SPECIAL SITUATION REPORT

08 August 2016

Snam SpA (SRG IM) Shares Assignment Tax Free Spin-Off 5 Snam = 5 Snam + 1 ITG Holding Deal Brief: Snam has decided to demerge its gas distribution business (Italgas) from the rest of Snam SpA the company which is involved in transmission, regasification and storage of natural gas. Italian government aims to consolidate the distribution industry and Italgas could substantially increase Country Italy its market share. Hence, Italgas is being demerged so that its management can solely focus on Bloomberg SRG IM this objective. It will be transferred to a holding company called ITG Holding which will be Sector Utility listed on Borsa Italiana in Milan. Spin-off’s timeline is detailed below.

Share price (€) 5.11  Shareholders meeting to approve the demerger 1 August, 2016 Market cap (€m) 17,888  Italgas listing process begins & Snam’s bondholders vote Q3 2016 Free float % ~69  Italgas capital markets day and roadshow Q4 2016  Listing of Italgas & effective date of merger Q4 2016

Snam’s investor relations told us that Italgas is expected to be listed by first half of November

or the latest first half of December. Shareholders approved the demerger on August 1, 2016.

Business Rationale:  Operationally: Distribution is carried out using metropolitan low-pressure pipeline networks. However, transmission is being carried out using high-pressure networks.

 Competitive Context: The distribution industry is fragmented in Italy, Italgas deals Snam Price Chart with local and regional competitors. Whereas, Snam has national and international competitors such as, Terna (Italy) and Enagas (Spain).

 Regulation: Distribution is a local business based on award of operating rights by local and regional authorities for fixed term. In contrast, Snam’s other businesses have national and international scope.

 Investment Requirements: Distribution needs continuous small scale investment as compared to investment in large infrastructure for Snam’s other businesses.

Risks: There are certain conditions which need to be met as given below.  Borsa Italiana’s order admitting ITG Holding to trade on the MTA.  Status Judgment of equivalence by Italian Securities and Exchange Commission.  The approval by the bondholders of Snam. Demerger announcement: June 29, 2016 Shareholders’ approval on August 1, 2016 In addition, Italgas will be going through an auction process conducted by the Italian government to consolidate the Italian distribution industry. According to the company, it expects Italgas to increase market share from 33% to 40%. However, there is a risk that this expectation may not Author be realized. These contracts will be awarded for 12-year period and there will be no guarantee if Italgas would be able to retain them at the end of this period. Muhammad Daniyal Event Driven Analyst IGR View: According to our SOTP peer model there is an upside potential of 13.1% and according to our SOTP DDM an upside potential of 11.7%. Given the upside potential we [email protected] recommend to be long Snam at the current upside potential keeping in mind its long +36 1 888 0563 (direct line) term potential (less than €5 would be an attractive price and we would significantly increase position). Italgas could face selling pressure post-split, as investors might not Krisztian Szentessy be willing to hold the stock due to very low expected dividend. However, we don’t have [email protected] any clear evidence to support this claim as we expect Italgas to remain in FTSE MIB Gabor Kokosy index. If post-split, Italgas faces selling pressure it would be a good opportunity to buy Italgas (€2.25-€2.50 would be an attractive entry price and we would significantly increase [email protected] position below €2). Tomas Stanay [email protected] In the long run, we believe Snam would turn out to be an attractive investment. It pays out an attractive dividend which mitigates potential downside. In addition, given its long term plans of Gabor Szabo, CFA demerging Italgas and acquiring stakes in international gas transportation companies further [email protected] indicates potential upside. For Italgas, the first six auctions are expected in 2016 and the whole process will run for 4 to 5 years. Gradually, Italgas will also start paying out dividends. Moreover, Chain Bridge Research increase in income from Snam’s international subsidiaries and investments would boost Snam’s value. We see Snam playing a crucial role in the European gas unification project. However, 100 Wall Street, 20th Floor having said that it could take some time to realize the upside potential. Our recommendation New York, NY 10005 accounts for the timeline as discussed. Tel (UK): +44 207 570 0322 Tel (New York): +1 212 796 5769

CHAIN BRIDGE RESEARCH Please read the important disclosures and disclaimers at the end of this report

Snam Tax Free Spin-Off 08/08/2016

Part 1: Present Situation

Company Structure ■ Snam is in the process of spinning off its dispatching/distribution business (Italgas). ■ The below exhibit 1 shows demerged activities (pre-Demerger) with a light blue highlight. ■ It consists of Italgas and its subsidiaries (Napoletanagas, ACAM gas, Toscana Energia and others).

Exhibit 1: Snam’s Group Structure (pre-Demerger)

Source: Company

■ The plan is to demerge Italgas and transfer it to a holding company called ITG Holding. ■ ITG holding will be listed on the Mercato Telematico Azionario (MTA) of Milan. ■ Snam, CDP Reti and CDP Gas will keep equity investments in ITG Holding equal to 13.50%, 25.08% and 0.97%, respectively along with other Snam shareholders. (see exhibit 2 below) ■ CDP Reti is a holding company controlled by the Italian state.

Exhibit 2: Snam’s Group Structure (post-Demerger)

Source: Company

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Snam Tax Free Spin-Off 08/08/2016

Demerger Details Board of Directors Approval ■ On 29 June, 2016 Snam’s Board of Directors approved the separation of Italgas from Snam.

Shares Assignment 5 Snam = 5 Snam + 1 ITG Holding ■ For every 5 Snam shares, 1 share of ITG holding will be assigned to current shareholders. ■ There will be dilution at ITG level as current Snam shareholders will own 86.5% of ITG directly and Snam will own 13.5% of ITG.

Timetable ■ Demerger announcement: 29 June 2016 ■ Credit ratings assessment of the transaction: 29 June 2016 ■ Financing commitments granted to Italgas: 29 June 2016 ■ Snam lender’s waivers obtained (banks): 29 June 2016 ■ Shareholders meeting to approve the demerger: 1 August 2016 ■ Italgas listing process: Q3 2016 ■ Snam bondholders consent solicitation: Q3 2016 ■ Italgas capital markets day & management roadshow: Q4 2016 ■ Closing of financing commitments with banks: Q4 2016 ■ Expected Effective Date of the demerger: Q4 2016 ■ Listing of ITG Holding: Q4 2016

Ownership Structure ■ After completion of the demerger CDP Reti will continue to hold significant proportion of shares in both the entities as shown in the below exhibit.

Exhibit 3: Snam Direct Shareholder Proportion of Ordinary Share Capital (%) CDP Reti 28.98 CDP Gas 1.12 Finanziaria Ceramica Castellarano S.p.A. 0.26 Iris Ceramica Group S.p.A. 1.41 Minozzi Romano 1.36 Source: Company

Exhibit 4: ITG Holding Direct Shareholder Proportion of Ordinary Share Capital (%) CDP Reti 25.08 CDP Gas 0.97 Snam 13.50 Source: Company

Capital Structure ■ According to 2015 pro-forma financials, Snam has €10.317Bn of Net Debt and Italgas has €3.482Bn of Net Debt. In addition, Snam and Italgas have Net debt/RAB of 0.49 and 0.59, respectively (see exhibit 5). ■ The demerger will cause reduction of approximately €1.57Bn in Snam’s shareholders’ equity through reduction of approximately €0.96Bn in share capital and a reduction of approximately €0.61Bn in reserves. ■ The demerger will cause increase of approximately €1.57Bn in ITG Holding shareholders’ equity through increase of approximately €0.96Bn in share capital (via the issue of approximately 0.7Bn new ordinary shares) and an increase of approximately €0.61Bn in reserves. ■ Snam’s current credit rating: BBB+ Fitch, Baa1 Moody and BBB S&P ■ Independent Italgas rating: Expected BBB+ Fitch and Provisional Baa1 expected by Moody

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Snam Tax Free Spin-Off 08/08/2016

Exhibit 5: ITG Holding

Source: Company

Incorporation ■ Italy

Demerger Presentation ■ Click here

Preconditions ■ The issuance of Borsa Italiana’s order admitting ITG Holding to trade on the MTA. ■ The issuance of the judgment of equivalence by CONSOB (The Italian Securities and Exchange Commission). ■ The approval by the bondholders of Snam. ■ Shareholder approval is required as detailed below (shareholders approved the demerger on August 1, 2016). i. On the 1st gathering more than 50% of shares voted would be required for approval. ii. If the attendance in the 1st gathering falls below 50% then the 2nd gathering would take place. In this gathering more than 67% of shares voted would be required for approval. iii. Finally, if the attendance in the 2nd gathering falls below 33% then the 3rd gathering would take place. In this gathering more than 50% of shares voted would be required for approval (attendance should be 20% in the 3 rd gathering).

Requirements of FTSE ■ On the first day after a FTSE MIB constituent spin-off both companies are included in the index. MIB Membership on ■ At the end of that day, FTSE Russell runs an extraordinary ranking of the index universe. Spin-Off ■ In order to run ranking of the index universe, it uses last day before spin-off shares in issue and free float, last month before spin-off average price and last six months before spin-off turnover, splitting the values for the two companies involved in the spin-off according to first day post spin-off market capitalization. ■ It could result in three possible scenarios as detailed below.

i. If both companies (the index constituent and its spin-off) are within the first 45 companies in the basket ranking, the index will consist of 41 up until the next review. At the subsequent periodic review, the constituent with the lowest ranking (not necessarily one of the two involved in the spin- off) is removed from the index. ii. If one of the two companies is below the first 45 in the basket by ranking, the smaller company will be excluded from the FTSE MIB basket. The exclusion is effective two days after the announcement date. iii. If both companies are below the first 45 companies by basket ranking, neither company is chosen to remain in the index, and the first company in the reserve list is included in the index. The exclusions are effective two days after the announcement date.

■ Snam currently has a sizable weight in FTSE MIB of 5.31%, this places Snam in the top 5 companies of FTSE MIB. ■ We can allocate Snam’s current index weight based on a ratio of 70:30, according to our post separation value. ■ Based on these calculations both companies will still have significant individual weight which would enable both companies to stay in the top 20 companies out of the top 45 companies by basket ranking. Hence, it is highly likely that both of them would remain in FTSE MIB after the spin-off.

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Snam Tax Free Spin-Off 08/08/2016

Rationale Behind the ■ The main reason behind the transaction is the belief that the gas distribution business has very specific characteristics Demerger that are different from the rest of Snam group’s activities. ■ Distribution industry in Italy consists of very small independent distributors. Italgas, a subsidiary of Snam group, is being spun off to better compete with these independent distributors. ■ These characteristics are different in terms of operational organization, competitive context, regulation and investment requirements as explained below. ■ Therefore, to unlock greater growth opportunities and enhance shareholder returns both the businesses should pursue strategies separately with their own managements.

Operationally ■ Distribution is mainly a local business which is being awarded on a fixed term concession basis by local and regional authorities. It is being carried out using metropolitan low-pressure pipeline networks. ■ On the contrary, Snam’s other businesses have national and international scope. In addition, these businesses are being carried out using high-pressure networks. ■ To improve efficiency and the quality of service the Italian government has decided to consolidate the currently fragmented gas distribution sector. ■ Currently, there are 6,700 concession areas (auctioned by government for a fixed term) which were auctioned to gas distributors. ■ There are a couple of big players (Italgas and 2i Reti Gas) and several other small operators. Hence, resulting in a highly fragmented sector with inefficiencies and poor quality of service. ■ The plan is to reduce concession areas to just 177, a reduction of 97%. ■ The 177 new concession areas will be auctioned over the next four to five years and the auction process is expected to significantly reduce the number of network operators. ■ Italgas has a huge opportunity here to increase its market share significantly in gas distribution sector via leveraging its current market position. ■ Hence, Italgas will be focused on capitalizing on this opportunity with a separate management team.

Competitive Context ■ As stated above competitive landscape of distribution business in Italy is fragmented. Italgas is the leader with 33% of market share. ■ The second largest player has 17% market share (2i Reti Gas). ■ In addition, there are several small players with very small market shares. ■ Italgas has local and regional competitors. However, Snam’s other businesses have national and international competitors. For example, Terna in Italy and Enagas in Spain.

Regulation ■ Due to highly fragmented nature of the Italian distribution sector, in which there are many competitors, operating costs are recognized on a parametric basis (operating costs are recognized for regulation purposes by averaging industry’s operating costs as it is less tedious for the regulator as compared to going through each player’s books on individual basis). ■ It requires frequent interaction with local and regional authorities. ■ However, other businesses require more interaction with national and international authorities such as EC and Regulatory bodies.

Investment Requirements ■ Distribution business requires continuous small scale investment. In addition, it is more labor intensive business than Snam’s other businesses. ■ In addition, Snam’s other businesses need investment in large infrastructure as it plays a strategic role in building the energy union. ■ The following exhibit 6 highlights different characteristics of the two businesses.

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Snam Tax Free Spin-Off 08/08/2016

Exhibit 6: Two businesses with distinct characteristics

Source: Company

Future Outlook/Plans for Plans for Snam (ex Italgas) the Demerged Entities ■ Snam will be able to concentrate on its transportation, storage and regasification activities in Italy and abroad in order to maximize value of its existing assets. ■ It will also be able to capitalize on new development opportunities in Italy and internationally due to enhanced financial flexibility. ■ Post demerger Snam will keep a strategic minority stake in Italgas to capture future value.

Plans for ITG Holding ■ Management will be focused on tender process (concession areas). ■ As ITG Holding will be involved in gas distribution service tenders, it needs to update its technical structures and the related process by the end of 2016. ■ Majority of its technical and production processes are being revised and computerized. ■ It will aim to obtain a higher market share through the consolidation process in the distribution industry. ■ Moreover, it will have more flexibility with regards to investments. Formerly, being part of Snam group i.e. competing against other investment opportunities and being bound by Snam’s debt. ■ As a consequence of listing of ITG Holding, it will have direct access to the capital markets, enabling it to finance future growth.

Tendering Process: ■ As stated above the Italian government has decided to consolidate the gas distribution sector in the country. Concession Areas (Italgas) ■ First auctions are expected late in H1 2016, with the first results coming in the latter end of 2016. ■ The process is expected to run for four to five years. ■ The winner of each auction will have right to operate the designated area for a 12-year period and will own the associated assets.

Process ■ This is less of a traditional auction as it is a three stage tender. ■ Snam and its peers will compete on the three fronts: economic profile, quality of service criteria and network development criteria. ■ Weightings given to each front: Economic profile – 28%, quality of service criteria – 27% and network development criteria – 45%. Economic Profile o Key terms are defined as follows. o Industrial value: The auction or acquisition price, this incorporates RAB (regulatory asset base) and any other subsidies. Industrial value will be greater than RAB. o RAB: The regulated asset value set by the regulator. o Premium: The difference between the industrial value and asset base (IV-RAB). This premium will be repaid to the winning operator over a 12-year contract. o Operators will compete to offer discount on premium. o 0% discount: The winning bidder pays the premium for the asset but gets it repaid over the 12-year contract. This is the best case. o 100% discount: The winning bidder will receive the premium but then must repay 100% of the premium. The net total of this will be negative contribution to total regulated revenues. This is the worst case.

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Snam Tax Free Spin-Off 08/08/2016

Quality of Service o Information regarding quality of service, safety and other criteria must be submitted to the regulator.

Network Development Criteria o Plans regarding future development of ATEM (concession area) must be submitted. o It should include information on key targets and future investments. This is the most important as it has a weighting of 45%.

Call with Investor We had a detailed investor relations call. Details are given as follows. Relations ■ Cost recognition on parametric basis was explained as mentioned above. ■ In 2002, ENI initially went through Snam’s IPO and later in 2012 ENI was forced by the Italian government to off load its stake in Snam due to antitrust issues. ■ Hence, it opened up Italy’s gas transportation network to greater competition. ■ Growth prospects or success with tendering process will not be impacted due to Italian government’s stake. ■ Snam is included in FTSE MIB and SX6P indices. ■ Discussion on management compensation as discussed in the below section. ■ Discussion tax implications in case of acquisition of Italgas also discussed below.

Management Incentives & Snam Group Competence Level ■ We believe the current management of Snam is competent to realize the envisioned strategy. ■ CEO of Snam group Mr. Marco Alvera has held the position since April 27, 2016. Prior to this he was COO from January to April 2016. ■ He spent around 10 years in various positions with Eni before joining Snam. He was also Director of Group Corporate Strategy at Enel (manufacturer and distributor of electricity and gas). He has Philosophy and Economics degree from the London School of Economics. ■ Currently, Snam’s management is compensated with fixed remuneration and variable monetary incentives. ■ Fixed remuneration includes gross annual salary and variable remuneration consists of bonus paid according to achievement of defined targets.

Italgas ■ The future CEO of Italgas Paolo Gallo is a good fit given his diverse background. He held CEO positions in utility, railway stations and electricity generation companies. ■ He also developed new opportunities in India and Brazil when he was at Fiat. ■ There will not be any special compensation for Italgas’ management after the spin-off such as, stocks, warrants or options. ■ We expect that the compensation policy at Italgas after the spinoff will be similar to Snam’s current policy. ■ Thus, we believe this compensation structure would financially motivate the management to increase stock price. ■ Overall, we are bullish on the management.

Eni Snam Split & Stock ■ Initially, Snam was a subsidiary of Italian energy company Eni. Subsequently, it has since become an independent Performance Post Split company. ■ Firstly, through an IPO in 2002, Eni sold 35% of its stake in Snam. Eni wanted to focus on its core businesses of exploration, production and natural gas. ■ The sale of remaining Eni’s stake in Snam was imposed by Mario Monti’s technocrat government with the aim of boosting competition in Italy’s gas pipeline network. ■ Later it issued a decree requiring the sale by Eni of at least 25.1 per cent of Snam to CDP. ■ The Italian government considers Snam as a strategic asset and wanted to ensure the gas network had a stable shareholder able to guarantee its development and long-term future. ■ Finally, Eni sold its remaining stake gradually in 2012 and 2013. ■ Since 2002 IPO, Snam’s stock has performed quite well against FTSE MIB, particularly after the spinoff, as shown in the below exhibit 7. ■ Eni’s stock also outperformed S&P 500 after the spinoff as it focused on its core businesses of exploration, production and natural gas (as shown the below exhibit 8). ■ The Italian government has sizeable stakes in other utility companies as well such as, Terna (Italian electricity transmission system operator). ■ The Italian government tends to have significant stakes in these assets due to their strategic importance as mentioned above.

Exhibit 7: Snam’s Stock Performance Relative to FTSE MIB

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Snam Tax Free Spin-Off 08/08/2016

Source: Yahoo Finance

Exhibit 8: ENI Stock Performance Relative to S&P500

Source: Yahoo Finance

Possible Acquisition of ■ Post-split we assign a low probability to a potential acquisition of Snam or Italgas. Snam or Italgas ■ As stated above the Italian government would likely block potential acquisition attempt of Snam due to its strategic nature. ■ We see possible acquisitions by Snam of other companies to grow its international footprint with the aim of playing a growing role as one of the largest gas operators in a more interconnected Europe. ■ There will be consolidation in distribution after the auction process. However, we do not expect acquisition of Italgas post-split as it is the largest player in the industry. ■ Although, there could be a possibility of Italgas taking over some smaller players in the distribution industry. ■ CDP Reti will continue to hold 25% of Italgas post spin-off. ■ Hence, international acquirer targeting Italgas for takeover is highly unlikely as the Italian government would likely block such an attempt. ■ However, in case of acquisition of Italgas within one year of the spinoff, shareholders will have to pay tax on 100% of the capital gain. ■ If stake would be sold after one year of the spinoff, then the tax will be paid on 5% of the capital gain.

Key Risks Possible Opposition from Creditors ■ The creditors of both companies participating in the demerger could oppose the execution of the demerger. ■ In case of opposition by creditors, there could be a failure or delay to complete the transaction. ■ As shown in the exhibit below there is no CoC (Change of Control) clause in the covenants of Snam’s bonds. However, there is a Cross Default clause in all of the bonds. ■ Cross default clause is not a huge threat given the net debt/RAB ratio of Italgas (ex-Snam) of 0.59 as compared to 0.49 of Snam. Hence, it puts them at almost same level of creditworthiness. ■ Moreover, Italgas (ex-Snam) will not have any bonds initially but even if it issues, Snam will only have 13.5% of the interest in Italgas which would not qualify Italgas as a significant subsidiary of Snam. Thus, cross default clause will not be applicable.

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Snam Tax Free Spin-Off 08/08/2016

Exhibit 9: Snam’s Bonds Outstanding Amount Currency Ask Yield to Maturity Bid Yield to Maturity Ask Price Cross Default CoC Clause 1,250,000,000 EUR -10.20% -1.49% 112.82 Yes No 1,200,046,000 EUR -14.58% -3.66% 106.63 Yes No 1,000,000,000 EUR 13.62% 21.13% 131.30 Yes No 999,915,000 EUR -15.98% -2.02% 102.36 Yes No 850,050,000 EUR -12.43% -1.13% 112.74 Yes No 750,000,000 EUR 24.07% 31.46% 108.22 Yes No 750,000,000 EUR 16.41% 24.24% 108.94 Yes No 600,000,000 EUR 29.58% 37.40% 121.86 Yes No 500,000,000 EUR -14.91% -5.17% 104.54 Yes No 500,000,000 EUR -4.79% 3.80% 115.46 Yes No 300,000,000 EUR -19.93% 5.61% 100.17 Yes No Source: Bloomberg, IG Research

Preconditions to be met The transaction is subject to fulfillment of preconditions as stated below: ■ The issuance of Borsa Italiana’s order admitting ITG Holding to trade on the MTA. ■ The issuance of the judgment of equivalence by CONSOB (The Italian Securities and Exchange Commission). ■ The approval by the bondholders of Snam. ■ In case of failure to fulfill the above mentioned conditions, there could be a failure or delays to complete the transaction. ■ According to the company (investor relations) they do not see any reasons for not meeting the aforementioned preconditions. ■ They see the listing and CONSOB approval by the first half of November. ■ Vote of shareholders was scheduled on August 1, 2016 (Shareholders approved the demerger).

The Tax Treatment of the Transaction ■ According to the company the demerger is a neutral transaction for the purposes of income tax and business tax in Italy. ■ Hence, it will not result in the realization of any taxable income. ■ Snam has submitted a request to the Italian Tax Authority for a tax ruling. ■ However, in the light of Fiat Chrysler and Ferrari spin-off it is plausible that the tax authority will agree with Snam on this matter.

Regulatory ■ Snam will have a regulatory review of its transportation business in 2017. ■ It only has 2 years of regulatory certainty. Hence, its set returns will be reviewed in 2017 which could result in downward revision of set returns.

Tender Process ■ All the employees previously employed by other operators in each region will be taken over by successful operator. ■ In addition, they must be employed on the same terms as their previous employers ■ Thus, if Italgas emerges as a winner, it may have to take on a large number of employees with higher wages and benefits. ■ This is only a 12-year contract, at the end of the 12 years there will be a new auction. Hence, there will be uncertainty at the end of the12 year period. ■ Arguably, Italgas can even lose market share to its competitors in the auction process. ■ In case, Italgas wins auctions, it will have to finance growth with equity or debt. However, it is in a healthy financial condition with a Net Debt/RAB ratio of 0.59. ■ Hence, we don’t see this as a substantial risk and we believe it will most likely use debt financing (due to low interest rate environment).

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Snam Tax Free Spin-Off 08/08/2016

Part 2: Company description

Company’s Business ■ Snam provides natural gas transportation and dispatching, storage and distribution services, LNG regasification services, and plays a leading role in the natural gas infrastructure system. ■ It has over 6,000 employees and is a leading European operator in terms of regulatory asset base (RAB) in its sector. ■ These activities are being conducted throughout Italy through its four wholly owned subsidiaries: Snam Rete Gas, Stogit, Italgas and GNL Italia. ■ It also operates in other major European energy corridors through agreements with and equity investments in the leading industry players. ■ The business is capital intensive and focused on regulated activities ■ It has been listed on the Italian stock exchange since 2001. ■ Its largest shareholder is CDP Reti. The largest shareholders are shown below in the exhibit.

Exhibit 10: Snam’s Shareholder Structure Shareholders % CDP RETI SRL 29.0 BLACKROCK 2.2 CDP GAS SRL 1.8 VANGUARD GROUP 1.5 JPMORGAN CHASE & CO 1.5 NOMURA 1.5 IRIS CERAMICA SPA 1.4 MINOZZI ROMANO 1.4 PICTET FUNDS 1.1 LAZARD LTD 1.0 NORGES BANK INVESTMENT MANAGEMEN 1.0 Source: Company

■ Blackrock and Vanguard are two shareholders exposing Snam to ETFs. However, as explained in prior section there is a high probability of both companies remaining in the index (post spinoff). Hence, we do not expect any selling pressure emanating from this exposure. ■ Group structure is detailed in the below exhibit.

Exhibit 11: Snam’s Group Structure

Source: Company

■ Group structure is mainly divided into wholly owned subsidiaries and international subsidiaries and associates. ■ Snam Rete Gas is the leading Italian natural gas transportation and dispatching operator, and owns almost all of the transportation infrastructure in Italy. o Snam is also a partner in PRISMA through Snam Rete Gas, an international project involving 37 European gas transmission operators from 16 countries. o Its goal is the creation of a single European natural gas market by offering transportation capacity through a single shared digital platform.

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Snam Tax Free Spin-Off 08/08/2016

■ GNL Italia owns the terminal at Panigaglia (La Spezia). It was the first ever regasification plant built in Italy. ■ Stogit is one of the largest storage operator in Europe and in Italy. ■ Italgas is the market leader in Italian natural gas distribution. o Napoletanagas distributes and retails natural gas such as methane and is based in Naples, Italy. o AES Torino distributes and manages natural gas and is based in Turin, Italy. o Acam Gas through Italgas operates the gas distribution service in the city of La Spezia and in another 28 municipalities located in the La Spezia province. o Toscana Energia distributes energy and gas and is based in Florence, Italy. ■ Snam has undertaken foreign growth strategy through its international subsidiaries and associates. o Acquisition in 2012 in 50-50 JV with Fluxys of: 31.5% of Interconnector UK, 51% of Interconnector Zeebrugge and 10% of Huberator. (The interconnector is a natural gas pipeline between the United Kingdom and continental Europe and Huberator is a natural gas marketplace in Europe) o It acquired a stake in TIGF in 2013 and with a current equity investment of 40.5%, alongside GIC (31.5%), EDF (18%) and Crédit Agricole (10%). (TIGF transports and stores natural gas in southwest France) o In 2014, it acquired 84.47% of TAG (89.22% of economic rights). (TAG owns the gas pipeline linking the Slovakian/Austrian border with the Tarvisio entry point) o In December 2015 it acquired 20% of TAP. (TAP is a pipeline to transport natural gas from Azerbaijan via Greece, Albania and the Adriatic Sea to Italy and further to Western Europe)

Exhibit 12: Snam’s Revenues by Subsidiaries: Pie Chart

Source: Company

Subsidiaries ■ Snam plays a critical role in the gas system. ■ It stands between procurement, production and importing of gas and selling gas to thermoelectric power stations, manufacturing plants and residential and business customers as shown in the below exhibit.

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Snam Tax Free Spin-Off 08/08/2016

Exhibit 13: Snam’s Role in the Gas System

Source: Company

Snam Rete Gas ■ It is the leading natural gas transporter in Italy with 32,534 km of high and medium pressure gas pipelines which is approximately 94% of the entire transportation system. ■ It manages the pipeline network through 8 districts, 48 maintenance centers, 11 compression stations and a new dispatching unit in Italy. ■ The gas from outside the country is fed into the national network through import points (blue arrows in exhibit 14) and joins with the methane pipelines and with the LNG regasification terminals as shown in the exhibit below. ■ The gas is transported to the local distribution networks, the regional network redelivery points or large end users such as thermoelectric power stations or manufacturing plant once it has been imported and regasified.

Exhibit 14: Snam’s Compression Stations, Import Points, Regasification Terminal & Storage Fields Map

Source: Company

GNL Italia ■ GNL Italia owns a regasification terminal. (labelled with a blue solid circle in the above exhibit 14) ■ It has a daily regasification capacity of 17,500 cubic meters of LNG. ■ Thus, at maximum operating capacity, it injects 3.5 billion cubic meters of natural gas into the transportation network every year. ■ LNG Chain briefly: First the natural gas is extracted from the deposit, then it is liquefied for transportation and finally it is regasified for end users. ■ At the regasification terminal the LNG is unloaded, then heated and returned to a gaseous state before being fed into the natural gas transportation network for distribution to the end users. Stogit ■ It is a major storage operator, with 4.5 billion cubic meters of strategic storage space and 11.5 billion cubic meters of available capacity which is approximately 95% of the available space throughout Italy.

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Snam Tax Free Spin-Off 08/08/2016

■ The gas storage business helps in managing varying demands of gas consumption and supply. ■ It also ensures that gas is available to compensate for any lack of or reduction in non-EU supply or crises in the gas system. ■ It makes use of integrated infrastructure comprising deposits, wells, gas treatment plants, compression stations and the operational dispatching system. ■ It has nine storage concessions located in Lombardy (five), Emilia-Romagna (three) and Abruzzo (one). (labelled with a green solid circle in the above exhibit 14)

Italgas ■ It is a leading natural gas distributor in Italy (as shown in the exhibit 15 below). It has 1,472 municipal concessions, 56,717 km of medium and low pressure network and 6.526 million active meters at redelivery points which is over 30% of the Italian market. ■ Gas distribution service is provided to sales companies authorized to market to end users by means of the transportation of the gas through city networks. ■ It leverages integrated system of owned infrastructure to undertake natural gas distribution activities. ■ Integrated system of infrastructure comprises of stations for withdrawing gas from the transportation network, pressure reduction plants, the local transportation and distribution network, user derivation plants and redelivery points comprising technical equipment featuring meters at the end users. ■ This enables Italgas to take gas from the national transportation network and delivered to selling companies in the vicinity of the end users. ■ It also manages the gas distribution service in Naples and in another 133 municipalities in Campania region through its Napoletanagas subsidiary. ■ In addition, it also manages and distributes gas in Florence and Turin through other subsidiaries.

Exhibit 15: Market Share Split in Gas Distribution (%)

Other small operators

Gas Natural

Extra Reti

IREN

Hera

A2A

2i Reti Gas

Italgas (Including associates)

0% 5% 10% 15% 20% 25% 30% 35%

Source: Jefferies estimates, IGR

International Subsidiaries and Associates

Interconnector UK o Snam acquired stake in 2012 in Interconnector UK, Interconnector Zeebrugge and Huberator. o It is a strategic asset because it ensures supply security in North-Western Europe. o It links one of the biggest gas market of the UK to the continental network (as shown in the exhibit 14 below). o Two-way flow adds to its advantage due to flexibility and diversification of sources between the UK and continental Europe.

TIGF o Snam acquired stake in TGIF in 2013 with an equity investment of 40.5%. o TGIF transports and stores natural gas in southwest France (as shown in the exhibit 16 below). o It is considered to be a strategic infrastructure given the increasing integration energy infrastructure at the European level. o It connects French and Spanish markets with those of central and northern Europe.

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Snam Tax Free Spin-Off 08/08/2016

TAG (Trans Asutria Gasleitung) o It is the company that owns the gas pipeline linking the Slovakian/Austrian border with an entry point in Italy (as shown in the exhibit 16 below). o It plays an important role for the integration of east-west gas corridor. o There could be an opportunity to create reverse flow capacity to southern Germany and eastern Europe.

TAP (Trans Adriactic Pipeline) o It imports Azerbaijani gas which results in diversification of supplies in the EU. o As a consequence of TAP, Italy could be transformed into a gas hub. o It consists of a portfolio of related initiatives along the southern corridor.

Exhibit 16: Snam’s International Subsidiaries and Associates

Source: Company

European Gas: Trends ■ Disruption of gas supply from Russia to Ukraine in 2014 motivated discussions on creating an energy union to counter and Future Strategy such a threat. ■ European Commission gave high importance to gas supplies because: o One quarter of the EU energy mix is represented by gas. o One third of this gas is imported from Russia. o As opposed to oil and coal, gas transportation needs infrastructure to be in place. ■ A large chunk of European gas imports come from non-European countries of Norway, Russia, Algeria and Qatar. ■ This depicts that EU is dependent on few external suppliers which could cut their supplies due to geopolitical or technical reasons. ■ For instance, Norway could cut off supplies due to depleting resources or Algeria might cut its supplies due to political turbulence in the region. ■ Major gas producing EU countries of the Netherlands and the UK are seeing declining gas production due to restrictions imposed on production (because of frequent earthquakes resulting from extraction activities) and depletion of resources, respectively. ■ Hence, EU import requirements will surge in all possible scenarios and there is a dire need to work on new gas supply routes such as Nord Stream II (to tap into Russian gas supply), South Stream (abandoned, a project to transport natural gas from Russia through the Black Sea to Bulgaria) and Turk Stream (Gas pipeline from Russia to Turkey through the Black Sea). ■ As some member states import most of their gas solely from a single supplier there is a need for the development of proper interconnections between EU member states to ensure security of gas supply at member state level.

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Snam Tax Free Spin-Off 08/08/2016

2016-2020 Strategy & Italgas Targets ■ Net financial debt at the end of 2016, can be estimated as approximately Euro 3.7 billion. ■ Expected debt structure after the demerger is shown below in the exhibit 17. ■ This will enable Italgas to optimize the debt structure in the current market scenario, securing a very attractive cost of debt. ■ During the period 2016-2020, ITG Holding plans to make technical investments of approximately Euro 2 billion. ■ Currently, there are more than 200 distribution companies operating in the Italian market. However, at the end of tendering process strong consolidation is expected. ■ This will provide efficiency advantages and economies of scale for larger players. ■ According to Italgas strategic plan current market share of approximately 30% can be increased to approximately 40% at the end of local tendering process. ■ Italgas is the market leader in terms of redelivery points (the point of demarcation between the distribution plant and the plant of the end user, where the distribution company redelivers the natural gas for supply to the end user) as shown in the below exhibit 18. Out of 177 concession areas which will be auctioned it is present in 113. ■ Hence, it will be able to leverage this status to gain market share through the tendering process.

Exhibit 17: Expected Debt Structure of Italgas

Source: Company

Exhibit 18: Italgas Redelivery Points Share

Source: Company

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Snam Tax Free Spin-Off 08/08/2016

Snam ■ Gas demand and production in Europe and Turkey is shown below in the exhibit 19. Gas demand is increasing and production is flat. ■ Hence, Infrastructure operators will be playing a pivotal role in ensuring stability, security of supply and diversification given increasing dependence on imports. ■ Europe is tending towards a single energy market which would result in potential infrastructure requirements of over Euro 70 billion. ■ Italy’s location and Snam’s connection with the 4 main European gas hubs (UK Interconnector, TAP, TIGF and TAG) helps Snam to be an excellent fit with gas corridors and new supply sources and routes. ■ Hence, it can play a pivotal role in integration of European energy market transforming Italy in gas hub. ■ In the 2016-2020 period, post-demerger it plans investments for a total of Euro 4.3 billion. ■ Domestic investment projects in Italy: Interconnection with TAP, Transportation capacity at new southern entry points, projects in North West of Italy and Completion of the new Bordolano storage field. ■ There could be investments in projects to support European market integration. ■ Snam will see Increasing net profit contribution from international subsidiaries, TAP is expected to enter into operation in 2020. ■ It is also eyeing on other acquisitions such as DESFA in Greece and Gas Connect Austria (owned by OMV). ■ It will carry out fixed rate bond roll over as the current bonds will be expiring. It would result in lower financing cost based on current Snam yield curve (as shown below in the exhibit 20). ■ Growing dividend: FY2016: €21 cents & FY2017-FY2018: +2.5% yearly

Exhibit 19: Gas Demand in EU & Turkey

Source: Company

Exhibit 20: Fixed Rate Bond Roll-Over

Source: Company

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Snam Tax Free Spin-Off 08/08/2016

Financial Analysis Revenue Growth and EBIT Margins ■ As shown in the below exhibit 21, gas storage business is the fastest growing in terms of revenue. In addition, it also has the highest EBIT margin. ■ Italgas is also growing at a reasonable pace. Moreover, growth would be further supported by winning auctions. ■ Its EBIT margin is lower than the transportation and storage businesses. ■ Margins are driven by WACC and operating costs which are specified by the Italian regulatory authority. ■ WACC is derived using several factors including gearing of individual businesses and risk free rate. ■ Margins are trending downward due to decline in WACC as a result of falling yields on the Italian treasuries. ■ LNG Regasification business has a negligible chunk of share in the total revenue of Snam. ■ Snam’s businesses enjoy healthy margins which ensures stability of returns. ■ Although, margins are falling we still believe the company is in a strong financial position. ■ We don’t see any further decline in margins as treasury yields are already very low. ■ Hence, we expect margins to stay flat or trend upward in the future.

Exhibit 21: Revenue Growth and EBIT Margins Revenue & EBIT 2013 2014 2015 CAGR (Revenue) Italgas Revenue 1,038 1,053 1,098 2.85% EBIT 505 477 469 Gas Transportation Revenue 2,075 2,087 2,145 1.67% EBIT 1,217 1,196 1,165 LNG Regasification Revenue 31 28 25 -10.20% EBIT 5 - 1 Gas Storage Revenue 489 541 535 4.60% EBIT 315 318 319

EBIT Margins 2013 2014 2015 Italgas 48.65% 45.30% 42.71% Gas Transportation 58.65% 57.31% 54.31% LNG Regasification 16.13% 0.00% 4.00% Gas Storage 64.42% 58.78% 59.63%

Management Snam Group

Marco Alvera o He has been the Chief Executive Officer at Snam since April 27, 2016. o Prior to this he was Chief Operating Officer from January to April 2016.

Carlo Malacarne o He has been appointed Chairman of the Board of Directors of Snam on April 27, 2016. o He was Chief Executive Officer of Snam from 2006 to 2016.

Antonio Paccioretti o He returned to Snam from ENI in 2007 as Group CFO. o He is a graduate in Business and Economics at the Bocconi University in Milan, he began his career at Snam in 1989.

Snam Rete Gas

Paolo Mosa o He is Chief Executive Officer of Snam Rete Gas since April 2014. o He is a graduate in Mechanical Engineering from the Polytechnic of Milan in 1985 and began his career in the Snam Group in 1987.

Marco Alvera o He is Chairman of Snam Rete Gas.

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Snam Tax Free Spin-Off 08/08/2016

Italgas

Luca Schieppati o He is Chief Executive Officer of Italgas and is a nuclear engineer. o The Board of Directors of Italgas appointed Luca Schieppati as CEO on 11 April, 2014. o Prior to this he was general Operations Manager of Snam Rete Gas, since January 2012. o For the separately listed ITG holding, Board of Directors designated Paolo Gallo as Chief Executive Officer candidate.

Marco Reggiani o He is a lawyer by profession, graduated in Law at the University of Parma o Since April 2012 he serves as Chairman of Italgas.

GNL Italia

Marco Galletti o In July 2011 he was appointed Chief Executive Officer of GNL Italia. o Subsequently, in April 2012 he was appointed Chairman GNL Italia. o He is a graduate of Electrical Engineering from the Polytechnic of Milan, he began his career in Snam in 1981 in the technical area of plants and power stations.

Stogit

Paolo Luigi Bacchetta o He became Chief Executive Officer of Stogit in April 2010. o He is a graduate of Hydraulic Engineering from the University of Pavia. o He began his career at Snam in May 1985 in the technical service of gas transportation, handling permits for the construction of pipelines.

Italgas (post demerger)

Paolo Gallo o As mentioned above he will be the CEO of Italgas after the demerger. o He has a vast experience spanning several industries. o In 1990, he completed his MBA. In addition, he has an aeronautical engineering degree from polytechnic of Turin.

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Snam Tax Free Spin-Off 08/08/2016

Part 3: Valuation

SOTP PEER VALUATION (WITH GROWTH)

■ Based on our SOTP peer valuation of Snam we estimated that the current share price of Snam is lower than the fair value. ■ Based on EV/EBITDA of peers of Italgas (ex-Snam) given below, we assigned 9.5x EV/EBITDA to Italgas as it has a high potential to grow its market share from current 33% to 36%. ■ In addition, Italgas is the market leader in gas transmission in Italy. Its biggest competitor has a market share of around 15% which is far below 33% of Italgas. Hence, we assign EV/EBITDA of 9.5x. ■ EV/EBITDA of peers of Snam hovers around 7x, however given the market position of Snam in Italy and its strategic importance we assigned EV/EBITDA of 9.5x. ■ Altogether, we see 13.1% upside on the basis of our SOTP peer valuation. Fair value is €5.80/share and current market price is €5.13/share (see below tables for detailed information).

EUR (In Billions) Italgas (ex-Snam) 2015A 2016E 2017E 2018E 2019E 2020E Revenue 1.10 1.12 1.14 1.17 1.19 1.20 EBITDA 0.76 0.78 0.79 0.81 0.82 Margin 0.68 0.68 0.68 0.68 0.68

WACC 3.39% EBITDA (2016) 0.71 EBITDA Multiple (x) 9.5 EV 6.78 Net Debt 3.90 Outstanding Shares 0.81 Eq. Value 2.88 FV/share 3.57

EUR (In Billions) SNAM (ex-Italgas) 2015A 2016E 2017E 2018E 2019E 2020E Revenue 2.70 2.71 2.73 2.74 2.75 2.77 EBITDA 1.98 1.99 2.00 2.04 2.08 Margin 0.73 0.73 0.73 0.74 0.75

WACC 2.27% EBITDA (2016) 1.90 EBITDA Multiple (x) 9.5 EV 18.03 Net Debt 10.20 Outstanding Shares 3.50 Eq. Value 7.83 FV/share 2.24

Fair Value (Snam + Italgas) 5.80 Current share price 5.13 Upside/downside 13.1% Source: IG Research, Bloomberg

Assumptions: ■ Italgas market share increase from 33% to 36%, based on this we estimated future sales. However, according to the company the market share should grow to 40%. ■ FY1 Net Debt of €3.9 Bn for Italgas as given by the company and Net Debt of €10.2 Bn for Snam as per estimates of analysts. ■ We calculated WACC using cost of debt of 2.50% considering the information given by the company on debt and tax rate of 30%. ■ We estimated cost of equity assuming adjusted beta of 0.6, risk free rate of 1.30% (based on 10-year Italian Government Bond yield) and market risk premium of 5.50%. ■ Italgas (ex-Snam) WACC: 3.39% ■ Snam (ex-Italgas) WACC: 2.27% ■ We assumed that both companies will be independent.

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Peers (Snam) Company Ticker FY1 EV/EBITDA EBITDA CAGR (E16-E19) Snam SRG IM 11.96x 2.28% Terna TRN IM 6.94x 2.17% National Grid NG/ LN 7.31x 1.71% Enagas ENG SM 6.33x -2.33% Red Electrica de Spana REE SM 7.52x 2.94% Source: Bloomberg, IG Research

Peers (Italgas) Company Ticker FY1 EV/EBITDA EBITDA CAGR (E16-E19) Snam SRG IM 11.96x 2.28% A2A A2A IM 6.94x 3.32% HERA HER IM 7.31x 2.29% IREN IRE IM 6.33x 2.05% Gas Natural GAS SM 7.52x 2.31% Source: Bloomberg, IG Research

Sensitivity table of SOTP peer valuation: Italgas ex-Snam FV/Share (WACC & EBITDA) WACC 3.57 3.00% 3.20% 3.39% 3.70% 4.00% 8 2.35 2.29 2.24 2.16 2.08 9 3.24 3.18 3.12 3.03 2.94 9.5 3.69 3.63 3.57 3.47 3.37 11 5.04 4.96 4.89 4.77 4.66

EBITDA(x) 12 5.93 5.85 5.77 5.65 5.53 Source: Bloomberg, IG Research

Sensitivity table of SOTP peer valuation: Snam ex-Italgas FV/Share (WACC & EBITDA) WACC 2.24 1.67% 2.00% 2.27% 2.60% 3.00% 7 0.97 0.92 0.88 0.83 0.78 8 1.53 1.47 1.42 1.37 1.30 9.5 2.36 2.29 2.24 2.17 2.09 10 2.64 2.57 2.51 2.44 2.36

EBITDA(x) 11 3.19 3.11 3.05 2.97 2.88 Source: Bloomberg, IG Research

SOTP DIVIDEND DISCOUNT MODEL

■ We estimated based on our SOTP DDM of Snam that the current share price of Snam is lower than the fair value as is the case with the peer valuation. ■ Based on €0.25/share dividend in the past two years we assigned €0.21/share to Snam (ex-Italgas) according to the company and €0.04/share to Italgas (ex- Snam). ■ Altogether, according to DDM we see 11.7% upside potential. Fair value is €5.73/share and current market price is €5.13/share (see below tables for detailed information).

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Snam Tax Free Spin-Off 08/08/2016

Italgas (ex-Snam) 2015A 2016E 2017E 2018E DPS 0.04 0.044 0.048 Discounted DPS 0.04 0.04 0.04 Discounted Perpetual Dividend 2.55 LT DPS Growth 3.20% Cost of Equity 4.90% Sum of Discounted DPS 2.67

Outstanding Shares 0.81 FV/share 3.29

SNAM (ex-Italgas) 2015A 2016E 2017E 2018E DPS 0.21 0.22 0.23 Discounted DPS 0.20 0.20 0.20 Discounted Perpetual Dividend 7.94 LT DPS Growth 2.00% Cost of Equity 4.60% Sum of Discounted DPS 8.54

Outstanding Shares 3.50 FV/share 2.44

Fair Value 5.73 Current share price 5.13 Upside/downside 11.7% Source: IG Research, Bloomberg

Assumptions: ■ We assumed that long term DPS growth will be 3.20% for Italgas as expectations of increasing market shares through tendering process will be realized. ■ In case of Snam we assumed long term DPS growth will be 2%. ■ We assumed cost of equity of 4.90% for Italgas and 4.60% for Snam as Italgas has Net Debt/RAB of 0.59 as compared to 0.49 of Snam. ■ We assumed that both companies will be independent.

Sensitivity table of SOTP DDM: Italgas ex-Snam FV/Share (Cost of Equity & LT DPS Growth) Cost of Equity 3.29 4.60% 4.70% 4.90% 5.30% 5.60% 3.00% 3.51 3.30 2.95 2.44 2.16 3.10% 3.74 3.50 3.11 2.55 2.24 3.20% 4.00 3.73 3.29 2.66 2.33 3.30% 4.30 3.99 3.49 2.79 2.43

DPS Growth 3.40% 4.65 4.29 3.72 2.93 2.53 Source: IG Research, Bloomberg

Sensitivity table of SOTP DDM: Snam ex-Italgas FV/Share (Cost of Equity & LT DPS Growth) Cost of Equity 2.44 4.40% 4.50% 4.60% 4.70% 4.80% 1.00% 1.90 1.85 1.79 1.75 1.70 1.50% 2.21 2.13 2.07 2.00 1.94 2.00% 2.64 2.54 2.44 2.35 2.27 2.50% 3.31 3.14 2.99 2.86 2.73

DPS Growth 3.00% 4.45 4.15 3.89 3.66 3.46 Source: IG Research, Bloomberg

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Snam Tax Free Spin-Off 08/08/2016

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