coal gas renewables old coal Source: Tauron 7% 7% modern coal gas renewables old coal Source: Tauron Planned investments in the distribution network total PLN 12.8 until 2020, PLN 3.1 bn thereof is to be spent within the next three years. The Group also plans investing PLN 0.8 bn in other operations (such as heat production and distribution). 15

16 Investment plans in the years (PLN bn) 100% % % 40% % 0% 2 capex mining generation renewables ditribution others Source: Tauron s prospectus Tauron has a very strong balance sheet facilitating the anticipated investments with its net debt/ebitda standing at 0.4. Assuming its investment program, we currently see no problem to increase its debt to 2.5x EBITDA. We also see no need to conduct a capital increase at the moment. However, our model shows a potential breach of the safe indebtedness levels in potentially leading to a necessary capital increase (the management, though, does not exclude to conduct the transaction earlier). Overemployed company with little scope to restructure soon Employment Tauron employs 28,750 people. Being a large state-owned company usually implies, however, overstaffing and difficulties with employment restructuring. 75% percent of all employees belong to trade unions, which historically have been strong in Poland. Additionally, there are social agreements with trade unions in place, providing long-term employment guarantees (from six to nine years). The restructuring could potentially be facilitated by the employment age structure in terms of age as almost 27% of all employees are over 50 years old, therefore reduction is possible via retirements. Tauron is the least efficient group in terms of EBITDA/Employee from the power peer group operating in the region (as indicated by the chart below). 16

17 EBITDA/Employee (2009 in EUR ths) Verbund Enel E.ON RWE CEZ EVN PGE Enea Tauron Source: Thomson Financials, Companies, Raiffeisen Centrobank Government to sell 53% of existing shares during the IPO IPO, Reverse split, shareholders, capital increase, state s privileges The State Treasury of Poland, being the dominant shareholder of Tauron (87.53%) is selling almost 7.4 mn shares, constituting 53% of the existing shares. All the shares are to be reverse-split 9:1 after the subscription period but before the shares are allocated to investors, thus increasing the nominal value of one share from PLN 1 to PLN 9. Furthermore, the selling shareholder is subject to a 180-day lockup on the remaining shares. Additionally, employees of PKE, Enion, Energia Pro and ESW are entitled to convert their shares in those subsidiaries into Tauron s shares owned by the State Treasury. Once the conversion of all employee shares be completed (the program lasts until August 2010), the employee shareholding participation will increase to 13.4% from 12.5% at the current state. Please note that there is no lockup on the employees shares, thus there is the risk of employee shares flooding the market after Tauron s first listing. Parallel to the IPO, two subsidiaries - Enion Zarzadzanie Aktywami and Energomix Service - are to merge with Tauron with an accompanying issue of mn shares (par value of PLN 1). Those shares will be received by the current partners of the aforementioned subsidiaries. Tauron also plans to exchange the State Treasury s stakes in PKE, Enion, EnergiaPro and ESW via a capital increase and an issue of up to 170 mn shares (par value of PLN 9) to take place after the August 13, 2010 (dilution of 10.7%). Tauron s ownership structure Shareholder Current status After IPO* mn shares capital increase* State Treasury 87.53% 33.00% 39.49% Employees 12.47% 15.34% 13.86% Share sold at IPO % 46.65% Source: Tauron, *assuming all employees convert to Tauron s shares 17

18 Despite the fact that the State Treasury will not be the majority shareholder should the IPO be successfully conducted, it will maintain the control over the company as other shareholders voting rights are capped at 10% as long as the State Treasury holds more than 25% of all shares % long-term dividend payout ratio Dividend policy Tauron s management aims at a dividend payout ratio of no less than 30% for the next three years, increasing to 40-50% afterwards. We remain sceptical considering high capex needs in the years to come. Our model indicates a possible breach of 2.5 Net Debt/EBITDA levels, assumed by the management to be safe. Thus, temporarily a potential dividend payout ratio decrease may happen. Financial outlook and planning model Planning assumptions Our planning model is based on the following assumptions: We build our detailed model until 2020 in order to fully reflect the impact of no free CO2 emission certificates allocation. Taking into account the decommission plans, increase in electricity demand, low import capacities and resulting reserve margin decline, we assume price convergence towards German prices within the next three years. There is an upside risk, however, that the prices exceed those of Germany once the demand increases faster and major capacity construction projects are delayed. There is also a downside risk related to planned interconnection to Nordpol, where the electricity prices are lower than those in Germany. Household electricity consumption is deemed to increase at a lower pace than industrials. We link the industrial electricity consumption to our industrial production forecast. However, we believe there are still inefficiencies in the economy, thus the electricity intensity is likely to decrease per unit of output. Household tariffs are expected to remain regulated for the next three years; afterwards they should increase at a higher pace. We do not incorporate the purchase of Boleslaw Smialy mine (output of 1.6 mn tons of hard coal), as in our opinion too few details have been revealed. We assume NAV neutrality of the acquisition for the moment. We incorporate a gradual increase in mining capacities to 5.4 mn tons in 2011 and 5.9 mn tons in We have modelled the RAB revaluation and according to our calculations it will take 5 years for Energia Pro s and 7 years for Enion s to fully incorporate the fair value of their asset base to distribution tariff calculations. We do not expect distribution tariffs to be liberalized in the future. We also assume the other components of the regulated tariff calculations to increase in line with our inflation projections and reckon with demand growth by 2.0% per annum to be assumed by ERO. Tauron has revealed its capex plans amounting to an impressive PLN 48.8 bn until We incorporate into our model projects indicated in the prospectus, including three joint ventures (total capacity 1.62 GW). For the joint ventures we assume equal participation of Tauron and the partners (KGHM, PGNiG, ZAK, respectively) in investment costs, revenues and operating costs. Our estimated total capex included in the model (without the JV partners share) stands at PLN 36.3 bn until As a result, the total capacity for Tauron Group will stand at 7.68 GW in Please note that the depreciation is deemed to 18

19 increase substantially due to the capex (once the new power plants are running). We also factor in a potential depreciation decrease once some of the old plants are decommissioned. We do not believe the company can increase its production from 2009 levels before new capacities are installed due to increasing maintenance and limited scope to increase capacities in a short-term. Our generation model after 2012 factors in a gradual decrease in free CO2 emission certificates amounting to 70% of its verified emissions of in 2013 falling to 0% of free certificates in We also factor in an increase of the certificate prices to EUR 25 per ton post Additionally, we assume the new capacities to be erected to be less carbon intensive as well as them being granted partially free CO2 emission certificates (just as with the rest of the fleet). We take into account the electricity sold generated from renewables and cogeneration in a percentage share as assumed by the regulator. We assume that the percentage will be kept constant beyond 2017 for the green certificates and beyond 2012 for the yellow and red ones. We do not yet incorporate the potential white certificates as too little is known. We also assume that the certificate prices will increase post-2010 in line with our inflation estimates. We do not fully factor in the planned cost savings announced by the management of a total of PLN 1 bn till However, despite the employment security agreements in place we assume a slight employment decrease via retirement and voluntary employment termination. We assume that Tauron will keep selling coal to external clients at a higher price (duet to its calorific value). Tauron also sells more electricity at the peak prices and we assume this proportion will be maintained. The business will also be affected by the decrease of LTC contracts compensation. We assume a substantial drop to PLN 140 mn in We do not incorporate the ongoing excise tax dispute (regarding an overpayment in the past amounting to PLN 901 mn) due to the related uncertainty. We are not assuming any changes to the minorities. Macro assumptions PLN/EUR PLN/USD GDP growth 2.7% 3.2% 4.1% 5.1% 5.5% 5.0% Inflation 2.7% 2.3% 2.2% 2.6% 2.4% 2.1% Industrial output 4.2% 5.7% 5.0% 3.0% 3.0% 3.0% CO2 price EUR/ton PLN baseload price PLN peakload price Source: Raiffeisen Centrobank estimates Main downside risks to our planning model: Slower than expected increase in electricity demand Longer electricity price conversion to European levels Electricity price to be below German ones due to import increased import from Nordpol Delays in power plant construction projects and costs overruns Faster than assumed decrease to zero free CO2 emission certificates after 2013 No free CO2 certificates allocation to new projects 19

20 Revaluation of Regulated Assets Based to take longer than the modelled 5 years for Energia Pro and 7 years for Enion Postponed deregulation of the household tariffs High maintenance costs of existing fleet Increase in financing costs resulting from high leverage and risk of losing BBB rating. Higher CO2 emission certificate prices Main upside risks to our planning model: Accelerated electricity price convergence or even Polish prices exceeding international ones as a result of squeeze on the reserve margin and limited interconnectedness. Higher free CO2 emission certificates allocation post 2013 Implementation of efficiency programs resulting in employment restructuring Higher than assumed increase in regulated household tariffs. Financial outlook Tauron s planning model PLN mn e 2011e 2012e 2013e 2014e 2015e Mining revenue 1,167 1,207 1,442 1,483 1,388 1,421 1,451 % yoy 3% 19% 3% -6% 2% 2% Production revenue 5,462 4,787 5,309 5,671 5,886 5,812 6,514 % yoy -12% 11% 7% 4% -1% 12% Distribution revenue 4,085 4,698 5,039 5,369 5,782 6,164 6,510 % yoy 15% 7% 7% 7% 6% 5% Sales revenue 11,522 12,124 13,469 14,544 15,424 16,186 16,923 % yoy 5% 11% 8% 6% 5% 5% Other revenue % yoy 3% 2% 2% 3% 2% 2% Exclusion 9,121 9,554 10,604 11,372 11,966 12,277 13,275 % yoy 1% 10% 7% 5% 5% 5% Total revenue 13,634 13,795 15,200 16,279 17,085 17,891 18,720 % yoy 1% 10% 7% 5% 5% 5% COGS 11,522 11,919 12,848 13,427 13,948 14,937 15,656 % yoy 3% 8% 5% 4% 7% 5% Gross profit 2,112 1,875 2,352 2,853 3,137 2,954 3,065 % yoy -11% 25% 21% 10% -6% 4% Gross profit margin 15.5% 13.6% 15.5% 17.5% 18.4% 16.5% 16.4% Sales, Admin and OP % yoy -2% 4% -1% 2% 2% 8% EBIT 1,260 1,038 1,484 1,990 2,261 2,062 2,100 % yoy -18% 43% 34% 14% -9% 2% EBIT margin 9.2% 7.5% 9.8% 12.2% 13.2% 11.5% 11.2% Depreciation 1,321 1,365 1,409 1,467 1,523 1,547 1,681 % yoy 3% 3% 4% 4% 2% 9% EBITDA 2,581 2,402 2,893 3,457 3,784 3,609 3,781 % yoy -7% 20% 19% 9% -5% 5% EBITDA margin 18.9% 17.4% 19.0% 21.2% 22.1% 20.2% 20.2% CAPEX 1,440 1,359 1,836 2,581 4,336 6,492 5,029 % yoy -6% 35% 41% 68% 50% -23% Source: Raiffeisen Centrobank estimates Tauron will generate higher revenues from its mining segment due to its increased output (in our planning model assumed to increase from current 4.9 mn tons to 5.9 mn tons in 2012). In addition to that, rebounding global growth with an associated increase in coal demand will move the coal prices north. 20

21 Revenues of the production segment are deemed to decrease this year based on significantly lower revenues from the long-term contract termination. However, we see a rather steep increase from 2011 based on rebounding electricity prices, higher generation and sales of green and red certificates and predominantly (from 2015 on) the increase in electricity production capacities. Electricity Production (TWh) of the Group Short power position to hold but lower 40 30% 20 25% 35 20% % 10% % 20 0% 5-5% % electricity sales less production % yo y (rhs) production TWh (lhs) 18,70 Source: Raiffeisen Centrobank Source: Raiffeisen Centrobank Much of the distribution revenue increase will come from the revaluation of the Regulated Asset Base from PLN 3,641 mn to PLN 9,836 mn. Our model indicated the RAB to be fully incorporated in the regulated revenues in 5 and 7 years for Energia Pro and Enion, respectively. We have also assumed a rather conservative increase in the electricity demand incorporated by ERO in tariff calculations. Should it be higher, a further revenue increase in likely to materialize. The sales revenues will increase with CAGR of 5.6% until 2015 supported by demand and electricity price increases particularly post-2010, when accelerated (5.7% in 2011 from 4.2% in 2009) industrial production will translate into higher demand and higher electricity prices also supported by the decreasing reserve margin on the national scale. We believe that prices will quickly converge to the German levels and are even likely to surpass them once the decommissioning takes place and new power projects are delayed. All in all, we do see a constant progressive increase in Tauron s revenues in our model particularly on the basis of increasing electricity demand with an associated price rise. We also do not believe, despite the heavy capex plan, that Tauron will eliminate its short electricity production position. On the margins front, despite an expected decrease thereof in 2010, we anticipate the margins to start increasing from 2011 with their peak in 2013 and then we see them gradually decreasing once the company has to carry the burden of increasing CO2 emission costs and depreciation from new projects start being charged against profits. Please note that Tauron is a heavily geared company from the operating point of view, thus its profitability reacts very dynamically to changes in the top line. 21

22 We also see Tauron s net results to be significantly affected with its increasing financial costs post-2013, associated with our assumption of heavy debt financing of the coming power projects. We arrive at an overall valuation of PLN per share Valuation We base our valuation on two approaches, namely a DCF model and peer group multiples. Our detailed DCF valuation (until 2020 to fully incorporate increasing CO2 emission costs) indicates a value of PLN 0.76 per share, whereas our peer multiples comparison gives us a valuation ranging in between PLN After narrowing it down, however via a more detailed look at the closest peers to Tauron, we believe the fair value is between PLN and is rather geared towards the lower band due to high inefficiencies and short generation position. All in all, having combined those two approaches, we see Tauron s shares worth from PLN 0.62 to PLN DCF yields PLN 0.76 per share DCF model Out DCF model is based on the following assumption: We assume the EBITDA margin post-2020 to be at the 2020 level. We would like to point out, however, that an improvement is possible when all the old fleet is replaced with a new, less carbon-intensive one. We do not incorporate this factor due to a very high uncertainty regarding timing and costs of doing so. For our terminal value calculation, we assume a risk free rate of 4.8%, equity risk premium of 5.0% and beta of 0.9. Terminal value stands at 2%, in line with our long-term inflation estimation. We also assume that the company pays on its debt160 bps above the long-term government bonds. Terminal value capex is assumed to exceed depreciation to support the assumed 2% demand increase and replacement of the old generation fleet. We take into account Tauron s mining decommissioning provision in equity value calculations. Taking the aforementioned into account, our detailed DCF model indicates a value per share of PLN 0.76 (PLN 6.84 after the reverse-split). 22

23 Peer group valuation based on European peers gives a wide range of PLN per share Peer Group Valuation We have looked at a number of peers to Tauron and their valuation multiples of EV/EBITDA, P/E as well as P/BV based on earnings estimates for 2010 and We prefer to use the median to the consensus estimates, however please be aware that implied valuations based on the average consensus estimates do not differ significantly. The multiples give a valuation range of PLN 0.40 to PLN Valuation multiples EV/EBITDA P/E P/BV 2010e 2011e 2010e 2011e 2010e 2011e PGE Enea CEZ RWE PPC Enel E.ON Endesa Median Average Implied value per share Source: Bloomberg, Raiffeisen Centrobank estimates Comparison to the closest peers gives valuation bounds of PLN The implied share price ranges from as little as PLN 0.40 to PLN To make the valuation range narrower we, however, imply a second view. Namely, we believe Tauron should not be valued higher than PGE, but on the other hand we think the floor for the valuation is the one of Enea s as those two operate on the very same market as Tauron. We believe, however, that Tauron should be valued at a discount to PGE based on a) PGE s younger fleet, b) PGE s own lignite mines providing a cheaper power production fuel, c) a long position on power production d) 35-36% EBITDA margin compared to 17-19% for Tauron. Based on a low efficiency and margins comparable to Enea, we gear Tauron s towards Enea s multiples; however, believe a premium is justified with Tauron having its own mines and thus lower prices and higher price stability. EV/EBITDA vs. EBITDA margin EV/EBITDA 2010e EV/EBITDA 2011e EBITDA margin 2010e EBITDA margin 2011e PGE % 35.9% Enea % 20.8% Tauron 17.4% 18.9% Source: Bloomberg, Raiffeisen Centrobank estimates We prefer the EV/EBITDA multiple so that the picture is not distorted with different depreciation levels. Taking the above into consideration, we find Tauron s share price to be between PLN 0.62 and PLN We are inclined to value Tauron closer to Enea s implied PLN per share rather than PGE s implied PLN per share. Tauron s per share value based on PGE and Enea PGE 2010e PGE 2011e Enea 2010e Enea 2011e Average PLN/share Source: Bloomberg, Raiffeisen Centrobank estimates 23

24 DCF valuation FCF projection (PLN mn) 2010e 2011e 2012e 2013e 2014e 2015e TV CF NOPLAT , , , , , ,056.1 Adj. NOPLAT , , , , , ,056.1 Depreciation of PPE & intangibles 1, , , , , , ,298.2 Gross investment in PPE & intangibles -1, , , , , , ,533.2 Change in working capital NWC/Sales -4.7% -4.8% -4.8% -4.8% -4.9% -4.9% -4.9% Change in LT provisions other than tax Net acquisitions & disposals Free cash flow to firm , , ,844.3 Adj. free cash flow to firm , , ,844.3 EV DCF, mid-year assumption 13, ,795.8 MV of non-operating assets MV of net debt MV of minorities 2, ,367.7 Adjustments to EV Fair value of equity 10, ,690.6 Shares outstanding (mn) 13, ,986.3 Price target per share per 01/01 (in PLN) Value drivers 2010e 2011e 2012e 2013e 2014e 2015e TV CF Consolidated sales yoy 1.2% 10.2% 7.1% 5.0% 4.7% 4.6% 2.0% EBITDA margin 17.4% 19.0% 21.2% 22.1% 20.2% 20.2% 20.5% Rate of taxes paid -19.0% -19.0% -19.0% -19.0% -19.0% -19.0% -19.0% Working capital/sales -4.7% -4.8% -4.8% -4.8% -4.9% -4.9% -4.9% Capex/depreciation 99.6% 130.3% 176.0% 284.7% 419.7% 299.2% 110.2% Free cash flow margin 6.4% 5.8% 3.6% -5.3% -17.9% -8.4% 7.8% WACC 2010e 2011e 2012e 2013e 2014e 2015e TV CF Target capital structure (at MV) 93.5% 98.8% 102.4% 102.2% 89.5% 68.0% 70.0% Debt/equity ratio (at MV) 7.0% 1.2% -2.4% -2.2% 11.8% 47.0% 42.9% Risk free rate (local) 3.6% 4.7% 5.2% 6.2% 6.2% 5.7% 4.8% Equity market premium 5.5% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% Levered beta Cost of equity 8.1% 8.7% 9.3% 10.3% 10.3% 10.2% 9.3% Cost of debt 4.1% 5.4% 6.3% 7.5% 7.6% 7.2% 6.4% Tax rate -19.0% -19.0% -19.0% -19.0% -19.0% -19.0% -19.0% WACC 7.8% 8.6% 9.4% 10.3% 9.8% 8.8% 8.1% Sensitivity analysis Growth sensitivity (PLN) Terminal growth rate WACC 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 6.6% % % % % % % Margin sensitivity (PLN) FCF margin TV WACC 6.3% 6.8% 7.3% 7.8% 8.3% 8.8% 9.3% 6.6% % % % % % % Source: Raiffeisen Centrobank estimates 24

25 Financial statements (IFRS) Income statement (PLN mn) 12/ / / /2010e 12/2011e 12/2012e Consolidated sales 12, , , , , ,279.2 Cost of sales -11, , , , , ,426.6 Gross profit , , , , ,852.6 Other operating income Selling expenses Administrative expenses Other operating expenses EBITDA 1, , , , , ,456.5 Depreciation of PPE and intangibles -1, , , , , ,466.6 EBITA , , , ,989.9 Amortisation, impairment of goodwill EBIT , , , ,989.9 Investment income Net interest income Other financial result Financial result Earnings before taxes , , ,943.9 Taxes on income Extraordinary result Net profit before minorities , ,574.6 Minority interests Net profit after minorities ,283.3 Balance sheet (PLN mn) 12/ / / /2010e 12/2011e 12/2012e Current assets 2, , , , , ,439.5 Liquid funds 1, , , , , ,323.1 Receivables 1, , , , , ,301.9 Inventories Other assets Fixed assets 17, , , , , ,859.0 Property, plant & equipment 16, , , , , ,795.9 Intangible assets Goodwill Financial assets Deferred tax assets Total assets 20, , , , , ,455.4 Current liabilities 2, , , , , ,215.9 Long-term liabilities 2, , , , , ,509.3 Shareholders' equity 11, , , , , ,218.8 Minority interests 2, , , , , ,367.7 Deferred tax liabilities 1, , , , ,143.8 Total liabilities 20, , , , , ,455.4 Cash flow statement (PLN mn) 12/ / / /2010e 12/2011e 12/2012e Earnings before taxes , , ,943.9 Taxes paid Amortisation and depreciation 1, , , , , ,466.6 Other non-cash items Cash flow from result 1, , , , , ,075.8 Change in working capital Operating cash flow 1, , , , , ,135.8 Capex PPE and intangible assets -1, , , , , ,581.2 Acquisitions Disposal of fixed assets (total) Other items (investments) Investing cash flow -1, , , , , ,581.2 Dividend payments Other changes in equity Change in interest-bearing financial assets Other items Change in NIBD -1, Source: Tauron, Raiffeisen Centrobank estimates 25

26 Financial ratios Changes yoy 12/ / / /2010e 12/2011e 12/2012e Consolidated sales yoy n.a. 1.5% 9.5% 1.2% 10.2% 7.1% EBITDA yoy % 16.7% 59.7% -6.9% 20.4% 19.5% EBITA yoy % 85.7% 263.0% -17.6% 43.0% 34.1% EBIT yoy % 85.7% 263.0% -17.6% 43.0% 34.1% EBT yoy % 67.3% 365.5% -15.1% 44.9% 35.7% Net profit after minorities yoy % -14.8% 459.7% -10.9% 44.9% 35.7% Margins 12/ / / /2010e 12/2011e 12/2012e Gross margin 6.4% 9.5% 15.5% 13.6% 15.5% 17.5% EBITDA margin 11.3% 13.0% 18.9% 17.4% 19.0% 21.2% EBITA margin 1.5% 2.8% 9.2% 7.5% 9.8% 12.2% EBIT margin 1.5% 2.8% 9.2% 7.5% 9.8% 12.2% EBT margin 1.2% 2.0% 8.5% 7.2% 9.4% 11.9% Net margin 1.3% 1.1% 5.4% 4.7% 6.2% 7.9% Financing (x) 12/ / / /2010e 12/2011e 12/2012e Interest cover Internal financing ratio Net gearing 7.7% 9.1% 6.0% 1.0% -1.8% -1.6% Quick ratio Fixed assets cover Capex / depreciation Equity ratio 65.2% 64.1% 64.0% 65.3% 66.5% 67.8% Profitability 12/ / / /2010e 12/2011e 12/2012e Return on assets 3.3% 1.6% 4.9% 3.8% 5.3% 6.8% Return on equity % 1.2% 6.4% 5.4% 7.4% 9.4% Return on capital employed % 2.2% 6.7% 5.3% 7.3% 9.5% Per share data (PLN) 12/ / / /2010e 12/2011e 12/2012e Weighted avg. no. of shares (mn) 13, , , , , ,986.3 EPS reported EPS pre-goodwill Adjusted EPS diluted Operating cash flow per share Book value per share Dividend per share Payout ratio 0.0% 0.0% 0.0% 30.0% 30.0% 30.0% 26

27 Fact Sheet Company description Tauron Group is one of the largest electricity utility in Poland, leading in terms of distribution of electricity and being the second largest electricity producer. Tauron Group is fully vertically integrated and operates in the areas of mining, generation, distribution and supply and trading. Its mines provide the group with 30% of needed fuel used in the current 5.6 GW of capacities. The company serves 4.1mn customers and sold 30.4 TWh of electricity in Shareholder structure 12 % Free float State Treasury 88% Strengths/Opportunities Operating on the one of the most dynamically developping markets in Europe Own fuel sources, currently covering 30% of total needs Operations predominantly in southern Poland being the most industrialized Ambitious investment plan increasing the efficiency and own generation capacities The largest power distributor in Poland Upcoming deregulation of household tariffs and increase in power prices Weaknesses/Threats Old fleet with high carbon intensity and low efficiency Environmental issues increasing the costs of CO2 emissions High employment with the lowest efficiency among peers on EBITDA/Employee basis State-owned enterprise Increase in financial costs to finance capex Delays in projects launching Income statement 12/ /2010e 12/2011e 12/2012e Per share data 12/ /2010e 12/2011e 12/2012e (PLN mn) (PLN) Consolidated sales 13, , , ,279.2 EPS pre-goodwill EBITDA 2, , , ,456.5 Adj. EPS diluted EBIT 1, , , ,989.9 Operating cash flow EBT 1, , ,943.9 Book value Net profit bef. min , ,574.6 Dividend Net profit after min ,283.3 Payout ratio 0.0% 30.0% 30.0% 30.0% Balance sheet Cash flow statement Total assets 22, , , ,455.4 Operating cash flow 1, , , ,135.8 Shareholders' equity 11, , , ,218.8 Investing cash flow -1, , , ,581.2 NIBD Change NIBD Source: Tauron, Raiffeisen Centrobank estimates 27

28 Acknowledgements 28