Highlights. Reason for report: Initial Coverage

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1 S a e c o G r o u p Primary Exchange - Milan. Segment STAR. Bloomberg/Reuters SAE IM/SAE.MI Open 3.52 Sector Segments Appliances Espresso and home coffee machines STOCK RATING BUY PRICE TARGET ,2% Stock ratings are relative to the expected 12 months performance vs. price target. Stock rating system (see on last page): BUY > ADD > HOLD > NEUTRAL > REDUCE > SELL Reason for report: Highlights Considering the high capacity to generate cash flow, the segments leadership and the niche position a fundamental drivers for the success of Group s business model, we believe that Saeco is an investment opportunity in medium-term horizon. Major shareholders 30.34% Zappella Sergio (Consob October ) 16.13% Schmed Arthur 6.64% Zaccanti Giovanni 6.09% Marinoni Romeo 2.43% JP Morgan Securities Ltd Market Capitalisation 704,00 million 52 Weeks Range Shares outstanding SMAVG on Vol. (25 dd) 200 million ordinary shares 1,651 million The niche core business of Saeco, the Group s market leadership and the specialisation of its activity, permits to Saeco an average marginality of 50% respect to the comparable. Therefore, considering those advantage, the historical and estimates premium on EV/EBITDA multiple, we believe right a plus-value range of 25/35% respect to peer group, that implied an equivalent price would be in the range of 3.8 / 4.1 per share. Beta vs. MIBSTAR Index Beta vs. MIBTEL 1.10 (Source Bloomberg) 0.66 (Source Bloomberg) On the basis of the our research and the valuation system, we believe that a 12 months price target of 4.12 per share reflect the reasonable Saeco s value, consequently we initiate coverage with BUY recommendation. Valuation model Check method DCF Market Multiple Stock Price Performance Fiscal Year Ends (Dec 31) FY01 FY02 A FY03 E FY04 E FY05 E Net sales 348,1 411,1 451,7 499,2 556,6 Value added 137,3 174,9 193,3 213,6 238,2 EBITDA 80,7 110,0 120,9 134,1 149,7 EBIT 51,9 76,5 84,8 94,1 105,2 Profit before tax 19,5 69,5 78,9 87,7 98,0 Net income 4,0 44,3 44,5 49,5 55,3 Gross cash flow 32,8 77,7 80,7 89,4 99,8 EPS basic 0,02 0,22 0,22 0,25 0,28 DPS 0,007 0,074 0,074 0,082 0,092 Net financial debt (cash) 64,7 49,9 24,2 (19,4) (59,8) Company description The Group designs, manufactures and distributes coffee machines for Values are in million except for EPS and DPS. home and professional use, both of its own brands (Saeco, Gaggia and Spidem). The Group is European leader in espresso and home coffee machines segment with a market share of 32.8% in 2002.

2 Index Highlights 1 Index 2 Executive summary 3 Company profile 4 Reference market 4 s position 4 Consolidated profitability 5 Geographical breakdown 6 Product lines 7 Home coffee machines 7 Professional coffee machines 8 Vending machines 8 Air conditioners and dehumidifiers 9 Steam appliances 9 BRANDS & OEM 10 Manufacturing & Distribution 11 Manufacturing activities 11 Distribution 12 Development strategy 13 Investment thesis 14 Valuation & Rating 15 Valuation model: discount cash flow 15 Check method: EV/EBITDA market multiple 16 Price target and stock rating 17 Financial tables 18 Disclosures information 20 2/20

3 Executive summary Company profile The Group is the leading European manufacturer of espresso coffee machines for domestic use in terms of sales. Its principal business activities include the design, manufacture and distribution of espresso coffee machines for domestic use, as well as espresso coffee machines for professional use and vending machines. The Group s products are marketed primarily under the Saeco and Gaggia brand names. The main reference markets, in which the Group's products are sold, in addition to Italy, are: Germany, Switzerland, Austria, Spain, Benelux, France and United States. Product lines The Group s main products are espresso coffee machines for domestic and professional use, automatic vending machines for the distribution of espresso coffee and other hot drinks and snacks, steam appliances such as domestic steam cleaners and irons, air conditioners and dehumidifiers. Manufacturing & Distribution The Group s manufacturing processes are vertically integrated and characterised by a high degree of automation and flexibility in production. The Group s operations are principally focused on espresso coffee machine production and the Group is involved in most of the main production and pre-production phases, including the production of its own assembly lines. The Group controls distribution companies in each of its principal geographic markets and has established close ties with OEMs, wholesalers, large-scale retailers and clients in the espresso coffee machine product segment in its principal markets. Development strategy The Group's growth objectives concentrate on the core business. The Group intends to exploit the competitive advantages and experience it has acquired, transferring them to all the market segments in which it operates. The Group intends to diversify products and develop non core business areas, by boosting the air-conditioning and steam sectors and exploiting the synergies of its own distribution system and the image and renown of its brands. The Group also intends to increase its presence world-wide by incorporating or acquiring new distribution companies in new strategic markets while nominating new authorised distributors in others. Investment thesis In our point of view, considering the high profitability of Group s Consolidated Income Statement (year average from 1999 to 2002 EBITDA%, EBIT% - is 24.1 and 16.1%, respectively), the capacity to generate cash flow and considering the brands recognition a fundamental driver for the success of Group s business model, we believe that is an investment opportunity in medium-term horizon, as we show our valuation. Valuation & Rating On the basis of the consideration above and the our valuation system, we believe that a 12 months price target of 4.12 per share reflect the reasonable Saeco s value, consequently we initiate coverage with BUY recommendation. 3/20

4 Company profile Saeco International Group designs, produces and markets coffee machines for household and professional use, automated vending machines for hot, cold beverages and snacks, and a range of "climate" and "steam" line products. The Group is the Italian market leader in the production of espresso coffee machines for home use, with a market share of over 65%. With market share of over 30%, the Group is also the European leader. With its principal manufacturing plants located in Italy, the Group distributes its coffee machines and other products throughout Europe as well as in the United States, Australia, Argentina, Canada and Japan and other espresso coffee-drinking markets throughout the world. In 2002, markets outside of Italy accounted for approximately 83% of the Group s total sales. In addition, in certain countries the Group distributes a limited selection of other products produced by third parties but sold under the Saeco brand such as small household appliances, water filters, cigarette machines and office water distributors. Approximately 76 % of the Group s sales in 2002 were under the Group s own brand names, Saeco, Gaggia and Spidem. The rest are manufactured for third parties, primarily home appliance manufacturers, referred to as Original Equipment Manufacturers ( OEMs ), which market and sell them under their own labels. Reference market Coffee is prepared world-wide in many forms corresponding to local tastes and traditions (espresso, filter, instant and others), generating annual sales of tens of millions of coffee machines per year. Originating in Italy at turn of the century, consumption of espresso coffee has become widespread throughout Southern Europe, and in recent years, has become increasingly popular in Northern Europe and North America, in part due to the general high acceptance of products associated with Italian culture and lifestyle. Espresso coffee is traditionally consumed in small doses and is characterised by its distinctive strong taste. Espresso coffee is produced by applying water at extremely high pressure and at high temperature to ground coffee so as to extract the required level of flavour and the distinctive slightly frothy crema covering. Coffee machines, whether filter or espresso, are produced in models designed principally either for professional or domestic use. Professional machines, designed for use in bars, hotels and restaurants, tend to be larger than domestic machines, are made of more robust materials with larger motors, so as to be more durable, to have more capacity, and to withstand higher frequency of use and are therefore generally more expensive than machines for home use. However, market practice varies from country to country and machines designed primarily for domestic use are sometimes used for professional purposes depending on the frequency of usage required. s position GFK data for 2002, following the acquisition of Gaggia, indicates the Group as is the market leader in Italy in the domestic espresso coffee machine segment with a market share, in terms of value, over 65 %. The remainder of the domestic espresso coffee machine market segment in Italy is fragmented and divided between a number of operators selling brands such as De Longhi and Krups (Seb Groupe), none of which have a significant market share compared to the Group. 4/20

5 According to the same source, the Group is also the domestic espresso coffee machine market leader in Europe based on data from the markets of Austria, Belgium, France, Germany, the United Kingdom, Italy, the Netherlands, Portugal, Spain and Switzerland in terms of value of its Saeco and Gaggia brands with a market share over 30% in The main competitors of the Group in the sale of domestic espresso coffee machines in Europe is Krups (Seb Groupe). Several of the Group s retail market espresso machine competitors in Italy and the rest of Europe are also OEM clients selling, at least in part, re-branded Group products. The Group currently supplies manual domestic espresso coffee machines for re-sale to Starbucks, one of the main chains of coffee shops in the United States. The filter coffee machine market in the United States is highly fragmented and characterised by a large number of small and medium-sized producers. The Group does not have a significant market share in either the professional espresso coffee machine sector and the automatic vending machine sector in Italy or abroad as both these sectors are highly competitive and fragmented with a large number of producers. The Group s main competitors in Europe in the professional espresso coffee machine market segment are Cimbali and Faema and, in the automatic vending machine market, Zanussi. In addition to price, the Group competes in this market sector mainly on brand name recognition and on technological features and reliability. The Group does not hold a significant market share in the overall steam appliances sector, which includes both irons and steam-cleaning appliances. The steam cleaning appliance sector is practically limited to Italy, which is the only European country in which there are significant sales of such products. The Group competes in this market sector primarily on the basis of the technological features and multifunctional nature of its products and, to a lesser extent, on price. In the air conditioner and dehumidifier segment, the Group is progressively building its market position. The Group has a significant presence in this segment only in the Italian market which is dominated by the De Longhi Group. The Group competes in this market segment primarily on the basis of price and design and, to a lesser extent, on its product range. Consolidated profitability Net sales from operations are principally derived from the Group s sales of domestic espresso coffee machines with the remainder of sales made up of professional espresso coffee machines, vending machines, steam appliances, air conditioners and dehumidifiers, other related products and spare parts. Net sales are gross sales net of sales deductions including customer volume discounts, early payment discounts and costs associated with the sales of products. The consolidated results 2002 showed a impressive CAGR 1999/02 in Net sales, EBITDA and EBIT of 19.9%, 29.9% and 34.5%, respectively. ( 000 ) FY99 FY00 FY01 FY02A CAGR 99/02 Net sales 238,8 317,5 348,1 411,1 19,9% Change % 33,0% 9,6% 18,1% EBITDA 50,2 80,5 80,7 110,0 29,9% Change % 60,3% 0,2% 36,4% EBITDA margin % 21,0% 25,3% 23,2% 26,8% EBIT 31,5 55,7 51,9 76,5 34,5% Change % 77,0% -6,8% 47,5% EBIT margin % 13,2% 17,5% 14,9% 18,6% Table 1. Source: Company data. 5/20

6 Geographical breakdown The main reference markets, in which the Group's products are sold, in addition to Italy, are Germany, Switzerland, Austria, Spain, Benelux, France and United States. Other markets in which the Group has a significant or strategically important presence are Australia, Japan, Canada, England and Brazil. Finally, a large network of direct importers, having different size and structure, distributes the Group's products in over 60 countries all over the world. The Group's internationalised outlook has made overseas sales increase from 79.2% in FY 2001 to 82.7% in FY The CAGR 99/02 underlines a weight increase in term of net sales in Germany of 6.9%, a pronounced decrease in Italy and Switzerland of 9.8% and 5.1%, respectively, like showed in next tables. Breakdown by area '000 FY99 FY00 FY01 FY02A CAGR 99/02 Italy 62,4 68,6 72,4 70,9 3,3% Germany 56,7 79,8 100,5 127,5 22,5% Switzerland 35,5 44,8 42,3 49,4 8,7% Other countries in Europe 50,7 68,3 76,2 89,8 15,4% Other countries 33,6 56,0 56,7 73,4 21,6% No Italy net sales 176,4 248,9 275,6 340,1 17,8% Net sales 238,8 317,5 348,1 411,1 14,5% % of total sales FY99 FY00 FY01 FY02A CAGR 99/02 Italy 26,1% 21,6% 20,8% 17,3% -9,8% Germany 23,7% 25,1% 28,9% 31,0% 6,9% Switzerland 14,9% 14,1% 12,1% 12,0% -5,1% Other countries in Europe 21,2% 21,5% 21,9% 21,8% 0,7% Other countries 14,1% 17,6% 16,3% 17,9% 6,2% No Italy net sales 73,9% 78,4% 79,2% 82,7% 2,9% Growth YoY FY99 FY00 FY01 FY02A Italy 10,0% 5,6% -2,1% Germany 40,8% 25,9% 26,8% Switzerland 26,4% -5,7% 17,0% Other countries in Europe 34,7% 11,5% 17,9% Other countries 66,7% 1,3% 29,5% No Italy net sales 41,1% 10,7% 23,4% Net sales 33,0% 9,6% 18,1% Table 2. Source: Company data. 6/20

7 Product lines The Group s main products are espresso coffee machines for domestic and professional use, automatic vending machines for the distribution of espresso coffee and other hot drinks and snacks, steam appliances such as domestic steam cleaners and irons, air conditioners and dehumidifiers. All of the main products sold by the Group are manufactured by the Group save for its steam cleaning appliance marketed under the Gaggia brand name and domestic irons marketed under the Saeco brand name, which are produced by third parties. In certain countries, the Group is also involved in distributing a limited range of other third party manufactured products under the Saeco brand such as small home appliances, water filters, cigarette machines and office water dispensers. The Group s principal product lines are: espresso coffee machines for domestic use; espresso coffee machines for professional use; vending machines; air conditioners and dehumidifiers; steam appliances. Home coffee machines Coffee machines designed for domestic use constitute the core business of the Group and related sales with 70.9% weight in FY Domestic espresso coffee machines can be divided into two main product categories: automatic machines and manual machines. The Group s automatic machines accounted for 81.3% of Home coffee machine sales in Automatic. Espresso machines are the Group s most technologically advanced product. One of the key factors in the Group s initial success in the espresso coffee machine market was its patented Removable Espresso Brewing Unit used in all of its automatic espresso coffee machines. This device collects the freshly ground coffee, measures the precise quantity of coffee to be used, brews the coffee and removes the used coffee grounds in one small combined unit that can be removed and cleaned easily without the need to involve specialised maintenance personnel. Most models also include a hot water tap and steam tap for the preparation of teas, hot milk and cappuccinos. The Group produces up to 25 different models of automatic espresso machines in its product lines. Each has a distinct design and is available in a range of colours with different accessories. Settings of water and coffee quantities are adjustable according to consumption habits in different geographic markets. Manual. The Group produces three main types of manual espresso coffee machines: single, combined and filter. Single coffee machines are electrically powered espresso coffee machines with a filter holder which require the user to manually carry out the preparations necessary to make a cup of espresso coffee (loading coffee grounds, adding water, launching brewing process and disposing of used grounds). They are relatively simple machines, usually small in size. This is a market segment where competition is stronger, though the Group has recently reinforced its competitive position with the acquisition of the Gaggia brand. The Group differentiates itself in this market with its high quality innovative products, characterised by features such as its Cappuccinatore and Pressurised Filter Holder. 7/20

8 Combined coffee machines are electrically powered espresso coffee machines similar to single coffee machines, with the addition of a coffee grinder incorporated into the machine which automatically grinds coffee beans and dispenses the required quantity of ground coffee for manual transfer to the filter holder. This type of coffee machine facilitates the use of freshly ground coffee beans and therefore produces a higher quality drink. Each product line has a distinct design and is available in varying colours with different accessories. Settings of water and coffee quantities are adjustable according to consumption habits in different geographic markets. Filter coffee machines are used to prepare American-style filter coffee, by way of hot water filtered through ground coffee. The Group, which has traditionally specialised in the production of espresso coffee machines, recently entered this market segment with an innovative filter coffee machine that produces Americanstyle filter coffee and hot milky drinks using its patented Cappuccinatore. Professional coffee machines Professional coffee machines produced by the Group are more complex and larger in size than domestic machines, designed for use in hotels, bars and restaurants. Professional coffee machines represented approximately 3% of the Group s consolidated net sales in Professional coffee machines can be divided into two main categories: automatic and manual. The Group s automatic espresso coffee machines for the professional sector are essentially larger, more complex and robust versions of the automatic coffee machines produced by the Group for domestic use. The whole process for the preparation of espresso coffee (coffee grinding, quantity measurement, brewing and removal of used coffee grounds) is carried out automatically by the machine upon the press of a button. These coffee machines are sold primarily outside Italy in countries where the procedures and techniques for the preparation of espresso coffee are not well established even among professional operators. The Group currently has two product lines in the automatic professional sector, Profimat and Modular. Each product line has a distinctive design and is available in varying colours with a range of different features. Manual professional espresso coffee machines produced by the Group have removable filter holders and require an operator trained in manually grinding, quantifying, pressing and dispensing the coffee and removing the coffee grounds after use. The Group entered the market recently with the acquisition of the Gaggia brand. Vending machines The Group manufactures and sells a wide range of automatic vending machines. The Group s activities in this market segment grew out of the application of its expertise gained in the design and production of espresso coffee machines in the domestic and professional sectors. The Group produces 10 different models with various dimensions. These machines are available in table top and free standing versions. The table top version is smaller, making it flexible and suitable for use in different environments such as offices and shops. The free standing version is used to cater for large public spaces such as hospitals and airports. Automatic vending machines represented 7.1% of the Group s consolidated net sales in FY /20

9 Air conditioners and dehumidifiers The Group s air conditioning and dehumidifier product lines cover both portable and fixed air conditioners. Portable air conditioners come both as mono systems (without external condensing motors) and split systems (with external condensing motors). Fixed air conditioners are available in mono system versions (with external condensing motors connected to an internal conditioning unit) and dual systems (an external condensing motor connected to two internal conditioning systems). Moreover has been introduced a new product line of portable air conditioners called Minisplit. Air conditioner and dehumidifier sales represented 3.1% of the Group s consolidated net sales in FY Steam appliances The Group started to manufacture and sell steam cleaning appliances including traditional steam cleaning products, multifunctional steam cleaning systems, which produce steam for cleaning purposes and also function as a bag less vacuum cleaner with a water filter system which simultaneously dries the area cleaned. Steam Appliances represented 3.8% of the Group s consolidated net sales in FY Breakdown by product line'000 FY99 FY00 FY01 FY02A CAGR 99/02 Net sales 238,8 317,5 348,1 411,1 19,9% Change % 33,0% 9,6% 18,1% Home Coffee Machines 157,1 212,3 238,7 291,4 22,9% Change % 35,2% 12,4% 22,1% weight % 65,8% 66,9% 68,6% 70,9% Breakdown by product line'000 FY99 FY00 FY01 FY02A CAGR 00/02 Manual machines N.A. 47,7 49,6 54,4 6,7% Change % 3,9% 9,6% weight % 22,5% 20,8% 18,7% Automatic machines N.A. 164,6 189,1 237,1 20,0% Change % 14,9% 25,4% weight % 77,5% 79,2% 81,3% Breakdown by product line'000 FY99 FY00 FY01 FY02A CAGR 99/02 Professional Coffee Machines 9,5 10,0 9,9 12,3 9,0% Change % 4,8% -0,6% 24,3% weight % 4,0% 3,1% 2,9% 3,0% Vending Machines 20,6 34,1 31,8 29,3 12,4% Change % 65,2% -6,6% -7,8% weight % 8,6% 10,7% 9,1% 7,1% Breakdown by product line'000 FY99 FY00 FY01 FY02A CAGR 00/02 Air Conditioning 16,4 8,6 9,0 12,5 21,1% Change % -47,9% 5,4% 39,2% weight % 6,9% 2,7% 2,6% 3,1% Steam - 15,6 16,9 15,5-0,10% Change % 8,2% -7,8% weight % 4,9% 4,8% 3,8% Spare Parts 18,8 18,3 19,1 24,7 16,0% Change % -2,7% 4,0% 29,3% weight % 7,9% 5,8% 5,5% 6,0% Table 3. Source: Company data. 9/20

10 BRANDS & OEM During the FY 2002, approximately 76% of the Group s products, including those manufactured by third parties and sold by the Group, were sold under the brand names Saeco or Gaggia while the balance were produced by the Group primarily for OEMs and sold under their brand names. The Group also owns the Spidem trademark used in certain countries for a limited number of the Group s coffee machine lines which are not material in the context of the Group s consolidated net sales. For each of these product lines, the Group also sells replacement and spare parts which accounted for approximately 6% in FY All spare parts for products manufactured by the Group are produced and sold by the Group. Breakdown by brand '000 FY99 FY00 FY01 FY02A CAGR 99/02 Saeco 145,9 195,7 242,6 270,0 16,6% Gaggia 26,4 31,0 32,0 36,7 8,6% Spidem 2,0 3,2 5,0 6,5 33,7% Brands 174,3 229,9 279,6 313,3 15,8% OEM 29,3 59,3 40,1 62,5 20,8% Spare parts 18,8 18,3 19,1 24,7 7,0% Others 16,3 10,0 9,3 10,7-10,1% Net sales 238,8 317,5 348,1 411,1 14,5% % of total sales FY99 FY00 FY01 FY02A CAGR 99/02 Saeco 61,1% 61,6% 69,7% 65,7% 1,8% Gaggia 11,1% 9,8% 9,2% 8,9% -5,2% Spidem 0,9% 1,0% 1,4% 1,6% 16,7% Brands 73,0% 72,4% 80,3% 76,2% 1,1% OEM 12,3% 18,7% 11,5% 15,2% 5,5% Spare parts 7,9% 5,8% 5,5% 6,0% -6,6% Others 6,8% 3,1% 2,7% 2,6% -21,5% Growth YoY FY99 FY00 FY01 FY02A Saeco 34,1% 24,0% 11,3% Gaggia 17,3% 3,4% 14,6% Spidem 59,0% 52,7% 31,6% Brands 31,9% 21,6% 12,1% OEM 102,1% -32,4% 55,9% Spare parts -2,7% 4,0% 29,3% Others -38,6% -6,5% 14,1% Net sales 33,0% 9,6% 18,1% Table 4. Source: Company data. 10/20

11 Manufacturing & Distribution Manufacturing activities The Group s manufacturing process is divided into eleven full-cycle plants. The entire production process coffee and other products manufactured by the Group take place in the three main plants: the two plants of Saeco International Group S.p.A. in Gaggio Montano (Bologna) and the Gaggia S.p.A. s plant in Robecco sul Naviglio (Milan). During 2002 the plant of Sogeco Romania S.r.l. was completed and it is manufacturing manual coffee machines for domestic use and ironing systems. The other plants mainly produce spare parts and components are engaged in preassembly and assembly operation. The Group s manufacturing processes are highly automated in their main phases. This gives the Group flexibility as its production lines can be adapted to various different types and/or models of products quickly in order to follow changing customer demands. Standardisation of parts among the Group s main products also means that work stations at the assembly lines need only be partially modified in order to change product lines. The Group continuously increase the automation of its production lines which allows it to increase capacity within existing plants and reduce time to market. Each of the five main components used in the manufacture of the Group s automatic espresso coffee machines, the pump, turbine, Removable Espresso Brewing Unit, boiler and coffee grinder are manufactured by the Group. All of these, save for the coffee grinder, are manufactured using completely automated processes ensuring speed, consistency and high quality. Commercially available assembly line parts, including all electronic parts, are purchased but all lines are assembled by the Group and the majority of industry specific specialised parts and components are designed and manufactured by the Group. 11/20

12 Distribution With regard to the Italian market, the Group s sales network is divided into three sectors: domestic appliances, professional appliances and vending machines. The domestic appliance sector includes, in addition to coffee machines, air conditioning and steam products. To make Saeco and Gaggia brands better known to end consumers, the Group intends to maintain two separate distribution networks, one for Saeco and one for Gaggia products. Each agency has a number of employees or collaborators proportionate to the size of the territory it is operating in and to the size of the relative market. Saeco International Group S.p.A. also maintains direct relations with main customers, such as Metro, Coop, Media World, UniEuro, Auchan and Mercatone Uno. As for the domestic appliances sector (Coffee Line, Climate Line, Steam Line), products are sold to independent or specialist stores; chain-shops; large-scale or multiple retailing. The professional distribution sector deals with the sale of machines to bars, restaurants and communities in general. Machines are chiefly sold to two different types of operator in the sector: toasters, who purchase machines to supply them to their customers, mainly consisting of bars and restaurants; resellers and agents, operating in the various Italian regions who deal with the installation of machines and technical assistance. A network of resellers is in place for the vending machine sector. These resellers cover the needs of small/medium operators, while large-scale operators are directly supervised by the Group. Operators usually machines to their customers on a freeloan basis, with a contractual agreement binding customers to product supply (coffee, sugar, tea, etc.) and assistance services. With regard to foreign markets, the Group s products are sold by companies belonging to the Group operating in different Countries through a distribution network, similar to that in place in Italy. In countries where the Group is not represented by subsidiaries, the Group s products are marketed by importers who buy products directly from the Group, sell them in the respective market and then handle after sales assistance activity. There are basically three importer categories: those with a territorial selling rights, with product exclusive right and those without exclusive right. In addition to sales of Saeco, Gaggia and Spidem brands, the Group also produces coffee machines and vending machines on behalf of leading manufacturers of household appliances and vending machines, which then sell them under their own brand names. O.E.M. customers purchase products manufactured under their name directly from the Group, sell them in the market through their own sales structures and handle after sales assistance. Leading brand names include: Germany s Krups, Miele and Bosch-Siemens, Switzerland s Solis, Migros, Turmix and Rotel and Spain s Azkoyen. The Group also manufactures espresso coffee machines (Linea Barista, Zia and Athena) that are sold under the brand name Starbucks in the coffee shop chains of Starbucks Coffee Company Inc. present in the United States and in other countries worldwide. 12/20

13 Development strategy The Group's growth objectives concentrate on the core business. The Group intends to exploit the competitive advantages and experience it has acquired, transferring them to all the market segments in which it operates. For this reason, the Group intends to consolidate and develop relations with O.E.M.s (Original Equipment Manufacturers) with a view to ensuring production volumes sufficient for achieving economies of scale and to stimulating continuous product innovation. The Group intends to diversify products and develop non core business areas, by boosting the air-conditioning and steam sectors and exploiting the synergies of its own distribution system and the image and renown of its brands. In these sectors the Group intends to introduce new products and focus its attention on technologically advanced and innovative products in the high price range: expansion in the professional machines market with launch of new products and re launch of the Gaggia brand and expansion in the vending machines market with launch of new innovative models, completing the product range and geographic expansion (2003). The Group also intends to increase its presence world-wide by incorporating or acquiring new distribution companies in new strategic markets while nominating new authorised distributors in others. In particular, the Group intends to achieve expansion in new markets having high growth potential where the Group does not already occupy a significant position and consolidation the existing geographical markets (Italy, Germany, Switzerland, Austria, Spain, Portugal, Benelux, France, Poland, Canada, USA, Brazil, Argentina, Japan, Hong Kong, Australia). Investment will continue in research of more efficient and automated production processes, which are key to the Group s costs savings: of Raw materials by seeking out new materials, improve buying efficiency throughout the specialisation of the industrial factory following the introduction of the new introduction plants (ex.: Romania); of Labour Costs thanks to the introduction of new automation process efficiency deriving from increased product volumes. 13/20

14 Investment thesis The Group s products are sold primarily under the Saeco and the Gaggia brand names and under the Spidem brand name. The Saeco brand name is associate primarily with high quality, technologically-advanced and design-conscious domestic espresso coffee machines. The Gaggia brand name, on the market since 1947, is one of the oldest and most established brands in the espresso coffee machine market in Italy and several other European countries. Thanks to the constant use of technological innovation, the Group boasts highly flexible production lines capable of handling the introduction of model improvements and changes in design and ergonomics. The Group not only takes care of the production of its machines, but it also handles the planning and assembly of the individual components, in order to control and monitor all fundamental phases of the production process. The Group s sales do not reflect a significant seasonal trend. However, Group sales of domestic coffee machines are slightly lower in the summer months since consumers tend to drink less hot drinks in summer and consequently are not as inclined to purchase coffee machines. This decrease in sales is compensated by a rise in sales in the fourth quarter, in part due to Christmas season present buying. The Group s production levels are relatively stable throughout the year and, consequently, the Group experiences periods of inventory build up of domestic coffee machines during the third quarter in anticipation of higher levels of sales in the fourth quarter. The Group s sales of air conditioning and dehumidifiers are concentrated primarily in the summer months. With significant changes in culture and lifestyle in recent years, the consumption of espresso coffee has increased in many countries throughout the world, thereby opening up new markets for manufacturers of espresso coffee machines. The Saeco International Group is currently well positioned to capitalise on these growth opportunities in a timely manner. In pursuing the conquest of new markets, the Group has invested in expanding its production plants in Italy and in constructing a new fullcycle production facility in Romania. In our point of view, considering observation above, the high profitability of Group s Consolidated Income Statement (year average from 1999 to 2002 EBITDA%, EBIT% - is 24.1 and 16.1%, respectively) the capacity to generate cash flow and considering the brands recognition a fundamental driver for the success of Group s business model, we believe that is an investment opportunity in medium-term horizon, as we show our valuation paragraph. 14/20

15 Valuation & Rating It is difficult to value on the basis of market multiples both in dimension terms, the are no listed really comparable for the Group and the Group s core business which represent a niche segment with margins and growth rates different respect to Appliances sector, then it is difficult to identify suitable multiples for the Group. Given the stability of the Group s business, external growth apart, and the relative predictability of its cash flows in explicit horizon, we view the DCF model as the most appropriate to valuation and the market multiples as check method. Valuation model: discount cash flow We have assumed a growth rate to infinity (g) of 0.5%, which factors in the maturity and stability of the Appliances sector. We have employed a two year historical beta of 1.10 vs. Milan Mistar Index (Small-Cap Index) by Bloomberg. The DCF valuation that follows is calculated using a terminal WACC of 7.6%. The WACC is also based on a risk free rate of 4.5% (current Italian long term Bond rate 10Y) and a Bloomberg estimate risk premium of 4.0%. The conservative long-term EBIT margin used in the calculation is 19% and reflects our underlying revenues assumptions of compound growth in revenues of 8.1% (external growth apart) over the period 2003 to 2008 and a improvement in profitability over the same period, with a EBITDA margin rising towards 27% by the end of the forecast period from 26.8% in the current year. The key assumptions underlying our DCF model are summarised in the table below, while the model complete is situated at the financial tables paragraph. Cost of equity and capital estimates Stable Phase FIRM VALUATION EUR million Market risk premium 4,0% Growth Rate 0,50% Present Value of FCFF First Phase ,8% Risk free rate 4,5% FCFF ( million) 71 Present Value of Terminal Value ,2% BETA first phase 1,10 Cost of Equity 8,5% Value of the firm % Estimated Cost of Debt 5,5% After-tax Cost of Debt 3,3% - Book Value of Net Debt (E FY03) 24 Table 5. Source: Studio M. Mortari estimates. Debt/ (Equity + Debt) 17,1% Value of the Equity 826 Cost of Capital 7,6% Shares outstanding (million) 200,00 Value of the Equity per share 4.13 Weight 15/20

16 Check method: EV/EBITDA market multiple Comparable companies Saeco to belong to Appliances sector, in the Espresso and Home coffee machines segment. In addition, the high specialisation and the market leadership of Saeco Group to give to it niche advantage. Usually, for a niche player such as Saeco, the absence of listed comparable companies and the high differences in profitability terms respect to average sector, are the typical issues when selecting the peer group. The listed companies that we are choice from Household Appliances sector and that which could be considering as Saeco peer group are De Longhi and Seb Groupe. De Longhi operates in two business segments that are linked by the concept of wellbeing and products for food preparation and cooking, providing more quality leisure time. Products are marketed under the brands De Longhi, Kenwood, Simac, Vetrella, Ariagel, Elba and Ariete; the products are sold in Italy, UK, Europe, the Americas and rest of world. Seb Groupe manufactures small domestic appliances. The company produces cookware, electric cookers, food and beverage preparation equipment, vacuum cleaners and personal care items. Products are marketed in France and Belgium under the Calor, Rowenta, Seb and Tefal brands and elsewhere such as the Americas, Egypt, Australia and in Asia, under the Rowenta, Tefal, Arno and Samurai labels. EV/EBITDA market multiple The niche core business of Saeco, the Group s market leadership and the specialisation of its activity, permits to Saeco an average marginality of 50% respect to the comparable. Therefore, considering those advantage, the historical and estimates premium on EV/EBITDA multiple, we believe right a plus-value range of 25/35% respect to peer group, that implied an equivalent price would be in the range of 3.8 / 4.1 per share, as show tables below. Company Market cap (EUR) Market Cap. multiples EBITDA% 2003 E De Longhi 598,0 0,8 x 14,1% Seb Groupe 1.417,4 2,0 x 11,8% Average 1,4 x 13,0% 704,0 1,0 x 26,8% Table 6. Source: Studio M. Mortari estimates and JCF data to 11/05/2003. Company EBITDA% 2001 EBITDA% 2002 EBITDA% 2003E EBITDA% 2004E EBITDA% 2005E De Longhi 13,7% 14,2% 14,1% 14,3% 14,8% Seb Groupe 11,6% 9,9% 11,8% 12,7% 13,0% Average 12,7% 12,0% 13,0% 13,5% 13,9% 23,2% 26,8% 26,8% 26,9% 26,9% Advantage on average 45,4% 55,1% 51,5% 49,8% 48,3% Table 7. Source: Studio M. Mortari estimates and JCF data to 11/05/ /20

17 We choosing EV/EBITDA multiple because it isn t to feel the accounting and tax effects due to difference principles and laws in respective countries. Company EV/EBITDA 2001 EV/EBITDA 2002 EV/EBITDA 2003 E EV/EBITDA 2004 E EV/EBITDA 2005 E De Longhi 5,7 x 5,0 x 4,5 x 3,9 x 3,4 x Seb Groupe 6,4 x 6,6 x 5,9 x 5,1 x 4,5 x Average 6,1 x 5,8 x 5,2 x 4,5 x 3,9 x Table 8. Source: JCF data to 11/05/2003. We have obtained Saeco s EV/EBITDA multiple through the average by a range premium applied to comparable multiples, like show in the next table. We have calculated also the Saeco s implicit multiple on the basis of ratio from our estimates Enterprise Value and EBITDA We have observe that market multiples are in line with implicit multiple as we showing in the last table below, then we deduce that our DCF valuation is reasonable. EV/EBITDA 2003 E EV/EBITDA 2004 E EV/EBITDA 2005 E Market multiples 5,2 x 4,5 x 3,9 x Niche Advantage 25,0% 6,5 x 5,6 x 4,9 x ,0% 6,8 x 5,9 x 5,1 x ,0% 7,0 x 6,1 x 5,3 x Implicit multiples 7,0 x 6,0 x 5,9 x 4.1 Value from DCF model 4.1 % over/(under) valuation (14,8)% Open price to 11/05/ Table 9. Source: Studio M. Mortari estimates and JCF data to 11/05/2003. Price target and stock rating On the basis of the consideration above and the our valuation system below summarised, we believe that a 12 months price target of 4.12 per share reflect the reasonable Saeco s value, consequently we initiate coverage with BUY recommendation. Rating system parameters BOT12M 2,3% Dividend yield (FY03 E) 2,1% Open Price to 11/05/ Output Lenght Phase 4.13 Table 10. Source: Studio M. Mortari estimates and JCF data to 11/05/ /20

18 Financial tables History Explicit Horizon Implicit Horizon Stable Phase ESTIMATED CASH FLOWS '000 ) FY02 FY03 FY04 FY05 FY06 FY07 FY08 TV Net sales Operating Expenses EBITDA Depreciation & Amortisation (33) (36) (40) (45) (47) (51) (53) (53) EBIT EBIT * t EBIT (1-t) Depreciation & Amortisation Capital Expenditure (26) (19) (20) (22) (24) (21) (29) (59) - Chg. Net Working Capital (30) (8,4) (9,8) (11,8) (7,2) (7,5) (6,5) (0,7) Free Cash Flow to Firm Terminal Value Present Value Table 11. Source: Studio M. Mortari estimates. Consolidated Income Statement '000 FY00 FY01 FY02 FY03 E FY04 E FY05 E Net sales 317,5 348,1 411,1 451,7 499,2 556,6 Production Value 324,0 354,4 418,5 459,9 508,2 566,6 Material consumption (126,8) (135,1) (149,9) (164,4) (181,2) (201,5) Service costs (63,4) (76,7) (88,1) (95,8) (106,3) (119,1) Other costs (4,6) (5,4) (5,7) (6,3) (7,0) (7,8) Value added 129,1 137,3 174,9 193,3 213,6 238,2 Lobour costs (48,6) (56,6) (64,9) (72,3) (79,9) (89,1) Gross operating margin (EBITDA) 80,5 80,7 110,0 120,9 134,1 149,7 Provision for bad debt (1,1) (1,7) (1,7) (1,8) (2,0) (2,2) Provision risks (0,7) (3,1) (6,5) (6,3) (7,0) (7,8) Depreciation and amortisation (23,0) (23,9) (25,3) (29,4) (31,8) (33,9) Operating profit (EBIT) 55,7 51,9 76,5 84,8 94,1 105,2 Profit before income tax & Minority Interest 51,0 19,5 69,5 78,9 87,7 98,0 Taxes (24,7) (12,2) (22,0) (30,8) (34,2) (38,2) Profit before Minority Interest 26,3 7,4 47,5 48,1 53,5 59,8 Minority Interest (2,8) (3,4) (3,3) (3,6) (4,0) (4,5) Net income 23,5 4,0 44,3 44,5 49,5 55,3 Table 12. Source: Company data, Studio M. Mortari estimates. 18/20

19 Balance Sheet '000 FY99 FY00 FY01 FY02A FY03E FY04E FY05E NWC 44,6 52,9 86,6 116,9 99,5 109,3 121,2 Fixed assets 245,9 282,2 264,1 274,0 280,5 285,0 300,2 Other net current assets (liabilities) (3,7) (9,5) (6,8) (15,6) (6,0) (14,3) (21,1) Invested capital 286,8 325,6 343,9 375,3 374,0 380,0 400,2 Severance fund (7,1) (7,6) (8,6) (9,4) (10,5) (12,1) (14,2) Net invested capital 279,7 318,0 335,3 365,9 384,5 392,2 414,4 Group's net equity 25,1 264,3 263,2 305,8 350,1 403,8 473,7 Minorities 2,0 5,0 7,4 10,3 8,8 10,1 11,8 Net financial debt (cash) 252,6 48,7 64,7 49,9 25,6 (21,7) (71,0) Capex 14,0 19,0 23,0 26,0 19,0 20,0 22,3 Capex/Sales 5,9% 6,0% 6,6% 6,3% 4,2% 4,0% 4,0% ROE 38,4% 8,7% 1,5% 14,0% 13,2% 13,4% 13,5% Net profit 10,4 23,5 4,0 44,3 44,5 49,5 55,3 Shareholders equity 27,0 269,4 270,6 316,1 338,5 368,9 408,6 Table 13. Source: Company data, Studio M. Mortari estimates. Dividend FY02A FY03E FY04E FY05E Dividend per share 0,074 0,074 0,082 0,092 Shares outstanding (million) 200,00 200,00 200,00 200,00 Gross dividend '000 14,8 14,8 16,5 18,4 Net income '000 44,3 44,5 49,5 55,3 Pay out ratio 33,3% 33,3% 33,3% 33,3% Dividend yield (Open price to 11/05/2003) 2,1% 2,1% 2,3% 2,6% Table 14. Source: Company data, Studio M. Mortari estimates. 19/20

20 Disclosures information Stock Rating System Effective September 01, 2003, Studio di Analisi Fondamentale Massimo Mortari will utilise a Rating System which consists of a Recommendation and Predictability Level: The Rating will be Buy, Add, Hold, Neutral, Reduce, Sell. The Recommendations are based on the predicted excess return, determined by the target price assigned. The target price is used to generate an excess return potential 1 according to the following formula: (Price target divided by Current Price) 1 + (Gross Dividend Yield 12 months Interest Rate 2 ) The Predictability will be Higher (1) and Lower (2): analyst must determine whether there is a higher or lower predictability in the stock s forecasted target price. Rating BUY ADD HOLD NEUTRAL REDUCE SELL Definition (1) Excess return potential > 15%, smaller range around price target (2) Excess return potential > 15%, larger range around price target (1) Excess return potential between -15% and 15%, smaller range around price (2) Excess return potential between -15% and 15%, larger range around price target (1) Excess return potential < -15%, smaller range around price target (2) Excess return potential < -15%, larger range around price target 1 Excess return potential is the return in excess of the risk-free rate months Interest Rate is that of the subject company s country of incorporation, in the same currency as the predicted return. This publication has been prepared by Donatello Caggiano in his quality as a member of A.I.A.F (Italian association of financial analysts). The information contained in this publication is based on sources believed to be reliable. Although Studio Massimo Mortari makes every reasonable endeavour to obtain information from sources that it deems to be reliable, it accepts no responsibility or liability as to the completeness, accuracy or exactitude of such information. Studio Massimo Mortari has adopted internal procedures able to assure the independence of its financial analysts and that establish appropriate rules of conduct for them. The purpose of this publication is merely to provide information that is up to date and as accurate as possible. The publication does not represent to be, nor can it be construed as being, an offer or solicitation to buy, subscribe or sell financial products or instruments, or to execute any operation whatsoever concerning such products or instruments. Studio Massimo Mortari does not guarantee any specific result as regards the information contained in the present publication, and accepts no responsibility or liability for the outcome of the transactions recommended therein or for the results produced by such transactions. Each and every investment/divestiture decision is the sole responsibility of the subject receiving the advice and recommendations, who is free to decide whether or not to implement them. Therefore, Studio Massimo Mortari and/or the author of the present publication cannot in any way be held liable for any losses, damage or lower earnings that the subject using the publication might suffer following execution of transactions on the basis of the information and/or recommendations contained therein. The estimates and opinions expressed in the publication may be subject to change without notice. Studio Massimo Mortari dose not guarantee continuos coverage of the studies published. Studio Massimo Mortari is authorised to publish information and statistical data to the public and could have a direct interest in the company in examination or to the operations under study. 20/20