26 February 2015 Europe/United Kingdom Equity Research Integrated Telecommunication Services BT Group (BT.L) Rating OUTPERFORM* Price (24 Feb 15, p) 447.00 INCREASE TARGET PRICE FOCUS LIST STOCK Target price (p) (from 440.00) 495.00¹ Market cap. (£ m) 37,410.40 Enterprise value (£ m) 42,914.0 Raise price target to 495p on EE deal *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ■ We reiterate our Outperform rating on Credit Suisse Europe Focus List ¹Target price is for 12 months. stock BT Group and raise our price target to 495p. We believe the upside from Research Analysts the EE deal and lower than previously forecast TV content costs more than offset Paul Sidney the negative impact of (1) Virgin Media's (VMED) 4m footprint expansion and (2) 44 20 7888 6015 uncertainty over a possible Labour government in the upcoming election driving [email protected] lower forecast fixed price rises. Post EE acquisition, at our 495p price target, BT would trade on 8x adjusted Mar-17E EV/EBITDA with EBITDA growth of ~4% pa. ■ BT fixed line forecasts cut 3-4% to reflect VMED footprint expansion and lower fixed price increases. We assume 30% VMED take-up 3 years after build with an additional 1.2m VMED customers in these new areas by 2023. We assume half of these customers taken from BT Retail and half from unbundlers (reducing Openreach LLU lines). Uncertainty over Labour telecoms policy drives much lower line rental increases. These are partially offset by lower Sports content costs (30% inflation now vs. 50% previously). ■ Everything Everywhere deal to boost FCF/share 8%. Despite cuts to UK wireline forecasts we see substantial share price upside from the announced £12.5bn EE deal with high probability of the deal completing. We calculate the deal is 8% FCF/share accretive in year 3 post-deal completion and boosts BT's EBITDA growth over the period Mar-16-21E to 4% per year. ■ Fibre to continue to boost BT revenue/line. We continue to see strong UK demand for high-speed broadband/fibre. This mix effect drives continued BT Retail rev/line (RPL) growth of ~4% p.a. over the next few years. We forecast BT to achieve 5m fibre retail subs by end December 2017. ■ Catalysts: BT will report FYMar15 results in early May. ■ Valuation: BT trades on 7.4x Mar-17E adjusted EV/EBITDA including EE. Share price performance Financial and valuation metrics Year 03/14A 03/15E 03/16E 03/17E Revenue (£ m) 18,288.3 17,888.5 18,044.7 18,108.0 412 EBITDA (£ m) 6,115.55 6,225.56 6,266.87 6,374.33 362 Pre-tax Profit Adjusted (£ m) 2,304.72 2,666.08 3,026.90 3,233.78 312 CS adj. EPS (p) 28.11 31.19 31.71 33.60 262 Mar-13 Jul-13 Nov-13 Mar-14 Jul-14 Nov-14 Prev. EPS (p) — 31.48 32.53 35.32 Price Price relative ROIC (%) 37.21 44.04 39.66 37.30 P/E (adj., x) 15.90 14.33 14.09 13.30 The price relative chart measures performance against the P/E rel. (%) 108.9 91.5 101.9 107.8 FTSE ALL SHARE INDEX which closed at 3742.58 on EV/EBITDA 7.3 6.9 6.7 6.4 24/02/15 On 24/02/15 the spot exchange rate was £.73/Eu 1. - Dividend (03/15E, p) 12.43 IC (03/15E, £ m) 6,434.00 Eu .88/US$1 Dividend yield (%) 2.8 EV/IC 6.7 Performance Over 1M 3M 12M Net debt (03/15E, £ m) 5,503.6 Current WACC 8.79 Absolute (%) 4.9 10.3 7.7 Net debt/equity (03/15E, %) 591.6 Free float (%) 99.94 BV/share (03/15E, £) 0.11 Number of shares (m) 8,369.22 Relative (%) 3.0 6.2 5.7 Source: FTI, Company data, Thomson Reuters, Credit Suisse Securities (EUROPE) LTD. Estimates. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access 26 February 2015 Table of contents Updating forecasts for recent events 4 Cutting BT wireline forecasts 3-4% 7 Virgin Media to pass 4m new UK premises 7 Labour Party policy presents an uncertainty 10 UK demand for high-speed broadband to remain strong 12 Recent English Premier League (EPL) auction cost below expectations 14 Conclusion—Cut UK wireline forecasts 3-4% 15 EE deal to boost FCF/share 7% 16 Our base case synergy assumptions could prove conservative 17 Combined BT/EE has 4% EBITDA growth on our scenario 19 Raise price target to 495p 19 Actuarial pension deficit £7bn 21 EC requests Ofcom re-designs "margin squeeze test" 22 Appendix 1—BT Group financials 23 BT Group (BT.L) 2 26 February 2015 BT Group BT.L Price (24 Feb 15): 447.00p, Rating: OUTPERFORM, Target Price: (from 440.00) 495.00p Income statement (£ m) 03/14A 03/15E 03/16E 03/17E Per share data 03/14A 03/15E 03/16E 03/17E Revenue (£ m) 18,288 17,888 18,045 18,108 No. of shares (wtd avg) 7,857 8,107 8,367 8,390 EBITDA 6,116 6,226 6,267 6,374 CS adj. EPS (p) 28.11 30.93 31.71 33.60 Depr. & amort. (2,696) (2,541) (2,450) (2,430) Prev. EPS (p) — 31.48 32.53 35.32 EBIT (£) 3,420 3,685 3,817 3,944 Dividend (p) 10.90 12.43 14.29 16.08 Net interest exp. (597) (549) (500) (421) Div yield 2.44 2.78 3.20 3.60 Associates (3) — — — Dividend payout ratio 38.78 40.17 45.06 47.85 Other adj, (515) (490) (290) (290) Free cash flow per share 34.39 36.81 35.33 36.83 PBT (£) 2,305 2,645 3,027 3,234 (p) Income taxes (292) (529) (605) (647) Key ratios and 03/14A 03/15E 03/16E 03/17E Profit after tax 2,012 2,116 2,422 2,587 valuation Minorities — — — — Growth (%) Preferred dividends — — — — Sales 0.1 (2.2) 0.9 0.4 Associates & other 196 392 232 232 EBIT 2.3 7.7 3.6 3.3 Net profit 2,208 2,508 2,654 2,819 Net profit 5.6 13.6 5.8 6.2 Other NPAT adjustments (196) (392) (232) (232) EPS (0.1) 5.0 (1.1) 4.6 Reported net income 2,012 2,116 2,422 2,587 Margins (%) EBITDA margin 33.4 34.8 34.7 35.2 Cash flow (£) 03/14A 03/15E 03/16E 03/17E EBIT margin 18.7 20.6 21.2 21.8 EBIT 3,420 3,685 3,817 3,944 Pretax margin 12.6 14.8 16.8 17.9 Net interest (597) (549) (500) (421) Net margin 12.1 14.0 14.7 15.6 Cash taxes paid (423) (426) (612) (662) Valuation metrics (x) Change in working capital (380) (250) (130) — EV/sales 2.4 2.4 2.3 2.3 Other cash & non-cash items 3,029 2,871 2,729 2,571 EV/EBITDA 7.3 6.9 6.7 6.4 Cash flow from operations 5,048 5,330 5,303 5,433 EV/EBIT 13.1 11.6 11.1 10.4 CAPEX (2,346) (2,345) (2,347) (2,343) P/E 15.9 14.5 14.1 13.3 Free cashflow adj. — — — — P/B (56.8) 40.1 14.0 8.1 Free cash flow to the firm 2,702 2,985 2,956 3,090 Asset turnover 0.73 0.73 0.70 0.68 Acquisitions — — — — ROE analysis (%) Divestments — — — — ROE stated-return on (444.3) 1,477.8 135.2 70.7 Other investment/(outflows) (330) (423) (443) (232) equityROIC 37.2 43.7 39.7 37.3 Cash flow from investments (2,676) (2,768) (2,790) (2,575) Interest burden 0.67 0.72 0.79 0.82 Net share issue/(repurchase) (50) 1,062 35 — Tax rate 12.7 20.0 20.0 20.0 Dividends paid (790) (917) (1,094) (1,251) Financial leverage (15.9) 8.8 2.7 1.3 Issuance (retirement) of debt — — — — Credit ratios (%) Other (247) (15) 139 (147) Net debt/equity (1,240.7) 591.6 177.9 77.2 Cash flow from financing (1,087) 130 (920) (1,399) Net debt/EBITDA 1.2 0.9 0.8 0.6 activitiesEffect of exchange rates (325) (850) (900) (250) Interest coverage ratio 5.7 6.7 7.6 9.4 Changes in Net Cash/Debt 960 1,841 693 1,209 . Net debt at start 8,305 7,345 5,504 4,810 Source: FTI, Company data, Thomson Reuters, Credit Suisse Securities Change in net debt (960) (1,841) (693) (1,209) (EUROPE) LTD. Estimates. Net debt at end 7,345 5,504 4,810 3,602 Balance sheet (£ m) 03/14A 03/15E 03/16E 03/17E Assets Cash and cash equivalents 695 695 695 695 Accounts receivable 2,933 2,962 2,992 3,022 412 Inventory 190 190 190 190 362 Other current assets 1,888 1,888 1,888 1,888 Total current assets 5,706 5,735 5,765 5,795 312 Total fixed assets 13,840 13,645 13,542 13,455 262 Intangible assets and goodwill 3,087 3,087 3,087 3,087 Mar-13 Jul-13 Nov-13 Mar-14 Jul-14 Nov-14 Investment securities 34 34 34 34 Other assets 2,231 2,158 3,412 4,263 Price Price relative Total assets 24,898 24,659 25,840 26,634 Liabilities The price relative chart measures performance against the FTSE ALL SHARE Accounts payable 5,261 5,261 5,261 5,261 INDEX which closed at 3724.11 on 23/02/15 Short-term debt 1,873 1,873 1,873 1,873 On 23/02/15 the spot exchange rate was £.73/Eu 1.