Arnoldo Mondadori Editore (MNDI.MI)

Transcription

1 Europe Italy Publishing Media - General Company In-Depth 56 pages Arnoldo Mondadori Editore (MNDI.MI) In the Midst of a Mid-Life Crisis Sound Business, Little Growth Mondadori has traditionally been a sound cash-cow, profiting from its market leadership in Italy. But it is experiencing little organic growth if any, as external growth in Italy is capped by media laws. The group has several options: return cash, invest in new media or go abroad. Mondadori decided to enter the French market. The Italian Business Mondadori has limited gearing to advertising, being mainly exposed to low-growth magazines. Books enjoy the highest margins across Europe but growth is shy of 2%. Magazines, printing and books have benefited from the add-on sales boom, but a slowdown now appears highly likely. Other businesses are even more mature and add little to the bottom line. Why France? In 2006 EMAP France was acquired for 551m, becoming one of the main magazine publishers in that highly competitive market. However this business suffers from the same short-comings: a lack of growth opportunities while post-merger execution risks could dent future results. Only a successful launch of Grazia could create value, but this seems unlikely before Crunching Numbers We estimate flattish revenues from 2007E onwards with EBITDA margins growing from 12.8% in 06E to 13.5% in 2011, or 14.3% assuming a successful breakthrough of Grazia. FCF is expected to remain sound at m or 5% yield. Hardly exciting for a low-growth company. Initiating with a Sell We believe that the share price overestimates future opportunities in France, while dismissing the maturity of the businesses. Assuming a 50% prospect of success for Grazia in our DCF and FCF analysis points to 7.33 per share. The stock also appears expensive on 2008 multiples and fairly valued on We see no reason to be invested in the short term and initiate with a 3M (Sell/ Medium Risk) rating and 7.30 target price. Sell/Medium Risk 3M Price (23 Mar 07) 8.00 Target price 7.30 Expected share price return -8.8% Expected dividend yield 4.6% Expected total return -4.1% Market Cap 2,075M US$2,767M Price Performance (RIC: MNDI.MI, BB: MN IM) See Appendix A-1 for Analyst Certification and important disclosures. Arnoldo Mondadori Editore (EUR) Year to 31 Dec 2004A 2005A 2006E 2007E 2008E Sales ( M) 1, , , , ,074.3 Net Income ( M) Diluted EPS ( ) Diluted EPS (Old) ( ) PE (x) EV/EBITDA (x) DPS ( ) Net Div Yield (%) Mauro Baragiola mauro.baragiola@citigroup.com Alessandro Falcioni 1 alessandro.falcioni@citigroup.com Pierluigi Amoruso 1 pierluigi.amoruso@citigroup.com Alberto Checchinato 1 alberto.checchinato@citigroup.com Citigroup Research is a division of Citigroup Global Markets Inc. (the "Firm"), which does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Non-US research analysts who have prepared this report are not registered/qualified as research analysts with the NYSE and/or NASD. Customers of the Firm in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at (for retail clients) or (for institutional clients) or can call (866) to request a copy of this research. 1 Citigroup Global Markets Ltd

2 For further data queries on Citigroup's full coverage universe please contact CIR Data Services Europe at or Fiscal year end 31-Dec E 2007E 2008E Valuation Ratios P/E adjusted (x) EV/EBITDA adjusted (x) P/BV (x) Dividend yield (%) Per Share Data ( ) EPS adjusted EPS reported BVPS DPS Profit & Loss ( M) Net sales 1,620 1,657 1,798 2,079 2,074 Operating expenses -1,426-1,470-1,605-1,847-1,840 EBIT Net interest expense Non-operating/exceptionals Pre-tax profit Tax Extraord./Min.Int./Pref.div Reported net income Adjusted earnings Adjusted EBITDA Growth Rates (%) Sales EBIT adjusted EBITDA adjusted EPS adjusted Cash Flow ( M) Operating cash flow Depreciation/amortization Net working capital Investing cash flow Capital expenditure Acquisitions/disposals Financing cash flow Borrowings Dividends paid Change in cash Balance Sheet ( M) Total assets 1,869 1,872 1,999 2,123 2,188 Cash & cash equivalent Accounts receivable Net fixed assets Total liabilities 1,243 1,362 1,470 1,555 1,580 Accounts payable Total Debt Shareholders' funds Profitability/Solvency Ratios (%) EBITDA margin adjusted ROE adjusted ROIC adjusted Net debt to equity Total debt to capital

3 Contents Investment Thesis 4 A Former Sleeping Beauty 7 The Italian Leader 7 Vive la France 11 A E Zero-Growth Business 12 Valuation 14 Cash-Flow Approaches 14 Us & Them (Consensus) 18 Stock Performance 18 Risks 20 The Italian Operations 21 Business Units in depth 21 Magazines 21 The Advertising SBU 29 Books 30 Printing 33 Direct & Retail 35 France: EMAP acquisition 37 Financials 43 Shareholder Structure 47 Some more background on Mondadori 48 Arnoldo Mondadori Editore 50 Appendix A

4 Investment Thesis Mondadori is the leading publisher of magazines and books in Italy and it has one of the largest printing facilities in Europe. For many years Mondadori has been seen by investors as a sleeping beauty : a well-managed company with little organic growth coupled with a limited appetite for acquisition and new media initiatives while media laws capped M&A in Italy. After having lost some market share in the key magazine business, Mondadori decided to go shopping abroad while buying EMAP France for 551m in August However, this move has not solved Mondadori s original short-comings: i) the lack of growth opportunities and ii) the need to enter new media to cope with secular trends in the advertising industry. We fear that most of the optimistic expectations on France (e.g. cross-selling, cost synergies) will fail to materialize, while the launch of Grazia in France is unlikely before With or without France, Mondadori s growth looks set to remain uninspiring at best, at least for 2007 and But the stock doesn t come cheap: FCF and DCF point to values ranging from 6.66 to 7.61 (worst case FCF without Grazia/ best case DCF including it), while on multiples the stock appears fairly valued on 2007 and at a premium on Accordingly, we initiate coverage with a 7.30 target price and a 3M (Sell/ Medium Risk) rating. The sound Italian businesses are now ex-growth We believe that Mondadori is suffering a mid-life crisis, in the wake of the extremely good results the current management achieved over the last decade when re-vitalizing the lacklustre businesses of the early nineties. Now Mondadori is market leader in whatever it does and enjoys some of the highest margins in its sector: books 17%, magazine 15% and printing 7.5%. However the growth in these segments is not expected to beat inflation. More worryingly, add-on sales (which have a positive impact on the three business lines) have probably peaked and this could negatively impact results from 2007E onwards. Hence, we see little if any organic growth ahead, while the cost-base is set to grow by inertia. (Note that Mondadori is due to report results on March 28.) 4

5 Figure 1. Italian Operations 2005A-2009E 2005A 2006E 2007E 2008E 2009E Magazine Books Printing Advertising Direct & Retail Others Total 2, , , , ,168.6 Intercompanies (529.0) (499.8) (503.6) (508.6) (513.7) Net Revenues 1, , , , ,654.9 EBITDA EBITDA margin 13.5% 12.7% 12.9% 13.2% 13.7% Growth -6.7% -5.3% 1.1% 2.4% 3.7% Change YOY Magazine 2.3% -5.2% -3.0% -1.6% -1.6% Books 2.5% 2.7% 1.8% 1.8% 1.8% Printing 2.1% 0.5% -1.8% -0.2% -0.2% Advertising 1.3% 1.0% 1.0% 1.0% 1.0% Direct & Retail 18.6% 0.8% 3.9% 2.1% 1.2% Others 16.0% 21.4% 16.8% 10.8% 6.4% Total 3.3% -0.8% -0.4% 0.2% 0.2% Intercompanies 6.5% -5.5% 0.8% 1.0% 1.0% Net Revenues 2.3% 0.7% -0.8% 0.0% -0.1% Source: Company reports and Citigroup Investment Research estimates Could Mondadori grow in Italy by external growth? Unfortunately not - apart from bolt-on acquisitions - given both the group s leading position and media laws. Hence, Mondadori has had three challenging alternatives: i) return cash to shareholders; ii) invest in new media and dilute margins or iii) go abroad. And the management decided to buy EMAP France for 551m. Vive La France! Although in the short term such a move might divert attention from the uninspiring Italian outlook, we believe that it doesn t solve Mondadori s mid-life crisis. While we see execution and culture clash risks, we also believe that it may be very difficult to stop the downward trend experienced by EMAP s topline, especially for a newcomer in a much more competitive market. We also believe that the French market is not very interested in add-on sales and in most of Mondadori s key titles. And costs synergies are likely to remain on paper for more than a while (e.g. printing French magazines in Italy ). So what is left? Grazia of course! This Italian women magazine has been experiencing much success in the UK since EMAP Plc launched it in Mondadori want to duplicate such success in France. Although we fully appreciate Mondadori s point on Grazia, we would rule out any launch before 2008 and any impact on the bottom line before 2009 or

6 Figure 2. Best Case vs. Worse Case 2007E-2010E 2007E 2008E 2009E 2010E Best Case Revenue 2, , , ,142.9 EBITDA EBITDA Net Income Base Case Revenue 2, , , ,062.7 EBITDA EBITDA Net Income Best Case/Base Case Revenue 100% 101% 102% 104% EBITDA 99% 96% 103% 110% EBITDA 99% 95% 104% 112% Net Income 99% 95% 104% 113% Source: Citigroup Investment Research analysis Hence we fear that Mondadori hasn t sorted out its mid-life crisis with its French campaign. Sooner or later, we believe the group will have to address its strategic vision and though dilutive in the short term Mondadori should embrace new media with more enthusiasm (as Espresso is doing, though failing to monetize in the short term despite a very good strategy). Valuation hardly compelling Being a non growth business does not necessarily imply a Sell recommendation. But in Mondadori s case, we believe that the stock doesn t come cheap either. We valued Mondadori using both free-cash flow approaches and multiples. Our average FCF and DCF valuations point to a fair value of 7.33, by weighting base case with a best case scenario that envisages a success launch of Grazia in France. And Mondadori doesn t come cheap on 2008 multiples either. Little growth, pricey stock: why be long? Accordingly we initiate our coverage with a Sell (3M) rating and a target price of 7.30 per share. 6

7 A Former Sleeping Beauty The Italian Leader Mondadori is one of the leading Italian media groups, operating in several businesses: books, magazines, printing, advertising, direct marketing, retail and radio. Mondadori is among market leaders in all areas except radio. Generating revenues in excess of 1,700m, the Italian businesses offer limited space for organic growth while external growth is capped by antitrust and media bills. Accordingly, Mondadori moved abroad in 2006 via the acquisition of EMAP France (now Mondadori France), the third largest magazine publisher in France with revenues in the range of c 425m (our estimate for 2007). Breakdown of gross revenues is summarised in the following tables. Figure E Revenues by main Business Unit Figure E Revenues by Geographic Area Direct&Retail 7.7% Books 17.2% Abroad 18% France 16.4% Printing 17.5% Advertising 13.5% Magazines 27.7% Italy 82% Source: CIR Estimates Source: CIR Estimates Following the French acquisition, magazines will account for 44.1% of gross revenues in For 2007 we estimate gross revenues of 2,582.6m and net revenues of 2,079m with most of intra-groups affecting advertising (captive 84% or 291.3m corresponding to 11.3% of gross revenues) and printing (captive 59% or 268m corresponding to 10.4% of gross revenues). Although Mondadori is a media company, the business is little geared to advertising while failing to cover the whole spectrum of media. Figure 5. Competitive Positioning of Leading Media Groups in Italy Espresso Mondadori RCS Mediaset National newspapers Local Newspapers Magazine Radio TV Internet Source: Citigroup Investment Research 7

8 We now summarise a brief overview of the different SBUs while providing an in-depth analysis in the next chapters. Given that 2006 will consolidate only four months of Mondadori France, all of SBU weights as indicated in the following snapshots are related to the Italian operations only. As a starting point we provide a flavour of 9M06. Figure 6. Mondadori Business Units Key Data ( m) Magazine 2004A 2005A 9M05A 9M06A* Sales EBITDA Books Sales EBITDA Printing Sales EBITDA Advertising Sales EBITDA Direct & Retail Sales EBITDA Others & Radio Sales EBITDA Intercompany Sales TOTAL Sales 1, , ,230 1,233.8 TOTAL EBITDA *Mondadori France is included in the results from Sept06. Source: Company Reports and Citigroup Investment Research Magazines generate the bulk of Mondadori s revenues (c.34.0% of group s gross revenues in 2006E). Revenues of magazine SBU can be divided in advertising (29.7% in 2006E), add-on sales (27.6%) and core circulation (41.2%) which can be further split into newsstands (c.85-90%) and subscription. In the 9M 06, the three sources of revenues were experiencing different trends: circulation and add-on sales were down 8.3% and 11.8% respectively while advertising was marginally up by 1.3%. Although price increases in Q4 might help circulation, we believe add-on sales and advertising will not invert their trends and our estimates point to revenues of 737.5m, down 5.2% YoY. Having no launches in the pipeline, we expect flattish performance in It is worth noting that Mondadori has been losing some market share to new entrants over the last few years (Cairo Communication), resulting in lower copies sold and a lower base to leverageoff for add-on sales. Finally, we expect a further decline in add-on sales due to the growing maturity of the business while we see advertising growing in line with inflation. Magazines enjoys a healthy EBITDA margin in the range of 15.1% but add-on sales profitability is above 20%. Due to the limited weight of advertising, the operational gearing is pretty modest. 8

9 Books: In 2006E Mondadori should reach revenues of 436.6m (or 20.1% of Italian gross revenues) corresponding to a market share of c. 28% in Italy. Books have been experiencing fair growth in recent years as reading books gained in popularity (Italy still has one on the lowest reading population in Europe) in the wake of both add-on sales and Dan Brown s phenomenon. We deem that Mondadori enjoys one of the highest EBITDA margin across Europe (17% vs. an estimated average of 14%), although part of these margins can be ascribed to add-on sales (5% of sales but 30% of EBITDA). We estimate 2.7% growth in 2006 (2.2% for the 9M 06) but we see flattish performance for 2007, given the likely free-fall in rights for add-on sales sold to competitors (for Espresso we estimate a -30% tumble). We see a flattish/slightly declining EBITDA margin of 17% again the industry best practice across Europe for large publishers. Printing: Mondadori owns and operates one of the biggest printing facilities across Europe. In 2006E revenues should account for 461.4m (+0.7% in 9M06) or 21.3% of gross revenues (in line with 2005) with a 58% / 42% split between captive and third parties. Printing is benefiting from an add-on sales boom enjoyed by the whole sectors in Italy even though margins are suffering from spikes in energy costs. Although in the longer term Mondadori could in-source some of the printing for EMAP France (notably monthly magazines), we deem this unlikely to happen in We thus see a flattish 2007 with declining margins due to lower contribution from add-on sales. Advertising: Mondadori Pubblicità should account for 15.9% of 2006 Italian gross revenues while posting a +0.4% growth YoY. This SBU is mainly captive (84%) though it collects advertising for third parties as well (including newspaper Il Giornale). Captive advertising running at zero margin is cancelled off when consolidated accounts are taken into consideration. Being mainly intra-group, EBITDA margin of the SBU is very modest (in the range of 0.8% or 5% of third parties ad-collection) and we see little room for improvement. Mondadori is exposed mainly to slow growth magazines and second/third tier publishers, resulting in under-performance of the overall advertising industry. Accordingly, we expect a very modest increase from 2007 onwards. Direct & Retail: This SBU includes very different businesses: direct marketing, property stores and franchising network. Direct marketing ( 22.8m of sales in 2006E) is a small but profitable business, which is fading away because of more stringent laws on privacy. Retail ( 94.1m and 48m for own stores and franchising in 2006E) is a low margin business which anyhow has a big strategic rationale for Mondadori which can directly test authors and books. For the 9M06, Direct marketing, through CEMIT services, generated 17.2mn revenues (-16.1% YoY) and 93.3mn (+4.1% YoY) in the Retail business through Mondadori Retail and Mondadori Franchising. We see revenues reaching 164.9m in 2006 with an EBITDA of 7.3m. We expect flattish performance in 2007 with the EBITDA margin hovering around 4.4%. 9

10 Radio: Mondadori is a new entry in the sector. The radio unit was started up in 2005 with the acquisition of Radio 101, a national Italian broadcaster with a 30-year history. This business reported 6.1mn revenues in 9M06 ( 2.8mn in 9M05) and is a fast-growing one combining brand awareness, intensification of communication activities and the acquisition of new frequencies, the latter leading to a 85% coverage. Although highly synergic with some key magazine and add-on sales (notably Sorrisi & Canzoni TV), radio is a small business and it will take quite some time before it can make any difference on the bottom line. We note that Radio DeeJay (owned by competitor Espresso) the established market leader had revenues of 60m with an EBITDA margin above 50% in Radio 101 should have revenues of 8.2in 2006 growing to 11.9m in 2007, but EBITDA should be negative in both years while achieving break-even from 2008 onwards. Uninspiring Italy All in all we expect the following trend for the Italian business from 2005A to 2007E. Figure 7. Mondadori Italy: Key Data per Business Unit ( m) Magazine 2005A 2006E 2007E Sales EBITDA Books Sales EBITDA Printing Sales EBITDA Advertising Sales EBITDA Direct & Retail Sales EBITDA Others (Radio included) Sales EBITDA Intercompany Sales TOTAL Sales Italy 1, , ,656.0 Total EBITDA Italy Source: Company Reports and CIR Estimates Although the word flattish might appear redundant while reading the above description of the different businesses, we think it is quite appropriate to use in describing the Italian business: it is a very simple and sound one, highly predictable but offering little if any room for organic growth. Even worse, the combination of i) fierce competition from new entrants (like Cairo Communication on blockbuster TV/gossip magazine segment), ii) the lack of any exposure to new media and iii) the difficulties of creating community on Mondadori proprietary content has in our view started to weaken the market position of Mondadori in its core magazine business. The declining trend of add-on sales (both captive and third parties we expect a 30% free-fall in 2007 sales for market leader Espresso) should negatively impact magazine, printing and books. All in all, we see little if any organic growth ahead, while costbase is set to grow by inertia. 10

11 Could Mondadori grow in Italy by external growth? We see very little scope for external growth in Italy apart from bolt-on acquisitions, given i) the group s leading position limits the opportunity to make acquisitions in books and the magazine sector, which may impact the bottom line; ii) Media laws prevent Mondadori from entering newspapers, while iii) being controlled by Fininvest (which controls Mediaset) expansion in TV does not appear an option. Although Mondadori could expand into new media mirroring RCS Mediagroup in its acquisition of Dada we believe the management is still unconvinced by the potential of new media (or prefers to monetize new media in the short term). In sum, Mondadori s Italian operations are zero-growth businesses and external growth is capped. Competition is getting stiffer on magazines while books and printing are likely to suffer from add-on sales and direct marketing is fading away. Having little room to revert such unwelcome trends (apart from new media which are not exploited for the time being), Mondadori has had two key alternatives: i) return cash to shareholders or ii) go abroad. This time the management decided to go for the bolder strategy: entering the French market. For a traditionally cautious Mondadori, this represents a form of U-Turn strategy. Management in the past had suggested, in effect, that Mondadori was born to be number one and didn t want to be second tier in other countries. The key vision of the recent Mondadori past had been to be a mono-country/multiproduct market leader. Vive la France In August 2006 Mondadori acquired EMAP France for 551m in cash while establishing itself as the third largest magazine publisher in the highly competitive French market (EMAP has some 12% market share and some 40 titles). EMAP France had a proven track record of rolling out EMAP Plc s successful portfolio of UK brands. EMAP France s annual circulation exceeded 200 million copies and it publishes three of the top 20 weekly magazine in France and five of the top 20 monthly magazine. EMAP France had revenues in excess of 440m (gross revenues of 516m including distribution) with an EBITDA margin in the region of 13.4%. Similarly to Italian magazines in 2006, EMAP France had been suffering from top-line decline, especially in TV listings. Why EMAP France? The rationale behind the acquisition of EMAP France (now Mondadori France) can be summarised in the following table. Figure 8. Mondadori/EMAP Synergies (medium term) Initiatives Mondadori Estimate Launch of Mondadori in France in new segments +++ Import of Emap France (in Italy & in the Mondadori intl. ++ network) Economies of scale in paper procurement + Optimisation of existing printing capacity + Possible export of the add-on sales model To Be Defined Source: Company Reports 11

12 We also believe that Mondadori also wanted to finally gear up its highly inefficient financial leverage. All of the above issues make sense at least on paper. But how realistic are they? We think that some caution is in order. It might be very difficult to stop the downward trend experienced by EMAP s top-line, especially for a newcomer in a much more competitive market. We do believe that add-on sales success in Italy is due to the capillarity of newsstands across the whole of Italy supplying the high fragmentation of traditional retail distribution. In France, such a competitive advantage is likely to disappear limiting the potential for add-ons. Although Mondadori has more than 50 titles in its Italian portfolio, we believe that very few (notably Grazia) could be successfully exported to France probably the most competitive market in Europe. Recent launches of Mondadori in Italy have had mixed success. The above described cost synergies are unlikely to be achieved anytime soon. Taking printing as an example, we note that only monthly magazine are likely to be interested but Mondadori France is likely to expect natural expiration of current contracts. And logistic costs might reduce the overall benefits. In conclusion, we think that only a successful launch of blockbuster Grazia magazine in France could create significant value for Mondadori s shareholders. Mondadori believes that Grazia s segment (affluent women above 40 s) is underpenetrated even in a mature magazine market like the French one. Such an optimistic view is based on the very good performance experienced by Grazia UK licensed to EMAP Plc since its launch in February 2005 while reaching around 60m in revenues in 2006 with (we estimate) a 60:40 split between advertising and circulation (c200k weekly copies in line with Italian circulation). Assuming Grazia was to replicate the UK s amazing success in France, Grazia could reach revenues above 70m by 2010 while SBU s advertising would reach 44% from 35% on a stand-alone basis. This would translate into a long-term EBITDA goal of 20% (well above the 13.4% currently experienced by Mondadori France) while costs for the launch should be in the region of 15m. In such a scenario, Grazia s NPV could be valued in the region of 200m or c37% of the price paid for EMAP France making the acquisition by far more attractive. However, Grazia s launch could happen in Q4 07 at best and the impact on the bottom line (considering a 10-15m costs associated to its launch) is unlikely to be seen before A E Zero-Growth Business On the basis of the above snapshots, we estimate Mondadori will achieve the following results between 2005A and 2007E (assuming four months of Mondadori France in 2006E). 12

13 Figure 9. Group Sales 2005A-2009E ( m) Sales 2005A 2006E 2007E 2008E 2009E Italy 1, , , , ,654.9 France Total 1, , , , ,004.4 Change YOY Italy 2.3% 0.7% -0.8% 0.0% -0.1% France n/a n/a n/a -0.9% -0.8% Total 2.3% 7.9% 12.5% -0.1% -0.2% Weight Italy 100.0% 93.3% 82.3% 82.5% 82.6% France 0.0% 6.7% 17.7% 17.5% 17.4% Total 100.0% 100.0% 100.0% 100.0% 100.0% Source: Company Reports and Citigroup Investment Research To a nutshell, Mondadori is a sound business operating in a domestic mature market which has increased its operating risk while entering into an even more mature market with a weaker market positioning. This hardly sounds the sexiest investment case unless the valuation is attractive. But how compelling is Mondadori s share price? 13

14 Valuation Mondadori has traditionally been a highly predictable business operating in a mature industry and with limited gearing to advertising accounting for just 16% of total estimates in 2007E. The base case scenario we envisage for the recently acquired EMAP France doesn t change the overall outlook of flattish revenues and EBITDA. Hence, Mondadori can be defined a cash-cow and accordingly we believe that cash-flow based approaches are the most appropriate ones to value Mondadori, while trading multiples provide a necessary sanity check. Finally, we attribute a separate value to Grazia France a core project for Mondadori following the acquisition of EMAP France. Cash-Flow Approaches We value Mondadori using both a 5-year DCF and a FCF on three-year normalized cash-flow. DCF Our DCF embodies full projection till 2011 while assuming that from 2011 onwards capex would match depreciation and there will be no longer working capital requirements. We calculate a WACC of 7.4% for Mondadori while calculating terminal value using a Gordon Growth model assuming a 1% longterm growth below the long-term inflation rate of 2%. Such a conservative rate reflects the long-term risks hanging on circulation, add-on sales, new media s threats and execution risks in France. We also note that from 2006 onwards we see flattish revenues and EBITDA (eg. Italian sales of 2011E are 0.99x of 2005A while 2011 EBITDA of Italian operations is around 1.1x but 2010 is just 1.05x). Figure 10. How Sales and EBITDA are expected to Evolve 2005A 2006E 2007E 2008E 2009E 2010E 2011E Italy Sales, 2005= % 100.7% 99.9% 99.9% 99.8% 99.8% 99.8% France Sales, 2007=100 n/a n/a 100.0% 98.8% 97.7% 96.6% 95.6% Italy- EBITDA, 2005= % 94.7% 95.8% 98.0% 101.6% 105.7% 110.3% France EBITDA, 2007=100 n/a n/a 100.0% 98.0% 96.2% 94.3% 93.3% Source: Citigroup Investment Research In any case we note that the WACC we use for Mondadori is much lower than the one we use for Espresso: Figure 11. WACC A comparison between Mondadori and Espresso Mondadori Espresso Cost of Equity 8.6% 8.9% Leverage 25.0% 20.0% WACC 7.4% 8.0% Long Term growth 1.0% 1.0% Source: Citigroup Investment Research 14

15 It s worth anyhow noting that according to Bloomberg, Mondadori beta of 0.87x is higher than Espresso s one of Accordingly, the cost of equity of Espresso should be lower than Mondadori s one. However, we acknowledge that beta for Italian companies are often affected by liquidity and hence we calculate a higher cost of equity for Espresso to take into consideration higher operating gearing to advertising. Finally, we assume two scenarios: Base Case assuming no major impact from the launch of Grazia in France. Such a scenario points to a value of 7.09 per share; Figure 12. DCF Valuation Base Case Scenario m DCF valuation mln % PV of future cash flows % PV of Terminal value 1, % Enterprise value 2, % Net debt Minorities 0.0 Equity value 1,748.0 number of share Treasury shares m 5.0% Fair Value per share 7.09 Source: Citigroup Investment Research Best Case scenario assuming a successful launch of Grazia in France in In this case, our valuation would point to In such a scenario, we attribute a higher WACC to reflect higher execution risks but we assume a higher long-term growth to fully factor-in France s opportunity. Figure 13. DCF Valuation Best case Scenario m DCF valuation mln % PV of future cash flows % PV of Terminal value 1, % Enterprise value 2, % Net debt Minorities 0.0 Equity value 2,031.2 number of share m Treasury shares 5.0% Fair Value per share 8.24 Source: Citigroup Investment Research We attribute a 55:45 weight to base case and best case scenario resulting in a DCF fair a value of 7.61 per share, some 6% below the current price. Such value is calculated on an adjusted number of shares to sterilize treasury stocks owned by Mondadori linked to a convertible bond (7.27% of which 5% related to a convertible bond). 15

16 The terminal value accounts for roughly 75% of the enterprise value, leaving space for huge sensitivities on the fair value: as it often happens, in-depth strategic analysis might vary widely as a result of a few basis points change in either WACC or long-term growth. Figure 14. Sensitivity WACC/Long Term Growth Base Case Long-Term Growth /WACC 6.75% 7.00% 7.25% 7.50% 7.75% 8.00% 0.0% % % % % % Source: Citigroup Investment Research FCF Yield FCF yield approach on normalized cash flows of leads us to value Mondadori at 6.66 per share or 7.43 per share if Grazia France is included. Lower value of FCF compared to DCF reflects the short-term uninspiring results expected for Mondadori in 2007E-2009E (both Italy and France should achieve flattish EBITDA from 2006E to 2009E not even recovering inflation) while Grazia France if successful will start generating an impact on the bottom line from 2010E onwards while 2007E/08E will also be affected by costs associated to its launch. Figure 15. FCF Valuation ( m) 2007E 2008E 2009E Sales 2,079 2,074 2,068 EBITDA Adj. Taxes (88) (89) (90) Adj. Change NWC (14) (14) (14) Maintenance Capex (38) (39) (40) Free Cash Flow (FCF) Net debt (cash) Minorities FCF/Sales 6.1% 6.2% 6.2% Hurdle rate 7.4% 7.4% 7.4% Expected growth rate 1.5% 1.5% 1.5% Discount Rate 5.9% 5.9% 5.9% Target EV/Sales Multiple Target EV 2,153 2,173 2,165 Fair Equity Value (EV- 1,597 1,648 1,675 Debt+Own shares) Shares outstanding Treasury shares 5.00% 5.00% 5.00% Fair Value per share Average 6.66 Source: Citigroup Investment Research 16

17 Assuming a 50:50 weight to the two scenarios, we reach a fair value of 7.05 per share. The difference in the result provided by the two free-cash-flow methodologies reflects our assumption that Mondadori stands to benefit from the French acquisition from 2009E at best. Assuming a 50:50 weight for both DCF and FCF, we would reach a fair value of 7.33 per share. Peers We tend to not put too much weight on peer comparisons as often companies included in a sample offer only a limited little degree of comparability. In the case of Mondadori, we believe that the Italian competitors like RCS and Espresso have significant differences in their business model: Mondadori: i) doesn t have newspapers; ii) it is less geared to advertising than Espresso and RCS; iii) operates in two countries (Italy and France); iv) it is market leader in books; v) operates bookstores. Espresso (ESPI.MI ; 2M): i) fully domestic covering the whole spectrum of media; ii) market leader in newspapers, radio and internet; iii) little exposure to magazine; iv) highly exposed to advertising cycle. Espresso is probably the best comparable competitor. RCS (RCSM.MI ; Not Rated): operates in three countries (Italy, France, Spain) and it has large operations in books and little exposure to radio. RCS is a good peer in theory, but being a fairly illiquid stock it tends to be highly responsive to political developments (as the sharp rally that took place in 2005 suggests), and so its multiples might be somewhat misleading. RCS is not currently under Citigroup coverage so we use consensus as provided by Bloomberg, but note that consensus may not be particularly accurate. Figure 16. Italian Peers Price PE Ratio EV/EBITDA 21/03/ E 2008E 2009E 2007E 2008E 2009E Espresso RCS Average Mondadori Source: Citigroup Investment Research, Bloomberg On Italian peers, Mondadori is trading at discount on PE multiples and broadly in line on EV/EBITDA if 2007 is considered. However if growth is taken into account, Mondadori would be trading at premium to Espresso s EV/EBITDA for both 2008 (4%) and 2009 (14%). RCS data is more erratic as the stock is currently not widely covered. We deem EV/EBITDA as the most appropriate multiple. Hence Italian peers suggest that Mondadori is fairly valued at best. If analysis is extended to Europe, Italian media appear pretty expensive. However, we do believe it is relevant to note that Italy is still little exposed to the internet and classified revenues: some of the immediate threats confronting European publishers are having less of an impact on Italian profits. 17

18 Figure 17. European Peers Company Name Price PE EVEBITDA 21/03/ E 2008E 2007E 2008E Grupo Prisa Lagarder Groupe Emap PLC Pearson PLC Gruppo Editoriale l'espresso SpA Weighted average Source: CIR Estimates. (PRS.MC ; 1M); (LAGA.PA ; 2M); (EMA.L ; 2M); (PSON.L ; 1M) Us & Them (Consensus) Consensus on Mondadori as provided by Bloomberg may not be the most reliable benchmark as we deem it still reflects estimates for 2006, which do not incorporate Mondadori France. The farther out the horizon the better as it is likely only analysts with active coverage on Mondadori provide estimates for Our estimates are essentially in line with 2008E consensus for top line, EBITDA and net income. Figure 18. Citigroup and Consensus 2006E 2007E 2008E Revenues Citigroup 1, , ,074.3 Bloomberg 1, , ,048.5 Difference 4.3% 8.0% 1.3% EBITDA Citigroup Bloomberg Difference 1.7% 5.5% -1.1% Net Income Citigroup Bloomberg Difference -5.4% 5.0% -0.9% Source: Citigroup Investment Research, Bloomberg Summary In conclusion, we value Mondadori mainly on cash flows while trading multiples provide a necessary sanity check. We choose to give equal weight to DCF, which tends to capture future trends, and an FCF yield approach based on sustainable free-cash flow. We further weight such results by taking into consideration a base case scenario and a more bullish one envisaging a successful launch of Grazia in France (45% success rate in DCF). By cross-weighting such approaches, we believe we have reached a reasonable level of sensitivity on Grazia the only key driver which might impact the group bottom line. 18

19 Stock Performance Although the stock missed the market rally that Italian stocks have been experiencing over the last few years, Mondadori performed relatively well compared to Espresso its best peer and other Italian media stocks. Figure 19. Mondadori Stock Performance vs. Mibtel /19/2006 4/19/2006 5/19/2006 6/19/2006 7/19/2006 8/19/2006 9/19/ /19/ /19/ /19/2006 1/19/2007 MNDI.MI Mibtel 2/19/2007 3/19/2007 Source: Powered by datacentral Figure 20. Mondadori Stock Performance vs. Italian Media /19/2006 4/19/2006 5/19/2006 6/19/2006 7/19/2006 8/19/2006 9/19/ /19 / /19/ /19/2006 1/19/2007 2/19/2007 3/19/2007 MNDI.MI ESPI.MI RCSM.MI MS.MI Source: Powered by datacentral 19

20 Risks We rate Mondadori as Medium Risk. The risk rating on the stock derives from a number of factors. These factors include an assessment of industry-specific risks, financial risk and management risk. In addition, we consider historical share price volatility, based on the input of the Citigroup Investment Research quantitative research team, as a possible indicator of future stock-specific risks that may potentially impede the shares from achieving our target price. Mondadori is highly depend on add-on sales which sell i) directly to consumers and ii) indirectly to competitors in the form of rights. Margins from add-on sales are in the range of 60m or 22% of 2007E EBITDA. However, add-on sales may have peaked resulting in lower future margins. Mondadori is little exposed to advertising compared to other media companies. However, the focus is entirely on magazines which are a very old media, late cycle and with very limited upside if any. The same trend could be envisaged for magazine circulation, which could more easily fall from current levels than expand. Traditional media are highly exposed to the Internet and Mondadori lacks exposure to new media. Mondadori has invested 551m to buy EMAP France and diversify into a very competitive market. Given the results achieved by the French business in the recent past (accelerated trends of what Mondadori is experiencing in Italy in the magazine industry), we see little space for Mondadori to reverse the trends in the short term. However, Mondadori might succeed in re-launching this business while creating value for its shareholders. 20

21 The Italian Operations Business Units in Depth Business divisions in Mondadori Group comprise: books, magazines, advertising, printing, direct & retail, radio and other, where books and magazine sectors represent its biggest revenue drivers. Overall, the first four segments are among the leaders in their categories. Figure 21. Revenues by Division 2004A-2007E ( m) 9M2005A 9M2006A FY2004A FY2005A FY2006E FY2007E Books YoY chg 1.9% 2.2% 19.1% 2.5% 2.7% 1.8% Magazines YoY chg 3.6% -1.0% -2.8% 2.3% -5.2% -3.0% Advertising YoY chg 1.4% 0.4% -3.2% 1.3% 1.0% 1.0% Printing YoY chg -0.5% 0.7% 29.2% 2.1% 0.5% -1.8% Direct YoY chg 12.0% -16.1% -93.4% -12.3% -13.7% 2.0% Retail YoY chg 28.6% 4.1% -67% 27.2% 3.6% 4.3% Radio YoY chg - n.s % 45.1% Corporate and other business YoY chg 5% -5.3% % 2.0% 2.0% Intergroup sales YoY chg 8.4% 0.7% ns 6.5% -5.5% 0.8% Total consolidated revenues 1, , , , , ,656 YoY chg 1.5% 0.3% 5.4% 2.3% France Circulation Advertising TOTAL Revenues 1, , , , , ,079.0 YoY chg 1.5% 0.3% 5.4% 2.3% 7.9% 16.3% Source: Company Reports and Citigroup Investment Research estimates Although a media company, Mondadori is little geared to advertising which can be split between advertising accounted in the magazine and radio SBUs and revenues accounted in the advertising SBU. The latter collects advertising both for Mondadori and third parties. Captive advertising accounts for around 84% of advertising SBU and is eliminated when consolidating Mondadori s accounts. Magazines Mondadori is publishing over 50 titles generating revenues of 778.1m in 2005 but for FY 2006 we expect revenues of 737.5m, some 5.2% below According to ADS, Mondadori is market leader in Italy with a 38.7% circulation market share and 29% in advertising. 21

22 Figure 22. Magazines - Market Share in Italy, 2005 Other Publishers 18.5% Condè Nast 2.5% Mondadori Group 38.7% Cairo 11.1% Universo 10.0% Hachette Rusconi 7.6% RCS 11.5% Source: ADS certified: 2005 publisher s estimate Magazine s sales can be divided into: circulation, add-on sales and magazine. Each of these activities has different drivers of growth with circulation the main driver. Breakdown can be summarised as follows. Figure 23. Magazine s Key Drivers 2004A-2006E 2004A 2005A 2006E Circulation Add on Sales Advertising Others Sales Change YOY Circulation -23.9% -7.1% -5.7% Add on Sales 40.9% 23.7% -11.1% Advertising -33.8% 0.1% 1.0% Others -13.8% 9.2% Sales -2.8% 2.3% -5.2% Weight Circulation 45.6% 41.4% 41.2% Add on Sales 24.3% 29.4% 27.6% Advertising 28.5% 27.8% 29.7% Others 1.6% 1.4% 1.6% Sales 100.0% 100.0% 100.0% Source: Company Reports and Citigroup Investment Research The split between newsstand and subscription is around 85-90: Titles included in Mondadori s portfolio comprise several block-busters, including those in Figure 24 below. 22

23 Figure 24. Mondadori Key Titles Title Focus Frequency Circulation Main Driver Sorrisi & Canzoni TV TV Weekly above 1,100 Circulation Add-on Chi Gossip Weekly above 500 Circulation Advertising Donna Moderna Women Weekly above 500 Circulation Panorama News Weekly above 500 Add-on Advertising Circulation Grazia Women Weekly above 200 Advertising Flair Women Monthly above 150 Advertising Star TV TV Weekly above 150 Circulation Source: Company reports and Citigroup Investment Research Core Circulation Core Circulation revenues (excluding add-ons) were down 8.3% in the first 9M of 2006 as a result of three main factors: A 4% fall in volumes; A 3.5% fall due to price-mix effect on bundled initiatives (i.e. selling two magazines packed at lower prices); A 1% fall due to tough comparison with 9M 05 which included a couple of launches in the TV segment. Starting from July, Mondadori gradually increased its cover price and this move should allow the SBU to limit decline for the FY2006 (which we estimate falling by 5.7%) while providing an easy comparison for 2007E. It is important to note that the fall in volumes is due mainly to three factors: i) maturity of the sector; ii) aggressive launches from competitors (notably Cairo Communication in 2005) directly competing with Mondadori block-busters; and iii) the absence of new launches (by both Mondadori and main competitors in 2006). Mondadori is not planning any big launch for 2007 while budgeting some re-styling (currently undergoing for Panorama). Launches are important to revitalise brands and segments. Usually a title reaches the highest circulation in the first months and then declines. It is important to note that the recent launches of Mondadori have had mixed success (eg. Flair), further signalling the maturity of the industry. Unfortunately, we see a rather uninspiring future for magazines which are increasingly competing with the Internet and in the case of news magazine with newspapers. So we don t expect core circulation to achieve a healthy growth rate in future years while implied profitability looks set to remain well below the SBU average. We actually forecast a -3% circulation decline from 2007E onwards. Weak core circulation might imply weaker add-on sales. 23

24 Add-On Sales Mondadori has established a strong position in the Italian add-on sales market in two ways: Reaching revenues of 228.6m sales in 2005, ahead of any other player; Selling rights to other publishers (accounted in the books SBU). While exploiting a portfolio of 50 titles with several focus and targets, Mondadori has been selling everything from CDs to underwear. Mondadori is now shifting its focus on high quality/high content products while dropping CDs and clothing. Figure 25. Break-down of Add-on Sales in 2005A (%) W omen's products 10% Books 15% Music 20% CD-Roms 4% VHS 4% DVD 47% Source: Company Reports and Citigroup Investment Research Since 2003, add-on sales have been experiencing the following trend. 24

25 Figure 26. The Long Run ( m) A 2004A 2005A 2006E Source: Company Reports and Citigroup Investment Research estimates In the first 9M of 2006 add-on sales were down 11.8% (lead by a -88% free-fall in VHS and a -16% in music CDs) and we expect only a marginal recover in Q4E which should lead to a -11.1% for the year to 203.3m. Having said this, we expect Mondadori to have enhanced its margin on 2006E initiatives to above 20% (still far away from Espresso s 30%-like). As often happens at the beginning of the year, add-on sales tend to be viewed as a rather risky business on its way out despite the outstanding success of the last few years. However, we believe that the add-on is here to stay, even if it is reasonable to assume that the contribution to the bottom line will not attain 2003A-2006E levels. Once again, we believe that add-ons are a recurrent business for Italian publishers because of the structure of Italian distribution channels, which lack capillary organisations covering the entire territory. Newsstands, with a 40,000-strong network, allow publishers to reach a much wider audience than booksellers or traditional retail, sparking a vicious circle on other ancillary products. Mirroring 2006 strategy, we expect Mondadori from now on to concentrate more on strengthening the quality of its products, rather than developing new initiatives. That said, we expect a further 7.7% fall in 2007E and -3% decline onwards as we deem that the market is over-saturated. It is important to note that we estimate Mondadori to do much better than its competitors (we see a 30% free-fall for Espresso in 2007E); in our view such resilience is due to the wider portfolio of titles which reach a large chunk of the Italian population relative to Espresso which tend to target people with a more literary inclination. 25

26 As far as profitability of the business is concerned, we expect Mondadori to slightly increase margins and keep them above 20% threshold, above the SBU average. Advertising As previously said, within the Mondadori group, advertising is accounted in both magazine (and radio) SBU and in a separate SBU which mainly accounts captive advertising (c.84%) collected on behalf of Mondadori s titles. We first analyse magazine advertising which is a late-cycle/slow growth business. Figure 27. The Italian Advertising Industry 2002A-2007E ( m) 2002A 2003A 2004A 2005A 2006E 2007E Newspapers 1, , , , , ,860.5 Magazines 1, , , , , ,325.6 Print 2, , , , , ,186.1 Television 3, , , , , ,751.0 Radio Outdoor Cinema Internet Total advertising 7, , , , , ,887.0 Change YOY 2003A 2004A 2005A 2006E 2007E Newspapers -2.9% 2.5% 2.7% 3.2% 2.0% Magazines 1.0% 0.5% 4.5% 5.9% 2.2% Print -1.3% 1.7% 3.5% 4.3% 2.1% Television 4.9% 10.4% 2.7% 0.8% 0.8% Radio 15.9% 21.7% 0.3% 3.2% 2.5% Outdoor 3.2% 2.7% 3.4% -3.9% 0.0% Cinema 14.9% 9.3% -8.3% -9.2% 2.5% Internet n/a n/a 18.0% 44.4% 31.4% Total advertising 3.0% 7.4% 4.5% 2.6% 2.0% Weight 2002A 2003A 2004A 2005A 2006E 2007E Newspapers 23.5% 22.2% 21.2% 20.8% 20.9% 20.9% Magazines 15.7% 15.4% 14.4% 14.4% 14.9% 14.9% Print 39.2% 37.6% 35.6% 35.3% 35.8% 35.9% Television 53.5% 54.5% 56.0% 55.1% 54.1% 53.5% Radio 3.9% 4.3% 4.9% 4.7% 4.8% 4.8% Outdoor 2.5% 2.5% 2.4% 2.3% 2.2% 2.1% Cinema 1.0% 1.1% 1.1% 1.0% 0.9% 0.9% Internet 0.0% 0.0% 1.4% 1.6% 2.3% 2.9% Total advertising 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Source: AC Nielsen and Citigroup Investment Research Main ad-spenders for magazine include fashion, cosmetics, furniture and food & groceries with combined account for 65% of magazine sector and 70% of Mondadori s advertising sales. With a market share amounting to 29% (according to AC Nielsen in August 2006), the company is leader in the Italian market. Main competitors are RCS Media and Manzoni (Espresso) in this segment, with 16% and 12% market share respectively. 26