Hera. Italy. 2/Outperform. High visibility and sector consolidation. Gas Utilities. 01 June Update

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1 Italy 2/Outperform Gas Utilities 01 June Update Closing Price (31/05/07) EUR3.340 Target price +17.4% EUR3.92 Market capitalisation EUR3 395m BCI To 31/12 (EUR) - IFRS E 2008E 2009E Sales (m) Net att. profit, rest. (m) Free Cash Flow (m) 48.5 (21.6) EBITDA margin (%) Clean EPS Reported EPS P/E (x) Attrib. FCF yield (%) 1.4 NS EV/EBITDA (x) EV/EBIT (x) ROCE (%) ROE (%) P/BV (x) Net debt/ebitda (x) Net dividend Yield (%) Next event: Q2-07 results and business plan due on 12 September High visibility and sector consolidation We stick to our positive stance on HERA based on: (1) its successful multi-utility business model; (2) double digit growth; (3) consolidation potential. We believe that visibility on our E EBITDA CAGR forecast of 15% is high, thanks to the fully authorized plants which will soon become operative, synergies from past deals and tariff hikes. Moreover, HERA is the leader in the special waste business, which looks very promising, as it is a fastgrowing, fully liberalized and highly fragmented. We believe that HERA is now ready to take part in the consolidation process in Italy. We expect that in the next months, HERA could merge with a listed player of a similar size, which would yield synergies and thus significant upside. We think that ACEA or Iride would be the most likely partners. In our view, excluding ASM Brescia, the most value enhancing alternative would be Iride (which could justify EUR3.97/share). We confirm our 2/Outperform rating, with a new TP of EUR3.92/share (17% upside) based on a stand-alone valuation of EUR3.70/share to which we added a EUR0.22/share contribution from consolidation, based on the weighted average of our scenarios /03 12/03 06/04 12/04 06/05 12/05 06/06 11/06 05/07 mêáåé mêáåél_`f 52-week range Free Float No. of shares, adjusted Daily volume Reuters/Bloomberg EUR2.403-EUR3.475 EUR 1391 m m EUR m HRA.MI/HER IM 1 month 3 months 12 months Absolute perf. -1.5% 7.9% 32.4% Relative perf. -0.9% 0.3% 8.4% Francesca PEZZOLI Research Analyst fpezzoli@cheuvreux.com (39) Shareholders: E. Romagna Municipalities 59.0%, Free Float 41.0% Please see important disclosures at the end of this document

2 CONTENTS Investment recommendation I Valuation approach...page 06 DCF valuation... P.06 SOP valuation... P.07 Multiple comparison... P.08 II Business profile...page 10 III Consolidation scenario...page 14 IV Estimates summary...page 20 Financial structure... P.23 CHEUVREUX'S UTILITIES TEAM Laurent Poinsot (coord.) France (33) ( Direct ) lpoinsot@cheuvreux.com Marco Baccaglio Italy (39) ( Direct ) mbaccaglio@cheuvreux.com Damien De Saint-germain France (33) ( Direct ) ddesaintgermain@cheuvreux.com David Halldén Nordic (46) ( Direct ) dhallden@cheuvreux.com Sebastian Kauffmann Germany (49) ( Direct ) skauffmann@cheuvreux.com José Ramón Ocina Spain (34) ( Direct ) jocina@cheuvreux.com Francesca Pezzoli Italy (39) ( Direct ) fpezzoli@cheuvreux.com Benoit Trochu France (33) ( Direct ) btrochu@cheuvreux.com 2

3 HERA Company profile Valuation HERA is one of the biggest national managers of local public services (leader in waste management, with over 4m tons treated in 2006 and after ACEA, it is the second most important player in the water business, with 2.5m clients served). In 2006, sales totalled EUR2.3bn, with EUR427m EBITDA (o/w 27% from gas, 36% from waste/wte, 25% from water, 6% from electricity and 6% from other services). HERA was founded in November 2002 through the merger of 11 local utilities, based in the wealthy Emilia- Romagna region. It currently manages corporate activities and local operating companies in Bologna, Rimini, Imola, Forli', Ravenna, Ferrara and Modena. HERA has a safe financial structure with an expected net debt/ebitda of 2.7x at the end of It aims to spur growth by: (1) raising electricity sales from 5.5TWh in 2005 to 9.2TWh in 2009; (2) by increasing production at its 4 new WTE and 3 CCGT plants; and (3) consolidating smaller local utilities. HERA is 59%-owned by local municipalities. Free float stands at 41%. We set a new TP of EUR3.92 (from EUR3.75 share) based on a stand-alone valuation for HERA of EUR3.7/share + EUR0.22/share, representing the weighted average of our consolidation scenarios. DCF We used a 6.2% WACC and 1% terminal growth rate, which in our view accurately reflect the low risk underlying HERA's business model. With a terminal value corresponding to 8.7x EV/EBITDA we derive a EUR3.72 fair value (after a 3% deduction for minorities). SOP We valued the business units separately, using a mix of DCF, RAB and multiples to reflect the specific issues of each business, reaching a fair value of EUR3.68/share. Multiples HERA appears expensive based on multiples figures, but seems cheaper on 2009 (P/E at 16.3x vs. 16.2x for peers and 7.3x EV/EBITDA vs. 7.9x for peers). We think that HERA deserves to trade at a premium, given its strong growth profile and higher visibility on key growth drivers. Investment case We stick to our 2/Outperform rating based on: Superior growth compared to other Italian local utilities, with a double digit growth profile (we estimate 15% EBITDA CAGR and 32% EPS CAGR). High visibility for the next three years as growth should be driven by the fully authorised plants, the upcoming tariff increase and extraction of synergies (leveraging on HERA's strong track record). Investment in the highly profitable WTE business (IRR>13%) and leading position in the special waste business (which we consider very promising). Strong commitment and skill in delivering external growth could led to a major deal with a listed player in the next months. SWOT analysis Strengths 1 - Strong track record for acquisitions and synergies exploitation 2 - Balanced portfolio of regulated and unregulated businesses 3 - Strong market positions in liberalised businesses Weaknesses 1 - Limited electricity generation 2 - Limited upstream gas procurement 3 - Still low water and urban waste tariffs Opportunities 1 - Further acquisition opportunities 2 - Expansion in special waste business 3 - Upstream integration in gas and electricity Threats 1 - Mounting competition at the gas business 2 - Acquisitions may lead to dilution 3 - Expiration of some gas concessions in

4 EBITDA breakdown (2006A) Margin / Trends (%) Other 6% Gas 27% Waste 36% Water 25% Electricity 6% IFRS EBITDA margin EBITA margin Net margin PE after and before goodwill EV multiples IFRS IFRS P/E P/E bef GW EV/EBITDA EV/EBITA EV/Sales, (rhs) Gearing and Rest. ROE SRI Issues IFRS Efficient corporate governance structure: 15 independent members sit on the BoD, of which 4 are representatives of minority shareholders. CSR function reports directly to CEO Environmental issues addressed in corporate strategy and in financial communications. Very detailed sustainability report Gearing RoE, (rhs) : Peer comparison (EUR m, EUR, %) Price Target Market Performance P/E EV/EBITDA DY P/BV price cap 3m 1y ACEA AEM ASM BRESCIA IRIDE Average HERA

5 INVESTMENT RECOMMENDATION We like HERA's business model: it is a successful multi-utility, with a well-balanced portfolio of activities (in % of EBITDA was generated by regulated and 45% by unregulated activities in 2006). Moreover, HERA is in a leading position in many of the businesses in which it operates: it is the top player in special waste management, the second largest player in water (after ACEA) and the third largest gas supplier in Italy (after ENI and ENEL). Finally, we believe that HERA might be ready to merge with one of the other large players in the local utilities sector. These factors all lend weight to our positive stance and led us to upgrade our target price from EUR3.75 to EUR3.92. HERA's business plan targets double digit EBITDA growth over the next 3 years (EBITDA should jump from EUR427m at the end of 2006 to EUR650m in 2009). We consider the business plan targets to be reliable, as they are based on new plants, which have already received full authorisation, synergies from past deals, for which HERA has a strong track record and rising water and waste tariffs (which are due to be passed by law), therefore we think visibility is very high. HERA boasts the highest organic growth of all the Italian utilities: we expect a E EBITDA CAGR of 15% and EPS CAGR of 32%. A big chunk of the investment plan (~EUR220m) will be dedicated to the new wasteto-energy (WTE) business (which should post a 13% IRR on average, thanks to the incentive scheme) and electricity generation (HERA intends to keep equity stakes in these plants, without managing them directly as it still lacks expertise in this field). We estimate that by 2009 the WTE business will weigh for 15% of the group's EBITDA. At the end of the business plan, the mix will improve as the weight of the electricity and waste business will increase and HERA will no longer be so reliant on the gas business (whose weight should decline from 27% to ~18% of consolidated EBITDA). On the other hand, the business mix will remain very balanced, equally split between regulated and unregulated activities. HERA can leverage on a strong financial structure, with an expected net debt/ebitda ratio of 2.7x at the end of 2007, which should decline to 1.9x at the end of 2009, when the investment cycle is complete. As a result, the company should be slightly under-leveraged compared to peers (2.6x average multiple for local utilities in 2009). We think that HERA has considerable financial flexibility, which could be used to: (1) invest in its core business; (2) increase the dividend pay-out; (3) make small to medium size acquisitions in cash. Consolidation is still underway among the local players in Italy, supported by rising competition, the need for greater scale in the electricity-gas business and political pressure. We believe that the merger between AEM and ASM (now very likely) will lead other players to react accordingly. We feel that HERA will play a major role in the sector consolidation process, thanks to its experience and geographical position. We foresee two patterns of external growth in the coming months: (1) continuous exploitation of small-medium size acquisitions (according to the company, a deal could be announced by September); and (2) a merger with a listed player of a similar size. Given the scarcity of suitably sized targets in Italy and the shareholder structure, we think that: (1) HERA would probably opt for a merger (in an all-paper deal); (2) with either ACEA, Iride or ASM. We feel that ACEA and Iride would be the most likely targets and believe that ASM will definitely merge with AEM. Excluding ASM, we concluded that a merger with Iride would offer the best fit and highest value creation (7% additional upside), followed by ACEA (6%). In any case, we would consider a deal between any of these major players to be value-enhancing. Based on these different scenarios, we derive a range of fair values for HERA of EUR3.70/share (stand-alone - 15% probability) and EUR3.97/share (in the merger with Iride). The weighted average of these scenarios points to a fair value of EUR3.92/share, implying that the benefit from consolidation could be in the region of EUR0.22 per share. HERA is more expensive than peers on multiples, but it is cheaper than other Italian local utilities starting from 2009, due to its higher growth rate: P/E stands at 19.8x vs. 17.8x of peers in 2008 and at 16.3x vs. 16.2x in 2009 and EV/EBITDA stands at 8.3x vs. 8.6x of peers in 2008 and 7.3x vs. 7.9x in We think that HERA deserves to trade at a premium, given its strong growth profile and higher visibility on key growth drivers. 5

6 I VALUATION APPROACH TP at EUR3.92 (17% upside) We are trimming our stand-alone fair value from EUR3.75/share to EUR3.70/share (11% upside), but are setting a new TP for HERA of EUR3.92, factoring in a EUR0.22/share contribution from consolidation (based on the weighted average of our scenarios). All in all, we believe that upside on the stock is the region of ~17%. Target price in different scenarios (EUR, %) Stand alone valuation In a consolidation scenario DCF 3.72 SOP 3.68 Average Current price Upside 11% 17% DCF valuation We used a DCF model to value HERA in , assuming that it will complete its current investment plan by , with a terminal growth rate of 1% from 2010 onwards. The key assumptions underpinning our DCF model are: 6.2% WACC and 1% terminal growth rate 6.2% WACC based on the weighted average of 7.39% cost of equity (4% riskfree rate, 4% equity risk premium, 0.85x levered beta) and a 3.35% net cost of debt. The weight of equity and debt are based on market values, thus the equity component represents roughly 70% of the cost of capital. 1% terminal growth rate, which results in a terminal EV/EBITDA of 8.7x for the terminal year, which is below the current multiple of 10.2x. WACC assumptions DCF valuation Equity risk premium 4.0% Free risk 4.0% Unlevered Beta 0.70 Levered beta 0.85 Equity / EV 30% Debt / EV 70% Gross Kd 5.0% Net Kd 3.35% Ke 7.39% WACC 6.18% (EUR m) Total Per share % of EV UFCF % Terminal Value % Enterprise Value % Net debt 2006 (1 286) (1.3) -25% Minorities and equity stakes (30) 0.0-1% Equity Value % Terminal growth 1.0% Terminal EV/EBITDA (x) 8.7 Source:Cheuvreux EUR3.72/share According to our model, HERA's equity fair value currently stands at ~EUR3.8bn, based on an enterprise value of EUR5.1bn (91% attributable to the terminal value), EUR1.3bn net debt, EUR153m of minorities (3% of the group EV based on the weight of minorities on 2006 book value) and EUR123m of equity stakes (including also a 5.5% stake in Tirreno Power). We arrived at a valuation per share of EUR

7 We cross-checked our valuation by a using a SOP valuation of each business unit SOP valuation We cross-checked our DCF valuation by performing a SOP analysis, based on separate valuations of each business. We think that given HERA's well-diversified business and the difference between the regulated and unregulated businesses, this is a valid alternative valuation method. The gas business was valued using a DCF model (6.5% WACC and 1% terminal growth rate), yielding an EV of EUR996m. We valued the electricity business using a DCF model (6.5% WACC and 1.5% g), obtaining an EV of EUR676m, implying a multiple of 8.6x EV/EBITDA in 2009, when all the plants under construction will be fully operative. We valued the water business using a DCF model (5% WACC and 1.5% g) assuming a low risk profile for the business, which is fully regulated and the need for investment on the grid. The valuation implies a 25% premium to the RAB. The EV/EBITDA multiple at 9.3x in 2008 is lower than the current multiples of regulated utilities (9.8x). EUR3.68/share For the special waste business, we also used a DCF model (6.8% WACC and 1.5% g as it will enjoy strong growth in the next years and is a fully liberalised business) arriving at an EV of EUR1,650m. For urban waste (which is labour intensive, with lower margins) we used the RAB value (EUR150m), obtaining an EV of EUR1,800m. We valued the other businesses (district heating, public lighting and other activities) at 8x EV/EBITDA08E. After factoring in EUR1,393m of debt and pension provisions expected at the end of 2007, EUR150m for minorities and EUR123m for financial stakes, we reached EUR3,740m of equity, corresponding to EUR3.68/share. SOP valuation SOP valuation (EUR m) Method EV/EBITDA Gas 996 DCF (6.5% WACC, g=1%) Electricity 676 DCF (6.5% WACC, g=1.5%) Water DCF (5.5% WACC, g=1.5%) Environment DCF (6.8% WACC, g=1.5%) / RAB for urban waste Other 336 8x EV/EBITDA EV Net debt + pension provisions (1 398 ) 2007E Financial stakes 123 Book value Minorities (150) 3% EV Equity Number of shares Per share

8 Expensive based on figures, but cheap in 2009 Safe financial structure Multiple comparison HERA is more expensive than peers on multiples, but it is cheaper than other Italian local utilities from 2009, due to its superior growth rate: P/E stands at 19.8x in 2008 vs. 17.8x of peers but at 16.3x vs. 16.2x for peers in 2009 and EV/EBITDA stands at 8.3x vs. 8.6x of peers in 2008 and 7.3x vs. 7.9x in We think that HERA deserves to trade at a premium, given its strong growth profile and higher visibility on key growth drivers. In terms of the dividend yield, the company is committed to 15% dividend growth per year, therefore it will have 3.7% DY in 2009 in line with the sector average. Moreover, we believe that HERA'S healthy financial structure and the ongoing benefits from its investment program, could leave room for a further dividend increase. HERA boasts a very safe financial structure. In 2009, when the investment cycle is complete and all the plants are in operation, we expect the net debt/ebitda ratio to decline to 1.9x (vs. 2.6x sector average) leaving the company with a lot of financial flexibility. EBITDA margin will sharply improve ROCE pre-tax would jump from 7.7% to 13% The EBITDA margin could steadily improve from 19% at the end of 2006 to 24% thanks to: (1) growth at special waste business and WTE, where margins are considerably higher; (2) investments in electricity generation, which would allow the company to retain more of the margin vs. the current situation, where HERA is short in generation and long in supply; (3) efficiency and organic growth at the water business. We expect pre-tax ROCE to improve sharply in the coming years as it should grow from 7.8% at the end of 2006 to 13% in 2009, due to rising tariffs (which should bring the return on regulated businesses such as water and urban waste in line with the return allowed by law), higher efficiency, cost-cutting and investments in WTE. We believe that 2009 is the best year to look at, as at that time all the plants should be operative and the investment cycle should be complete. Moreover, we think that HERA might merit a premium in view of the: Superior visibility and growth very high visibility on the business over the next 3 years (as >50% of HERA's profitability is tied to its local monopolies in the water and waste businesses); superior growth drivers such as: (1) integration synergies from companies acquired in the past; (2) organic growth; and (3) new plants. 8

9 HERA: Peer comparison (EUR m, x, %) ACEA AEM ASM HERA IRIDE Average P/E EV/EBITDA Dividend yield Gearing Net Debt/EBITDA Capex / Depreciations EBITDA Margin (%) ROCE pre-tax 2006A E E E A E E E A E E E A E E E A E E E A E E E A E E E A E E E The scatter plots indicate that the high P/E and EV/EBITDA multiples in 2007 are basically explained by superior growth at both the operating (we are looking at EBITDA CAGR of 18%) and EPS levels (we estimate ~34% EPS CAGR) compared to other local utilities in Italy. HERA vs. peers: EV/EBITDA and EBITDA CAGR HERA vs. peers: P/E and EPS CAGR bslb_fqa^=mt NN NN NM NM V V ^`b^ ^bj ^pj fofab ebo^ mlb=ommtb PP OU OP NU NP ^pj ^bj ^`b^ fofab ebo^ U RB TB VB NNB NPB NRB NTB NVB b_fqa^=`^do=ommtjmvb U MB RB NMB NRB OMB ORB PMB PRB QMB bmp=`^do=ommtjmvb 9

10 II BUSINESS PROFILE Business profile and market position Diversified multiutility Strong market position in the waste, water and gas businesses HERA is one of the largest multi-utilities in Italy. Its interests range from gas and electricity distribution, to water, waste management, waste-to-energy and electricity generation. The company is mainly active in the Emilia Romagna region, where it has steadily expanded through acquisitions and mergers over the last few years. In 2006, HERA reported EUR427m of EBITDA, of which 36% was generated by the waste business, 27% by the gas business (distribution and sales), 25% by the water business and 6% by the electricity business (mainly distribution and supply). In terms of its market position, HERA is a leading player in many of the sectors in which it operates: it is the Italian leader in waste management (both urban and special waste management), with ~4m tons of waste treated in 2006; it ranks second in the water business, with ~2.5m clients and 244mcm of water sold (after the Rome-based ACEA with 655 mcm and ~8m clients) and third in the gas distribution business (after ENI and ENEL). HERA: Sales breakdown (2006A) HERA: EBITDA breakdown (2006A) Waste 22% Other Other 7% 6% Gas 27% Gas 39% Waste 36% Water 16% Electricity 16% Water 25% Electricity 6% Balanced mix of regulated and free market activities (55%/45%) 21% EBITDA CAGR in , fuelled by organic growth and M&A Despite the fact that it has gradually expanded its geographic presence over the last 4 years (the initial group of 11 public utilities has been expanded into adjacent areas, to include Ferrara and Modena), it has been able to maintain a very good balance between regulated and unregulated activities, which accounted for 55% and 45% of 2006 EBITDA respectively. HERA is the fastest-growing multi-utility in Italy. In , HERA's revenue CAGR reached 24%, EBITDA CAGR averaged ~20% and net profit grew by ~26% per year. In the same period, its dividend rose by a 15% CAGR. This outstanding performance was mainly driven by organic growth (new plants, higher tariffs and synergies), which accounted for ~54% of this increase and M&A operations which accounted for the other ~46%. HERA: key figures (EUR m, EUR, %) 2003A 2004A 2005A 2006A CAGR Revenues % EBITDA % Net profit % DPS % Source: HERA HERA: EBITDA growth drivers (EUR m) Organic growth M&A Total Total Source: HERA 10

11 We think that HERA has two key competitive advantages over other Italian local utilities: Competitive advantages: balanced corporate governance structure and synergies Corporate governance. HERA's corporate governance rules and the balance of power within the shareholder structure have been well-defined since the company was founded in late The public shareholders belong to a syndicate pact in which no single member holds the majority. Currently, the pact controls ~58% of the share capital and the main shareholders are the municipalities of Bologna with 20% and Modena with 14%. This is a major advantage in the aggregation process, making it easier to integrate small to medium size players, as they are simply incorporated into the existing pact, which is not controlled by any single shareholder. Synergies. HERA also has a strong track record for extracting synergies from newly-acquired companies. In the past, it achieved significant cost savings and has successfully increased the EBITDA of its new acquisitions by up to 25% by extending its best practice standard to the new companies (as all business units are benchmarked against the others), through cost-cutting and implementation of a common IT platform. Strategy and investment plan In September 2006, HERA released its new business plan in which 2008 targets were confirmed and set a new EBITDA target of EUR650m in 2009, with EUR1.4bn of capex. It implies a 15% EBITDA CAGR over the next 3 years. The new business plan mainly targeted: Upstream integration, crossselling and exploitation of synergies Upstream integration in liberalised businesses (specifically gas supply, electricity generation and waste management plants) to enhance its competitive position and profitability; Cross-selling of its services and expansion of its geographical reach by leveraging on its solid and loyal client base. The goal is to sell at least 3 services to each client, which is feasible in our view, given HERA's strong relationship with its customers (confirmed by the low churn rate at the gas business, less than 1% on average over the last two years). Exploitation of synergies and efficiency improvement through the development and sharing of best practice and further rationalisation of the organization. ~EUR1bn of capex planned for According to the business plan, HERA plans to invest ~EUR1.42bn during the E period (we estimate ~EUR1bn in ) split as follows: EUR740m of maintenance capex, EUR550m of development capex, and EUR130m worth of financial investments (including the EUR106m spent to buy the Modena electricity distribution grid in 2006). The capex plan will be fully financed through cash flow generation. Investments will be allocated in the following way: 32% will be spent on the waste business to construct 4 new WTE plants, 26% will be invested the water business to improve the existing grid in order to comply with ATO requirements, 20% will be spent on electricity to finance new CCGT plants and 9% on the gas business, mainly for grid maintenance. In 2006, HERA spent EUR320m on capex. We estimate that it will spend ~EUR370m in 2007 and 2008; and EUR240m in

12 HERA: Breakdown of E investment plan (%) HERA: Investment plan by year and sector (EUR m) Electricity 20% Other 13% Waste 32% QMM PRM PMM ORM OMM NRM NMM RM Gas 9% Water 26% M OMMS OMMTb OMMUb OMMVb t~ëíé t~íéê d~ë bäéåíêáåáíó líüéê Business plan targets: relevant waste, water and electricity growth EUR650m of EBITDA in 2009 According to the business plan, HERA expects to generate EUR650m of EBITDA in 2009, compared to the EUR427m reported in 2006 (implying ~15% CAGR). Our estimates are aligned with business plan targets, which appear quite reliable as: ~50% of the expected increase should stem from synergies (for which HERA has a strong track record) and new tariffs (already secured under current regulations); Our estimates are in line with business plan targets, which appear reliable ~50% should stem from new plants, which have all been fully authorised. Most of this growth should be fuelled by the waste and electricity businesses as new plants come on-stream. Synergies and higher tariffs should also drive growth at the water business, instead gas is expected to remain flattish as the target is to maintain the market share (95% in reference territory and third national player). The roll-out of the investment plan, organic growth and synergies from the acquisitions made over the last 3 years should fuel double digit growth until at least Our breakdown follows: EUR223m of additional EBITDA by 2009 o/w ~50% from organic growth + synergies and ~50% from new plants Synergies should add ~EUR50m over the next 3 years, corresponding to ~EUR16m/year (broadly in line with the level of past years and the ~EUR15m obtained in 2006). These synergies should be driven by: (1) the reduction of personnel costs, as HERA aims to streamline its workforce; (2) savings on procurement costs; (3) operating efficiencies, achieved by implementing a centralised control system for water and waste management, best practice sharing and reduction of the overall cost per client (i.e. HERA aims to reduce the cost per client from ~EUR8 to ~EUR6 by setting up a centralised client management and billing system). This could be a challenging goal, as it corresponds to ~3% of the total cost base, however given the company's strong track record and ability to deliver efficiency, we believe this target could be within reach. Organic growth should contribute EUR56m, mostly driven by tariff hikes (especially waste and water fees), for which there is high visibility, given the stable regulatory scenario. Higher volumes should account for the rest. New plants should contribute EUR117m, mainly driven by the 4 new WTE plants, which should become operative by 2008, delivering ~EUR75m of EBITDA. Visibility is good as all of the plants have received full authorisation. New CCGT plants should contribute the rest, as HERA plans to add ~430MW of installed capacity (mainly in CCGT) in the coming years. 12

13 HERA: 2006 and 2009E EBITDA breakdown HERA: E EBITDA growth drivers E Other Waste Water Electriciy Gas A Synergies Org.growth New plants 2009E By 2009, the weight of electricity and waste should rise, making HERA less reliant on the gas business If the targets are met at the end of the business plan period, HERA will enhance asset base of all businesses. The weight of the electricity business on group EBITDA will double, rising from ~6% to ~12%, the weight of waste management will rise from 35% to 37% and HERA will no longer be so dependent on the gas business, whose weight will decline from 27% to 19%. The business mix should remain very balanced, equally split between regulated and unregulated business. Some upside "on top" of the business plan Sonatrach 1bcm contract from 2010, LNG terminal and electricity generation In addition to the promising business plan, there are some other projects in the pipeline (that we think could be announced with the next business plan), which could spur additional growth and upside. HERA signed an agreement with Sonatrach to buy 1 bcm of gas from 2010 (representing ~1/3 of its need by 2009) importing it from Galsi pipeline that could be ready by We cautiously estimate that the new contract could add ~EUR10m of EBITDA thanks to a ~4%.supply costs reduction. Moreover, HERA stated that it plans to get involved in at least one LNG project. Although there is zero visibility at the moment, we think that HERA will likely participate in one of the many LNG projects currently in the planning stages in Italy. It might also invest in the generation business, as it still lacks ~2.3 TWh of generation capacity to fully cover its electricity sales until Committed to raising the dividend yield 15% dividend growth per year to 2009 One of HERA's main goals is to raise DPS by 15% per year as it has done in the past. We believe that this is a credible target as: (1) we expect a 32% EPS CAGR for the next three years; (2) its safe financial position and stable cash flow generation should allow it to couple high capex with rising dividends; (2) according to our estimates, the 90% pay-out ratio on 2006 earnings should decline to ~60% by As a result, the dividend yield should grow to 3.7% in 2009, in line with the average of local utilities in Italy. HERA: EPS and DPS trend HERA: Dividend yield and pay-out ratio MKOR NMMB TKMB MKOM MKNR MKNM MKMR MKMM m~ójçìí=ebf VMB UMB TMB SMB RMB QMB PMB OMB NMB MB SKMB RKMB QKMB PKMB OKMB NKMB MKMB aáîáçéåç=váéäç=ebf OMMR OMMS OMMTb OMMUb OMMVb OMMR OMMS OMMTb OMMUb OMMVb bmp amp aáîáçéåç=váéäç=ebf m~ójlìí=ebf 13

14 III CONSOLIDATION SCENARIO Consolidation process is going ahead HERA has a successful track record for achieving growth by aggregating smaller companies We estimate that small acquisitions strategy could deliver 2-3% value creation Over the last few years, local Italian utilities have begun to consolidate. AEM Turin and AMGA recently merged to found Iride, which has been in operation since 2006 (market cap ~EUR2.3bn) and AEM and ASM are planning to merge. Although negotiations between AEM and ASM are taking longer than expected, political consensus has been reached, meaning that the deal should be successfully concluded, once the disagreements over the shareholder structure and swap ratio have been resolved. After the merger, the new group should have a market cap of ~EUR9bn and should become a leading player in electricity generation in Italy, with a well-diversified business portfolio. In this consolidation scenario, HERA has probably the strongest track record for external growth, driven by its successful acquisition strategy. Over the last few years, it has steadily acquired, integrated and extracted value from small to medium size companies located in surrounding areas: (1) historically, multiples paid were quite low (well below HERA's); and (2) HERA has been able to boost the EBITDA of newlyacquired companies by up to 25% via cost-cutting. Over the last three years, HERA has acquired more than EUR100m of EBITDA, representing ~45% of the total EBITDA growth. We believe that it should continue to take an active role in the consolidation process leveraging on: (1) management's strong commitment and expertise; (2) sector consolidation in Italy; (3) smaller companies' interest in joining the group to benefit from the reliable dividend flows and to participate in the shareholders' pact. Without being overly aggressive, we believe that HERA could easily achieve 2-3% value creation by pursuing small acquisitions (two of them could be announced in September). Assuming: (1) that over the next three years, HERA could buy ~EUR15m of EBITDA per year through small deals; (2) that cost synergies will amount to 25% of the acquired EBITDA; and (3) if we apply a 8x EV/EBITDA multiple to reflect the value creation, we obtain EUR90m of value creation. Although admittedly, the upside is limited, we consider this a very reliable source of additional value. Past acquisitions (%, x) Year Stake EBITDA EV/EBITDA Agea % x Meta % x Geat Gas % 2 7.0x Aspes % * x SAT % x Potential additional value creation from small deals EBITDA target Cost synergies EV/ EBITDA Value creation Total % of Mkt. Cap. 2.7% * Reaching 49.7% stake Source: HERA ENIA: the best midsize option good future option, but an alliance is unlikely in the short term Last year, HERA entered preliminary talks with ENIA regarding a potential alliance. ENIA is an unlisted company based in the same region as HERA with a similar business portfolio and ~EUR150m of EBITDA in 2005 (14% EBITDA margin vs % of HERA). We think that an eventual merger (or alternatively an acquisition, given the size of the company) would deliver significant value (~5-6% additional upside). However, these negotiations were suspended in January 2007, as ENIA shareholders decided to list the company (likely in 2007). This was bad news for HERA, given the strong geographical and industrial fit. We believe that ENIA opted to list in order to extract value and exploit the strong momentum in the Italian utility sector and we feel that the new management team wanted to retain control. We believe that ENIA will remain a very valuable strategic growth option for HERA in the future as negotiations could be resumed after the listing, although it could take quite a long time. 14

15 Ready for a big deal Assumptions: synergies equal to 5-7% of the combined EBITDA and value creation shared between shareholders We estimate 5-7% of potential value creation The benefit from consolidation could be in the region of EUR0.22/share In any case, we feel that HERA might be ready to sign a big deal with another listed player, to increase the overall size of the company. Given the scarcity of targets and the shareholding structure of the listed players, we think that it would probably take the form of a merger. In the Italian market, there are only three players that would meet HERA's requirements: ACEA, ASM Brescia and Iride. We tried to assess HERA's strategic options by assigning various levels of probability to each scenario. We concluded that ACEA and Iride would be the most likely targets (40% probability respectively). We also included ASM on our short list, as we still believe it would offer the strongest fit, though we assigned a very low probability rate, as we think it will definitely merge with AEM. We simulated the potential value creation, that might be generated by each deal depending on the fit. We assumed that: (1) cost synergies would correspond to 5-7% of the new entity's EBITDA; and (2) we used a 8x EV/EBITDA multiple to calculate the value creation, assuming that the value creation would be proportionally shared between the new group's shareholders, according to their weight in the new entity's market cap (with no significant premium/discount arising from merger terms). Recently Iride presented the new group business plan, which targeted ~EUR30m of synergies from the merger, corresponding to ~6.5% of the combined EBITDA. For AEM/ASM ~EUR90m of synergies would be feasible, corresponding to ~5% of the combined EBITDA. For this reason a scenario delivering an additional EBITDA (an value creation) in the region of 5/7% of the combined entity can be considered reliable also in view of the outstanding track record of HERA on this front. We concluded that a merger with ASM Brescia and Iride would offer the best fit and highest value creation (7% additional upside), followed by ACEA (6%). In any case, we would consider a deal between any of these major players to be valueenhancing. Based on these different scenarios, we derive a range of fair values for HERA of EUR3.70/share (stand alone) and ~EUR3.97/share (merger with Iride). The weighted average of these scenarios lead to a fair value of EUR3.92/share implying that the benefit from consolidation could be in the region of EUR0.22 per share. Simulation of value creation in different merger scenarios (EUR m, EUR, %) ACEA ASM IRIDE No deal Probability 40% 5% 40% 15% Size (Market cap.) Size vs. HERA 103% 106% 67% - EBITDA Geographical fit Low High Low - Business fit Medium High High - Synergy potential Medium High High - Potential value creation (to be shared) Potential value creation for HERA Additional value per share HERA fair value Additional upside 6% 7% 7% 0% 15

16 HERA-ACEA: The Italian champion in water and waste 40% probability Increased size in the electricity business, leading Italian water player and potential synergies from WTE Expansion in the gas business would require heavier investment in the upstream EUR1.2bn of EBITDA by 2008 ACEA could be a target for HERA as it would be large enough to allow the new entity to make a sizeable jump in size (reaching a combined market cap of ~EUR7bn). ACEA's management team also said recently that a deal with HERA might be feasible, after it successfully consolidates the ATOs in Tuscany, thereby creating geographical continuity. Consequently, we assigned 40% probability to the deal. The new entity would sharply increase its size in terms of electricity generated and distributed and it would become the leading Italian player in the water business, with 0.9bcm of water sold and >10m of clients. Some synergies could also be generated in the waste to energy business, as HERA currently has 7 plants in operation (57MW of electric installed capacity and 640 k tons of waste treatment per year) and according to its business plan, it aims to double the installed capacity to 105MW through new plants and re-powering projects. In 2006, ACEA acquired TAE, which operates 2 WTE plants (installed capacity of 20MW) in Lazio and Umbria and has the right to expand its capacity to 60-70MW. On the other hand, part of HERA's business portfolio is still concentrated in the gas business, where ACEA is not present, although ACEA's management said it plans to bid for a Roman gas distribution concession in 2008, which is currently managed by Italgas (ENI Group). As a result, ACEA could expand its business portfolio and generate further synergies with HERA, but we think that in this scenario, the new group should improve its position in the upstream business. According to our estimates, the combined entity would generate EUR5bn of revenues in 2008, with EUR1.2bn of EBITDA and EUR383m of net profit (excluding synergies). HERA-ACEA: Key operating figures HERA ACEA HERA+ACEA Electricity sold (GWh) Installed capacity (MW) Gas sold (mcm) Water sold (mcm) Waste (k tons) HERA-ACEA: Merger simulation (EUR m) HERA ACEA HERA+ACEA 07E 08E 07E 08E 07E 08E Sales EBITDA EBIT Net profit In terms of multiples and the risk of dilution for HERA shareholders, the fact that ACEA's multiples are lower than HERA's in 2007 and 2008 and broadly in line in 2009 would probably be a point in favour of such a deal. An all-share deal with ACEA would be EPS accretive As a result, an all-share deal with ACEA would be accretive for HERA shareholders based on figures, and neutral in To assess the potential impact, we simulated the potential accretion or dilution for HERA shareholders in different scenarios. At current prices, an all-share deal would be ~9% accretive in 2008 and neutral in 2009, excluding any synergies. Whereas including synergies, we foresee 16% accretion in and ~7% in In a worst case scenario, 10% premium to ACEA shareholders and no synergies, the deal would be 6% dilutive on 2009 figures. 16

17 HERA-ACEA: Multiples comparison (x) HERA ACEA P/E EV/EBITDA 2007E E E E E E HERA: EPS accretion/dilution for shareholders (%) 2007E 2008E 2009E Current prices ex-synergies 23.4% 9.4% -1.2% Premium of 5% to ACEA shares 20.4% 6.7% -3.6% Premium of 10% to ACEA shares 17.5% 4.1% -5.9% Current prices cum synergies 26.6% 16.2% 6.7% HERA-IRIDE: Good fit and upstream integration 40% probability We think that Iride might also be a suitable target for HERA. Recently, HERA's CEO, Mr. Tommasi di Vignano, said in an interview that Iride might be a good candidate but no negotiations are currently underway. Similarly, Iride's management said that if the AEM-ASM merger closes successfully, other players in the sector will probably be forced to consolidate. Consolidation remains a hot topic in the sector, but at this stage, only hypothetical scenarios are on the table. We think that the business portfolios of the two companies present a good fit. Both are well-diversified players, with operations in many sectors: mainly water, electricity and gas. Moreover, we believe that they are compatible from an industrial standpoint as: Upstream integration Potential for consolidation in Piedmont and Liguria Double digit growth profile Iride has a valuable asset base in electricity generation, with ~1,000 MW of installed capacity (o/w ~45% hydro and 55% thermoelectric) and an 8% stake in Edipower (corresponding to ~600MW of installed capacity). Iride also has the skills to run and manage electricity plants and HERA could leverage on these capabilities to expand its activities. Iride is involved in an off-shore LNG project in Tuscany, which should be operative from It will boast a total capacity of 4bcm, of which Iride will have the right to 50%. In addition, Iride jointly acquired a 51% stake in MedGas, which is involved in the Gioia Tauro LNG terminal project (~8 bcm), with Sorgenia for EUR2.2m. HERA also plans to get involved in a LNG project soon. As both of companies have heavy gas requirements (we estimate ~6bcm supply needed in 2009 for gas distribution & sales and electricity generation), a stronger presence in the gas upstream would be a key competitive advantage. HERA has a strong presence and effective skills in waste management and WTE. Iride is not yet involved in this business, but it could expand as waste management in Turin is still held by the main shareholder Turin Municipality. The two companies have a strong presence in the water business and could further consolidate in ATOs. Moreover, Iride has strong potential for consolidation in the Piedmont-Liguria area (we estimate that it could easily acquire ~EUR100m of EBITDA in the water business, as Iride is a minority shareholder and operates in the region). Given its ability to successfully conclude small acquisitions, HERA could sharply accelerate the consolidation process in the region. Both companies expect double digit EBITDA and EPS growth over the next three years. We think that a merger would also be beneficial from this standpoint, as it would not jeopardize HERA's fast-growing profile. 17

18 HERA-Iride: Key operating figures HERA IRIDE HERA+IRIDE Electricity sold (GWh) Installed capacity (MW) Gas sold (mcm) Water sold (mcm) Waste (k tons) HERA-Iride: Merger simulation (EUR m) HERA IRIDE HERA+IRIDE 07E 08E 07E 08E 07E 08E Sales EBITDA EBIT Net profit Based on our figures, both HERA and Iride trade at higher multiples compared to other local utilities in Italy and we think it is due to their double digit growth profile. Based on our figures, Iride is slightly cheaper on 2009E P/E (15.7x vs. 16.3) but is more expensive based on EV/EBITDA (8.2x vs. 7.3x). The deal would be EPS accretive including synergies As a result, an all-share deal with Iride would have a broadly neutral impact for HERA shareholders at current prices in 2008 and The deal would be ~2.5% dilutive in 2009 if a 10% premium were paid and 11% accretive including synergies. HERA-IRIDE: Multiples comparison (x) HERA IRIDE P/E EV/EBITDA 2007E E E E E E HERA: EPS accretion/dilution for shareholders (%) 2007E 2008E 2009E Current prices ex-synergies 10.4% 0.0% 1.5% Premium of 5% to IRIDE shares 8.2% -1.9% -0.5% Premium of 10% to IRIDE shares 6.1% -3.8% -2.5% Current prices cum synergies 14.2% 8.1% 11.3% HERA-ASM: Best fit, but low probability 5% probability Similar business model and complementary strengths As we noted in our report Ready for the next step (published on 4 April 2006), we think that a merger between HERA and ASM would have strong industrial rationale and would also make sense from a geographic standpoint, given the contiguity of some of the assets. However, at this stage we feel a deal is highly unlikely, as we expect ASM to close the merger with AEM. As a result, we assigned only 5% probability to this scenario. HERA and ASM have similar business models as both are multi-utilities with highly diversified business portfolios, but different strengths: ASM is more heavily involved in electricity generation and district heating, whereas HERA is more exposed to waste management and water. In our view, the merger would be highly beneficial as both companies aim to raise their exposure to businesses in which the other is a market leader. ASM can leverage on an installed capacity of 470MW, which should jump to ~1,700MW towards the end of the business plan period (by 2009). In addition, it owns 20% of Endesa Italia (corresponding to ~1,400MW of capacity). On the contrary, HERA is short in electricity and could take advantage of ASM's expertise and installed capacity. HERA has a strong presence in the gas business, with 2.4bcm of gas sold. ASM is less exposed, but a big chunk of its power generation is gas-fuelled and therefore the merger would unlock significant potential for cost savings at the gas business, while increasing its size (and negotiating power) in gas procurement. 18

19 In addition, the new group would become a natural consolidator in the Veneto region and could eventually acquire other local players in the region. EUR1bn of EBITDA by 2008 According to our estimates, the combined entity would generate EUR5bn of revenues in 2008, with ~EUR1bn of EBITDA (excluding synergies) and ~EUR380m of net profit. HERA-ASM: Key operating figures HERA ASM HERA+ASM Electricity sold (GWh) Installed capacity (MW) Gas sold (mcm) Water sold (mcm) Waste (k tons) HERA-ASM: Merger simulation (EUR m) HERA ASM HERA+ASM 07E 08E 07E 08E 07E 08E Sales EBITDA EBIT Net profit In terms of multiples and the risk of dilution for HERA shareholders, we note that: An all-share deal with ASM would be accretive in 2008 and dilutive in 2009 at current prices ASM trades at lower P/E than HERA on figures, but is more expensive in 2009, due to the companies' different growth profiles: HERA expects robust EPS growth in the next years, whereas ASM's net profit should remain broadly stable; based on EV/EBITDA, ASM trades at higher multiples (9.1x vs. 8.3x in 2008). As a result, an all-share deal with ASM would be EPS accretive for HERA based on 2008 figures (+7% at current prices and +15% considering also synergies), but on 2009 figures it would be ~5% dilutive at current prices and ~4.4% accretive including synergies. HERA-ASM: Multiples comparison (x) HERA ASM P/E EV/EBITDA 2007E E E E E E HERA: EPS accretion/dilution for shareholders (%) 2007E 2008E 2009E Current prices ex-synergies 35.6% 7.0% -4.8% Premium of 5% to ACEA shares 32.2% 4.3% -7.2% Premium of 10% to ACEA shares 28.9% 1.7% -9.5% Current prices cum synergies 39.4% 14.8% 4.4% 19