Telecommunications. ISSN X Warsaw,

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1 ANALYTICAL REPORT Telecommunications ISSN X Warsaw, With Market Liberalisation Looming in the Background 16 PLN units ' TPSA's introduction of calculating the actual times of local calls will have less of a negative influence on the company's results than we initially assumed, which induces us to adjust forecasts of the operator's sales revenues for 2003 from PLN 18.2 bn to PLN 18.6 bn. Moreover, we are raising the forecast of operating profit 3.3% and net profit 12%. We expect the consolidated EBITDA margin to grow to 42.4%, among others due to the company's restructuring and an improvement in the operating results of Centertel, benefiting from the effects of scale of conducted activity. We are maintaining our accumulate recommendation with a target price of PLN 16.2 (DCF). Based on the comparative method, the implied value of a share amounts to PLN 14.1, which gives 11% growth potential in the short term. The Regulator continues to support the dominant position of TPSA on the market of fixed line telephony (95% of international connections, 99% of outgoing connections in international traffic), the consequences of which are limited pressure to reduce connection prices as well as a loss of telecom traffic to competitors. We believe that, beginning in mid-2004, TPSA will begin to feel the effects of the competition's activity, resulting from, among others, the introduction of the amended telecommunications act. However, in our opinion, an overly aggressive scenario involving a drop in prices and rapid loss in TPSA's market share, which would be possible only with a fundamental change in the position of the Regulator, is factored into the company's current share price. As long as the State Treasury remains a principal shareholder of TPSA, we do not expect such a change. Moreover, as the example of long distance and international connections shows, passing a law is not enough to initiate real competition. We believe that, in this environment, the Executive Board of TPSA is taking good advantage of the time offered by the Regulator for company restructuring. In the course of the last two months TPSA's shares have under performed relative to the telecommunications sector, which is a consequence of a risk involving a supply of shares from the State Treasury and zloty depreciation, which had a negative influence on the company's 1Q results. Moreover, TPSA shares, characterised by the largest exposure on the Polish market, were sold by some foreign investors due to the political risk. While the two latter elements should no longer influence price, the risk of a supply of shares still exists Recommendation ACCUMULATION Price 12,70 Target price 16,20 Basic Data No. of shares (units mn) Free float 34,6% Market cap (PLN mn) Shareholder Structure France Telecom 33,93% State Treasury/Kom. Węglowa 17,92% Kulczyk Holding 13,57% GDR-holders 9,99% Others 24,59% Analyst Michał Marczak tel (22) fax (22) michal.marczak@breinwest.com.pl Dom Inwestycyjny BRE Banku S.A. ul. Wspólna 47/ Warszawa, skr. poczt Sales EBIT Net profit Cash earn. Price EPS P/E BVPS P/BV CEPS P/CE EV/EBDIT (PLN mn) (PLN mn) (PLN mn) (PLN mn) (PLN) (PLN) (PLN) (PLN) ,7 1,0 13,4 8 1,6 3,1 4,0 4, ,7 0,5 25,9 8 1,5 2,8 4,5 5, ,7 0,6 21,2 9 1,4 3,7 3,5 4,6 2003F ,7 0,7 18,1 10 1,3 4,1 3,1 4,1 2004F ,7 1,0 12,6 11 1,2 4,3 3,0 3,8 NOTE: F - BRE Bank Securities forecast BRE Bank Securities does not rule out offering brokerage services to an issuer of securities being the subject of a recommendation. Information concerning a conflict of interest arising in connection with issuing a recommendation (should such a conflict exist) is located on the final page of this report.

2 TPSA shares against the sector index (prices in EUR) BETELES TPSA relative Source: BRE Bank Securities based on Bloomberg data TPSA against Matav and SPT (prices in EUR) 3,80 3,60 3,40 3,20 3,00 2,80 TPSA Matav 2, Source: BRE Bank Securities based on Bloomberg data Index of telecom companies against broad index DJEURO BETELES Source: BRE Bank Securities based on Bloomberg data 1

3 Valuation We prepared a valuation of the company s shares applying the DCF (PLN 16.2 PLN) and comparative (PLN 14.1 PLN) methods. We are adopting the valuation obtained from the DCF model as the target price. In the short term, the company represents a 12% growth potential resulting from undervaluation in relation to companies operating in EMEA countries. Comparative method EV/EBITDA EV/Revenues EBITDA margin EMEA SPT % 47% 48% Hellenic Telekom % 39% 39% Matav % 39% 38% Portugal Telecom % 40% 40% TPSA % 42% 43% Average Leaders in EU BT % 31% 31% DT % 31% 32% FT % 30% 32% KPN % 35% 36% TDC % 27% 28% TI % 45% 46% TELEFONICA % 41% 41% AVERAGE Implied valuation of TPSA on the basis of average for EMEA 14.1 Matav, SPT 14.6 Justified premium / discount in valuation Leaders in EU % Source: Bloomberg, BRE Bank Securities For the valuation applying the comparative method we adopted the average EV/EBITDA ratio in 2003 for the incumbents operating on EMEA markets. In addition, we adopted a 10% discount in the valuation of TPSA, which is in our opinion the company s lower net profitability, higher level of indebtedness as well as smaller share in the local market of mobile telephony justify. Based on these assumptions, we estimate the value of one TPSA share at PLN 14.1, which reflects 12% upside potential at the current price level. DCF model Detailed assumptions concerning the DCF model are presented in the table below. Based on these assumptions, we estimate the value of one TPSA share between PLN 15.6 and PLN The range in the valuation results from the different method of calculating terminal value (TV). In the first case, it is designated at 2.5% based on FCF growth to perpetuity. In the second case, we assumed a EBITDA 2010 multiple equal to the prospective EV/EBITDA multiple for the sector (companies presented in the comparative valuation leading operators) of 5.7. The final valuation is designated by the average of the range equal to PLN

4 DCF model (PLN mn) 2003F 2004F 2005F 2006F 2007F 2008F 2009F 2010F Fixed-line telephony Subscription and installation Telephone connections Interconnect Link leasing and data transmission Others Mobile telephony Other companies Consolidation exclusions TOTAL REVENUES change 3.3% 2.1% -0.4% 1.7% 2.7% 3.1% 2.8% 2.7% Wages and salaries Interconnect Outside services Other costs excluding amortisation TOTAL OPERATING COSTS change 1.8% 4.5% 1.0% 2.6% 3.6% 4.0% 3.7% 3.6% Result on other operating activity EBITDA change 10.2% 1.7% -2.2% 0.5% 1.5% 1.8% 1.5% 1.4% margin 42.4% 42.3% 41.5% 41.0% 40.5% 40.0% 39.5% 39.0% Amortisation EBIT change 10.4% 8.2% -1.0% 4.6% 4.4% 4.4% 0.9% 0.5% margin 17.1% 18.1% 18.0% 18.5% 18.8% 19.0% 18.7% 18.3% Amortisation NOPLAT CAPEX CWC FCF DFCF WACC 9.5% 9.5% 9.5% 9.5% 9.5% 9.5% 9.5% 9.5% Forecast TV Perpetuity gr / EBITDA x 2.5% 5.9 PV TV DFCF Net debt Valuation Valuation per share Forecast TV Beta Tax rate 27% 22% Risk premium 5.5% 5.0% Risk free rate 6.5% 5.0% Cost of debt (after taxes) 5.8% 4.7% Debt / Equity 50% 40.0% WACC 9.5% 8.2% 3

5 Risk factors Supply of shares from the State Treasury remains a risk factor The State Treasury officially confirmed that it had transferred mn shares of TPSA, representing 3.13% of the company s capital, to the company Kompania Węglowa. The agreement concluded between the parties limits the possibility of Kompania to sell the shares without the agreement of the State Treasury. These shares currently constitute the collateral for a bank loan. Considering the catastrophic financial situation of Kompania, there is a risk that an appreciation in the price of TPSA s shares will be used as an opportunity to sell them and pay off company debts. For KW, this means a savings in the amount of paid interest as well as the fact that the company would have approximately PLN 500 mn in cash at its disposal and not, as at present, only PLN 250 mn (the amount of an extended loan equal to half of the value of the TPSA shares). KW s problems with financial liquidity could become a factor accelerating a transaction. In our opinion, the State Treasury s control over a transaction provides a guarantee that a supply of shares will not make it directly to the market. However, there is also a likelihood of accelerated book-building and an offer being directed to selected investors, as occurred in the case of shares held by BGŻ and BGK. The market should be prepared for such an eventuality even before the end of the year. Together with an improvement of the situation on the Warsaw Stock Exchange (WSE), the likelihood of such a scenario increases. According to information provided by TPSA, it results that France Telecom possesses a purchase option for 10% of the operator s shares in a public offering that could be conducted at the turn of the year. Should the offer go forward, other investors could assume a maximum of 111 mn shares of the company (including shares sold by KW, at current prices, the value of the transaction amounts to PLN 1.3 bn/usd 330 mn), which would finally remove the State Treasury as a shareholder and thereby eliminate a significant risk factor. Expected changes in shareholder structure of TPSA in the next two years (current prices, excluding KH option) current situation change final situation shares* holdings KW offering ST offering** KH option shares* PLN mn shares* PLN mn shares* PLN mn shares* holdings France Telecom (FT) % % State Treasury (ST) % % Kulczyk Holding (KH) % % Komp. Węglowa (KW) % % Others % % * mn, ** in accordance with the option, FT assumes 10% of TPSA s shares Source: BRE Bank Securities In accordance with the agreement concluded between Kulczyk Holding and France Telecom, from October 2003 the Polish shareholder could sell (put option) its entire stake to the French company, at a per unit price equal to the purchase price of the shares increased by the value of money over time and less dividends. According to FT, this amount is currently EUR 1.9 bn. In accordance with the possessed call option, the participation of FT in the public offering means the necessity of designating a subsequent EUR 400 mn (PLN 12 per share). Considering the current financial situation of FT and the assumed strategy of debt reduction as its key element, the realisation of the presented scenario (participation of FT in ST offering and purchase of shares from KH) is by no means certain. The exit of the State Treasury from the company s shareholders structure could also mean that the Regulatory Office of the Telecommunications Industry and Post Office (URTiP) will cease protecting TPSA s market position, which will translate into the company s revenues declining and operating results worsening. The potential influence of such a scenario on its valuation is presented below. 4

6 For TPSA, liberalisation of the market means: the loss of telecommunications traffic to the competition a drop in connection prices a growth in revenues from interconnect a growth in telecom traffic for the entire market It is currently difficult to predict how quickly real liberalisation of the telecommunications market will occur (i.e., how long TPSA will maintain its quasi-monopolistic position). Activities to date of bodies influencing the structure of the market show that the market will not change significantly in the next year, although information will reach the market from time to time about changes in regulations unfavourable for TPSA and about increasingly more aggressive activities of the competition. According to our forecasts, TPSA will begin to lose market share in a more significant way beginning in mid In analysing TPSA s future market position and revenues generated from core activity we most frequently cite the example of telecom markets in other European countries, where this process began earlier and proceeded more rapidly. Based on comparisons, in the next 3-4 years TPSA should lose approximately 30-40% of the market of voice services, mainly in long distance and international connections. These connections are still characterised by high margins that will shrink, together with the appearance of competition and a drop in prices. Share of British Telecom in individual segments of the voice services market Drop in prices of connections in Great Britain 90% 80% 70% 60% 50% GBpp/min 40% 10 30% 20% Local ILD DLD F2M Local DLD ILD F2M Source: BRE Bank Securities based on Oftel data The charts above show the influence of market liberalisation on the position of the national operator and on prices of connections based on the example of the most open market in Europe the market in Great Britain. It should be stressed that the process of its liberalisation began back in 1992, which means that the presented structure of the market was formed over a 10-year period. In , average prices of connections to mobile telephones (F2M) as well as long distance and international connections in Great Britain fell 38%, 34% and 46% respectively. The price of local connections (the weakest competition) fell to a much smaller degree, only 9%. During this period BT systematically lost market share, which in the segment of international connections, fell to only 30%. The size of the long distance market in Great Britain is so attractive that such operators as Worldcom and Viatel appeared on it. However, the dynamic growth in traffic was accompanied by a decline in prices of connections. In the discussed period, the growth in traffic amounted to 21% and 39% for long distance and international connections respectively. It should be stressed that this growth occurred despite a rapid increase in the number of mobile telephony subscribers (+37 million in the discussed period), which partially consumes fixed line traffic. As results from the presented data, mobile telephony 5

7 influenced a decline in traffic only in local connections (20%). Despite this, considering the dynamic growth in volumes in F2M connections as well as the price flexibility of the long distance market, as a whole the market grew 5.6% in the discussed period. Considering the decline in connection prices in all segments, in terms of value the market shrank 2%. Telecommunications traffic in the networks of fixed line telephony operators in Great Britain Source: Oftel (min. bn) /1998 Local % DLD % ILD % F2M % Telecommunications traffic in the networks of fixed line telephony operators in Great Britain per subscriber Source: Oftel min./month /1998 Local % DLD % ILD % F2M % The presented trends should also be reflected in Polish realities, although the macroeconomic situation will be a barrier to a growth in volumes in the short term. Together with an acceleration in GDP growth, telecom traffic in individual market segments should grow. We believe that, in Polish conditions, a growth in volumes is still possible due both to a growth in the number of subscribers and a growth in traffic calculated per subscriber,. In the second case, the table below presents the importance of differences in the volume of traffic in individual types of connections calculated for the statistical PSTN subscriber. Telecommunications traffic in the networks of TPSA, Deutsche Telekom and on the British market in 2002 TPSA Deutsche Telekom Great Britain DT/TPSA GB/TPSA Telecom traffic (min. bn) Local DLD ILD F2M PSTN subscribers Telecom traffic (min. per subscriber, per month) Local % 28% DLD % 429% ILD % 564% F2M % 136% Source: Data of operators 6

8 The lower level of telecom traffic calculated per subscriber in the TPSA network is due to, among others, the relatively (in relation to the purchasing power of the population) and nominally higher prices of the Polish operator, even in relation to the British market. Currently, the nominal level of prices corresponds to prices offered by BT in 1998 (in nominal terms). Comparison of the effective price per minute of connection in the TPSA network and the average level in Great Britain PLN/min. TPSA GB TPSA2006F* Local DLD ILD F2M * BRE Bank Securities forecast Source: BRE Bank Securities based on Oftel data BT is losing share in the market of fixed line connections despite the fact that it continues to possess approximately 90% of subscribers (similar to the case of TPSA in Poland). This is occurring on the basis of pre-selecting the operator, which formally is also possible in Poland in long distance and international connections (also in local and F2M connections when the new telecommunications act goes into effect). In this way, without making huge investments, alternative operators obtain access to the client and are able to acquire market share from the monopolist relatively quickly. On the other hand, a portion of the lost revenues returns to BT in the form of interconnect. Moreover, the decline in prices of BT connections is partly compensated by an increase in the monthly subscription fee. BT interconnect revenues from fixed line telephony operators Source: Oftel Alternative valuation of TPSA A faster liberalisation of the telecom market than we assumed in our base model will have a negative influence on the valuation of the company. A scenario assuming that in the course of the next 3.5 years TPSA will lose more of the market and prices of connections will fall faster than those assumed in the base scenario is presented below. 7

9 Valuation of TPSA based on DCF model in the base and pessimistic scenarios Source: BRE Bank Securities pessimistic scenario base scenario Market share (connections) Local 75% 83% DLD 66% 73% ILD 67% 74% F2M 71% 79% Change in prices 2006/2002 Local -19% -13% DLD -60% -57% ILD -73% -63% F2M -70% -59% EBITDA margin 38.0% 41.0% Valuation (DCF)

10 Fixed line telephony The decline in telecom traffic in the TPSA network, lower prices of connections and lower revenues from radio telecommunications and interconnect are the main reasons for the PLN 600 mn decline in company revenues in 2002 in the segment of fixed line telephony, in relation to revenues noted in Breakdown of TPSA revenues Source: TPSA change % Fixed line telephony services % Interconnect % Phone cards and tokens % Link leasing % Radio telecommunications % Data transmission % Others % Total % The structure of revenues from fixed line telephony will change together with the introduction of new subscriber rates for voice services as well as the growing demand for TPSA s offer connected with access to the Internet through ISDN, SDI and ADSL. Lower income from telephone connections are compensated with higher revenues from subscription. The share of subscriptions in revenues from fixed line telephony (according to International Accounting Standards) grew from 29% in 2001 to 31% in This trend will increase in subsequent years, among others, due to the development of Internet access through Neostrada. Assuming that TPSA decides to reduce the monthly fee to PLN 150 for an ADSL link and the company sells 270 thous. subscriptions (planned this year by the Executive Board), quarterly revenues will increase to PLN 122 mn. This will reduce the negative influence of falling revenues from voice services. Falling revenues from interconnect are due to rate reductions in mobile telephony traffic as well as the decline in incoming telecom traffic to Poland, which has been largely (approximately 25%) taken over by VIOP. The fact that independent fixed line operators created direct contact points with mobile networks also has a large significance. We expect a further deepening of the downward trend this year. The degree to which TPSA will lose revenues from voice services largely depends on the position of the Regulator relative to the company. Current regulations in the telecommunications act allow the possibility of TPSA not permitting competition on the market of long-distance, international as well as local and F2M connections. (The new act permits competition in the mentioned areas of voice services). The continuing restraint of the Regulatory Office of the Telecommunications Industry and Post Office in exerting an influence on TPSA, mainly in regard to including the bills of independent operators on TPSA s invoices, allows the company to compensate for lower revenues from voice services with income from mobile telephony and, in the future, from broadband access to the Internet. In our opinion, the company will not experience a sudden drop in revenues that would significantly reduce the EBITDA result. It should also be kept in mind that the opening of the market of voice services does not mean a total loss in revenues for TPSA, as approximately 1/3 will return to the company in the form of interconnect (TPSA is the owner of access to the subscriber). 9

11 Subscribers In 2002 TPSA added an additional 342 thous. subscribers, reaching a total of mn. The growth is largely due to an increase in the number of clients using ISDN services as well as broadband access to the Internet (SDI, ADSL). In the segment of voice services, despite the operator obtaining approximately 200 thous. new subscribers based on NMT technology, their total number declined 15 thous., primarily due to the macroeconomic situation in the country as well as to competition from mobile telephony and alternative operators (mainly Telefonia Lokalna and, to a smaller degree, Netia in the segment of business clients). Fixed line telephony subscribers 11,5 mn 11,0 10,5 10,0 9,5 IVQ'01 IIQ'02 IVQ'02 IIQ'03P IVQ'03P Standard SDI ADSL ISDN Source: BRE Bank Securities, TPSA In 2003 we expect the high dynamic of ISDN line connections to be maintained. Their share in the total number of links will grow from 6.4% at the end of 2002 to 10.1% at the end of this year and to 13.1% in As in 2002 this segment will be the main factor driving the growth in the number of subscribers. In the case of standard lines, we expect a further decline in their number, although we assume that the negative trend will gradually slow down in the second half of the year, as a result of: an improvement in the macroeconomic situation less competitive pressure from Telefonia Lokalna, which no longer has the financial funds for further expansion and pilfering TPSA clients demand stimulation due to the ADSL offer (anyone wanting to use Neostrada must be a subscriber of voice services). The company presented its plans in regard to the sale of access to the Internet through Neostrada, which we believe will be one of the main areas of revenue growth for TPSA in the next several years. According to the Executive Board, the number of subscribers of this service will increase to 270 thous. by the end of the year, mainly due to the elimination of technical problems as well as to the resumption of the marketing campaign. In our opinion, meeting the planned level will only be possible if TPSA changes its price policy. Currently, services, and particularly the installation of Neostrada, are too expensive. We believe the Executive Board s plans in this regard will be difficult to meet, although the sales strategy of the product is promising. In order to meet plan, the company signed an agreement with retail chains, in which kits to independently install access by the client will be sold. This system has been very success in EU countries. In our forecasts, we assume that TPSA will have 144 thous. ADSL subscribers at the end of the year. 10

12 Telecommunications traffic As a result of growth in the segment of dial up access to the Internet, TPSA maintained the level of telecom traffic noted in However, due to the low effective per minute price of dial up connection, this has a relatively limited influence on TPSA s revenues (23% of total traffic and 6% of revenues from connections). Excluding dial up from the analysis, traffic fell 5.5% in Telecommunications traffic in the TPSA network min. mn IQ'01 IQ'02 IQ'03P local Dial-up 1050 min. mn IQ'01 IQ'02 IQ'03P F2M DLD ILD (left) Source: BRE Bank Securities based on TPSA data Dynamic of changes in telecommunications traffic (Y/Y) in individual market segments 30% 20% 10% Local Mobile 0% DLD -10% -20% -30% ILD Dial-up IQ'02 IIQ'02 IIIQ'02 IVQ'02 IQ'03P IIQ'03P IIIQ'03P IVQ'03P Source: BRE Bank Securities., TPSA The sharpest drop occurred in the segment of international connections (-11%), which is the most susceptible to an economic slump as well as to competition from VOIP services. A similar drop was noted in the local and F2M segments, which declined 6.7% and 5.4% respectively. Benefiting from the deficient telecommunications act, in the second half of 2002, TPSA recovered a greater portion of traffic in long distance connections, which in annual terms allowed the company to maintain the level of traffic noted the previous year. In forecasts for 2003, we assume that, following sharp declines in individual segments of connections, the situation will stabilise with a slight improvement at the end of the year in the segments of local and F2M connections. 11

13 Prices The weakness of the competition failed to exert strong pressure on TPSA to reduce prices. However, in connection with the expected (formal) opening of the international connection market at the end of 2002, the operator reduced prices of connections in this segment. Moreover, in connection with the reaction of the Regulator, prices of connections were lowered in the F2M segment. Effective price per minute of connection in individual segments 2,0 PLN/min. 0,4 Mobile 1,8 1,5 1,3 1,0 0,3 0,2 0,1 0,0 ILD Local (left) DLD (left) IQ'02 IIQ'02 IIIQ'02 IVQ'02 IQ'03P IIQ'03P IIIQ'03P IVQ'03P Source: BRE Bank Securities In 2003 we expect subsequent reductions in the international and F2M segments. However, we do not expect a negative influence this year (as we initially did) resulting from the introduction of calculating the actual time of a call in local connections. TPSA s price offer was constructed in such a way (fee for initiating a connection) that its influence on the company s revenues would be minimal. This is one reason why we have raised our forecast of the operator s revenues. 12

14 Centertel For mobile operators, 2002 was a record year. Together, they connected almost 4 mn subscribers, which increased the ratio of mobile telephones per 100 inhabitants to 36%. Despite the fact that this level differs significantly from the penetration achieved in EU countries, Czech Republic and Hungary due to a less favourable demographic structure and higher unemployment, we expect the rate of market development to begin to slow this year. In our forecasts, we assumed that the number of mobile telephone subscribers in 2003 will grow 3.4 mn, which will increase penetration to 45%. Share of individual operators in net connections Mobile telephone penetration in Poland 60% 50% 40% 30% 20% 10% 0% 70% 60% 50% 40% 30% 20% 10% ERA Polkomtel Centertel 0% IQ'00 IQ'01 IQ'02 IQ'03 IQ'04 IQ'05 IQ'06 IQ'07 IQ'08 1Q2001 IIIQ2001 IQ2002 IIIQ2002 Source: BRE Bank Securities., data of operators Centertel continues the process of increasing market share defined by the number of subscribers, although the second half of 2002 was not a period in which the operator dominated as was the case during the first two quarters. This year, we expect the company will connect 1.17 mn subscribers and increase its market share to 33%. Therefore, in regard to the number of subscribers, it will overtake Polkomtel. We believe that the company will achieve a 34% share in net connections (i.e., 9 percentage points less than in 2002). Number of subscribers of individual operators in the post-paid and pre-paid segments as well as total subscribers 3,0 4,0 mn mn 3,5 2,5 3,0 2,0 2,5 1,5 2,0 1,0 Centertel 1,5 Centertel 0,5 Polkomtel 1,0 Polkomtel PTC 0,5 PTC 0,0 0,0 IQ'00 IQ'01 IQ'02 mn IQ'03 IQ'00 mn IQ'01 IQ'02 mn IQ'03 7,0 mn 6,0 5,0 4,0 3,0 Centertel 2,0 Polkomtel 1,0 PTC 0,0 IQ'00 IQ'01 IQ'02 IQ'03 Source: BRE Bank Securities based on data of operators 13

15 The share of Centertel s pre-paid clients still remains on a higher level than in the case of the competition, although this difference declined in the fourth quarter. The general opinion that Centertel is acquiring market share through low income pre-paid clients is not totally true. This is shown by data concerning the number of post-paid clients connected to the network (net) in 2002, from which it results that in this segment Centertel was also the decided leader. This is particularly evident in the fourth quarter. The company s Executive Board stated that, after achieving a similar market position, in terms of the number of subscribers, improving the company s profitability will become a priority. 70% 60% 50% 40% 30% 20% 10% 0% Share of pre-paid clients of individual operators mln. Centertel Polkomtel PTC IQ'02 IIQ'02 IIIQ'02 IVQ'02 Net connections in post-paid segment 0,3 mln. Centertel Polkomtel PTC 0,3 0,2 0,2 0,1 0,1 0,0-0,1 IQ'02 IIQ'02 IIIQ'02 IVQ'02 Source: BRE Bank Securities based on data of operators A consequence of a higher share of clients using pre-paid services is a lower weighted ARPU. Breaking down APRU into individual segments, differences are lower, although Polkomtel remains the decided leader in the post-paid segment. Comparison of ARPU of individual operators in the post-paid and pre-paid segments as well as total APRU mn Centertel Polkomtel PTC IQ'02 IIQ'02 IIIQ'02 IVQ' mn Centertel Polkomtel PTC IQ'02 IIQ'02 IIIQ'02 IVQ' mn Centertel Polkomtel PTC IQ'02 IIQ'02 IIIQ'02 IVQ'02 Source: BRE Bank Securities based on data of operators Due to achieving effects of scale in 2002 Centertel improved operating results considerably. With an increase in revenues to PLN 3.4 bn, the operator achieved an EBITDA result of PLN 732 mn, in relation to the PLN 165 mn noted the previous year. According to International Accounting Standards, the company s net loss fell from PLN 471 mn in 2001 to PLN 69 mn. 14

16 Financial results of Centertel Revenues Change 46% 52% 46% EBITDA EBITDA margin -11% 7% 21% Amortisation EBIT Net profit Source: TPSA, IAS The improvement in operating results is also due to reducing the costs of obtaining a subscriber. Centertel significantly reduced subsidies for telephones in the pre-paid segment. They fell from PLN 216 the previous year to PLN 118 in all of This policy shortened the return period of costs borne on obtaining a subscriber from 6.9 months to only 3.8 months. In the post-paid segment, the difference in relation to 2001 is small (a decline from PLN 719 to PLN 708), which means the return period did not change and amounts to 5.1 months. Average cost of obtaining a subscriber (Centertel) Return period PLN 10,0 8,0 months 600 6, , , Post-paid Pre-paid Weighted 0, Post-paid Pre-paid Source: TPSA The company s Executive Board presented its forecast of Centertel s results for It assumes that the operator will obtain 1 million subscribers, generate sales revenues 25% higher than the previous year and achieve an EBITDA margin of 28%. For the first time Centertel is to generate a net profit. Our forecasts are more optimistic and based mainly on the assumption that the company will acquire more subscribers. We assume that at the end of the year Centertel will have 5.64 mn subscribers (i.e., 170 thous. more than the number forecast by the Executive Board). According to the operator s data, in the first three months of the year, the number of subscribers increased 260 thous. With a 6% decline in weighted ARPU (growth in share of pre-paid services as well as a drop in prices), we expect the operator to note a 28% growth in revenues and 29% growth in the EBITDA margin. 15

17 Operating results in I Quarter 2003 IQ2003 IQ2002 change Revenues (PLN mn) TPSA and separated % companies Centertel % Others % Consolidation exclusions % Total % Subscribers ( 000) POTS* % ISDN % Mobile telephony % post-paid % pre-paid % Total % Employment TPSA % TPSA and separated % companies Centertel % Others % Total % * including SDI, ADLS Source: TPSA The operating results of TPSA for 1Q 2003 fell just short of our expectations. In the first three months of the year the company generated revenues of PLN bn (BRE Bank Securities forecast: PLN bn). Data concerning the number of subscribers, both in terms of fixed line and mobile telephony, were somewhat disappointing. During the discussed period, the parent company lost approximately 65 thous. voice service subscribers (standard links) and the growth in the number of total lines is traditionally due to the growing number of ISDN lines as well as broadband access to the Internet (ADSL, SDI). The growth in the number of ISDN lines sold in successive quarters is a positive signal. During the course of the last four periods the number of lines amounted to 37 thous., 83 thous., 128 thous. and 143 thous. in 1Q At the end of March, the number of ISDN lines accounted for 7.6% of all fixed line telephone lines. Considering the decline in the number standard links and the growth in the number of ISDN lines (143 thous. lines corresponds to 66.6 thous. Internet access lines), the balance of ADSL and SDI is positive for the company. In 1Q 2003, the number of access lines increased 11.2 thous. The PLN 141 mn (3.7%) decline in revenues from fixed line telephony, in relation to the analogous quarter of 2002, is largely due to the reduction in prices of F2M and international connections as well as to the decline in telecom traffic in all types of connections with the exception of long distance, where TPSA recovered market share. In the case of Centertel, in terms of the net number of connected subscribers (+271 thous.), 1Q 2003 was the worst period since 3Q The poor result is primarily due to the vastly smaller number of subscribers obtained in the pre-paid segment (+115 thous. vs. an average of 300 thous. per quarter in 2002). In turn, the higher number of subscribers obtained in the post-paid segment (+146 thous. vs. 100 thous. in 1-3Q 2002) seems to confirm the change in the sales strategy of the operator, which the Executive Board announced and which was already evident in results for the fourth quarter (240 thous. post-paid subscribers and 242 thous. pre-paid subscribers were obtained). The decline in the cost of obtaining a subscriber, by almost half, in the pre-paid 16

18 segment, in relation to 1Q 2002, also confirms this. The decline of ARPU in the pre-paid segment to PLN 27.1 and the post-paid segment to PLN is due to the seasonal decline in telecom traffic in the first quarter as well as to the decline in revenues from interconnect (reduction in settlement rates). 17

19 Consolidated Balance Sheet (PLN mn) F 2004F ASSETS Fixed assets Intangible fixed assets Goodwill of subordinated entities Tangible fixed assets Long-term trade debts Long-term investments Long-term interperiod settlements Current assets Inventories Short-term accounts receivable Short-term investments Short-term interperiod settlements (PLN mn) P 2004P LIABILITIES AND EQUITY Share equity Share capital Share capital not paid in Own shares (holdings) Reserve capital Capital from revaluation Other reserve capital Exchange differences from subordinated entities Profit (loss) from previous years Net profit (loss) Capital of minorities Negative goodwill of subordinated entities Liabilities and reserves for liabilities Liability reserves Long-term liabilities Short-term liabilities Interperiod settlements

20 Consolidated Profit and Loss Account (PLN mn) F 2004F Revenues Costs Gross profit (loss) on sales Selling costs General administration costs Net profit (loss) on sales Other operating revenues Other operating costs EBIT amortisation EBITDA Financial revenues Financial costs Profit on sale of holdings Profit (loss) on economic activity Result on extraordinary events Goodwill write-off of subordinated entities Negative goodwill write-off Gross profit (loss) Income tax Other mandatory reductions in profit Share in profits (Profits) losses of minorities Net profit (loss) Consolidated Cash Flow Statement (PLN mn) F 2004F Cash flow from operating activity Cash flow from investment activity Cash flow from financial activity Change in cash Cash at end of period

21 Previous recommendation issued for recommendation ACCUMULATE date issued price on day of recommendation WIG on day of recommendation EV net debt + market value (EV economic value) EBIT Earnings Before Interest and Taxes EBITDA EBIT + Depreciation and Amortisation PBA Profit on Banking Activity P/CE price to earnings with amortisation MC/S market capitalisation to sales EBIT/EV operating profit to economic value P/E (Price/Earnings) price divided by annual net profit per share ROE (Return on Equity) annual net profit divided by average equity P/BV (Price/Book Value) price divided by book value per share Net debt credits + debt papers + interest bearing loans cash and cash equivalents EBITDA margin EBITDA/Sales Recommendations of BRE Bank Securities S.A. A recommendation is valid for a period of 3-6 months, unless a subsequent recommendation is issued within this period. BUY we expect that the rate of return from an investment in a company s shares will be at least 15% higher than the WIG ACCUMULATE we expect that the rate of return from an investment in a company s shares will be 5%-15% higher than the WIG HOLD we expect that the rate of return from an investment in a company s shares will be within +/-5% in relation to the WIG REDUCE we expect that the rate of return from an investment in a company s shares will be 5%-15% lower than the WIG SELL we expect that the rate of return from an investment in a company s shares will be at least 15% lower in relation to the WIG The present report expresses the knowledge as well as opinions of the authors on day the report was prepared. The present report was prepared observing principles of methodological correctness and objectivity, on the basis of sources available to the public, which BRE Bank Securities S.A. considers reliable. However, BRE Bank Securities S.A., in no case, guarantees the accuracy and completeness of the report, in particular should sources on the basis of which the report was prepared prove to be inaccurate, incomplete or not fully consistent with the facts. BRE Bank Securities S.A. bears no responsibility for investment decisions taken on the basis of the present report nor for any damages incurred as a result of investment decisions taken on the basis of the present report. It is possible that BRE Bank Securities S.A. renders, will render or in the past has rendered services for companies and other entities mentioned in the present report. Copying or publishing the present report, in full or in part, or disseminating in any way information contained in the present report requires the prior written agreement of BRE Bank Securities S.A. Strong and weak points of valuation methods used in recommendations: DCF acknowledged as the most methodologically correct method of valuation; it consists in discounting financial flows generated by a company; its weak point is the significant susceptibility to a change of forecast assumptions in the model Multiple based on a comparison of valuation multipliers of companies from a given sector; simple in construction, reflects the current state of the market better than DCF; weak points include substantial variability (fluctuations together with market indices) as well as difficulty in the selection of the group of comparable companies 20

22 Warszawa ul. Wspólna 47/49, Warszawa, skr. pocztowa 21 TELEFON (0-22) FAX (0-22) Centrala i informacja Kierownik Punktu Obsługi Klientów Obsługa Rynku Niepublicznego Sekretariat Biura Dep. Sprzedaży Instytucjonalnej Departament Analiz Departament Rynku Pierwotnego Departament Rozliczeń Finansowych do Zespół Zleceń Telefonicznych PUNKT OBSŁUGI ADRES TELEFON FAX BIELSKO-BIAŁA Pl. Wolności 7, Bielsko-Biała (33) (33) BYDGOSZCZ ul Grodzka 17, Bydgoszcz (52) (52) GDAŃSK ul. Okopowa 7, Gdańsk (58) (58) KATOWICE ul. Powstańców 43, Katowice (32) (32) KRAKÓW ul. Augustiańska 15, Kraków (12) (12) LUBLIN ul. Krakowskie Przedmieście 6, (81) (81) ŁÓDŹ ul. Piotrkowska 148/150, Łódź (42) (42) OLSZTYN ul. Głowackiego 28, Olsztyn (89) (89) POZNAŃ ul. Szyperska 20/21, Poznań (61) (61) RZESZÓW ul. Sokoła 6, Rzeszów (17) (17) SZCZECIN ul. Tkacka 55, Szczecin (91) (91) WROCŁAW ul. Podwale 62A, Wrocław (71) (71)