Euro LTE: Better late than never

November 5, 2014 Telecommunications Services Euro LTE: Better late than never European LTE data volumes are set to spike, positive news for revenues. Better Network, iphone 6 and consolidation are key catalysts. US LTE - First scepticism, then revenue growth: In 2011, Verizon W announced that it would not charge a premium for LTE's higher speeds. At that time, many observers viewed this move as a 'free give-away' to consumers. However, Verizon W has since successfully monetised LTE, via higher data volumes (as subs moved from from 500Mb to 1Gb/mth etc). Since Q1 2011, Verizon W has migrated 59% of its retail postpaid base to LTE (Sep 14) - or 17ppts of its base per annum. Over this period, Verizon W increased its service revenues by +7% pa, an illustration of LTE monetisation (Exhibit 1). MORGAN STANLEY & CO. INTERNATIONAL PLC+ Emmet B Kelly Emmet.Kelly@morganstanley.com Luis Prota Luis.Prota@morganstanley.com Terence Tsui Terence.Tsui@morganstanley.com Laura Ashforth Laura.Ashforth@morganstanley.com Telecommunications Services Europe Industry View +44 20 7425-6830 +34 9141-81217 +44 20 7425-3095 +44 20 7425-7123 Strong service revenue growth rate, as Verizon W steps up LTE device penetration Attractive Europe late to launch LTE: Delayed European 4G launch was triggered by late spectrum release (UK, Italy, Spain), low capex (sector indebtedness, in S Europe) and Moore's Law (operators waiting for kit prices to fall). Just 5% of the Vodafone Europe base is using LTE, a significant lag vs the US (Exhibit 2) - but a considerable top-line opportunity, going forward. E uropean data volume growth set to explode: We note two interesting data points. First, Cisco estimates that Global data volumes will continue to grow by +61% pa (13a-18e). Second, the move from 3G to 4G handset is a considerable driver of data volume growth - Cisco claims that the step-up from 3G (529Mb/mth) to 4G (1.98Gb/mth) is >3.5x (Exhibit 3). Rising data growth key to monetisation: Cisco estimates the average 4G phone will generate ca 5.4Gb/mth in 2018e (10x current 3G smart-phone usage). Our pricing survey (Exhibits 6-7) suggests that this data growth trajectory would trigger considerable European ARPU uplift (> +10% pa). Indeed, recent data from Tele2, Elisa (Exhibit 12) and Swisscom (Exhibit 13) points towards European operators securing a premium for LTE services. Further drivers of LTE monetisation - Better Network, iphone 6, M&A: We see three further drivers of LTE revenue trends. First, Better Networks (Orange, Telekom Germany, Vodafone in 15e) have a better chance of monetising LTE. Second, we expect that iphone 6 will prove a positive data driver in Europe, given larger screen size, tighter resolution and early indicators of demand. Third, we anticipate further Euro mobile consolidation to transpire, thus improving pricing power. Wireless video could also be a further positive game changer (Exhibit 9). We remain OW on Euro Telcos. Our preferred stocks remain Vodafone (revenue growth inflection, Better Network), Orange (easy comps, deleveraging, French consolidation), Telenor (DPS yield of 6.6% in 16e), KPN (FCF to double by 19e, no cash taxes), Com Hem (16e EFCF yield of 8.9%) and TDC (16e EFCF yield of 9.5%). We remain more cautious on DT and BT. Source: Company data, Morgan Stanley Research Data volumes to step up very markedly as customers move from smart-phones to 4G devices Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Source: Stanley Cisco Research Visual as only Networking a single Index factor (Feb in making 2014) their investment decision. For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report. += Analysts employed by non -U.S. affiliates are not registered w ith FINRA, may n ot be associated person s of th e member an d may n ot be su bject to NASD/NYSE restrictions on communications w ith a subject company, public appearances and trading securities held by a research analyst account. 1

LTE - strong start in the US, late start in Europe Verizon W has migrated an impressive 59% of its retail postpaid base over to LTE. This 3G-to-4G upgrade process has taken almost four years. The US market leader's service revenue growth has been +7% pa over that time period, with higher data usage a key driver of the revenue uplift. Europe was late to launch LTE as a result of later spectrum releases (UK, Italy and Spain) and lower overall capex spending on 4G roll-out. As a result Europe significantly lags the US. However this lag presents an opportunity (in our opinion) as LTE roll-out is now accelerating sharply across all of Europe. Markets that are more advanced in their 4G roll-out are showing promising early signs (of upgrades, data volumes, revenue growth). The US has seen strong service revenue growth as LTE adoption has increased The US has the highest 4G device penetration globally (24.5% of its total mobile devices are 4G) compared to just 2% 4G device penetration in Western Europe. Verizon Wireless has 59% of its retail postpaid base using LTE devices (30 September 2014). The US wireless market leader spent $9.5bn on 4G spectrum (Auction 73, 2008) and invested early in its LTE network (using Ericsson and Alcatel-Lucent kit). Verizon W has managed to maintain impressively strong service revenue growth (at an average rate of +7% pa in 2011-2014), on increasingly tough YoY comps, as its 4G device penetration (and date volume) has increased. (Verizon is covered by Simon Flannery) Exhibit 1: Strong service revenue growth rate, as Verizon W steps up LTE device penetration Source: Company data, Morgan Stanley Research 2

LTE penetration upside in Europe prevails In contrast to the more advanced US LTE market, we estimate that only 5% of Vodafone's European subscriber base is currently using 4G services. While off to a slow start, the upside opportunity bodes well for European operators (which are starting from low 4G penetration rates). The upside in Europe is two-fold: First, wireless subscribers will upgrade from a 3G smart-phone (ca 0.5Gb/mth) to 4G (ca 2.0Gb/mth); Second, 4G usage should increase over time, from 2.0Gb/mth in 2013a, to 5.4Gb/mth in 2018e. Essentially, using Cisco estimates suggests many European users will see their data usage levels step up ca 10x between 2013 and 2018. We expect this to be one of the drivers for a turnaround in service revenue growth trends, from -8% in 2013e to positive growth of ca +2% in 2016e. Exhibit 2: Verizon has much higher 4G penetration than Vodafone Exhibit 3: Data volumes to step up very markedly as customers move from smart-phones to 4G devices Source: Verizon Comm, MS estimates, * % of postpaid retail subs Source: Cisco Visual Networking Index (Feb 2014) iphone 6 & data package upside The iphone 6 could present a large 4G uplift for EU operators We view the new iphone 6/iPhone 6 Plus as transformational devices, which will be key to increasing mobile video consumption: The larger screen and greater resolution moves the phone up the complexity ladder - increasing data volumes, markedly - and moving the phone closer to phablet status (phone/tablet hybrid); The better screen should encourage consumers to increase the volume of video (and HD video) they watch, thus triggering larger data download volumes; The consumer demand for the product has been very high, with Apple reporting record shipments for the new iphone 6. (Apple is covered by Katy Huberty) 3

We expect 4G devices to encourage customers to move up the value chain As usage patterns move towards streaming and higher data packages, we expect operators will benefit from: Up-selling to higher data tariffs; and Increased out of bundle data usage (or increased data bolt-ons). According to Vodafone's data usage calculator, even a small increase to content streaming consumption can double monthly data consumption. Increasing video consumption by 8mins a day and music consumption by 5mins a day could increase monthly data usage by 2GB. Well-invested 4G networks (fibre backhaul, large spectrum positions) best positioned We believe that operators with Better Networks will have the best chance of monetising LTE. Only well-invested networks will cope with the rising data loads; Fibre backhaul, LTE coverage and spectrum holdings will be critical success factors; Customers who spend premium ARPU will expect a premium customer experience. These networks include (in our opinion): Orange in France; Telekom (DT) in Germany; Vodafone Europe, notably in Italy (as of mid-2015e); Telenor (Norway); Tele2 Sweden. Exhibit 4: Vodafone data usage calculator: 2mins video + 10mins music = 1.89GB/month Exhibit 5: Vodafone data usage calculator: 10mins video + 15mins music 3.9GB/month Source: 1GB = 1024MB 1MB = 1024KB. One minute of streaming video: 3.75MB. One minute of streaming music: 716.8KB (normal quality 96kbps). One social media post: 350KB (we're assuming you have a photo or link within the post). One web page browsed / app checked: 1MB Pricing study suggests significant ARPU upside, from higher data usage Source: 1GB = 1024MB 1MB = 1024KB. One minute of streaming video: 3.75MB. One minute of streaming music: 716.8KB (normal quality 96kbps). One social media post: 350KB (we're assuming you have a photo or link within the post). One web page browsed / app checked: 1MB 4

Below, we have examined how ARPU would evolve, if a European subscriber moved from 0.5Gb/month to 5Gb/month, over time, as per Cisco forecasts: A Vodafone UK user would see his / her monthly bill increase by ca 7/month (or 32%) - from 22 to 29 - when moving from 0.5Gb to 5Gb/mth (assuming up-selling to the 4GB package with a data bolton) A Telekom Germany subscriber would see his / her monthly outlay rise by 35/month (or 115%) - from 30 to 65/month. (assuming up-selling to the Magenta L tariff with a data bolt-on) Essentially, the average ARPU upside would be +70% over 5 years or +14% pa (ceteris paribus). Exhibit 6: Vodafone UK 12 month 4G SIM only tariff prices with unlimited voice+sms Operator Price Promotional price Data (GB) 4G Contract length Notes Vodafone 42 10 Y 12 12 months of Netflix/SkySports/Spotify Vodafone 32 25.6 7 Y 12 12 months of Netflix/SkySports/Spotify Vodafone 27 21.6 4 Y 12 6 months of Netflix/SkySports/Spotify Vodafone 22 16.5 1 Y 12 Addition extra data is 10/month for 2GB extra Source: Company data, Morgan Stanley Research Exhibit 7: Telekom Germany 24 month 4G SIM only tariff prices with unlimited voice+sms Operator Price Promotional price Data (GB) 4G Contract length Notes T-Mobile 79.95 71.95 5 Y 24 3 month spotify T-Mobile 49.95 44.95 3 Y 24 3 month spotify T-Mobile 39.95 35.95 1.5 Y 24 3 month spotify Source: Company data, Morgan Stanley Research 5

LTE networks will also facilitate video 4G connections help to drive mobile data usage. Mobile video is the big unknown, and could provide considerable upside to data volumes 4G connections have higher bandwidth and lower latency, which will lead to higher adoption of new mobile technologies by end users. High-end 4G devices deliver higher speeds which should encourage the use and adoption of higher-bandwidth applications, most notably video streaming. Exhibit 8: Video streaming is the most data intensive data service Video streaming is a key driver of data traffic. Mobile video content uses higher bit rates than other content types and therefore contributes to a large share of total data traffic. The high bandwidth requirements mean that 4G is best able to offer video services. Video services are so data intensive that they already account for 53% of mobile data traffic. For example streaming a 30minute TV show uses around 160MB of data compared to 10MB used for internet browsing over a similar time frame. Video streaming will only increase in the future as video on demand services increase in popularity. Video cloud based services like Netflix, hulu, etc are already very popular. Cisco estimates that in 2018 video will account for 69% of total mobile data traffic vs 53% in 2013. Source: American Tow er slides. Note 1MB = 1024kb. Source: Altman Vilandrie&Co.rsearch, Verizon, AT8T. Note: Computing device represents the w eighted average usage for tablets and laptops. Source: Altman Vilandrie&Company analysis and Cisco VNI Mobile Forecast Exhibit 9: Cisco forecasts of data usage - Video services will account for 69% of total data traffic in 2018 Data usage by application category 2013 2014 2015 2016 2017 2018 Data 40.8% 36.9% 33.0% 29.6% 26.2% 22.3% File Sharing 4.5% 4.9% 5.1% 4.4% 3.6% 2.9% Video 53.4% 56.3% 59.3% 62.4% 65.6% 69.1% M2M 1.4% 1.9% 2.6% 3.5% 4.5% 5.7% Source: Cisco Visual Netw ork Index: Global Mobile Data Traffic Forecast Updated 2013-2018 W hite Paper 6

Exhibit 10: Devices with higher complexity services show higher data consumption patterns Exhibit 11: Usage per device, MB per Month: 4G tablets consume the most data of the mobile devices Device Type 2013 2018 Nonsmartphone 10.8 45 Smartphone 529 2,672 4G Smartphone 1,984 5,371 Tablet 1,374 5,609 4G Tablet 2,410 9,183 Laptop 2,455 5,095 Source: Cisco VNI Mobile 2014 Note: * multiples of monthly basic mobile phone data traffi. Source: Cisco VNI Mobile 2014 Positive early 4G indicators in Europe European operators that are more advanced in their 4G roll-out - such as Tele2 and Swisscom Mobile - are signs of top-line improvement 1. Up-selling data bundled plans - Tele2 is starting to monetise mobile data in Sweden Tele2 s Q3 2014 results report included a number of encouraging points on LTE & mobile data: Tele2 had 64% of its residential postpaid customers on bucket price plans by the end of Q3 2014; The Swedish operator saw data traffic grow 46% YoY in Q3 2014; Over 50% of new postpaid customers in Q3 took bundled plans with data allowances greater than 1GB/month; Moreover, around 20% of Tele2 s postpaid customers exhausted their bundled data allowances - and of those customers 50% elected to top-up their data allowances with bolt-on data packages (200MB, 500MB, 1GB or 3Gb). Indeed, top-up sales increased by +270%, YoY; 4G enabled smartphones accounted for close to 90% of handset sales during Q3 2014. Unsurprisingly, the above trends drove accelerating service revenue growth rates of +5% YoY in Q3 (following +1% in Q2 14, +3% in Q1 14, -2% in Q4 13 and -2% in Q3 13). 2. Swisscom tiering its customers by speed Swisscom moved to unlimited voice & SMS tariffs in early 2012: Swisscom tiered speed offers are charging CHF 30 more a month for LTE speeds (also included is a larger roaming allowance); Swisscom domestic wireless revenue growth was near-zero in H1 2014, considerably better than the European mobile average of -7.5% (YoY growth rates). 7

3. Elisa also charging a premium price for faster LTE speeds Elisa has one of the most advanced LTE / 4G networks in the world, with 95% POP coverage: The Finish operator is starting to see customers move up the speed ladder, from 21Mbit/s to faster 50Mbit/s LTE speeds; Elisa charges a EUR5-10/month premium for LTE speeds (Exhibit 9) which has been an effective boost to the top-line; Elisa delivered 9M 2014a revenue and EBITDA growth of +4% and +7%, respectively. Exhibit 12: Elisa mobile tariffs: LTE is at a EUR5-10/month premium Exhibit 13: Swisscom mobile tariffs: LTE speeds come at a >CHF30 premium Source: Elisa CMD presentation 2014 Source: Swisscom website 4. Not all good news - Telekom's LTE 'data give-away' is bad news for German data revenues in H2 2014e / FY 2015e In September 2014, T-Mobile Germany (Telekom / DT) announced that it would offer its wireless subscribers broadly double the download speed, and double the monthly data allowance, for the same monthly package prices. We believe that this move was stimulated by rising competition in the German wireless space (renewed commercial push from Vodafone, recent & forthcoming Drillisch tariffs etc); DT also slimmed their tariff portfolio to encourage upselling of smartphones, extra mobile data and roaming via simple options; We view this price change as bad news for German data revenue growth outlook. Essentially, assuming +70% YoY data volumes growth, Telekom has given away 18 months of data revenue growth to its subscribers, for no extra revenues. On the upside, beyond the 18-month period, in 2016e and beyond, we believe that the new Magenta tariffs from Telekom should stimulate higher data usage volumes, package upgrades, and therefore higher German wireless ARPUs. We have also noted that some US wireless operators are offering double your data promotions recently, as a result of increased competition. We continue to prefer Euro Telcos over US Telcos (we downgraded the latter to UW in Q3). 8

Exhibit 14: New Magenta tariffs from DT will encourage up-selling to higher data / devices through simplicity (albeit beyond mid-2015) Source: Company data, Morgan Stanley Research 9

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INDUSTRY COVERAGE: Telecommunications Services COMPANY (TICKER) RATING (AS OF) PRICE* (11/04/2014) Emmet B Kelly Deutsche Telekom (DTEGn.DE) U (07/17/2014) 11.77 Orange (ORAN.PA) O (03/04/2013) 12.31 Telefonica Deutschland Holding AG (O2Dn.DE) NA (07/22/2013) 3.84 Vodafone Group (VOD.L) O (07/22/2014) 203.55p Luis Prota Belgacom (BCOM.BR) U (08/07/2014) 30.16 Bouygues (BOUY.PA) NA (03/06/2014) 27.37 Iliad (ILD.PA) NA (07/31/2014) 179.45 Kabel Deutschland Holding AG (KD8Gn.DE) NA (09/05/2013) 109.50 KPN (KPN.AS) O (10/14/2014) 2.55 Numericable Group SA (NUME.PA) ++ 28.51 OTE (Hellenic Telecoms.) (OTEr.AT) O (09/09/2014) 9.48 Portugal Telecom (PTC.LS) ++ 1.20 Swisscom (SCMN.VX) O (01/21/2014) SFr 558.50 Telecom Italia (TLITn.MI) NA (09/19/2014) 0.70 Telecom Italia (TLIT.MI) NA (09/19/2014) 0.87 Telefonica (TEF.MC) NA (07/22/2013) 11.84 Telekom Austria (TELA.VI) NA (05/16/2014) 5.84 Telenet Group Holding (TNET.BR) E (02/27/2013) 45.10 United Internet AG (UTDI.DE) O (04/08/2013) 31.48 Ziggo NV (ZIGGO.AS) ++ 38.76 Terence Tsui BT Group plc (BT.L) U (10/24/2014) 362.20p Cable & Wireless Communications PLC (CWC.L) E (07/13/2010) 47.92p Colt Group S.A. (COLT.L) O (07/28/2011) 132.60p Com Hem Holding AB (COMH.ST) O (07/28/2014) SKr 53.75 Inmarsat (ISA.L) O (09/02/2013) 684.50p TalkTalk Telecom Group PLC (TALK.L) O (06/18/2013) 295.90p TDC A/S (TDC.CO) O (03/04/2013) DKr 45.42 Tele2 (TEL2b.ST) E (10/23/2013) SKr 94.60 Telenor (TEL.OL) O (03/04/2013) NKr 151.80 TeliaSonera (TLSN.ST) E (01/08/2013) SKr 50.85 Stock Ratings are subject to change. Please see latest research for each company. * Historical prices are not split adjusted. 2014 Morgan Stanley 13