CFA Institute Research Challenge IRC 2014 Team..."Złota Jesień" 5% Others 40% Figure no. 2...

CFA Institute Research Challenge

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Local Challenge CFA Society Poland

Wroclaw University of Economics

CFA Institute Research Challenge 4 Feb 2014

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WSE Ticker: NET

Netia: Wire up to cash flow

Highlights

We issue a HOLD recommendation with a target price of PLN 5.50. It implies 10% upside

potential including dividend payout. Netia is the biggest alternative fixed-line market

operator in Poland with one of the highest dividend yields on WSE.

Main price growth drivers: (1) Growing EBITDA margin as an effect of shift from regulated

access network to own infrastructure, average margin growth of 1.5% YoY in the forecast

period, from 15.2% in 2008 up to 31.3% in 2018E. (2) Profit distribution to shareholders,

annual dividend yield 8.0%.

Main price decline drivers: (1) -2.5% CAGR revenues decline driven by fixed-to-mobile

substitution effect at. (2) -2.6% CAGR ARPU decrease resulting from fierce price war on

telecom market. (3) Dominant market position of incumbent operator in fixed-line sector.

Sound financial position: low leverage and cash sufficiency. We believe Netia to maintain

healthy financial standing: (1) D/E equal to 17.2% in the forecast period;

(2) CFO/CAPEX; 202% in 2012, 207% in 2018E; (3) Cash ratio; 2013E; 0.4, 2018E; 1.9.

Main risk issues: (1) Strong telecom market consolidation may develop two scenarios:

development opportunities by further acquisitions, or by becoming an acquisition target,

(not incl. in valuation). (2) Recent legal regulatory changes in Poland concerning pension

funds impose significant risk of influence on capital market and forthcoming

undervaluation of stocks l isted on WSE.

Figure no. 1 Netia price last 52 weeks

Recommendation: HOLD

Current price 5.00 (as of 24-01-2014)

12 M target price 5.50 (upside 10%)

Market profile

52-week price range

[PLN] 3.91 – 5.65

Average daily volume 407 221

As % of shares

outstanding 0.12%

2013 dividend yield 7.87%

Shares outstanding 348m

Market capitalization

[PLNm] 1 740

Institutional holdings 60.34%

BV per share 6.3

P/BV 0.79

3.91 – 5.65

407 221

0.12%

7.87%

348m

1 740

60.34%

6.3

Valuation DCF Multipliers

Estimated price 5.50 -

Weights 100% 0%

Target Price 5.50

NETIA SA Telecommunications Industry


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Business Description Netia S.A. is the largest alternative provider of fixed-line telecommunication services in Poland. Company was established in 1990; it provides range of telephony and data transmission services, offered on Company’s own copper or fiber optic backbone structure and on the network infrastructure leased selectively from the incumbent operator (IO), Orange. The company’s ownership structure consists mostly (60%) of institutional holdings. Netia management is stable and comprise of four professionals members, realizing successfully development strategy by organic grow and acquisitions. (See appendix 15) Company strategic goals Netia announced its development strategy until 2020. The main goals are:

Broadband market share increase to 20% by the way of both organic development and acquisitions.

Increase in RGU from the level 1.3 to 2.0 per client. Continue client switch from regulated access network to own infrastructure.

Provision integrated solutions for home & business customers, extending TV services and multimedia solutions to three screens (TV, PC, and Mobile).

Key events The milestone in the company’s development was introduction of new telecommunication market legal regulations, forcing IO to allow alternative operators access to its network infrastructure. In order to take advantage of the arising provision of broadband internet access services based on IO network facilities, starting January 2007. Netia Group has been expanding over the time by the way of organic growth as well as intense acquisition program. The Company acquired Tele2 Polska for PLN 148m, a company providing broadband and voice services on a country-wide scale based on regulated access to IO infrastructure, in September 2008 and exceeded 1m of RGU. Netia Group has also been enlarging its customer base by acquiring vast number of local fast Ethernet operators. Since the beginning of 2007, the Company managed to acquire 37 operators with total number of over 129k active customers. Following the acquisitions strategy, Netia acquired Telefonia Dialog, along with its subsidiaries Avista Media, Petrotel as well as Crowley Data Poland for cumulative amount of PLN 1.07bn, in 2011. Dialog and Petrotel provided a similar range of telecommunication services and serve business and residential customers. Crowley was providing telecommunication services exclusively to business customers. Those acquisitions materially increased the size of Netia operations from 1.95m to 2.79m RGU. Over the last two years, Netia has conducted internal consolidation associated with previous large acquisitions. In order to broaden Netia product offer even further, the Company started offering IPTV services since 2011 . Besides, the company bought from the UPC cable network with access to 446k households in Warsaw and Cracow, constantly seeking the access to new customers and gradually upgrade its copper and Ethernet access networks to meet the NGA transfer (up to 30Mb/s) standards. Netia covered 1,240k households in NGA at the end Q3 2013.

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Jan/08 Jul/08 Jan/09 Jul/09 Jan/10 Jul/10 Jan/11 Jul/11 Jan/12 Jul/12 Jan/13 Jul/13 Jan/14

Figure no. 4 Netia market price (January 2008 - January 2014)

USA government announces contradictionary fiscal policy introduction

Acquisition of CDT S.A.

Acquisition of Telefonia Dialog S.A.

Deutsche Telekom acquires GTS CE

2.3bn

969m

Acquisition of TELE2 S.A.

101m

148m

Source: Stooq.pl

ING PTE S.A. 17%

Third Avenue Management

LLC 17%

SISU Capital Limited

13%

AVIVA OFE Aviva BZ

WBK 8%

OFE PZU "Złota Jesień"

5%

Others 40%

Figure no. 2 Ownership Structure in 2013

Ne

tia

Gro

up S

.A.

Internetia Holdings Sp. z o.o.

Net 2 Net Poland Sp. z o.o.

Netia Brand Management

Telefonia Dialog Sp. z o.o.

Centrina Sp. z o.o.

Dianthus Sp. z o.o.

Figure no. 3 Netia Group structure

Source: Company data

Source: Company data


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Industry Overview & Competitive Positioning Netia operates on fixed-line voice and broadband, PayTV and wholesale telecommunication market. The market is highly regulated by the Office of Electronic Communications – UKE, which realizes its strategy of market competition development in l ine with European Commission guidelines described in Digital Agenda and National Development Strategy 2020. UKE regulates the market by the way of Mobile and Fixed Termination Rate level control, frequency license tender offers announcements, regulated access restrictions and penalties imposition based on the SOR16 regulations. Due to approximate decrease of 2.4% YoY, the total value of telecommunication industry in Poland amounted to PLN 41.7bn in 2012 . Market decrease has been mainly driven by 13.5% YoY decline of fixed-line telephony segment. In 2012, first time since the beginning of market operations in Poland, mobile telephony segment decreased on a yearly basis, by 1% in terms of revenues.

Fixed-line telephony market value amounted to PLN 4.5bn in 2012 and its performance is strongly correlated with the mobile telephony sector due to worldwide observed fixed-to-mobile substitution effect. We forecast further market shrinking at pace of -5% a year. Segment is dominated by Orange with revenues of over 60% of market value, and Netia, the largest alternative operator, 20.4%. Main features of the segment are constantly diminishing number of subscribers, 1.8m over last 4 years, (-5.3% YoY), to the level of 7.4m, along with successively declining ARPU by PLN 14.1 over last 4 years to the level of PLN 51.1 per month. Due to stronger competitiveness, the ARPU of Netia has been gradually declining. ARPU declined by PLN 5 to PLN 45 on regulated access network and by PLN 21 to PLN 43 over own network, since 2009. 19.5% of all fixed-line telephony subscribers (1.4m) were provided the service over WLR, 54.8% of which was offered by Netia. The cost of WLR, determined by the telecom regulator UKE, is set at the level of PLN 20 monthly per subscriber, unchanged since 2007. Main determinant of service provider choice is price. Operators tend to combat churn rates by combining fixed-line telephony, broadband and Pay TV into bundle services .

Internet services sector is growing steadily in terms of popularity and availability. As a result, at the end of 2012, the penetration of broadband services reached the level of 83.5% for households and 29.3 per 100 inhabitants. The number of subscribers has grown to 11m, 7.4% in terms of CAGR in 2010-2012. Market value of broadband services amounted to PLN 4.4bn, 10.7% increase compared to 2011. Despite increasing total income, ARPU was successively declining, due to price cuts caused by fierce competition.

The fixed-line broadband is steadily growing and according to our forecast it will continue to increase 1.5% YoY in terms of CAGR, and is foreseen to reach 7.8m until 2018. PLN 3.4bn (76.7%) revenues was generated by fixed-line connections, of which 17.6% was covered by Netia. The most popular and profitable broadband connection technology (xDSL) is steadily declining due to the substitution effect, technological development and higher required connection transfer capacity. Main determinants of internet provider choice are price and transfer capacity.

PLN 1.03bn (23.3%) was generated by mobile internet services. There were 4.1m mobile internet users at the end of 2012, which constitutes 21% YoY growth compared with 3.3m at the end of 2011. The segment is quickly developing and according to our forecast it will continue to grow 5.9% YoY in terms of CAGR, and is expected to exceed 6.6m until 2018. Main determinants of mobile internet provider choice are price, access range and combination of transfer capacity and download allowance.

Taking under consideration fixed-line internet access, Orange serves the largest number of clients, amounting to 26.7%. The market share of incumbent operator declines consequently, mainly due to the growing competition on the part of CaTV providers.

Mobile telephony sector is dominated by four major operators, the revenue of which comprises 99.7% of total market value, PLN 18.9bn in 2012. Since the sale of P4 in 2008, the scale of Netia operations in the mobile sector is negligible. The management board does not intend to intervene on mobile market. Penetration of this industry segment reached the level of 140%, 15pp. above EU average. ARPU decreased by more than 16% in comparison to 2011 and equals 38.4 PLN/month. Due to fierce competition in the market, further ARPU decline is expected. The number of subscribers in 2020 is expected to grow by 1pp. YoY until 2020.

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Figure no. 5 Revenues on Telecom market in 2012 [bn]

Source: UKE

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pozostali

Orange

PTK Centertel

Netia

UPC Polska

Vectra

Multimedia Polska

Figure no. 6 Revenues on fixed-line broadband segment [m]

2012 2011

Source: UKE

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[years]

Figure no. 7 Broadband penetration in Poland, Dec 2012

Per 100 citizens

Per Household

Source: UKE, Team estimates

Others


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Wholesale market amounted to PLN 2.35bn in terms of total revenues. The major part of wholesale market is transit and wholesale services (75.6%), with l imited opportunity to grow in domestic market, however is expected to remain stable due to increasing participation in international transit services. Second most important factor is call termination services (19%), which was increasing constantly by 3.9% in terms of CAGR between 2007-2012. Revenues of Orange, the market leader, in this segment amounted to PLN 1.4bn (55.6%) in 2012. Netia, the second biggest operator in the sector realized sales at PLN 246m in 2013 (10.5%). According to estimations based on fixed-line market decline expectations, total revenues in the sector were forecast to have fallen by 4% to the level of PLN 2.25bn in 2013, as a result of prices cuts on the wholesale market and decreasing popularity of WLR services. We expect value of the market to remain unchanged in following years with declining WLR service share.

Polish pay TV market amounted to PLN 7bn with an increase of 8.6% measured by CAGR between 2007 and 2012. During this time the number of subscribers was increasing 6.2% YoY by CAGR up to 11.7m in 2012, but the growth has slowed down in last two years to 2% YoY. The major technologies used are satellite transmission TV, analogue cable and digital cable TV, gaining new users as a substitute for analogue cable TV, which is steadily losing its customers. IPTV, as the newest type of service, comprises only 2.5% of market but is rapidly developing. Netia initiated IPTV services in 2011. In 2013 total number of subscribers amounted to 111k, and currently Netia is second biggest IPTV operator. We forecast stable Pay TV market development by 1.5% YoY until 2018, with increasing IPTV market share.

M&A Insight

Fixed-line telecom is currently undergoing strong consolidation, following trends observed in Europe. Significant M&A transactions had been carried in Poland during 2013 and the outlook for 2014 shows that further consolidation is expected. The mos t important telecom transaction was acquisition of Polkomtel, 2nd biggest mobile operator in Poland by Cyfrowy Polsat, leading Pay TV operator, for PLN 15.1bn including debt. Moreover Emitel, telecommunication infrastructure developer, had been purchased by Alinda Capital Partners for PLN 3.1bn. In perspective of Netia valuation and competitive analysis, GTS Central Europe acquisition by Deutsche Telekom is considered to be important. GTS is a provider of integrated telecommunication solutions and data center services throughout Central and Eastern Europe. DT, a multinational enterprise, paid for GTS about PLN 2.3bn (6,3x EBITDA), and finally entered on the polish fixed-line market, being considered Netia major competitor in the area of B2B fixed-line services.

Despite the fact, that the biggest operators have already been sold, there is sti l l plenty space for further consolidation on the market. PGE, major player on polish energy market controlled by State Treasury, announced a due diligence of its subsidiary Exatel in 2010, telecom operator providing services for business and public sector institutions countrywide, currently valued at PLN 0.7-1.0bn. The company holds 20k km of fiber optic backbone structure and over 500 LLU units. Netia considers purchase of Exatel. Moreover, in 2013 PKP Group, polish railway operator, announced a tender offer for its subsidiary, TK Telekom. The company owns over 5k km of fiber optic backbone structure and over 30k km copper network. Netia was one of the companies interested in TK Telekom purchase however required price of PLN 400m has not been met.

Netia is a leading mid-cap telecom in Poland with high cash generation capacity and high profitability, therefore is an interesting acquisition target for foreign industry i nvestor. As of the date of the report, the company is traded at 3.7 EV/EBITDA. For more information please see appendix 15

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Figure no. 8 Value structure of the wholesale market in fixed-line telephony in Poland [k]

OthersCall terminationTransit and wholesale services market

Source: UKE, Team estimates

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Figure no. 9 Number of Pay TV subscribers in Poland [m]

Pay TV subscibers Growth rate

Source: PMR, Team estimates


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Investment Summary We issue a HOLD recommendation for Netia with 12M target price of PLN 5.50 per share translating to 10 % upside potential. Financial position of Netia is stable with high operating cash flow amounting on average for 2005-2013 PLN 328m annually, and has proven implicit policy of profit distribution to shareholders. With historically low price volatil ity, expected 8% Dividend Yield for the forecast period and Management Board with proven track of apt decisions, Netia makes for a safe investment in the times of uncertainty. Netia operates on market with high saturation and diminishing revenues determined by price war, which gives unfavorable outlook for growth opportunities.

EBITDA remains stable due to increasing margins Changing structure of client base will positively affect EBITDA margin giving it 1.5% YoY growth in forecast period. We expect the churn rate on low-margin services provided on regulated access network to exceed greatly churn rate on high-margin services provided over own network. Company’s intention to focus on B2B segment also supports margin growth as specialized services (l ike MPLS VPN, Frame Relay) are described by higher margins. See Appendix 8: Churn rates.

Profit distribution to shareholders We expect Netia to pay dividend in 2014 of PLN 145m translating to PLN 0.42 per share as declared by the management board, and to increase this amount by 2% YoY yielding 8% annually being one of the most attractive dividend-based investments on WSE. We base our forecasts on proved custom of profit distribution, realized in the years 2011-2013 by the means of share buyback programme.

Figure no. 11 Share buyback programme and dividend yield

2011 2012* 2013* 2014E 2015E 2016E 2017E 2018E Share buyback programme PLN m 50 123 128

Dividend PLN m 145 148 151 154 157

End of period no. of shares, m 392 386 348 348 348 348 348 348

DPS 0.13 0.32 0.37 0.42 0.43 0.43 0.44 0.45

Pro forma Dividend Yield 2.4% 5.5% 7.9%

Implied Dividend Yield 7.8% 7.9% 8.1% 8.2% 8.4%

Source: Company Data, Team Estimates. *- adjusted for overlapping 2012 share buyback programme from 2012 over 2013

Debt capacity Historically Netia avoided operational leverage getting indebted only in case of significant value one-off transactions. Current debt of PLN 448m is a result of credit of PLN 650m drawn in 2011 to finance acquisitions of Dialog and Crawley and will be paid off until end-2016E. However Netia Management intends to incur debt in order to maintain current D/E ratio of 17.2% lowering WACC, to create value for Shareholders. Ongoing market consolidation can influence forecast It is highly probable that Netia will participate in ongoing consolidation movements on telecom market. Company is prepared to take over if any remarkable opportunity arises with transaction value of up to PLN 300m at once, keeping an open credit l ine of PLN 200m and significant amount of assets in cash - PLN 130m as of 3Q2013, and rising under our assumptions to PLN 364m in 2015E. We do not include possible takeovers in our forecast. Possible developments in consolidation can significantly affect Netia financial position. Increasing leverage in case of active participation or pressuring management to revise profit distribution policy to increase dividend in case of lack of participation.

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Figure no. 10 Adjusted EBITDA margin

Source: Team estimates.

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Figure no. 12 CFO/E ratio

Source: Team estimates


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Valuation

12M Target price of PLN 5.50 is derived from DCF and peer companies’ valuation, weighted 100% and 0%, respectively. Decision of peer companies’ valuation 0% weight is based on uniqueness of Netia service mix and market position.

REVENUE FORECAST

We expect the overall decrease in Netia revenues from PLN 2.1bn in 2012 to PLN 1.6bn in 2018E. The loss will be driven by substantial erosion in the segment of fixed-line voice services and will be partially offset by increase in revenue coming from wholesale services, specialized business solutions and introducing CaTV services. Forecasts reflect main market trends and managerial decisions of marketing focus of the Company. (For detailed information see appendix 2)

Data Revenues. We expect data transmission services to become the main revenue generator of Netia in 2015E. Fixed-to-mobile substitution effect in the segment is less severe due to technological imperfections of mobile internet, at the same time Netia enlarges its revenue coming from specialized B2B soluti ons. The Company extended segment revenues from PLN 111m in 2008 to PLN 166m in 2012 and we expect this number to grow at 7% annually reaching PLN 224m in 2018E. The relation of regulated access to own network services observed in Voice segment holds. Chur n rate of 5% annually in regulated access and 0% on own network is expected. Price cuts effect on revenues in Data segment will be partially offset due to the fact that internet users reach for higher speed connections increasing ARPU. We expect ARPU decrease of 3% annually on own network and 1% annual growth on regulated access, reflecting TPSA’s investments in infrastructure quality enabling Netia to offer higher -speed offer to its customers.

Voice Revenues. We expect ARPU to decrease from PLN 45 to PLN 42 in the analyzed period. Voice revenues will exhibit the harshest decrease of 42.6% during next 5 years. Due to strong fixed-to-mobile substitution effect we expect the total number of voice l ines to drop in the forecasted period by 26% from 1.5m lines in 2013 to 1.1m in 2018E. We expect the decrease to affect stronger regulated access l ines with 10% disconnections annually. Services provided over own network will be described by lower churn rate of 0.9% annually due to Managements efforts to implement 3pl ay services and price cuts (ARPU drop from PLN 43 in 2013 to PLN 23 in 2018E). ARPU drop observed in telecommunications market in general will not affect strongly the regulated access segment as it is lowest priority segment with low EBITDA margin and market expectations, and there is no incentive to price cuts.

Other Services. Netia generated PLN 344m (16% of 2012 revenues) from other services including Interconnect, Wholesale, IPTV, Mobile Data and other. We expect that in 2018E as much as PLN 380m (23% of its revenue) will come from those operations being driven by TV services growth. Netia will benefit from increase in international data transmission boosting its wholesale services but increase in revenues will not be observed due to falling prices. Recent purchase of CaTV network will enable Netia to add another PLN 4.6m revenues in 2014E and extend this amount to PLN 49m until 2018E.

DCF VALUATION

Our DCF valuation values Netia 12M target share price at PLN 5.50, which implies EV/EBITDA ratio at the level of 4.1x, 4.2x and 4.3x in 2014E, 2015E and 2016E, respectively. EV/Sales comes in at 1.2x for 2014E, and 1.3x for 2015E and 2016E.

In our estimations, the following assumptions are set:

CAPEX does not cover D&A. Historically Netia CAPEX was significantly lower than D&A and FA growth was driven solely by acquiring Ethernet networks on the market. This fact is caused by highly saturated market and lack of investment in fixed assets opportunities.

In our forecast we expect CAPEX at diminishing level from PLN 245m in 2013 to PLN 214m in 2018E, followed by declining operating cash flow. Simultaneously we expect D&A to be decreasing but constantly well above CAPEX, causing signi ficant FA decrease from PLN 2.07bn to PLN 1.24bn in 3Q 2013 and 2018E, respectively. We assess this situation as highly accounting-based and with lesser impact on evaluation of operational stability, and

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5.00 5.40 5.80 6.20

Capex to sales

Market risk premium

Beta

Risk free rate

Tax rate

EBITDA margin growth

Cost of debt

D/E ratio

NET 12M TP

Upside Downside

Figure no. 14 Tornado sensitivity analysis

Residual 52%

FCFF Sum 48%

Figure no. 15 Enterprise Value Breakdown

Residual FCFF Sum



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Figure no. 13 Revenue breakdown



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thus in calculation of Terminal Value we assume Maintenance CAPEX in order to present most reliable value. See Appendix 5:

WACC. We expect rising WACC from current level of 9.3% to 10.8% in 2015E and then constant.

The growth in WACC is driven by expected interest rates increase. The reference rate in Poland was subject to gradual cuts from 4.75% in end-2012 to current 2.5% with last cut in July 2013 in order to stimulate economy subdued by crisis in EU. Current macroeconomic outlook of GDP growth increase from current 2% to 3% in 2015E and CPI inflation increase from current 1% to over 2% in 2015E will force NBP to increase interest rates. We use risk free rate at the level of 4.4% reflecting current 10Y Treasury Note yield, 4.9% and 5.9% for 2013, 2014E and post-2015E, respectively, following PKO BP forecast.

Market Risk Premium of 6.28% estimated by Aswath Damodaran for Polish equities as of January 2014

Beta coefficient derived from weekly returns of Netia vs. WIG broad index from last 3Y and adjusted with Blume method

Other Assumptions

Detailed free cash flow forecasts starting from 4Q 2013 and ending 2018E

Perpetuity growth rate of 0% based on telecom market outlook Leverage ratio kept at level of 17.2% as reached end-2013

Comparable valuation

In the process of companies’ selection for comparable analysis, European telecoms have been taken under consideration, perceived as most relevant due to area and scope of operations. Wide selection criteria were set as follows:

Fixed voice, broadband and TV services constitute at least 45% of company revenues

Market capitalization of comparable companies is lower than PLN 50bn

Netia

TDC Group

Orange

TEO LT Rostelcom

TURK

Talk Talk

Il iad

KPN

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Incumbent Alternative

Figure no. 18 Peer companies mapping

Figure no.17 Trading Multiples

Multiples 2013E 2014E 2015E

P/E (x) 45.3 26.7 19.9

EV/EBITDA (x) 3.5 4.2 4.3

EV/Sales(x) 1.0 1.2 1.3

P/BV (x) 0.7 0.9 0.9

Dividend Yield (%) 0.0% 7.6% 7.7%


Figure no. 16

WACC components

Risk-free rate 5.9%

Market risk Premium 6.3%

Beta 0.85

Cost of Debt 9.9%

Source: NBP, Aswath Damodaran,

Team estimates



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Companies meeting wide criteria have been mapped (see Fig. 18) in correspondence to market capitalization and portion of revenue coming from mobile services.

It has been proved by fundamental arguments that in case of Netia valuation, comparable analysis is not reliable valuation tool in comparison to DCF method. The following issues impair reliability of peer companies’ valuation in case of Netia:

Business profile and revenues breakdown of analyzed companies differs significantly from Netia. Majority of considered companies derives at least 30% of revenues from mobile sector.

Except for Il iad and Talk Talk Group, all companies are incumbent operators characterized by large market share and higher profitability driven by mobile segment

Market capitalization of Netia is much lower than peer companies (median PLN 25.3bn)

In comparison with peer group companies, Netia exhibits significantly lower amount of debt at the level of 17%, compared to group median of 37%.

(For more please refer appendix 17)

Financial Analysis Financial analysis of Netia reveals sound financial standing. During the analyzed period it shows rising operating cash flow profitability (CFO/E 12.6% in 2010, 23.6% in 2012). The growth was driven by increasing EBITDA margin (from 22.9% to 27.9%, 2010-2012) and positive effect of acquisition of Dialog. The cash gains were redistributed to its shareholders through shares buyback programme conducted 2011 -2013, in total PLN 300.6m worth of shares was used in the process translating into pro forma dividend yield of 8% annually. Bottom line of the profit and loss statement is heavily affected by numerous one-off positions as well as high D&A (23% of 2012 Revenues as compared to 19% peer median), and as such is not reliable indicator of Netia financial position and profitability. An important support to this statement is the fact that Netia carried out share buyback programme in 2012 in the value of PLN 166.2m when PLN 87.7m of net loss was reported.

During analyzed period Netia suffered significant drop in liquidity ratios due to incurred debt in 2011 (Current ratio at 2.49, 0.90 and 0.94 in 2010, 2011 and 2012 respectively; cash ratio at 0.73, 0.31 and 0.29 in 2010, 2011 and 2012 respectively). Due to strong cash generating capacities we expect the liquidity to increase (current rati o at 2.57 in 2018E, cash ratio at 1.95 in 2018E).

Internal financing ratio computed as CFO/CAPEX remained well above 100% in Netia historically, showing independence from external sources of financing in operational activities. In 2011 Netia reached for external financing to take over Dialog and as such internal financing ration dropped to 33%, but excluding this transaction remained at high 145% level. We expect CFO to CAPEX to remain at level above 200% reached in 2012.

DuPont analysis on EBITDA. We consider EBITDA to be far more suitable profitability indicator considering Netias financial analysis than Net Income. We used adjusted DuPont Analysis based on EBITDA; our decision is based on following observations:

Historically lower CAPEX than D&A distorts actual profitability measured by net income.

High volatil ity of Net Income levels driven by one-off positions of various sources: provisions, tax returns

High volatil ity of effective tax rate Profit distribution is an important value driver of Netia and is derived from

actual cash flows, and EBITDA is closest P&L position by amount to operational cash flows.

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Figure no. 18 Dividen payout

Dividend/buyback to CFO (lhs)

Dividend payout ratio (rhs)



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Figure no. 19 Adjusted DuPont analysis

2010 2011 2012 2013P 2014P 2015P 2016P 2017P 2018P

EBITDA/Equity 0.16 0.16 0.26 0.25 0.25 0.25 0.25 0.25 0.25

Leverage ratio 1.12 1.42 1.41 1.35 1.35 1.34 1.33 1.33 1.32

EBITDA/Assets 0.14 0.11 0.18 0.18 0.18 0.19 0.19 0.19 0.19

EBITDA margin 0.23 0.25 0.28 0.29 0.30 0.30 0.30 0.31 0.31

Tota l Assets Turnover 0.61 0.46 0.66 0.63 0.62 0.62 0.62 0.61 0.60


Netia exhibits growing return to equity ratio expressed in EBITDA from 0.16 to 0.25 in

2010-2013 period. Growth was driven in 2011 by significantly increasing assets level

after acquisition of Dialog in 4Q 2011. As the effect of acquisition, significant

improvement in return on assets in the years 2012 and 2013 is visible: 0.11, 0.18 and

0.18 in 2011, 2012 and 2013, respectively, what describes acquisition as successful

investment. We expect EBITDA/E ratio in forecast period at stable level, as growing

EBITDA margin will be offset by decreasing level of assets, pulling down in effect

leverage and asset turnover ratios.

Investment Risks Detailed analysis of investment risks, their probabilities and possible impact on the

Company price are presented in appendix 13 and figure no 20. Market risks Fixed-to-mobile substitution effect increases. Mobile services are a substitute for fixed services, successively enlarging its market share. The arise of new technologies such as LTE mobile services are a big threat for fixed operators, decreasing their revenues. If prices of mobile internet services fall sufficiently, and major development in data mobile transfer technology occurs, substitution effect will become more visible. Based on our expectations this risk is considered to be high with severe impact on Netia revenues.

Market competition in M&A market increases acquisition targets prices. Polish telecom market is about to experience strong consolidation due to synergies seeking and cost optimization. The company is still looking for possible acquisition targets to develop own network and boost revenues. Two scenarios are possible to occur. Netia may refuse to pay high price for the acquired target and therefore lose development opportunity or, being forced to buy in order to comply with management development strategy, overpay

Legal risk Pension Fund (OFE) regulatory changes. Provided that over 40% of Netia shares are controlled by OFE, new law regulations can have significant impact on Netia share price. (Please see appendix 10)

Operational risk Effective tax rate fluctuations. Tax refunds as well as fines were reported. Further volatil ity is expected, though scale and direction is highly unpredictable CAPEX increase. Consolidation on Polish telecommunications market is expected, and Netia has proved record of active involvement in M&A transactions. In case of any takeover CAPEX level as well as leverage will be heavily affected, having great impact on valuation. Taking into account that Netia profited from takeovers in the last years we consider this risk to be a high growth opportunity. EBITDA margin growth rate. In the perspective of shrinking revenues, substantial cost cuts are inevitable. This situation poses significant threat that Netia will be unable to reduce fixed costs at the level sufficient to support 1.5% EBITDA margin growth in the forthcoming years. ARPU decline applied to valuation model is conservative but risk of faster price war escalation prevails.

Figure no. 20 Risks matrix



11

Appendix 1. Financial Statements forecast

Balance Sheet (PLN m) 2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E

Tangible assets 1 475.7 2 184.8 2 066.3 1 871.3 1 690.4 1 542.4 1 421.0 1 321.7 1 240.8

Intangible assets 389.4 765.3 597.5 545.4 545.4 545.4 545.4 545.4 545.4

Other fixed assets 108.6 150.3 112.9 122.1 122.1 122.1 122.1 122.1 122.1

Cash and cash equivalents 173.6 156.5 142.7 187.7 278.4 363.6 442.3 516.9 588.8

Accounts receivables 139.7 255.6 248.3 251.2 230.2 211.0 189.6 171.5 156.2

Inventory 11.4 5.3 2.1 2.0 2.0 2.0 2.0 2.0 2.0

Other current assets 270.2 35.4 63.3 30.5 30.5 30.5 30.5 30.5 30.5

Total assets 2 568.6 3 553.1 3 233.0 3 010.3 2 899.2 2 817.1 2 753.0 2 710.2 2 686.0

Short-term debt 0.0 180.6 166.2 126.7 74.1 72.3 71.1 70.4 70.2

Accounts payables 206.4 263.2 260.1 280.8 255.8 234.5 210.6 190.6 173.6

Other current liabilities 32.8 56.8 59.3 58.5 58.5 58.5 58.5 58.5 58.5

Long-term debt 0.0 514.6 384.5 256.5 296.3 289.0 284.2 281.5 280.6

Other long-term liabilities 31.9 37.6 66.6 64.8 64.8 64.8 64.8 64.8 64.8

Long-term liabilities 31.9 552.2 451.1 321.2 361.0 353.8 349.0 346.3 345.4

Equity 2 297.5 2 500.4 2 296.3 2 223.0 2 149.8 2 098.1 2 063.8 2 044.5 2 038.3

Liabilities 271.0 1 052.8 936.7 787.3 749.4 719.0 689.2 665.8 647.7

NWC -55.3 -44.0 -56.0 -27.6 -23.5 -21.4 -19.0 -17.0 -15.3

Net Debt -173.6 538.7 407.9 195.5 91.9 -2.3 -87.0 -165.0 -238.0

Profit and Loss (PLN m) 2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E

Revenue 1 569.3 1 618.8 2 121.4 1 892.2 1 811.5 1 747.9 1 694.1 1 652.5 1 620.7

Adj. EBITDA 359.5 408.2 591.2 550.0 534.4 523.4 514.9 509.8 507.5

D&A 300.7 308.8 482.5 440.0 418.2 377.8 344.7 317.6 295.4

Adj. EBIT 58.8 99.5 108.7 110.0 116.2 145.6 170.2 192.2 212.1

Net financial cost 3.0 14.6 -39.9 -28.6 -27.6 -26.8 -26.3 -26.1 -26.0

Pre-tax profit 288.8 317.3 -60.9 71.4 88.6 118.8 143.9 166.2 186.1

Income Tax -24.9 -68.5 -26.8 -35.5 -16.8 -22.6 -27.3 -31.6 -35.4

Net Income 263.9 248.8 -87.7 35.9 71.8 96.2 116.5 134.6 150.8

Cash Flow Statement (PLN m) 2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E

Net income 263.9 248.8 -87.7 35.9 71.8 96.2 116.5 134.6 150.8

D&A 300.7 308.8 482.5 440.0 418.2 377.8 344.7 317.6 295.4

NWC change -21.2 11.2 -12.0 47.9 -4.0 -2.1 -2.4 -2.0 -1.7

Other non-cash items -253.9 -150.0 158.6 85.3 0.0 0.0 0.0 0.0 0.0

Operating cash flow 289.5 418.8 541.4 609.1 486.0 471.9 458.9 450.2 444.4

CAPEX -208.2 -288.0 -267.8 -245.0 -237.4 -229.8 -223.3 -218.3 -214.5

Acquisition of Dialog and Crowley 0.0 -976.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Other investing cash flow -80.9 191.9 -2.2 35.0 0.0 0.0 0.0 0.0 0.0

Investing cash flow -289.1 -1 072.7 -270.0 -210.0 -237.4 -229.8 -223.3 -218.3 -214.5

Share buyback 0.0 -49.6 -106.8 -144.2 0.0 0.0 0.0 0.0 0.0

Net changes in debt -0.4 695.1 -144.5 -167.5 -12.8 -9.1 -6.0 -3.4 -1.1

Dividend 0.0 0.0 0.0 0.0 -145.0 -147.9 -150.9 -153.9 -157.0

Other -7.5 -9.7 -52.2 -23.7 -22.5 -21.4 -20.3 -19.3 -18.4

Financing cash flow -7.9 635.8 -303.5 -335.4 -157.8 -157.0 -156.9 -157.3 -158.0

Change in cash -7.5 -18.1 -32.1 63.7 90.8 85.2 78.7 74.6 71.9


12

Appendix 2. Revenue breakdown by service.

Data in PLNm unless s tated otherwise.

2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E

Total 1 569 1 619 2 121 1 892 1 812 1 748 1 694 1 653 1 621

Voice 2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E

Own Network 276 253 380 325 296 269 245 223 203 ARPU (PLN) 60 56 49 43 39 36 33 30 28

RGU ('000) 386 374 648 635 630 624 618 613 607

Regulated Access 465 473 571 497 441 391 347 308 273 ARPU (PLN) 48 48 46 45 45 44 44 43 42

RGU ('000) 806 822 1 043 911 820 738 664 598 538

Other 37 21 35 20 17 14 12 10 8

Subtotal 779 748 986 843 754 675 604 540 484

Data 2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E

Own Network 190 204 345 325 322 319 316 313 310 ARPU (PLN) 69 67 70 68 66 64 62 60 58

RGU ('000) 231 252 408 396 406 416 426 437 448

Regulated Access 220 250 278 259 251 244 236 229 223 ARPU (PLN) 44 44 48 47 47 47 48 48 48

RGU ('000) 412 475 487 459 443 428 413 398 384

P4 contract 28 17 3 - - - - - -

Other (incl. B2B solutions) 141 147 166 163 174 185 197 210 224

Subtotal 580 617 791 747 747 748 750 753 757

Other Revenues 2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E

Interconnect 68 76 110 87 87 87 86 86 86

Wholesale 116 124 134 111 111 111 111 111 111

TV 0 3 36 44 50 57 65 74 83

ARPU (PLN) 0 42 42 37 35 33 32 31 29

RGU ('000) 0 5 71 101 120 142 169 200 238

Mobile 0 8 29 26 24 22 21 19 18

ARPU (PLN) 0 27 26 27 27 27 27 27 27

RGU ('000) 0 24 93 80 74 69 64 59 55

CaTV 0 0 0 0 5 15 24 36 49

Others 27 18 34 34 34 34 34 34 34

Subtotal 211 228 344 302 311 326 341 359 380


13

Appendix 3. Key Financial Ratios

Ratios 2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E

Liquidity ratios

Current ratio 2.49 0.90 0.94 1.01 1.39 1.66 1.95 2.26 2.57

Quick ratio 1.31 0.82 0.81 0.94 1.31 1.57 1.86 2.15 2.46

Cash ratio 0.73 0.31 0.29 0.40 0.72 1.00 1.30 1.62 1.95

Efficiency ratios

Total Asset Turnover 0.54 0.53 0.63 0.61 0.61 0.61 0.61 0.60 0.60

Fixed Asset Turnover 1.10 0.88 1.00 0.96 1.02 1.08 1.14 1.21 1.26

NWC Turnover -24.6 -32.6 -42.4 -45.3 -70.9 -77.8 -83.8 -91.7 -100.3

Receivables Turnover 10.0 8.2 8.4 7.6 7.5 7.9 8.5 9.2 9.9

Days Of Sales Outstanding 36.4 44.6 43.3 48.2 48.5 46.1 43.2 39.9 36.9

Inventory Turnover 215.9 193.8 572.7 914.8 886.7 855.6 829.2 808.9 793.3

Days Of Inventory On Hand 1.7 1.9 0.6 0.4 0.4 0.4 0.4 0.5 0.5

Payables Turnover 6.9 6.9 8.1 7.0 6.8 7.1 7.6 8.2 8.9

Number of days of payables 52.9 52.9 45.0 52.2 54.1 51.2 47.9 44.3 41.0

Cash Conversion Cycle -14.8 -6.5 -1.0 -3.6 -5.1 -4.7 -4.4 -4.0 -3.6

Profitability Ratios

EBIT Margin 3.7% 6.1% 5.1% 5.8% 6.4% 8.3% 10.0% 11.6% 13.1%

EBITDA Margin 22.9% 25.2% 27.9% 29.1% 29.5% 29.9% 30.4% 30.8% 31.3%

Net Profit Margin 16.8% 15.4% -4.1% 1.9% 4.0% 5.5% 6.9% 8.1% 9.3%

ROA 10.3% 7.0% -2.7% 1.2% 2.5% 3.4% 4.2% 5.0% 5.6%

ROE 11.5% 9.9% -3.8% 1.6% 3.3% 4.6% 5.6% 6.6% 7.4%

OpCF/Assets 11.3% 11.8% 16.7% 20.2% 16.8% 16.8% 16.7% 16.6% 16.5%

OpCF/Equity 12.6% 16.8% 23.6% 27.4% 22.6% 22.5% 22.2% 22.0% 21.8%

Solvency Ratios

Debt Ratio 0.0% 19.6% 17.0% 12.7% 12.8% 12.8% 12.9% 13.0% 13.1%

Debt to Equity Ratio 0.0% 27.8% 24.0% 17.2% 17.2% 17.2% 17.2% 17.2% 17.2%

Financial Leverage 1.1 1.3 1.4 1.4 1.4 1.3 1.3 1.3 1.3

Interest Coverage Ratio -19.5 -6.8 2.7 3.8 4.2 5.4 6.5 7.4 8.2

Cash Flow Ratios Internal financing of CAPEX (CFO/CAPEX)

139% 33% 202% 249% 205% 205% 205% 206% 207%

Relationship of CFO and

(NI+D&A+ΔNWC) 0.53 0.74 1.41 1.16 1.00 1.00 1.00 1.00 1.00

Cash sales performance 18% 26% 26% 32% 27% 27% 27% 27% 27%

Dividend Ratios

Dividend/buyback payout ratio 0% 20% -122% 402% 202% 154% 129% 114% 104%

Dividend/buyback to CFO 0% 12% 20% 24% 30% 31% 33% 34% 35%


14

Appendix 4. Sensitivity Analysis

perpetuity growth rate

-1.0% -0.5% 0.0% 0.5% 1.0%

WA

CC

of

Re

sid

ual

8.75% 5.81 6.03 6.27 6.54 6.85

9.75% 5.47 5.65 5.85 6.07 6.31

10.75% 5.19 5.34 5.50 5.68 5.88

11.75% 4.95 5.08 5.22 5.37 5.54

12.75% 4.74 4.85 4.97 5.11 5.25

Tax rate

15% 17% 19% 21% 23%

EBIT

DA

mar

gin

gr

ow

th

0.5% 5.10 5.02 4.95 4.87 4.79

1.0% 5.39 5.30 5.22 5.14 5.05

1.5% 5.68 5.59 5.50 5.41 5.32

2.0% 5.98 5.88 5.79 5.69 5.60

2.5% 6.28 6.18 6.08 5.98 5.88


15

Appendix 5. DCF Valuation

2013E 2014E 2015E 2016E 2017E 2018E Residual

EBIT 110 116 146 170 192 212 226

Tax rate 19% 19% 19% 19% 19% 19% 19%

Tax -35 -17 -23 -27 -32 -35 -38

NOPLAT 75 99 123 143 161 177 188

D&A 440 418 378 345 318 295 210

CAPEX -245 -237 -230 -223 -218 -214 -210

ΔNWC 48 -4 -2 -2 -2 -2

FCFF 317 276 269 262 258 256 188

TV

1 752

0.0 1.0 2.0 3.0 4.0 5.0

WACC 9.3% 9.8% 10.8% 10.8% 10.8% 10.8% 10.8%

Discount factor 1.000 0.911 0.815 0.736 0.665 0.600

Discounted FCFF 317.4 251.6 219.3 192.8 171.4 153.6

FCFF Sum 988.7

Enterprise value

breakdown

Discounted TV 1 051.7

Residual FCFF Sum

Enterprise value 2 040.4

52% 48%

Cash 130.9

Debt 448.2

Equity Value 1 723.2

Shares outstanding 347.9

Price at beg of 2014 5.0

12M TP 5.50

Upside potential 10.0%


16

Appendix 6. Monte Carlo sensitivity analysis

We performed Monte Carlo volatil ity simulation of Netia 12M target share price under assumptions used in

DCF model. We focused on sensitive inputs recognized in Tornado analysis. The distributions have been

established as follows:

Distribution Mean Standard deviation Explanation EBITDA margin growth Min Extreme 1.2% 0.6ppts

Possible threat of unequal cost cuts to revenue decrease

CAPEX to sales ratio Gamma 12% 1ppts Possible opportunities arising from the market substantially increasing CAPEX

Perpetuity growth rate Normal 0% 0.5ppts

Oscillations from the anchor due to economic fluctuations

Min Max

Tax rate Uniform 8% 30% High historical volatility

The outcome of the 100 000 simulations implies that the current price of NET (PLN 5.00) is lower than mean of

the distribution of PLN 5.52. Under our assumptions there is 42% certainty level of market and Netia

development implying proper Hold recommendation with higher probability upward price movement.


17

Appendix 7. WACC calculation

Target Capital Structure 2013 2014 2015 2016 2017 2018 2019 2020

Debt to Total Capitalization 14.7% 14.7% 14.7% 14.7% 14.7% 14.7% 14.7% 14.7%

Equity to Total Capitalization 85.3% 85.3% 85.3% 85.3% 85.3% 85.3% 85.3% 85.3%

Debt to Equity Ratio 17.2% 17.2% 17.2% 17.2% 17.2% 17.2% 17.2% 17.2%

Cost of Equity

Risk-free rate 4.4% 4.9% 5.9% 5.9% 5.9% 5.9% 5.9% 5.9%

Market risk Premium 6.3% 6.3% 6.3% 6.3% 6.3% 6.3% 6.3% 6.3%

Beta 0.85 0.85 0.85 0.85 0.85 0.85 0.85 0.85

Cost of Equity 9.7% 10.2% 11.2% 11.2% 11.2% 11.2% 11.2% 11.2%

Cost of Debt

Cost of Debt 8.4% 8.9% 9.9% 9.9% 9.9% 9.9% 9.9% 9.9%

Taxes 19.0% 19.0% 19.0% 19.0% 19.0% 19.0% 19.0% 19.0%

After Tax Cost of Debt 6.8% 7.2% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0%

WACC 9.3% 9.8% 10.8% 10.8% 10.8% 10.8% 10.8% 10.8%

Appendix 8. Churn rates

Churn rates 2011 2012 2013P 2014P 2015P 2016P 2017P 2018P

Voice Own Network 3.2% -73.4% 2.0% 0.9% 0.9% 0.9% 0.9% 0.9%

Voice Regulated Access -2.0% -26.9% 12.6% 10.0% 10.0% 10.0% 10.0% 10.0%

Voice total -0.3% -41.4% 8.5% 6.3% 6.0% 5.8% 5.6% 5.4%

Data Own Network -9.0% -62.2% 3.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Data Regulated Access -15.2% -2.5% 5.6% 3.5% 3.5% 3.5% 3.5% 3.5%

Data total -13.0% -23.2% 4.4% 2.6% 2.5% 2.5% 2.4% 2.3%

Mobile N/A -281.8% 13.9% 7.2% 7.2% 7.2% 7.2% 7.2%

Appendix 9. SWOT analysis

Inte

rnal

facto

rs

Strenghts Weaknesses

oppeness to new technologies limited growth opportunities

investing in pay TV sector operating mainly on fixed line segment of the Telecom market

price competitiveness strong bargaining power of subscribers

stable position on the market (2nd in terms of both fixed line voice and broadband)

dependency on incumbent

cash surplus high competition on the market

increasing profitability (in terms of net income) reduction in ARPU

Low leverage (easy to aquire debt financing)

Ex

tern

al

facto

rs Opportunities Threats

improving sector (Ministry of Administration and Digitization formation)

significant sunk cost

dependency on UKE regulation - favorable fixed-to-mobile substitution effect (fixed line broadbands market shrinking)

acquisitions pension fund (OFE) regulatory changes

increasing market penetration of fixed line segment of the market

growing dependency (popularity) on the internet


18

Appendix 10. OFE influence on WSE

According to the recent Pension Funds reform, OFE will be forced to transfer 51.5% of their assets from

treasury bonds and bills into Social Insurance Institution (ZUS). Moreover , pension funds investment limits will

be changed, legally obliging OFE to invest between 75% and 90% of assets in equities (now maximum is 40%).

The effect of anticipated regulation is hard to predict. We expect pension funds not to be willing to maintain

such a high level of assets in equities and therefore will review their stocks portfolios tending to a minimum

investment l imit. The domestic market may be weaker than foreign markets with increased volatility, because

OFE impact on WSE is significant.

The decrease in the size of pension fund assets invested in shares has already been recorded in December 2013

with significant negative influence on the market. Tot al market value of equities under control of OFE on WSE

amounted to PLN 120.6bn constituted 14.36% of total WSE market capitalization of PLN 840bn. declining

compared to November by -5.8% from PLN 128.1bn, which means the biggest monthly loss in value since

November 2011, when the MoM fall amounted to 6.8%. Increase in funds cash position by PLN 3.2bn reveals

that funds sold significant amount of shares. Provided that monthly new contributions cash inflow to OFE

equals approximately PLN 800m, we can estimate that Pension Funds sold the shares for at least PLN 1.2bn. It

is considered to be the main driver of -7% WIG index drop MoM in December. Results are visible in WIG20

index performance, which was weaker than MSCI World Index (MXWO) that grew in December 2013 and also

to MSCI Emerging Markets Index (MXEF) which decreased slower. This situation shows significant influence of

Pension Funds on WSE as well as weaker conditions of Emerging Markets.

Appendix 11. Acquisition of cable TV infrastructure from UPC

Netia acquired UPC’s overlapping cable TV network (pure infrastructure without clients) increasing subscriber

base for 446k households in Warsaw and Cracow, what constitutes a 17% of Netia’s current base. The price

paid will depend on acquiring new customers from this network, would be equal in the range PLN 6-21m. The

clue of the transaction is that Netia acquired potential client base at cities where none exists. We forecast that

Netia will acquire 10.7% of new client base. We estimate first positive impact on financial in 2014 and steadily

growth to 48k customers in 2018.

0.85

0.90

0.95

1.00

1.05

1.10

1.15

WIG20 MXEF MXWO


19

Appendix 12. Value at Risk estimation

Test Statistic Critical Value

Kupiec 0.267 3..41

Christoffersen 3.14 3.841

Variance estimate 100-day Historical Mean Covariance

Distribution applied Gaussian distribution

Significance level 5%

Value at risk Estimate in % Monetary units (PLN)

1-Day 3.39% 0.17

10-Day 8.29% 0.41

-20.00%

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

2010/06/10 2010/09/10 2010/12/10 2011/03/10 2011/06/10 2011/09/10 2011/12/10 2012/03/10 2012/06/10 2012/09/10 2012/12/10 2013/03/10 2013/06/10 2013/09/10 2013/12/10

Daily NET log returns

1-day VaR Estimate (100 day Historical Mean Covariance, normal distribution, significance level=5%)


20

PR

OB

AB

ILIT

Y

low

m

od

erat

e

h

igh

Appendix 13. Risk matrix

Effective tax

rate fluctuation

Fixed-to-mobile

substitution

effect

NBP increase

interest rate

OFE influence

on WSE

Market

competition in

M&A

CAPEX increase

Regulated price

increasing

Incumbent

operator

actions

Impose new tax

of telecom

cables

EBIDTA margin

growth rate

Changes in UKE

policy

New

investment in

unprofitable

technologies

Global specific

risk

Poland enters

to the Eurozone

Other investment risks which have an insignificant impact and low probability on estimated Netia price.

Market risks Risk of investment in unprofitable technologies. The telecommunications market is highly dependent on new

technologies, such as NGN, NGA, and FTTH, constantly implemented by the operators. Netia is gradually enhancing its telecommunications network to NGN to be competitive in relation to the market. According to legal changes predictions difficulties and actual level of market demand forecast, risk of overinvestment exists

and the company may never realize revenues level sufficient to cover capital expenditures. Incumbent operator actions impair alternative operator operations. Orange, being the biggest operator in the market, provides fixed and mobile services to the customers. The trend to offer bundled services is driving the

market rec ently allowing operators to increase the RGU number and decrease the churn rate. Moreover , many fines had been imposed on the incumbent operator in the past for market regulation disobedience with negative influence on alternative operators. The amount of fines does not convince the main operator to comply with UKE regulations and therefore are expected to occur in the future.

insignificant moderate severe

IMPACT

Legend


21

Economic risk Poland enters to the Euro Zone. Poland entering to the Euro zone during our forecast 7-year period is possible

but not much probable. If it occurs the interest rate would decrease because polish interest rates are higher than European interest rates. This situation could have positive impact on cost of debt in the future. NBP increases interest rates. National Bank of Poland (NBP) will probably increase interest rates during our

forecast 7-year period, because they are at the lowest level in history. We believe that NBP will increase referenc e rate from 2.5% to 3% in the end of 2014 and to 4% in 2015, because of the raising GDP and CPI in Poland. This situation could have negative impact on cost of debt in the future.

Legal risk New tax regulations hurt company’s profits. Legal authorities in Poland intend to impose tax on telecommunication cables in the sewage system based on nominal gross book value. It is estimated that due to the taxation of fiber optic cables operators will incur an additional 0.8k PLN to 1.2k PLN operating costs per kilometer of network. Cable and fiber optic networks are main asset positions of Netia. Net tax regulations hurt company’s profits. The probability and impact of actual tax imposing is moderate.

Regulated access prices increase . European Commission suggested changing monthly rental access prices of high-speed broadband networks per customer between 8 and 10 euros from January 2017. The EU executives believe that if established telecoms firms make more money from their legacy networks , they will be able to plough it back into investments in high-speed networks. The proposed rates would mean higher charges for

users in Poland and nine other EU countries , all of which currently offer rates below 8 euros , according to separate Commission data. Occurrence will boost operating costs and therefore impair profitability.

UKE policy and actions. Regulator aims to increase competitiveness in the telecommunication market and undermine the dominant position of the incumbent operator, having positive influence on alternative operators. The regulator strives to introduce the symmetric wholesale rates on fixed-line networks (FTR) and mobile networks (MTR). Mobile Termination Rates decrease may lower mobile communica tion prices and

enhance substitution effect, therefore impairing revenues of fixed-line operators.


22

Appendix 14. DuPont analysis on EBITDA

Appendix 15. Netia management board

Mirosław Godlewski, 46, President and CEO since February 2007, gained his business experience while serving on various managerial positions before. Holds Msc in Industrial Management of Warsaw University of Technology and MBA from Ashridge Management College, UK.

Jon Eastick, 46, Chief Financial Officer and Management Board member since April 2006, formerly CFO of PTC (currently known as T-Mobile Polska).

Tom Ruhan, 49, Chief Legal Officer since 2006. He played a major role in merging of over 40 acquired units , finally forming the Netia Group. Graduate in law of Warwick University, UK.

Mirosław Suszek, 48, Management Board member since May 2012. He served before as a COO of UPC Poland, largest Cable TV operator in Poland. Msc in Electrical Engineering from WUT, executive MBA from WUT Business School. Granted a postgraduate degree in telecommunications , IT and Management at the WUT Institute of Electronics.

EBITDA/Sales

22.9% 25.2% 27.9%

29.1% 29.5% 29.9%

30.4% 30.8% 31.3%

Sales/Assets

61.1% 45.6% 65.6%

62.9% 62.5% 62.0%

61.5% 61.0% 60.3%

Legend

2010 2011 2012

2013P 2014P 2015P

2016P 2017P 2018P

EBITDA/Equity

15.6% 16.3% 25.7%

24.7% 24.9% 24.9%

25.0% 24.9% 24.9%

EBITDA/Assets

14.0% 11.5% 18.3%

18.3% 18.4% 18.6%

18.7% 18.8% 18.9%

Asset/Equity

111.8% 142.1% 140.8%

135.4% 134.9% 134.3%

133.4% 132.6% 131.8%


23

Appendix 16. M&A transactions on telecommunication market in Poland.

(PLN m)

Company name Main service Status

Transaction value/market

cap PLNm Revenues

'13 EBITDA '13 TV/EBITDA

Emitel Infrasctructure

provider Acquired by Alinda Capital Partners 3 200.00 260.0 12.3

GTS CE Fixed-line B2B Acquired by Deutsche Telecom 2 300.00 1 462.0 366.5 6.3

Polkomtel Mobile

services Acquired by Cyfrowy Polsat 15 100.00 7 379.5 2 748.7 5.5

TK Telekom Wholesale Tender offer canceled. expected to be restored

under revised terms

The minimum price at

PLN 400m has not been reached

299.3 73.9 4.7

Exatel Infrastructure

provider Due diligence announcement canceled.

restoration expected in medium term Est. PLN 800m 450.6 29.9 26.7

Hawe Infrastructure

provider 365.00 39.9 33.0

Multimedia Fixed-line

services and CaTV

645.7 326.7

UPC Fixed-line

services and CaTV

Vectra Fixed-line

services and CaTV

Netia Fixed-line services

1 892.2 550.0


24

Appendix 17. Comparable companies description.

Market Enterprise LTM

Company Ticker Country of domicile Business Description cap Value Sales

NETIA SA NET PW Poland

Netia S.A. provides fixed-line telecommunications services in Poland. The Company offers

switched fixed-line telephone services, ISDN, Internet access services, leased lines, and voice mail.

[BBGID BBG000F6P9T1]

1 771 2 088 1 945

KONINKLIJKE KPN NV KPN NA Netherlands

Koninklijke (Royal) KPN NV provides telecommunications services throughout the Netherlands.

The Company provides local, long distance, international, and mobile telecommunications services,

voice-mail, call forwarding, ISDN Internet lines, faxing, and communications services for businesses

and individuals. KPN offers mobile telecommunications through E-Plus in Germany and BASE in

Belgium. [BBGID BBG000BBDX14]

47 989 88 316 45 671

ILIAD SA ILD FP France

Iliad S.A. provides a wide range of telecommunications services which include national

telecommunication and dial-up, and high speed DSL and TV Internet access. [BBGID

BBG000P48PF3]

39 356 43 713 14 684

TURK TELEKOMUNIKASYON AS TTKOM TI Turkey

Turk Telekomunikasyon A.S. is an integrated telecommunications services provider for businesses

and individuals. The Company offers land and mobile telecommunications solutions, as well as

Internet services. [BBGID BBG000BR8WS8]

27 924 38 022 22 811

ROSTELECOM RTKM RM Russia

Rostelecom is Russia's national telecommunications operator, with points of presence in all

Russian regions. The Company provides a wide range of telecommunications services, including

voice telephony, fixed broadband and mobile data, pay TV, cloud and IT solutions, to residential,

corporate and governmental subscribers and third party operators across all Russian regions.

[BBGID BBG004S682Z6]

27 504 46 143 33 672

TDC A/S TDC DC Denmark

TDC A/S provides telecommunications solutions. The Company offers fixed and mobile telephone

service, data communications, systems integration, website hosting, broadband Internet access,

and cable television services. TDC serves customers and clients throughout Europe. [BBGID

BBG000BX25Y3]

23 052 35 862 13 999

TALKTALK TELECOM GROUP TALK LN United Kingdom

TalkTalk Telecom Group PLC provides telecommunications services. The Company provides fixed

line communications services, serving residential and business-to-business customers in the

United Kingdom. [BBGID BBG000BCL3V6]

15 194 17 581 8 375

ORANGE POLSKA SA OPL PW Poland

Orange Polska SA owns, operates, and leases telecommunications networks throughout Poland.

The Company provides local and long-distance telephone, telegraph, paging, and Internet access

services. Orange Polska SA also offers mobile telephone services through its subsidiary company.

[BBGID BBG000F6YJD6]

13 281 17 928 13 250

TEO LT TEO1L LH Lithuania

Teo LT AB offers telecommunications services in Lithuania. The Company offers fixed-line

telephone service, e-mail, voicemail, call forwarding, call waiting, conference calling, speed dialing,

wake-up service, corporate local area networks, toll-free lines, and facsimile services. [BBGID

BBG000C43432]

2 557 2 326 885

Source: Company filings, Bloomberg

List of Comparable Companies

Netia SA (NET PW)

Financial Statistics and Ratios, part 1(PLN m)

Net Sales EBITDA EPS

Market Enterprise Net EBITDA EBIT Income Hist. CAGR Hist. Est. Hist. Est.

Company Ticker cap Value Sales EBITDA EBIT Income (%) (%) (%) 1-year 5-year 1-year 1-year 1-year 1-year

NETIA SA NET PW 1 771 2 088 1 945 538 88 (73) 27,7 4,5 3,1 (12,28) 11,01 (4,00) (0,07) 40,15 0,16

Peer group

KONINKLIJKE KPN NV KPN NA 47 989 88 316 45 671 16 232 4 302 (675) 35,5 9,4 -11,7 (7,51) (10,51) (14,30) (0,14) (81,67) 0,55

ILIAD SA ILD FP 39 356 43 713 14 684 4 488 2 116 1 046 30,56 14,41 7,9 15,29 21,45 41,36 0,25 - 28,04

TURK TELEKOMUNIKASYON AS TTKOM TI 27 924 38 022 22 811 8 287 5 243 2 861 36,3 23,0 7,0 4,79 5,35 (1,90) (0,13) (62,88) 0,98

ROSTELECOM RTKM RM 27 504 46 143 33 672 12 512 5 728 3 675 35,6 14,6 10,9 (0,71) - 1,17 (0,12) 51,17 0,95

TDC A/S TDC DC 23 052 35 862 13 999 5 823 3 027 1 653 41,6 21,6 9,9 (4,40) (7,16) (2,11) (0,06) (47,18) 2,16

TALKTALK TELECOM GROUP TALK LN 15 194 17 581 8 375 1 399 707 275 16,7 8,4 -0,8 1,69 3,88 (41,50) 0,09 - 0,74

ORANGE POLSKA SA OPL PW 13 281 17 928 13 250 4 157 998 447 31,4 7,5 7,5 (7,95) (6,78) (13,01) (0,06) (22,15) 0,27

TEO LT TEO1L LH 2 557 2 326 885 361 204 186 40,8 23,1 23,5 (4,48) (2,25) (4,71) (5,85) -

Mean 33,6 15,3 6,8 -0,4 0,5 -4,4 0,0 -21,1 4,2

Median 35,6 14,5 7,7 -2,6 -1,1 -3,4 -0,1 -14,0 0,8

High 41,58 23,09 23,51 15,29 21,45 41,36 0,25 51,17 28,04

Low 16,68 7,53 -11,68 -7,95 -10,51 -41,50 -0,14 -81,67 0,00

Source: Company filings, Bloomberg, Consensus Estimates

Market Valuation LTM Financial Statistics LTM Profitability Margins Growth Rates

Debt/ Debt / EBITDA / EBITDA

D&A OpFCF/CapexCapex/Sales ROIC/WACC ROE ROA Assets EBITDA Int. Exp. - Cpx/ Int.

Company Ticker Adjusted Beta(% of Sales) ratio % ratio (%) (%) % (x) (x) (x)

NETIA SA NET PW 0,85 23% 3,21 12,55 0,15 -3,15 -2,30 15,02 0,83 1 340,43 10,15

Peer group

TALKTALK TELECOM GROUP TALK LN 0,53 8% 1,93 3,20 3,65 14,55 4,27 36,98 1,71 18,00 6,56

KONINKLIJKE KPN NV KPN NA 1,08 26% 1,28 4,23 0,37 -3,95 -0,66 53,36 3,54 6,47 3,47

ILIAD SA ILD FP 0,61 16% 1,07 24,57 1,40 14,58 5,42 28,11 1,25 15,49 4,43

TURK TELEKOMUNIKASYON AS TTKOM TI 0,94 13% 1,91 18,66 0,88 30,47 9,39 46,76 1,77 15,83 n/a

ROSTELECOM RTKM RM 0,82 20% 1,07 28,38 1,06 13,60 6,43 36,96 1,80 7,55 1,78

TDC A/S TDC DC 0,71 20% 3,66 9,90 1,60 14,04 4,72 38,74 2,26 8,11 n/a

ORANGE POLSKA SA OPL PW 0,87 24% 1,42 21,65 0,71 3,48 1,91 21,39 1,17 9,66 4,36

TEO LT TEO1L LH 0,60 18% 2,16 19,46 2,75 15,25 13,91 0,23 0,01 2 088,99 n/a

Mean 0,77 18% 1,81 16,26 1,55 12,75 5,67 32,82 1,69 271,26 4,12

Median 0,76 19% 1,66 19,06 1,23 14,30 5,07 36,97 1,74 12,57 4,36

High 1,08 0,26 3,66 28,38 3,65 30,47 13,91 53,36 3,54 2 088,99 6,56

Low 0,53 0,08 1,07 3,20 0,37 -3,95 -0,66 0,23 0,01 6,47 1,78

LTM Coverage RatiosReturn on InvestmentExpenditure ratios LTM Leverage Ratios


25

Appendix 18. Peer multiples

Appendix 19. Glossary

Company 2009 2010 2011 2012 LTM 2013E 2014E 2009 2010 2011 2012 LTM 2013E 2014E 2009 2010 2011 2012 LTM 2013E 2014E

NETIA SA 0,8x 1,1x 1,6x 1,2x 1,1x 1,0x 1,2x 4,1x 4,9x 6,4x 4,5x 3,5x 3,5x 4,2x 16,0x 7,3x 8,3x n/a n/a 45,3x 26,7x

Peer group

KONINKLIJKE KPN NV 2,2x 2,2x 1,9x 1,4x 1,9x 2,0x 2,1x 5,8x 5,3x 4,9x 4,0x 5,5x 5,8x 6,3x 8,9x 9,5x 8,7x 7,6x 61,3x 20,0x 20,7x

ILIAD SA 2,7x 2,5x 3,0x 2,7x 3,0x 2,8x 2,5x 8,0x 6,5x 7,8x 9,4x 9,7x 9,2x 7,9x 26,0x 14,2x 20,7x 39,3x 37,7x 31,9x 24,5x

TURK TELEKOMUNIKASYON AS1,8x 2,4x 2,4x 2,3x 2,1x 2,1x 2,0x 4,9x 5,9x 6,1x 5,9x 5,7x 5,5x 5,3x 8,7x 9,3x 11,9x 9,2x 12,3x 11,1x 8,2x

ROSTELECOM 0,7x 0,8x 2,1x 1,7x 1,6x 1,6x 1,6x 1,9x 2,3x 5,2x 4,7x 4,6x 4,3x 4,3x 20,3x 17,0x 9,6x 9,9x 9,3x 11,4x 10,9x

TDC A/S 3,1x 2,4x 2,3x 2,1x 2,6x 2,6x 2,6x 7,8x 5,8x 5,4x 5,4x 6,2x 6,5x 6,6x 123,5x 26,3x 13,4x 8,9x 13,8x 12,6x 13,1x

TALKTALK TELECOM GROUP n/a 1,0x 1,0x 1,0x 1,8x 2,1x 2,1x n/a 7,6x 6,1x 5,3x 8,6x 12,4x 15,1x n/a n/a 35,7x 8,8x 24,1x 51,0x 35,4x

ORANGE POLSKA SA 1,5x 1,6x 1,7x 1,5x 1,4x 1,4x 1,5x 4,0x 4,3x 4,7x 4,2x 4,3x 4,4x 4,6x 204,1x 12,0x 18,8x 29,7x 42,9x 37,3x 0,0x

TEO LT 1,3x 2,2x 1,9x 2,4x 2,6x n/a n/a 3,2x 5,4x 4,6x 6,0x 6,5x n/a n/a 8,4x 11,8x 10,4x 13,0x 13,8x n/a n/a

Mean 1,9x 1,9x 2,0x 1,9x 2,1x 2,1x 2,1x 5,1x 5,4x 5,6x 5,6x 6,4x 6,9x 7,1x 57,1x 14,3x 16,2x 15,8x 26,9x 25,1x 16,1x

Median 1,8x 2,2x 2,0x 1,9x 2,0x 2,1x 2,1x 4,9x 5,6x 5,3x 5,3x 6,0x 5,8x 6,3x 20,3x 12,0x 12,6x 9,5x 18,9x 20,0x 13,1x

Premium to peer median -54,73% -48,01% -19,67% -35,81% -46,77% -50,42% -40,87% -16,27% -12,04% 20,47% -16,36% -40,76% -39,44% -33,84% -21,15% -38,75% -34,25% n/a n/a 126,77% 103,05%

High 3,1x 2,5x 3,0x 2,7x 3,0x 2,8x 2,6x 8,0x 7,6x 7,8x 9,4x 9,7x 12,4x 15,1x 204,1x 26,3x 35,7x 39,3x 61,3x 51,0x 35,4x

Low 0,7x 0,8x 1,0x 1,0x 1,4x 1,4x 1,5x 1,9x 2,3x 4,6x 4,0x 4,3x 4,3x 4,3x 8,4x 9,3x 8,7x 7,6x 9,3x 11,1x 0,0x

EV/EBITDAEV/Sales P/E

GLOSSARY

4G fourth generation of mobile technology, sometimes called LTE or Long Term Evolution

ARPU Average Revenue per User

BSA Bit Stream Access

B2B Business to business

CATV Cable Television

Churn Rate The percentage of subscribers to a service that discontinue their subscription to that service in a given time period.

FTR Fixed-line networks

FTTH Fiber To The Home

IO Incumbent operator

IPTV Internet Protocol Television

IVR Interactive Voice Response

LLU Local Loop Unbundling

LTE Long Term Evolution (4G)

MTR Mobile Termination Rates

NGA Next Generation Access

NGN Next Generation Network

OFE Polish Pension Fund

RIO Reference Interconnection Offer

RLLO Reference Leased Line Offer

S.A. Incorporated

SAC Subscriber Acquisition Costs

Sp. z o.o. Limited Liability Company

UKE Office of Electronic Communications - Regulator

VoIP Voice over Internet Protocol

WLR Wholesale Line Rental

WUT Warsaw University of Technology

ZUS Social Insurance Institution

xDSL X Digital Subscriber Line


26

Disclosures: Ownership and material conflicts of interest: The author(s). or a member of their household. of this report does not hold a financial interest in the securities of this company. The author(s). or a member of their household. of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue. Position as a officer or director: The author(s). or a member of their household. does not serve as an officer. director or advisory board member of the subject company. Market making: The author(s) does not act as a market maker in the subject company’s securities. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable. but the author(s) does not make any representation or warranty. express or implied. as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice . nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Society of Poland. CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock.

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