AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX

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1 Global Equity Research Company Focus Europe Italy Media Broadcasting 18 January 2005 Mediaset Reuters: MS.MI Bloomberg: MS IM Exchange: MI Ticker: MS.MI The beautiful game Company Review Buy Price at 14 January 2005 (EUR) 10.1 Price target - 12mth (EUR) week range (EUR) DTT soccer is a re-rating catalyst for Mediaset. TP increased to E12 The roll-out of DTT soccer offers significant financial upside to Mediaset (E0.8/share) but just as importantly, it is a means for Mediaset to shape the multichannel TV landscape in Italy in its favour. We expect the stock to positively re-rate. It is cheap against the sub-sector and has outstanding cash returns prospects. Our estimates are 13-19% ahead of EPS consensus. We are raising our price target to Euro 12 from Euro 11. Paul Reynolds (44) paul.reynolds1@db.com Alessandro Baj Badino (39) alessandro.bajbadino@db.com Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, 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. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1

2 Europe Italy Media Broadcasting 18 January 2005 Mediaset Reuters: MS.MI Bloomberg: MS IM Exchange: MI Ticker: MS.MI The beautiful game Paul Reynolds (44) Alessandro Baj Badino (39) DTT soccer is a re-rating catalyst for Mediaset. TP increased to E12 The roll-out of DTT soccer offers significant financial upside to Mediaset (E0.8/share) but just as importantly, it is a means for Mediaset to shape the multichannel TV landscape in Italy in its favour. We expect the stock to positively re-rate. It is cheap against the sub-sector and has outstanding cash returns prospects. Our estimates are 13-19% ahead of EPS consensus. We are raising our price target to Euro 12 from Euro nd January sees Mediaset s pay TV strategy launched in Italy We see the launch of Mediaset s pay per view soccer product at a fraction of the cost of its competitors as a strategic watershed. A successful launch will enable Mediaset to influence Italy s multichannel TV landscape in its favour. We expect Mediaset to complement its robust advertising franchise with a new, high-growth pay TV operation. Value enhancing investment for shareholders We see the DTT product increasing base EBITDA by 5% in 2006 and 7% in 07E. We ascribe a value per share of E0.8 to the DTT project. Our new estimates are ahead of 05E consensus by 13% and 19% in 06E. Valuation attractive- 19% upside to new Euro 12 price target Mediaset is currently trading at a discount to its sub-sector peers: an in line valuation would provide 15% upside potential. It trades on the cheapest price/growth multiple in the sub-sector (0.8x 05-07E FCF), and has the prospect of a 6.9% dividend yield on our 06E estimates. Coupled with almost 20% FCF and EPS growth from 05-07E, this represents a potent return combination. Key risks: an advertising slow-down, political fears over Mr. Berlusconi s 51% ownership and poor PPV take-up. Company Review Buy Price at 14 January 2005 (EUR) 10.1 Price target - 12mth (EUR) week range (EUR) Price/price relative /03 7/03 1/04 7/04 SXXE (L.H. SCALE) Mediaset (R.H. SCALE) Performance (%) 1m 3m 12m Absolute 15.3% 13.3% 7.1% SXXE 2.9% 7.8% 6.7% Stock data Market cap (EUR) 11,930 Shares outstanding (m) 1,181.2 Free float 49% Beta 1.00 CY04 P/E-to-growth 1.1x Est. 3 year EPS growth 18% SXXE Index membership.bcii Major shareholders: Fininvest 51% Forecasts and ratios Year End Dec E 2005E 2006E 2007E EPS New (EUR) EPS Old (EUR) EPS consensus N/A EPS Growth % 21% 17% 10% DPS (net) Div./Yield % 3.9% 4.0% 4.7% 5.3% P/E x EV/EBITDA x 12.1x 9.7x 8.1x 7.1x Revenue 2,634 2,851 3,074 3,269 PBT adj (Eur) (1) ,076 1,206 PBT stated (Eur) (1) Italian business ex Telecinco Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, 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. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1

3 Model updated: 18 January 2005 Year Ending 31 December E 2005E 2006E Equity Research SUMMARY Headline EPS (EUR) Europe P/E ratio Headline (x) Italy Headline EPS growth (%) EPS FD (EUR) Broadcasting P/E ratio FD (x) Operating CFPS (EUR) Free CFPS (EUR) Mediaset P/CFPS (x) Reuters: MS.MI Bloomberg: MS IM DPS (EUR) Dividend Yield (%) Buy BV/Share (EUR) Price/BV (x) Price as of 14 January EUR Weighted average shares (m) 1,181 1,181 1,181 1,181 1,181 1,181 1,181 1,181 Target price EUR Average market cap (EUR m) 10,755 20,913 11,565 9,501 9,236 11,909 11,909 11,909 Enterprise value (EUR m) 8,272 17,689 10,362 8,398 8,085 10,276 9,568 9,300 Company website EV/Sales EV/EBITDA EV/EBIT Company description EV/Operating Capital Mediaset S.p.A. operates television broadcasting, INCOME STATEMENT (EUR m) Sales revenue 2,049 2,364 2,351 2,316 2,425 2,634 2,851 3,074 television production, signal broadcasting Operating EBITDA ,024 1,188 management, and music production businesses. Depreciation Amortisation The Company owns and operates Italian television EBIT ,078 stations Canale 5, Italia 1, and Rete Quattro. Net interest income(expense) Associates/affiliates Mediaset also produces and markets record music Investment/other income(expense) albums, sells advertising time, and operates a Exceptionals/extraordinaries Income tax expense library of television rights. Minorities/preference dividends Net income CASH FLOW (EUR m) Cash flow from operations 1, , ,185 1,313 1,419 Movement in net working capital Research Team Capex Free cash flow Paul G Reynolds Other investing activities paul.reynolds1@db.com Equity raised(bought back) Dividends paid Alessandro Baj Badino Net inc(dec) in borrowings alessandro.bajbadino@db.com Other financing cash flows Total cash flows from financing Net cash flow Movement in net debt(cash) BALANCE SHEET (EUR m) Cash and other liquid assets Tangible fixed assets Goodwill Other intangible assets 1,931 2,003 2,078 2,033 1,939 1,932 1,888 1,857 Associates/investments Other assets ,013 1,072 1,130 1,190 1,222 Total assets 3,771 4,095 4,242 4,160 4,027 4,173 4,035 4,276 Interest bearing debt Other liabilities 1,425 1,359 1,323 1,121 1,028 1,039 1,109 1,145 Total liabilities 1,591 1,705 1,887 1,691 1,490 1,462 1,136 1,173 Shareholders' equity 2,178 2,388 2,353 2,467 2,535 2,710 2,898 3,102 Absolute Price Return (%) Minorities Total shareholders' equity 2,179 2,389 2,355 2,469 2,536 2,712 2,900 3,103 0% 2% 4% 6% 8% 10% 12% Net working capital Net debt(cash) m 11% Capital 2,004 2,264 2,602 2,640 2,999 3,134 3,101 3,088 3m 8% RATIO ANALYSIS Sales growth (%) m 4% Op. EBITDA/sales (%) EBIT/sales (%) Payout ratio (%) week Range: EUR ROE (%) Market Cap (m) EUR 11,909 Return on Capital (%) USD 15,596 Operating Return on Capital (%) Capex/sales (%) Company identifiers Capex/depreciation (x) Cusip NA Net debt/equity (%) SEDOL Net interest cover (x) nm Price and Price Relative /00 01/01 01/02 01/03 01/04 01/05 Mediaset (L.H.S.) Rel. to DJ EURO STOXX Pr (R.H.S.) Margin Trends (%) E 05E 06E Sales growth (%) Op. EBITDA/sales (%) Return Ratios (%) E 05E 06E ROE (%) Return on Capital (%) Operating Return on Capital (%) Net Debt (Cash) / Equity (%) E 05E 06E Net Debt / Cash (EUR m) Net debt/equity (%) Source: Company data, Deutsche Bank estimates Page 2

4 Investment thesis Growth of digital terrestrial TV a positive for Mediaset We see Mediaset as one of the best positioned TV broadcasters in Europe. It operates in one of the most underdeveloped advertising markets in the major European territories and enjoys a benign competitive environment with a clear duopoly between RAI and Mediaset. Cost control has been outstanding since 2000 and our analysis suggests that programming cost guidance is conservative in FY05 with US$ depreciation likely to contribute to subdued cost growth in FY05-07E. Most importantly however, it has the lowest risk of multichannel fragmentation damaging its core advertising franchise and is on the cusp of developing a unique mixed economy revenue model balancing its robust advertising franchise with a potentially high-growth pay TV operation. On 22nd January 2005, Mediaset will launch its commercial pay per view football offering at a fraction of the cost of its competitors and we see it as a significant generator of value (we estimate Euro 0.8bn in PV terms). Financially it contributes to the Italian TV business of Mediaset from FY06. But just as importantly, with the other levers at its disposal, Mediaset will use its digital terrestrial TV initiative to significantly influence the shape of the multichannel TV landscape in Italy, in which it will have a leading position, thereby ensuring robust growth into the medium term. For this reason, we believe Mediaset should trade at a premium to its sector peers. Mediaset s valuation is compelling There is 15% upside potential if Mediaset trades up to the sub-sector multiple of 17x CY06 EPS or P/FCF, which would put the stock on Euro 11.6/share: this is despite the company having one of the highest growth rates in FCF for E (19% cagr). Given its financial and strategic outlook, we believe a premium to the sub-sector is supportable. We believe that the DTT opportunity is worth Euro 0.8/share or 8% of the current share price. We do not believe this is reflected in market estimates and our revised estimates are 13-19% above consensus earnings for The company's dividend policy suggests a significantly rising pay-out ratio - whilst the business will still deliver close to compound 20% EPS growth from E. Mediaset's historic dividend yield has been around 3%. Were Mediaset to leave its balance sheet debt free, as it has said it intends to, this would imply a 4.4% yield in 05E rising steeply to 6.9% in 06E. Our analysis indicates the stock has historically traded on 1.06x forward PE/g multiple implying a Euro 12.4 price target for end 05 based on our forecast EPS growth for FY06. Blending these valuation metrics, we raise our price target to Euro 12/share from Euro 11/share. Risks The risks to our call are a slow-down in the advertising market; greater competition for ratings from RAI leading to loss of advertising market share; disappointing take up for the DTT soccer project; and perceived or actual political risk related to Mr. Berlusconi s ownership of 51% of Mediaset s shares. Page 3

5 Table of Contents Valuation... 5 Relative valuation cheap but should trade at a premium...5 The value of the DTT opportunity...6 Estimates 13% above consensus in 2005E, 19% in 2006E....8 Dividend/cash yield support...8 Historic trading ranges...9 Reverse DCF...9 Structure of the note Introduction...11 Digital Terrestrial TV in Italy Political sponsorship of DTT...15 Transmission revenues...17 The football PPV opportunity...17 Scenario Analysis...18 Valuing the DTT opportunity...22 The strategic significance of DTT - beyond soccer...24 Mediaset s dividend policy scope for positive surprise? Conservative cost guidance? What about the political risk? The IPO of RAI Summary and conclusions...36 Appendix A Appendix B Appendix C Appendix D Appendix E Page 4

6 Valuation Mediaset is our top large cap TV broadcasting pick for We see the valuation as compelling for a number of reasons. In this section we essentially focus our valuation on the Italian business ex Telecinco, where Mediaset has a controlling 52% interest, to identify the value of the core Italian activities, given investors can buy Telecinco exposure directly should they choose to do so. Relative valuation cheap but should trade at a premium As a starting point, a comparative valuation against the sector sees Mediaset trading toward the bottom of the range against its peers PE and Price/FCF metrics. Figure 1: PE multiple analysis Price Recom. 2004E 2005E 2006E SBS Broadcasting $38.1 Buy Antena 3 Euro 59.2 Buy ITV 118p Hold TF1 Euro 24.9 Hold RTL Group Euro 57.2 Hold Pro Sieben SAT1 Media Euro 13.0 Hold Telecinco Euro 16.8 Buy Free-to-air Broadcasters median (ex Mediaset) Mediaset Euro Mediaset discount to sector (%) Figure 2: Price/FCF multiple analysis Price Recom. 2004E 2005E 2006E SBS Broadcasting $38.1 Buy Antena 3 Euro 59.2 Buy n/m ITV 118p Hold TF1 Euro 24.9 Hold RTL Group Euro 57.2 Hold Pro Sieben SAT1 Media Euro 13.0 Hold Telecinco Euro 16.8 Buy Free-to-air Broadcasters median (ex Mediaset) Mediaset Euro Mediaset discount to sector (%) There is 15% upside if Mediaset trades up to the sub-sector multiple of 17x CY06 EPS or P/FCF, which would put the stock on Euro 11.6/share. However, it is posting the fastest growth in EPS and cashflow growth in the sub sector on our estimates with similar advertising revenue growth rates to its peers. As such this generates the cheapest Price/growth multiple in the subsector as indicated in Figure 3: Page 5

7 Figure 3: FTA broadcaster FCF-to-growth ratios Price Recom. P/FCF 2005 FCF growth FCF PEG ratio Antena Buy Telecinco 16.8 Buy ProSieben SAT1 13 Hold TF Hold RTL Group 57.2 Hold ITV 118 Hold Mediaset 10.1 Buy We also believe that Mediaset should command a premium rating and not a discount to its peers to reflect its strategic position as we will argue in this note but summarise here: It operates in one of the most underinvested advertising markets in the major European countries. Mediaset operates in one of the most benign competitive environments with a clear duopoly between RAI and Mediaset. It faces none of the market structure change risk facing say the Spanish market for instance, and it is one of the least developed multichannel TV markets. Cost control has been outstanding since 2000 and our analysis suggests that programming costs will remain subdued for 05-07E. Most importantly however, it has the lowest risk of multichannel fragmentation damaging its core advertising franchise and is on the cusp of developing a unique mixed economy revenue model balancing its robust advertising growth outlook with a burgeoning pay TV business. For these reasons, we are highly confident in the rerating potential of the stock. The value of the DTT opportunity We assert that the market has not valued the DTT opportunity within the Mediaset share price. Since the Telecinco IPO in June 2004 in which Mediaset has a 52% controlling interest, the value of the residual business has underperformed the sector and has not reflected in our view the significant developments that have occurred in the multichannel market in Italy that we describe in this note. The following chart sets out the price performance of the Italian business rump ex- Spain. Page 6

8 Figure 4: Mediaset rump share price performance ex Telecinco /23/2004 7/7/2004 7/21/2004 8/4/2004 8/18/2004 9/1/2004 9/15/2004 9/29/ /13/ /27/ /10/ /24/ /8/ /22/2004 1/5/2005 Implied core MS value, Datastream If we compare this performance to the peers, it does not suggest the market has factored in any DTT upside. Figure 5: Absolute share price performances since IPO of Telecinco Jun Jan % chg Antena T RTL Mediaset ITV Media (headline) Mediaset ex Telecinco TF M P We see DTT contributing Euro 66m of EBITDA by CY06E and Euro 87m by CY07E. This implicit value is clearly not reflected in forecasts or the share price. We see an enduring value for the PPV opportunity beyond the season given the position that Mediaset has engineered for itself. Assuming a 400% increase in the rights costs on renewal in 2007, we value the opportunity at E0.8/share in PV terms based on a 16x FCF exit multiple in Page 7

9 Estimates 13% above consensus in 2005E, 19% in 2006E. Our estimates are 13% above consensus for 05 and 19% higher in 06E. Figure 6: DB estimates vs. consensus estimates 2005E 2006E IBES Nelson DB Difference (%) , IBES, Nelson In summary the impact of DTT on Mediaset s core Italian business EBITDA is as follows. Figure 7: Summary of DTT contribution to Mediaset 2005E 2006E 2007E Transmission revenues Soccer PV revenues (Euro m) Soccer advertising revenues Total revenues Total costs (Euro m) Rights costs (Euro m) Fixed overhead Production costs Call centre management Marketing costs Distribution/card costs Transmission costs EBITDA Pre DTT EBITDA 1, , ,242.0 Impact on Group EBITDA (%) Additionally, we believe the cost guidance for Italian TV business growth of 2.5% in 2005E is potentially too high and we are forecasting 1.6% growth by comparison. Dividend/cash yield support Management has stated that their divided policy will be consistent with a pay-out ratio designed to achieve balance sheet neutrality holding neither debt nor cash. We have followed this logic through and see the potential for a 6.9% dividend yield in 2006E which would more than double the historic level of pay-out from the stock. Page 8

10 Figure 8: Historic and potential dividend yield 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% E 2005E 2006E Yield Upside pay-out case On our new price target of Euro 12/share, the stock is implying a 3.75% cash yield in 05E and a 5.8% cash yield in 06 if the Euro 0.7 dividend implied by balance sheet neutrality is declared. This is whilst the company is growing at almost 20% in FCF terms from 05-07E. Historic trading ranges The stock is also trading toward the lower end of its trading range based on EV/EBITDA and PE multiples. The stock is trading on 17.4x CY 05E PE. Historically, the stock has traded in a range of 18.8x 48.6x based on the average share price in the year. As such, Mediaset is trading at a discount to its own valuation history. Figure 9: Mediaset historic PE multiple (x) E 2005E PE multiple On a prospective PE multiple basis, Mediaset has traded on a median PE/g multiple of 1.06x the growth rate of 1 year forward earnings. Based on our forecast 17.4% 06E EPS growth rate, this would imply a multiple of 18.3x. Applied to our 2006E EPS of E0.68/share, this would derive a fair value of Euro 12.4/share for YE 05. Figure 10: Mediaset forward PE multiple analysis (x) PE/G based on 1 year fwd EPS E Median Reverse DCF We looked at reverse DCF analysis in our 2005 sector outlook note of 7 th January (Money Talks) and in it, using common assumptions as to Beta and the risk free rate, we generated the following output for the broadcasters. Again, what is clear is that the market is discounting the lowest growth from our terminal year of forecasts Page 9

11 form Mediaset versus the other TV broadcasters save for ITV. Doubling the implied perpetuity growth rate to 2.5% (mid-range) from 1% supports a valuation of Euro 12.5/share. Figure 11: Reverse DCF analysis- what terminal growth is implied? 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Antena 3 (Buy) Telecinco (Buy) TF1 (Hold) ProSiebenSAT1 (Hold) Mediaset (Buy) ITV (Hold) Summary We believe that's Mediaset's valuation is compelling when cross-referenced by the metrics in this section. There is 15% upside based on Mediaset trading up to the media sub-sector multiple alone of 17x 06E EPS or FCF - although we believe that a premium is justifiable. An in-line valuation would put the stock on Euro 11.6/share. We believe that the DTT opportunity is worth Euro 0.8/share or 8% of the current share price (over 9% of the ex Telecinco valuation). Our estimates are 13-19% higher than 05-06E consensus estimates suggesting that if we are right the market must raise forecasts significantly. The company's dividend policy suggests a significantly rising pay-out ratio - whilst the business still delivers close to 20% EPS growth from E. Mediaset's historic yield has been around 3%. Were Mediaset to leave its balance sheet ungeared as it has said it intends to, this would imply a 4.4% yield in 05E rising steeply to 6.9% in 06E. A PE/g ratio analysis suggests the stock trades on 1.06x forward earnings implying a Euro 12.4 price target for end 05 based on our forecast EPS growth in 06E, A reverse DCF pitched at 2.5% growth into perpetuity (mid cycle for the TV group), rather than the 1% Mediaset is currently discounting suggests upside to Euro 12.5/share. Blending these valuation metrics, we raise our price target to Euro 12/share from Euro 11/share. Page 10

12 Structure of the note Introduction The market seemed to lose interest in Mediaset in First came the confusing machinations of passing of the Gasparri cross media ownership law which carried the risk of Mediaset losing one of its three core channels. Once this risk had passed the market focused on the implications of 51% shareholder Mr. Berlusconi fighting to stay in office and thereby potentially triggering a significant disposal of Mediaset stock. Why should investors buy Mediaset with a big placing seemingly imminent? Finally, the market looked through the upgrades in CY04 to 2005 where momentum seemed tougher to deliver effectively de-rating the stock. Mediaset had one of the strongest upgrade cycles in 04 yet was one of the sector s laggards in performance terms in CY04. Figure 12: Analysis of multiple changes versus 05E EPS revisions in % 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% EMI Pearson Reed Elsevier (UK) VNU Wolters Kluwer WPP Reuters TF1 Mediaset Publicis Multiple expansion/(compression) 2005 EPS f/c changes Mr. Berlusconi is still there and his tenure seems increasingly assured until the next election (due mid 2006). The Gasparri law is passed and Mediaset is now free to organically expand its share of media revenues. We think the consensus view on Mediaset needs updating. This is a company with almost none of the competitive concerns of its peers. Operating in one of the most underdeveloped advertising markets in Europe, Mediaset has significant scope to see growth in its domestic advertising market. And in its DTT strategy, a source of major differentiation from its broadcasting peers that leads us to believe the stock deserves rerating. We have written this note in response to the legitimate question asked of us through much of the second half of In this note we review the following: What are Mediaset s DTT plans? What is the dividend policy? What is the real Berlusconi risk? What is the impact of the RAI IPO likely to be? Page 11

13 We also take a look at the cost guidance for 2005 for the Italian TV business and conclude that this too gives scope for optimism that guidance may prove too conservative. Page 12

14 Digital Terrestrial TV in Italy We believe that understanding Mediaset s digital terrestrial TV strategy in Italy is core to the investment case. Multichannel TV is an inevitability in each TV market. The question for the market leading broadcasters is how to address this threat. Italy is a unique TV distribution landscape in a European context. In Italy, the level of pay TV penetration is very low given the existing number of terrestrially delivered TV channels funded by advertising. Whilst one of the key hooks of pay TV is the broadening of choice, in markets where free TV choice is that much greater at the outset, pay TV has typically struggled to generate a significant market share. Figure 13: Penetration of pay TV 2004E with free TV channels indicated Germany Italy Spain France UK 2004E Compared to other pay TV operators at this point of time from launch - pay TV s progress in Italy has been fairly pedestrian. This was in part as a result of high piracy and a two player market pre April 2003 when the rival Tele+ (ex Vivendi/Canal+) and Stream (ex NewsCorp/Telecom Italia) were permitted to merge to form Sky Italia. Page 13

15 Figure 14: Pay TV market penetration since launch Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10 Yr 11 Germany UK France Spain Italy As such Mediaset is developing its multichannel strategy in what can still legitimately be described in a European context as virgin territory. Satellite TV is established but still in the early stages of development. Cable has a very limited subscriber base. The rival platform operators are largely DSL based offerings. DTT does not start with the disadvantage of needing to convert significant numbers of customers from other platforms. At the start of 2004, 86% of the 21.7m TV homes in Italy were available to sell to. Page 14

16 Figure 15: Summary Italian television market Terrestrial free to air Ownership Market statistics RAI 1/2/3 RAI Households (m) 21.7 Canale 5 Mediaset TV penetration (%) 99.0 Italia 1 Mediaset PC penetration (%) 59.0 Rete 4 Mediaset Broadband penetration (%) 10.0 La7/MTV Telecom Italia Media Sport Italia 51% Tarak Ben Amar 49% TF1 Pay TV Digital Subs.(m) Penetration Medium Rights ownership Sky Italia 2.7 (Sept 04) Satellite Movies (first showing) SKY Italia Fastweb 0.2 (Sept 04) Cable Football (Serie A) Satellite (Sky), DTT (Mediaset, TCM), Cable (Fastweb, Mediaset), ADSL (TI, Mediaset) Alice (TI) 2.2 (June 04) ADSL Other key rights Limited soccer on state-owned (National team, FA Cup, highlights of Serie A) Other Regulation Telecoms Broadcasting Analogue Terrestrial TV switch off Ministry of Communication Ministry of Communication, Antitrust Authority starts 2006 Competitive offerings Type of offering TV only TV + phone Triple play Comment Availability Sky Italia Satellite Euro Equipment free if sign 12 month E47 ARPU pcm package 97% Italian homes Fastweb DSL/Fibre Euro 85 Unlimited national voice Regional Mediaset DTT Football Serie A games Euro 3 per match Alice (Flat) ADSL Football Serie A games Euro 4 per month, Euro 2.5 per match Source: Company data, Deutsche Bank estimates N/A N/A Football Serie A games Euro3 per match, the offer will be available from beg Jan Euro 70 equipment cost Subscription fee Euro per month including VAT, Modem Euro 3 per month including VAT 70% population Political sponsorship of DTT The Government in Italy has adopted a policy of subsidizing the roll-out of digital hardware to facilitate the take up of digital TV such that the analogue TV signal can be switched off. The official start date for this switch off is Completion of analogue switch off is targeted for the end of 2010 although our assumptions assume that there is three years of slippage. Through 2004, the Government made available E110m in financial incentives to consumers to buy set top boxes STBs. The discount of Euro 150 was at the point of sale to customers producing a TV licence. We estimate the average cost per box through 2004 to customers was Euro The factory gate price during the year has fallen from E290 to E150 (before State contribution). Unlike the UK where boxes retail for as little as 35 (or E50/box), the specification in Italy is higher as it requires conditional access and interactivity to qualify for a subsidy. As a consequence, the decoder inside the box is able to decode pay per view content. The system does not lend itself to a conventional monthly pay TV service currently given that there is Page 15

17 no direct customer billing relationship established at point of sale. The system is plug and play and is essentially free. The new budget law passed in December 2004 approved a further Euro 110m to be set aside for box subsidies in FY05. At an average subsidy of E70 per box, the number of devices that we estimate could be sold whilst benefiting from a retail price point of E75 is therefore 1.5m. We believe that E75 is the right level of box cost. When one considers that the pay per view soccer will in itself be a driver of hardware sales, given the media echo around the pay per view product launch we are confident that by end 2005, the installed base of digital devices will have reached at least 2.4m. Already, the market has offers of less than Euro 70 per box and we estimate from Government data that 180,000 new boxes have been sold to consumers in the last 6 weeks. At this rate, we estimate that the subsidy will be exhausted by end Q305 although our assumptions are somewhat less aggressive. Beyond 2005, the economies of scale in manufacturing of the various hardware producers should mean that the unit costs will have fallen to sub E100 meaning the reliance on supportive regulatory policy will have dropped away by end of 05 and DTT will have been established as a credible platform in its own right. At just under 3m homes, DTT will represent an equivalent audience to pay satellite. Mediaset has been at the forefront of the roll out of digital terrestrial TV given that, uniquely among listed European broadcasters, it owns one of the two key Italian signal transmission companies directly. Whilst this has meant that Mediaset has incurred the costs of acquiring digital licences and upgrading the network to carry digital signals, it also means that it is in a position to influence the complexion of the channel line-up that constitutes the digital terrestrial TV offering in future. By the end of 2004, the technical reach of the DTT platform was up to 70% of the Italian population. The limit is defined by the number of frequencies that the transmission companies have available to them. Obtaining frequencies is a piecemeal process whereby the national broadcasters such as Mediaset or RAI must buy them from local entrepreneurs who have hitherto used them on a quasi legal basis to transmit local TV signals for an area often no bigger than a small town. The cost of acquiring the licences to operate the first multiplexes was E70m. Mediaset also paid Euro 118m for the soccer pay per view rights for the DTT window out to of which more later. This has been treated as capex along with the network transmission costs. The total costs to date of the infrastructure investment therefore total around Euro 200m. The current digital terrestrial TV offering can be summarised as follows: Page 16

18 Figure 16: Italian DTT multiplex channel offerings (Euro m) Operated by Coverage (%) Multiplex 1 RAI 70.0 RAI1 RAI2 RAI3 RAI DOC (public service) Multiplex 2 RAI 70.0 RAI news 24 Multiplex 3 Mediaset 70.0 Rete 4 BBC World (news) Multiplex 4 Telecom Italia Media RAI Sport News RAI EDU (Educational channel) 67.0 La7 MTV Home Shopping Europe Multiplex 5 D-Free 54.0 Canale 5 Italia 1 LCI (French news) 24 Ore TV Class News (financial news) Music Box Italia Sport Italia RAI Utile (public service) Boing (kids) Radio Italia TV This means that currently 20 channels comprise the DTT offering. Viewers have the possibility of watching in wide screen, interactivity, original language alternatives for movies as an alternative to sub-titles. Dependent on band width, HDTV could also possible although we doubt it will be commercially viable. A normal TV household would receive 11 national analogue channels so the DTT offer doubles the choice and improves reception quality. Revenue opportunities from DTT Transmission revenues From its transmission activities, Mediaset will generate some E15m in fees in FY04 which, with greater penetration of the network, should increase to E20m by end 05. We assume Mediaset generates revenue per subscriber for the bandwidth used at a rate of Euro 3 cents per 1MBit Datastream proportionately based on the population reached. We estimate a channel typically consumes 3-4MBits of bandwidth. Mediaset s contracts with its channel operators currently run to 2006E. A decision to launch a second digital multiplex, carrying 5-6 channels, will be conditional on the cost to acquire it and, partly, the transmission income it can generate. We estimate that it would cost Mediaset around Euro 150m to acquire the frequencies and build out the infrastructure. Assuming it could generate a further Euro 20m of revenues on this investment (if all new capacity was subleased) - the post tax pay back would crudely be around 10 years. The football PPV opportunity Mediaset has negotiated the rights to show the live matches of 8 Serie A clubs (the Italian soccer Premiership). The clubs include the 4 most heavily supported and therefore, from a rights ownership perspective, the most commercially interesting AC Milan, Inter Milan, Juventus and Roma. Independent research by Eurisko in 2004 indicated that there are almost 20m fans (one suspects loosely defined) that support these four clubs. The other 4 teams games allow the possibility of the away matches of the four super clubs to be seen. Also broadcasting on DTT, rival operator Telecom Italia Media has acquired the rights to a further 9 clubs leaving 3 unsigned. These are Siena, Lazio and Udinese. The details of the rights costs by club are set out in Appendices A and B. Page 17

19 Allowing for scheduling of their rights (excluding Telecom Italia Media s), there are a total of 154 matches per season possible of which Mediaset estimate that 92 have genuine commercial merit. Mediaset also announced a JV with Telecom Italia Media to produce a 90 minute show Diretta Premium, which broadcasts all the Serie A goals live (with appropriate studio based commentary) which would be potentially attractive for viewers whose clubs were playing in relatively unchallenging matches. This adds a further 38 commercially attractive matches per season. It seems to us that the potential to add DTT event programming (e.g. Big Brother season tickets) or movie rights is an inevitable step at some point further down the track. Scenario Analysis In order to model the potential financial impact of the soccer to Mediaset, we have generated the following base case scenario, the assumptions for which we detail below. The assumptions that we make are as follows. The most contentious surround the revenue generating aspects of the PPV model: Revenues We increase the DTT installed customer base as set out in Figure 17. We slow the base growth after 2005 when the explicit subsidies end but do not expect the effective price to the customer to meaningfully increase after this point (i.e. it will stay at around Euro 70 per box). We expect subs growth to start to pick up again from 2008 onwards as the analogue switch-off process will be in full swing in various regions of Italy. We set out our multichannel universe assumptions to 2009 in Appendix C. Figure 17: Italian DTT customer base (000s) Charts E 2005E 2006E 2007E 2008E DTT subs ,650 3,750 4,600 6,000 Net adds 875 1,775 1, We assume some 70% of box owners at the outset will subscribe to some PPV soccer product although many will be very infrequent customers. Soccer has been the primary driver of the first 20% or so of pay TV penetration in the major European TV markets and we see no reason why this should not be different in Italy. This would suggest a hard core universe of 4.5m pay TV soccer homes in Italy of which 1.6m would be DTT and around 3m pay TV. DSL is not a medium particularly well suited to live sports broadcast. We think that the primary driver of take-up for a number of the DTT homes in H204 and 2005 will have been the opportunity to watch the soccer without the prospect of having to pay for a Sky Italia service. Clearly as the hardware installed increases, so the soccer fan base will be diluted. However we see a high risk for Sky Italia of a spike in churn as the pay per view opportunity is very significantly cheaper than the DTT rival platform football offerings, and particularly Sky s service. Page 18

20 Figure 18: Football offers comparison - VAT Included SKY Italia Rosso Alice Fastweb Mediaset / TI Media Type of transmission Satellite ADSL Cable DTT Hardware one-off cost Euro 0.00 Euro 0.00 Euro (1) Euro (1) Subscription fee Euro yearly (2) Euro yearly Euro yearly No subscription PPV Serie A games Euro Euro 2.50 Euro Euro 2-3 Monthly subscription Serie A games Euro (2) Euro 4.00 Euro Product N/A (1) Net of the State subsidy of Euro (2) New promotion - free box and installation if take sports/ movie package including Serie A soccer. Implies E568 cost p.a. We model DTT s rate of customers interested in soccer falling off sharply to 60% by the third season (06-07). How many viewers will watch the matches on average? On Sky Italia, the nearest comparable platform, data from 11 Sept to 6 th January 05, suggests the average Sky Italia audience was as follows (source: Studio Frasi analysis based on Auditel data): Saturday evening match: 1.3m viewers Sunday 3.00pm match: 1.5m viewers Sunday 8.30 pm match: 1.7m viewers As such, having shown 12 matches over four weekends, Sky Italia was attracting some 1.5m viewers an average. Let s assume this equates to 750,000 homes (2 viewers per home) out of their 2.8m subscribers. It implies that Sky Italia is generating some 9m homes watching their 12 matches per month. If we discount 62 of the Mediaset DTT matches as unattractive and only focus on the 92 most significant live matches plus the 38 Diretta Premium (highlight) shows, this means Mediaset is showing 13 matches per month (130 matches/9months). To make our estimates in 2005, Mediaset needs to generate in H105, an average of 1.5m customers per month, paying Euro 3 per match and in H205, 2.5m customers paying Euro 5/match once the new season commences. What is the best way to think about the reasonableness of the higher 2.5m buys per month? Given the size of the fan bases of the big four clubs, and given each month in the season will feature at least 1 match between the super clubs themselves (12 matches per season), we expect a significant proportion of the target to be achieved from these single matches alone. Let s assume that the big match generates 500k viewers not even the same level as a single Sky Italia average weekend match. Then let s assume that each of the four major clubs has 200k fans that are willing to watch two matches per month. This amounts to a further 1.6m matches bought. Assuming some overlap for the big match we can discount this to say 1.4m. In total that represents 1.9m games bought so far. This means that the balance of the commercially significant games (4 x month) must pick up 150k customers each to hit the 2.5m total with the fall-back that the 60 non commercial games will add something. This presupposes that Sky Italia does not start to lose customers. Faced with the choice of a subscription of over Euro500/year for Sky Italia s soccer package or a Page 19

21 choice of buying a STB for Euro 70 and having the remaining Euro 430 to spend on 143 matches at Euro 3/match (every match for 3 seasons), it is highly likely that DTT will attract a number of die-hard soccer fans from the satellite service given the cost advantage. Tele+ and Sky Italia s historically high churn rates (15%-20%) suggest that the customer base can hardly be considered particularly loyal. The risk to Sky Italia of this initiative is considerable. We assume a match fee of Euro 3/match the current opening published price. We think this is a teaser price for the 2005 season and in 2006, Mediaset will increase prices to E5/match which is still 33% of the price per match charged by Sky Italia (Euro 15). Mediaset is retailing cards to the service currently on a pre paid basis. Cards are being sold right now for Euro 18/match generating 5 credits of Euro 3 per match with a Euro 3 commission to the retailer. Mediaset takes no credit risk nor does it get bogged down in anything but the most rudimentary call centre management issues. The distribution of the cards is cleverly structured: whilst at present they are being sold in the electrical retailers, in future, (from June) they will be distributed through the 38,000 kiosks that are dotted around Italy ensuring multiple points of sale. Costs Mediaset s costs (in addition to the E30m overhead and the soccer rights amortisation) are set out in Figure 19. In short the additional costs should be modest in the context of the revenue generating potential: Production costs we estimate at Euro 50k per match transmitted. Call centre management we estimate a base E10m cost that increases in line with DTT box growth. Marketing costs we start out at Euro 10m and increase this at 20% in Not only do we think the word of mouth effect and media coverage will be significant but with promotions in the existing Mediaset channel soccer shows as well as on-screen advertising breaks, the effective marketing impact will be very considerable. We estimate at that understate the true impact of the coverage. Distribution/card costs we estimate at 5% of sales Transmission we estimate at 2% of soccer revenues. Page 20

22 Figure 19: DTT base case key assumptions seasons (Euro m) 2005E 2006E 2007E 2008E 2009E YE DTT subs (000s) 2,650 3,750 4,600 5,350 6,000 Homes viewing of total (%) Cost per match Football 2005E 2006E 2007E 2008E 2009E Transmission revenues Soccer PV revenues (Euro m) Soccer advertising revenues Total revenues Total costs (Euro m) Rights costs (Euro m) Fixed overhead Production costs Call centre management Marketing costs Distribution/card costs Transmission costs EBITDA We set out our detailed working in Appendix D. As a sensitivity analysis, we can model the following upside scenarios based around revenue per match and the growth in the installed base. Figure 20 sets out various sensitivities. The three sensitivities are described below: 1. Price sensitivity: Euro 3/match in season not increased thereafter. 2. Sky Italia implodes: Prices as for base case but 30% higher buy rates 3. Disappointing take-up: Mediaset generates 30% lower forecast buy-rates versus base case. Figure 20: Sensitivity analysis on 06E EPS Base case Sensitivity 1 Sensitivity 2 Sensitivity 3 Forecast 06 EPS % variation from Base case N/A The key sensitivity is price. Not increasing the cost per match to Euro 5 significantly reduces EPS by around 5% in FY06. We do not expect Mediaset or TI to increase prices during the season. Tactically, the challenge is to get the market excited about the hardware and get the manufacturers behind the technology hardware such that subsidy is no longer required. Then, once the installed base is up and the subsidy no longer required, the strategy will be to push prices up in our view. As such, the first year in which the financial opportunity can be assessed in EPS terms is 2006 when Mediaset will enjoy a full calendar year of Euro 5/match prices. This analysis is simplistic but it serves to make the point. It may be that second tier matches are priced at Euro 4 and super matches at Euro 8. It could well be that Mediaset makes a season ticket other to improve visibility and cash flow and Page 21

23 reduce the need for incessant reminders to buy specific matches. This would still represent good value we think for customers and upside for Mediaset. Further there could be upside from movies and event programming if that were to be introduced although that would certainly need more dedicated marketing. Is it safe to attribute value to the project without a whistle having been blown? We think so. We have ignored the value of 60 matches altogether. We have assumed no non-soccer product is added. We need only 10% of the universe of box owners to buy soccer product and with the huge club support for the major clubs and low pay TV take-up we think this project is a winner. We know the overhead and rights costs that is the big component of the overall investment. We also believe that in the first three days of card sales, 140,000 prepaid cards were sold ahead of the first match on 22 nd January. Thematic channels In terms of launching thematic channels, Mediaset currently has two channels that are carried exclusively on Sky Italia the Happy channel (comedy genre) and Duel TV (game shows etc). Mediaset will therefore need to generate alternative programming for DTT and in December 2004 launched a children s channel (Boing) with Turner Broadcasting for DTT, and is actively considering launching a shopping channel and music channel - possibly in conjunction with other US media operators. We believe that on a three year view these channels will attract fairly marginal revenues to offset fairly marginal costs but will serve to undermine the competitive proposition of pay TV whether delivered by Sky Italia or DSL providers. We do not attribute any value at this stage to the thematic channel opportunity. Is Mediaset a turkey voting for Xmas? Surely the risk is that in accelerating multichannel fragmentation, Mediaset is helping undermine its own terrestrial franchise. Whilst this is a legitimate concern, we believe that on an 8-10 year view, as analogue TV will be switched off, it is far more sensible to capitalize on the opportunity created by the technological pay TV hardware vacuum arising due largely to Italy s unique broadcasting infrastructure. We suspect Mediaset and RAI will jointly continue to dominate audience shares in a heavily DTT skewed environment of channels just as they do in the current environment of 12 channels where they jointly command almost 90% of viewing share and 95% of TV adspend. Given their control of access to DTT customers for new entrant channels seeking to join their multiplexes, we believe their control of the competitive landscape is assured. At present the non Mediaset-RAI channels generate around 10% audience and 4-5% of the net advertising revenues. Their ability to generate significant advertising market share gains based on higher audience shares in DTT homes is unlikely to materially impact the pricing power of the two major market players within the next 3-5 years, in our view. The upside to be gained in DTT revenues and strategic positioning significantly outweighs the risk of advertising revenue loss. It is hard to measure this impact given that at present the non analogue terrestrial TV channels do not generate measurable audience shares according to Auditel. Valuing the DTT opportunity The issue as concerns the pay TV opportunity in isolation is what continuing value to attach to the project. Depending on the project s success, excessive returns will see the clubs attempting to increase their share of the economic rent. And without a full line up of clubs, the project will struggle. For this reason we see Mediaset setting the charge per match no higher than the Euro 6 level so as not to create Page 22