European Investment Perspectives (PDF) by manurich75017

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									                                                                                             MORGAN STANLEY RESEARCH
                                                                                             Morgan Stanley & Co. International plc

          December 8, 2010

                                                                                              UK equities – 2011 rocky but ultimately
America                                                                                        rewarding: Reasonable growth, reasonable

          INVESTMENT                                                                           value are key watchwords
                                                                                              ## Consumer Discretionary for equities in
                                                                                               2011. Graham Secker sets a year-end
                                                                                              ## Consumer Staples
                                                                                               FTSE100 target of 6400 (12% upside) (P4).
                                                                                               ## Energy/Utilities
          PERSPECTIVES                                                                        ## Financials top pick: Winners in 2011 will
                                                                                                Big Oil – BP
                                                                                                accelerate restructuring and emphasise
                                                                                               ## Healthcare
                                                                                                exploration and medium-term growth, says
                                                                                               ## Industrial/Business Services
                                                                                                the team. They prefer UK majors (P30).
                                                                                               ## Materials
                                                                                              Unilever – a new model: Michael Steib
                                                                                              ## Media
                                                                                               double-upgrades to OW, encouraged by the
                                                                                              ## Property of a new ‘Unilever model’. He
                                                                                              ## Retail the derating overdone and the risk-
                                                                                               reward the most attractive in 3 years. (P48).
                                                                                              ## Technology
                                                                                              ## Telecommunications published our 2011
                                                                                                2011: Big Debates. We
                                                                                                cross-sector outlook report on December 8.
                                                                                               ## Transportation

          Strategy and Economics                                                              18    Global Interest Rate Strategy
                                                                                                    Outlook 2011: Bonds to Adjust for Rising Growth
                                                                                                    and Inflation Risks
            4   UK Strategy                                                                         Jim Caron
                2011 Outlook: A Rocky, But Ultimately                                         20    China Strategy
                Rewarding, Ride                                                                     2011 Outlook: A Year of Re-rating
                Graham Secker                                                                       Jerry Lou, Allen Gui, James Cao, Corey Ng
            8   UK Economics                                                                  22    Hong Kong Strategy
                2011: Pace of Recovery to Slow                                                      2011 Outlook: Extending the Asset Price Cycle to
                Melanie Baker, Cath Sleeman                                                         Equities
          12    UK Interest Rate Strategy                                                           Jerry Lou, Corey Ng, James Cao
                UK Rates: 2011: A Year of Two Halves                                          24    Taiwan Strategy
                Anthony O'Brien                                                                     2020 Vision – Taiwan Super-Cycle
          Global                                                                                    Frank Wang, Angel Lin, Philip Yang
          14    Global Equity Strategy                                                        Industry Analysis
                $7,000 Question
                                                                                              26    Airlines
                Gerard Minack
                                                                                                    Charting the Skies; Resuming Coverage of BA
          16    US Economics                                                                        (OW), Lowering LHA to EW
                Tax Deal Could Boost Growth to 4%+ Next Year                                        Suzanne Todd, Penelope Butcher, Menno Sanderse
                Richard Berner, David Greenlaw

          Morgan Stanley does and seeks to do business with companies covered in its research reports. As a result, investors
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          consider this report as only a single factor in making their investment decision. Customers of Morgan Stanley in the U.S.
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          For analyst certification and other important disclosures, refer to the Disclosures Section.
          + = Analysts employed by non-U.S. affiliates are not registered pursuant to NASD/NYSE rules.
                                                                       MORGAN STANLEY RESEARCH

                                                                       December 8, 2010
                                                                       Investment Perspectives — Europe

Table of Contents (continued)
Industry Analysis (cont’d)                                              Portfolio and Valuations
 30    Oil & Gas                                                        50    Industry Valuations
       2011: The Big Oil Scorecard                                            Economic Forecasts
       Theepan Jothilingam, James Hubbard, Matthew Lofting,
       Sasikanth Chilukuru, Albina Sadykova                             51    European Model Portfolio

 34    Telecom Services                                                 52    Events Diary
       Stocks for 2011
       Nick Delfas, Luis Prota, Frederic Boulan, Terence Tsui,
       Ryan Fox
 38    Utilities
       Staying Cautious into 2011
       Emmanuel Turpin, Bobby Chada, Antonella Bianchessi,
       Nicholas Ashworth, Sean Lee, Igor Kuzmin
Company Analysis
 42    Henkel
       Valuation Catching up, Take Profits, Moving to EW
       Mark Christensen, Michael Steib, Erik Sjogren
 44    National Grid
       US Disappointment to Outweigh UK Growth
       Bobby Chada, Nicholas Ashworth, Arsalan Obaidullah
 46    OTE (Hellenic Telecoms.)
       5 Reasons to Turn Positive on OTE: Upgrading
       to OW
       Luis Prota, Nick Delfas, Frederic Boulan, Terence Tsui,
       Ryan Fox
 48    Unilever NV
       The New “Unilever Model” – Double Upgrade to
       Michael Steib, Erik Sjogren, Audrey Borius,
       Mark Christensen

****** 2011 – The Big Debates ****** Morgan Stanley analysts look at the key debates that are likely to drive European
stocks in the year ahead – debates (both industry and company-specific) that are likely to be important; debates that may be
resolved or moved forward in 2011; and debates for which they have a view that differs sharply from the market’s.
To download the report, please click Europe – 2011: The Big Debates

Contributing Editors: Simon George (Editor-in-Chief), Rod Cant, Antonia Grey, Denise Lombardi
NM                                  Not meaningful               NSA                                 Not seasonally adjusted
NA                                  Not applicable               YTD                                 Year to date
N/AV                                Not available                YOY                                 Year on year
FCF                                 Free cash flow               A                                   Actual
FFO                                 Funds from operations        e                                   Morgan Stanley Research estimates
SA                                  Seasonally adjusted                                              unless otherwise indicated

All of Morgan Stanley’s published equity research is available on the Internet through Client Link on
If you wish to receive this service, please contact your institutional sales representative.

                                                                                                    MORGAN STANLEY RESEARCH

                                                                                                    December 8, 2010
                                                                                                    Investment Perspectives — Europe

  Best Ideas

  Morgan Stanley Best Ideas                                                                                                                   Overweight
  We have added British Airways, following Penny Butcher’s resumption of                                                                      ABB
  coverage (Overweight, PT 350p) – she believes the market will be positively                                                                 British Airways NEW
  surprised by the benefits of increased scale and leveraging the partnership with
  American Airlines; this will manifest itself in stronger yield growth, a thesis which is                                                    Danske Bank
  also supported by the team’s proprietary survey of corporate travel spending.                                                               Fiat
  Although not in her base-case forecasts, there is scope for further upside, should
  merger synergies replicate those of precedent deals. The call also resonates well with                                                      InterContinental Hotels
  our Strategy team’s preference for stocks exposed to rising bond yields, corporate                                                          Nokia
  spending and a stronger US economy.
  The Best Ideas List is a collection of stock ideas from European Research
  that look most promising based on differentiated analysis and views, long-term                                                              Underweight
  fundamentals and short-term potential catalysts. The list is not an investment
  portfolio. It has no mandated sector allocation, no minimum/maximum number of                                                               Drax
  stocks, no turnover constraint or minimum holding period, and no “style” bias.

  Differentiated research
  We seek out-of-consensus thinking that incorporates fresh data, analysis, and insight.
  Analysts are expected to consider what the market may be discounting and address
  market assumptions on key investment debates.

  Favourable risk-reward profiles
  Scenario analysis lies at the heart of our disciplined approach to research, so we look
  beyond single-point estimates and price targets. We examine the full risk-reward
  profile of the investment, assessing the range of plausible outcomes and the scenario
  skew as indicators of analyst conviction.

  Clear catalysts
  We require a clear roadmap for upcoming data and events in the following few
  months that can help corroborate our analysts’ medium-term projections.

                                                                                        EPS                            Net Debt          Interest                 Upside/
                                      P/E           Div Yield         FCF Yield       Growth          RNOA             /EBITDA            Cover                 Downside To          R/R
                                2010        2011   2010    2011     2010     2011     2010-12      2010     2011     2010     2011     2010    2011       PT       Bull       Bear   Skew


ABB                             18.3        14.7   0%      0%        6%       6%        18%       36%       35%      NM       NM       NM      NM         28%      66%      (17%)    +3.9

British Airways                 13.7        6.1    0%      0%       16%      13%        68%        8%       13%       1.7      1.0     3.8      5.5       30%     104%      (83%)    +1.2

Danske Bank                     18.7        8.7    1%      2%        NA       NA        87%        5%       11%       NA       NA      NA       NA        45%      55%      (25%)    +2.2

FIAT                            36.3        12.1   1%      1%        2%       NM       112%        8%       10%       2.4      2.2     2.2      2.9       16%      50%      (38%)    +1.3

InterContinental Hotels         19.9        18.4   2%      2%        4%       5%        12%       26%       31%       1.3      1.0     6.9      8.6       7%       38%      (43%)    +0.9

Nokia                           13.5        10.0   5%      6%        7%       9%        22%       21%       32%      NM       NM       NM      NM         27%      86%      (34%)    +2.5

ThyssenKrupp                    16.4        11.3   1%      3%       NM        NM        54%        6%       8%        4.2      3.4     NA       NA        0%       58%      (55%)    +1.1


Drax                            6.4         7.9    8%      6%       16%      13%       (16%)      28%       22%      NM       NM       NM      NM         2%       77%      (49%)    -0.6
Note: The 'skew' is an expression of Risk/Reward. We calculate by dividing the upside to Bull by the downside to Bear (for OW); vice versa for UW.
As of December 7, 2010 Prices: ABB SFr 20, BA 270p, Danske Bank DKr 148; Fiat €14, InterContinental Hotel 1,230, Nokia €8, ThyssenKrupp €32, Drax 372p,
NM = Not meaningful        NA = Not available     Source: Morgan Stanley Research estimates

                                                                     MORGAN STANLEY RESEARCH

                                                                     December 8, 2010
                                                                     Investment Perspectives — Europe

Strategy and Economics
December 8, 2010                                                     Analysts appear optimistic on margins …
                                                                     This brings us to the outlook for corporate margins.
UK Strategy                                                          Aggressive cost cutting during the financial crisis meant that
                                                                     corporate margins (ex financials anyway) troughed at
2011 Outlook: A Rocky, But                                           relatively benign levels when compared to the depth of the
Ultimately Rewarding, Ride
                                                                     Exhibit 1
Morgan Stanley & Co.     Graham Secker                               2/3rds of UK market revenues come from overseas
International Limited+
                                                                                                                                  UK        DM ex UK                EM
Is there enough growth to paper over the cracks?
The key question for 2011 is whether there is enough growth                                           50

                                                                       % of 2009 Revenues By Region
in the global economy to continue to paper over the cracks of
an imbalanced world; or whether disappointing growth
dynamics will exacerbate these differences and create
disorder in the global financial system. We are relatively
optimistic and look for around 4% global GDP growth to drive                                          20
double-digit EPS growth and similar upside for stocks.

Key equity drivers for 2011 are: growth, inflation, asset
allocation flows, sovereign debt issues and FX/politics                                                0
                                                                                                           UK Market           Mega Cap    Large Cap               Mid Cap         Small Cap
While there are plenty of moving parts that may have an
                                                                     Source: Morgan Stanley Research
impact on equities over the next year, we believe the key
topics that will ultimately drive market and sector performance      Exhibit 2
are: 1) economic and profit growth; 2) inflation trends; 3) shifts   Calculating top-line growth estimates from Morgan
in asset allocation; 4) sovereign debt issues; and                   Stanley’s economics forecasts
5) geopolitical pressures around FX and trade. By way of                                                                                       Contribution to revenue-weighted global real
                                                                                              UK company's                                      GDP growth (based on MS GDP forecasts)
summary, we assume: 1) the global economy produces                                             revenue split                                            2010            2011            2012
                                                                     UK                                 35%                                               0.6            0.6              0.7
reasonable growth of around 4% next year; 2) inflation               Europe ex UK                       21%                                               0.4            0.3              0.4
becomes a more important theme for those economies with              US                                 21%                                               0.6            0.6              0.7
                                                                     EM                                 22%                                               1.6             1.4             1.4
good growth and/or weak currencies; and 3) sovereign debt            Revenue-weighted global GDP - REAL                                                   3.1            2.8              3.1

fears escalate further in Europe and ultimately provoke more         Revenue-weighted global GDP - NOMINAL                                                   6.3             5.8                     5.9
aggressive policy action from the authorities, which, in turn,       Source: Morgan Stanley Research estimates

puts downward pressure on the euro.                                  Exhibit 3
                                                                     Sensitivity of 2011e UK earnings growth to different
UK profits are a play on global growth.                              revenue growth and margin assumptions
Although domestic economic growth is likely to be modest
                                                                                                                                          YoY Revenue Growth (%)
again next year (we forecast 1.6%), we regard UK earnings
                                                                                                                        0          2       4            6             8        10              12
as a play on global growth given that two-thirds of stock                                                  -200        -12.7      -10.9   -9.0         -7.2          -5.3     -3.5         -1.7
                                                                        YoY PTOP Margin Expansion

market revenues come from overseas. To account for this                                                    -100        -5.8       -3.8    -1.9         0.1           2.1       4.1             6.1
increasingly international exposure, Exhibit 2 shows a global                                               0          1.1         3.2    5.3          7.4           9.6      11.7         13.8
GDP growth figure based on our economists’ GDP forecasts                                                   100         8.0        10.2    12.5         14.8          17.0     19.3         21.5

and the geographical split of UK revenues. This implies 2011                                               150         11.4       13.8    16.1         18.4          20.7     23.1         25.4

top-line growth for the UK market of c.2.8% in real terms and                                              200         14.9       17.3    19.7         22.1          24.5     26.9         29.3

5.8% on a nominal basis.                                                                                   250         18.3       20.8    23.3         25.7          28.2     30.7         33.1
                                                                                                           300         21.8       24.3    26.9         29.4          31.9     34.5         37.0
                                                                     Note: The table assumes non-operating income (expense) and tax rate are in line with MS
                                                                     analyst expectations.
                                                                     Source: Morgan Stanley Research estimates

                                                                       MORGAN STANLEY RESEARCH

                                                                       December 8, 2010
                                                                       Investment Perspectives — Europe

Strategy and Economics
recession. Rising input costs suggest investors should be              Exhibit 4
cautious with regard to margin expansion expectations.                 The median stock is on a 12m forward P/E of 12.4 –
However, the large commodity bias of our market provides a             this is in line with the long-term average
strong offset to this. Based off ModelWare data, our analysts                                          28
expect margins to rise by around 200bps in 2011 – we want to                                           26
be more prudent than this in our top-down forecasts and                                                24
assume approximately half this expansion, which is closer to

                                                                         Median 12m Fwd PE - FTSE350
consensus forecasts. Based on our assumption of 6%                                                     20

nominal revenue growth and a margin improvement of                                                     18

100bps, we forecast 2011 UK EPS growth of 15%, as                                                      16

illustrated in Exhibit 3. From a dividend perspective we                                               14

believe DPS growth could reach 20% next year, although this                                            12

falls to around 8% if we were to exclude BP.                                                           10


In the context of a reasonable macro environment and decent                                            6
                                                                                                       Jan-87 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09
profit growth, we believe equity valuations are moderately
                                                                       Source: MSCI, Global Financial Data, Morgan Stanley Research
attractive, albeit not excessively cheap. We would
characterise our view on equity valuations as follows:                 Exhibit 5
                                                                       Equities look moderately expensive on a Shiller P/E
1. Equities are around fair value in absolute terms                    basis when we compare to long-term averages
We believe UK equities are close to fair value in absolute
terms, with FTSE350’s 12-month forward P/E of 10.4
(compared to our fair value range of 10-12) and the median
                                                                        40                                                         UK Real Shiller PE    US Real Shiller PE
stock’s 12-month forward P/E of 12.4 (versus its long-run
average of 12.4).

2. Equities look expensive on a Shiller basis                           25

It is hard to argue that UK equities are structurally cheap with        20

a current Shiller P/E of 14.8 that compares to an average               15

reading of 12.7 since the 1930s. While bearish investors and            10

commentators often use the Shiller P/E as a reason to avoid              5

stocks, our view is that such normalised or cyclically-adjusted          0

metrics tend to be ignored by the wider market when earnings             1937                               1942     1947   1952   1957   1962   1967   1972   1977   1982     1987   1992     1997    2002    2007

are trending up; however, they attain great relevance when             Note: Shiller P/E defined as inflation adjusted price to 10Y average EPS. Source: FTSE,
                                                                       MSCI, Various National Sources, Global Financial Data, Morgan Stanley Research
economies and profits are contracting.
                                                                       Exhibit 6
3. Equities are cheap relative to other assets                         Equities look very cheap versus government bonds
Although equities are not particularly cheap in absolute terms,         30
they do appear attractive relative to other asset classes and                                                                                                                     All-Share PE

especially bonds. Exhibit 6 illustrates that you have to go back        25

to the first half of the 20th century to find the last time equities
consistently traded at this valuation discount against                  20

government bonds. On consensus data, UK stocks offer a
2011 dividend yield of 3.7% today versus a gilt yield of 3.4%
– since 1920 the DY/BY ratio has averaged 0.72.
                                                                                                                                                                                               Gilt Yield


                                                                                                                                          All-Share Div Yld
                                                                         Dec 33                                    Dec 43      Dec 53       Dec 63       Dec 73       Dec 83          Dec 93          Dec 03

                                                                       Source: MSCI, Global Financial Data, Morgan Stanley Research

                                                                   MORGAN STANLEY RESEARCH

                                                                   December 8, 2010
                                                                   Investment Perspectives — Europe

Strategy and Economics
Bull market for global stocks is not over as nominal GDP           selectively invest in financials (predominantly diversified
growth > 10Yr bond yields in US and EM …                           financials and insurance) and stocks with good growth
When we consider the prospects for equities next year, we          prospects. Stocks with a high and secure dividend yield are
believe Exhibit 7 provides a compelling case to suggest that       likely to remain in demand, especially where there is decent
the bull market for global stocks is not over. In this chart we    dividend growth. On the assumption that sovereign fears
show how the S&P performs against differing levels of US           remain a regular backdrop to 2011, banks are likely to remain
nominal GDP growth and 10-year treasury yields. In short, the      under pressure and we would also avoid stocks with little
chart suggests that over the last 15 years investors should        growth, especially those in sectors such as Utilities and
buy equities when bond yields are below nominal GDP growth         Pharmaceuticals. Evidence of more significant monetary
rates and sell them when they are above.                           tightening in EM would likely put pressure on stocks with
                                                                   relatively high exposure to EM consumers.
We like this rule of thumb as it is both intuitive (stocks go up
when a country grows faster than its cost of capital – and vice    Exhibit 7
versa) and has given us successful buy and sell signals in the     Based on last 15 years, investors should buy
past. For example, investors who had followed this rule would      equities when bond yields are below nominal GDP
have sold equities in 2Q98 (and then bought them back in           growth and sell when they are above
4Q98), sold equities in 4Q00 (and bought back in 3Q03),
                                                                          8                                                                                    2000
started to sell some stocks in 1H07 and then really hit the sell                                                          US Nominal GDP YoY

button in 2Q08. This rule has also worked in Japan on the                 6

basis that JGB yields have been above nominal GDP growth                                                                                                       1600

rates almost continually since 1991.                                      4

                                                                                                                                                                      S&P 500 Price Index
                                                                                                                     10yr UST Yield                            1400

                                                                          2                                                                                    1200
… though this isn’t the case in Europe or Japan
For 2011, our economists expect US nominal GDP growth of                                                                                                       1000
around 4.5-5% next year and hence a comfortable cushion                                           S&P - rhs
above US 10-year treasury yields that are currently around                -2
3%. This rule of thumb, however, suggests a more
problematic outcome for Europe. At the aggregate level our                -4                                                                                   400
                                                                            1996     1999            2002              2005                 2008           2011
economists expect EMU nominal GDP growth of around 2.5%
                                                                   Source: BEA, Datastream, S&P, Morgan Stanley Research
for this year and next, compared to a current EMU bond yield
of 3.4%. While attention tends to focus on the top four            Exhibit 8
countries in Exhibit 8, we note that the only countries in         Across Europe, only Germany, Scandinavia and the
Europe where we expect nominal GDP growth to be above              UK offer nominal GDP growth >10-year yields
current 10-year government bonds for 2010 and 2011 are                                                                                      Differential: 10-yr yield
Germany, Scandinavia and the UK.                                              Nominal GDP Growth YoY (%)                10-yr Govt            minus GDP gr (%)
                                                                                2010e     2011e    2012e              Bond Yld (%)                  10e            11e
                                                                   Greece         -0.5      -2.9      0.9                     11.6                 12.0           14.5
BASE CASE = “reasonable growth, reasonable value”                  Ireland        -2.1      -1.8      1.5                      8.0                 10.1            9.8
                                                                   Spain           0.3       2.3      3.1                      4.7                  4.4            2.4
FTSE100 index target is 6400 = 12% potential upside.               Portugal        2.8      -0.3      1.3                      6.8                  4.0            7.1
For our base case we adopt Morgan Stanley’s economic               Italy           2.7       3.1      3.4                      4.2                  1.5            1.1
                                                                   EMU             2.4       2.6      3.5                      3.4                  1.1            0.8
forecasts, as detailed earlier. In short, reasonable global GDP    Austria         3.0       3.2      3.4                      3.1                  0.1           -0.1
growth should drive 15% profit growth in an asset class that       France          3.1       3.4      3.6                      3.1                  0.0           -0.3
                                                                   Netherland      3.1       2.7      3.3                      2.9                 -0.2            0.3
offers reasonable value, particularly against alternatives.        Belgium         4.0       3.2      3.5                      3.6                 -0.4            0.4
Despite a plethora of possible risk events, we assume              Finland         3.7       4.2      4.2                      2.9                 -0.8           -1.3
                                                                   Denmark         3.7       3.4      4.7                      2.8                 -0.9           -0.6
pragmatism wins out on the global stage with the authorities       UK              5.3       4.9      4.9                      3.5                 -1.8           -1.4
willing and able to suppress such matters for a bit longer. With   Germany         5.1       3.3      3.0                      2.7                 -2.4           -0.6
                                                                   Sweden          6.6       4.7      5.3                      2.9                 -3.7           -1.9
equity markets around fair value currently, in our opinion, we
look for stocks to move broadly in line with our expectations      China            15.9      15.3            12.3                    3.8          -12.1        -11.5
for 2011 EPS growth.                                               India            16.9      14.5            14.6                    8.0           -8.9         -6.5
                                                                   Korea             8.8       6.6             5.8                    4.5           -4.3         -2.1
                                                                   e = Morgan Stanley Research estimates
Under our base case scenario we recommend investors                Source: Datastream, Bloomberg, Morgan Stanley Research

maintain an overweight position in commodities and

                                                                                         MORGAN STANLEY RESEARCH

                                                                                         December 8, 2010
                                                                                         Investment Perspectives — Europe

Strategy and Economics
BULL CASE = “liquidity driven equity chase”                                              yield. Commodities, industrials and financials are likely to
FTSE100 index target is 7000 = 23% potential upside.                                     suffer the worst performance.
Under our bull case we look for the global economy to
surprise on the upside as the authorities leave fiscal policy                            We highlight six key investment trades for 2011.
unchanged while global real interest rates remain highly
accommodative/negative. Inflation pressures rise modestly in                                1) Rising inflation expectations: i) Equities to
EM and, although we get only a modest uptick in inflation in                                   outperform bonds; ii) Sectors with pricing power
DM, it is evident that deflation risks are receding fast. A                                    include Mining, Oil Services, Chemicals and Food
renewed focus on inflation creates a meaningful shift in asset                                 Retail; iii) Buy stocks with inflation-linked pricing such
allocation with investors keen to rotate out of nominal assets                                 as Regulated Utilities, Transport and Software.
and into real assets. Under our bull case scenario investors
should look to buy financials, commodities and stocks with                                  2) Higher bond yields would benefit commodity names,
high pension deficits (where a combination of rising equity                                    financials and stocks with high pension deficits.
prices and higher bond yields should quickly reduce funding
deficits). Defensive stocks and those with high and secure                                  3) Reliable growth: Macro uncertainty suggests
dividend yields are likely to underperform.                                                    investors will pay for security and growth yet valuation
                                                                                               dispersion is low and our reliable growth basket trades
BEAR CASE = “Double-dip and/or sovereign strife”                                               at a discount to the market.
FTSE100 index target is 3900 = 32% potential downside.
A bear case outcome for UK stocks would likely follow one,                                  4) Solid dividend stories: Our basket of ‘high and
two or even three not-mutually-exclusive scenarios. In the                                     secure yielding’ stocks offers a 5.3% dividend yield
first, we would look for the economic recovery to run out of                                   and a reliable 8% dividend growth.
steam (global GDP growth falls below 3-3.5%) due perhaps to
the removal of economic stimulus or the impact of higher input                              5) Too early for domestic cyclicals: Consumers are
prices depressing disposable income. Our second scenario                                       likely to remain under pressure in 2011 due to high
envisages a contagion of sovereign debt fears into core                                        inflation, weak wage growth, tax hikes and a falling
Europe, UK and even the US with a higher cost of capital                                       housing market. Falling inflation would make us more
weighing heavily on growth. Third, in an environment of weak                                   positive.
economic growth and ongoing de-leveraging pressures in DM,
we see an outbreak of trade frictions and/or currency wars                                  6) EM outperformance looks set to slow: We remain
that threaten the performance of the global economy. Under                                     OW EM exposed stocks, particularly commodity
our bear case scenario investors should look to buy defensive                                  names, due to superior growth prospects. However,
stocks with low economic sensitivity (pharmaceuticals,                                         the rate of their outperformance over DM is likely to
telecoms, etc) and stocks with a high and secure dividend                                      decline.

Exhibit 9
Stocks with large pension deficits could benefit if
both equities and bond yields rise in 2011
                                                         Surplus/Deficit   Liabilities
FTSE100 Stock                                Price (p)         as % MV      as % MV
British Airways                                  2.73              -74%         603%
BT Group                                         1.65              -73%         400%
BAE Systems                                      3.34              -45%         174%
GKN                                              1.93              -38%         121%
Invensys                                         3.25              -22%         226%
TUI Travel                                       2.11              -21%           66%
Aviva                                            3.78              -15%         106%
Whitbread                                       16.99              -15%           60%
Serco Group                                      5.53              -13%           58%
Royal Bank Of Scotland Group                     0.41              -11%         113%
Severn Trent                                    14.55              -11%           57%
Rexam                                            3.11              -10%         102%
Barclays                                         2.67              -10%           57%
National Grid                                    5.80               -8%         105%
Wolseley                                        17.40               -8%           22%
RSA Insurance Group                              1.23               -7%         115%
Smiths Group                                    11.52               -7%           65%
United Utilities Group                           6.10               -7%           56%
Lloyds Banking Group                             0.64               -7%           55%
Marks & Spencer Group                            3.75               -6%           86%
Source: Pension Capital Strategies, November 2010

                                                                        MORGAN STANLEY RESEARCH

                                                                        December 8, 2010
                                                                        Investment Perspectives — Europe

Strategy and Economics
December 7, 2010                                                        Exhibit 1
                                                                        Expecting a Weak Recovery in Consumer Spending
UK Economics                                                                          108.0 100 = quarter before start of recession
2011: Pace of Recovery to Slow                                                        106.0
                                                                                                                            Level of consumer spending in previous recessions
Morgan Stanley & Co.    Melanie Baker, CFA                                            102.0
International plc+
                        Cath Sleeman
The pace of growth seen in 2Q and 3Q this year looks                                               96.0
unsustainable to us; the boost from inventories and                                                94.0                                                                         Early-1980s
construction will fade and fiscal tightening in 2011/12 will                                       92.0                                                                         Current
                                                                                                                                                                                Our forecast to end-2011
subtract around 1pp from growth, in our view. We expect a                                          90.0
weak recovery in investment and in consumer spending. Most                                                                     0 1 2 3 4                  5    6      7   8     9   10 11 12 13 14 15
                                                                                                                              Number of quarters
of the growth we see in 2011 comes from net exports.
Although we remain optimistic on this, there are a few causes           Source: ONS, Morgan Stanley Research estimates

for concern in recent data.                                             ii) We expect the savings rate to stabilise: The household
                                                                        saving rate fell sharply in 2Q10, helping to prop up consumer
Our GDP growth forecast for next year (1.6%), after likely              spending despite a fall in real disposable income. We think
1.7% in 2010, remains below consensus (2.0%), the OBR                   that several factors will help to ensure that the household
(2.1%) and the BoE’s central case (around 2.6%). Regarding              savings rate doesn’t continue to decline. These include:
the BoE’s forecasts, however, their central inflation forecast,
beyond 2011, looks too low to us. We expect inflation                                                  Households, in aggregate, are still highly indebted.
expectations to rise next year and for that to help prompt a
rise in rates from the MPC in 2H11.                                                                    Credit availability is not buoyant.

                                                                                                       We expect house prices to decline in 2011 by around 7%
Our forecasts are conditional on the UK not seeing significant                                          (with upside risks following changes to our interest rate
contagion from euro area periphery debt market problems,                                                forecasts). Much of UK households’ ‘wealth’ comes from
either in the form of sharply higher UK bond yields, a                                                  housing. Lower levels of household wealth are associated
re-emergence of significant problems in UK banks or                                                     with higher savings rates (see Exhibit 2).
significantly worse-than-expected euro area GDP growth
(feeding into lower UK exports).                                        Exhibit 2
                                                                        Falling house prices to lower household assets
Consumer spending: Not a consumer-led recovery …
We look for a relatively weak recovery in consumer spending
                                                                            Household total assets as a % of disposable

(0.9% growth in 2011) for two main reasons: i) Likely weak                                                                  1000.0                            2Q 2010

growth in real disposable income; and ii) We expect the
household savings rate to rise somewhat from 3Q levels (we                                                                                                                Our estimate for 2011
expect a savings rate of 5.3% on average in 2011 from 3.2%                                                                   800.0
in 2Q10, but remaining below the mid-2009 peak of 7.7%):

i) Weak real disposable income growth: Our labour market                                                                     600.0        Total assets uses interpolated non-financial assets
analysis supports our view that consumer spending growth is                                                                               series and we assume non-financial assets move with
                                                                                                                                          house price inflation after 4Q 2009
unlikely to be a driver of recovery in the UK (see The UK Labour                                                              500.0
                                                                                                                          -2.0      0.0        2.0     4.0      6.0       8.0       10.0   12.0    14.0
Market: A Second Softening, Nov 25, 2010). We expect weak
                                                                                                                                                                   Saving as % disposable income
employment growth (public sector job losses, weak private sector
jobs generation), higher unemployment and only a gradual recovery       Source: ONS, Morgan Stanley Research; 2011 estimate (Morgan Stanley) leaves financial
                                                                        assets steady and grows non-financial assets in line with house price forecast.
in wage growth (inflation + profit recovery vs. higher unemployment).
Combined with inflation likely above target throughout 2011
(largely reflecting January 2011’s VAT rise), this should help
to ensure weak real disposable income growth.

                                                                                MORGAN STANLEY RESEARCH

                                                                                December 8, 2010
                                                                                Investment Perspectives — Europe

Strategy and Economics
Investment: Caps on growth in each main sector                                  of the degree of destocking we saw over the recession. The
Our forecast for overall fixed investment (-0.2%) is one of the                 rationale is somewhat similar to factors we see as likely to
key areas where we remain more downbeat than consensus                          hold back business investment, where inventories are costly
(3.6%). Government fixed investment is set to be cut sharply                    to maintain.
(we expect real growth of -16% in 2011). We expect only a
weak recovery in home-building (reflected in a weak recovery                    Net exports: Optimistic, but some cause for concern
in household fixed investment – we expect 1.4% growth in                        We are still waiting for the full benefits of the 2007/08 25%
2011), held back by the transition between planning regimes.                    sterling depreciation to come through in the net export figures.
We expect a continued recovery in business fixed investment,                    3Q10 saw the first positive contribution to GDP growth in
but expect that to be more gradual than stellar (4.7%).                         more than a year from net exports. We are hopeful that this
                                                                                won’t be the last and we forecast positive or neutral
Business investment was cut sharply over the recession, and                     contributions to GDP growth over the next four quarters. Over
we anticipate a continued recovery. However, in comparison                      the recession, companies, rather than use the sterling
to the scale of investment cuts during the recession, the                       depreciation to price more competitively in international
recovery in investment we look for is relatively modest                         markets, appear to have used it to support their profit
(Exhibit 3). Firm finances are in good shape (in aggregate)                     margins, helping to see them through the recession. In 2H10,
and non-financial companies appear to have large amounts of                     however, Bank of England agents noted more businesses
cash. However, there is still some spare capacity in the                        actively seeking new trade opportunities.
economy on most metrics and credit constraints are still
assessed by firms to be above average levels of the past 10                     Three things, however, stop us from getting too upbeat on the
years. If firms are not convinced that they can count on a                      prospects for a strong export-led recovery in the UK:
bank lending ‘safety net’, they may be reluctant to embark on
significant investment projects.                                                1. About half of UK exports go to the euro area (Exhibit 4),
                                                                                   where our euro area team’s forecast for 2011 GDP growth
Exhibit 3                                                                          is weaker than ours at 1.4%. The UK also exports a great
Business Investment: Modest recovery envisaged                                     deal to the troubled periphery of Europe.
   120.0    100 = quarter before start of recession
                                                                                2. To the extent that the recovery is to be export-led, that will
   115.0        Level of business investment in previous recessions                require investment by UK firms. The same factors that are
   110.0                                                                           likely to hold back business investment can therefore hold
   105.0                                                                           back an export-led recovery.
   100.0                                                                        3. We had been very encouraged by an apparent increase in
     95.0                                                                          UK exporter market share. Recently, however, we note
     90.0            Mid-1970s                                                     some deterioration in our export share indicator.
     85.0                                                                       Exhibit 4
     80.0            Current                                                    The UK’s top export destinations
                     Our forecasts to 4Q 2011
     75.0                                                                        Hong Kong                                 % share of UK exports (goods and services) exports
            0  1    2   3    4       5    6     7   8   9   10 11 12 13 14 15       Canada
            Number of quarters                                                    Singapore
Source: ONS, Morgan Stanley Research forecasts                                                                                                           Services
Inventories: Fading contribution                                                      Japan

Inventory de-stocking contributed around 1pp of the 5%                           Switzerland
decline we saw in UK real GDP in 2009. On national                                     Spain
                                                                                                                                                             Close to half of UK
accounts data, we have now seen restocking for two                              Belgium-Lux                                                                  exports go to the euro
                                                                                     Ireland                                                                 area
consecutive quarters and we have seen positive contributions                         France

to GDP growth from inventories in six of the last seven                          Netherlands
quarters. This growth contribution will naturally fade as                                US

companies restock to more ‘comfortable levels’. We expect a                                     0   2   4     6        8         10        12       14       16       18        20

weaker recovery in restocking than might be expected in light                   Source: ONS, Morgan Stanley Research

                                                                                         MORGAN STANLEY RESEARCH

                                                                                         December 8, 2010
                                                                                         Investment Perspectives — Europe

Strategy and Economics
Fiscal tightening: About 1pp off GDP growth                                              Exhibit 6
Fiscal tightening is the main reason why we expect UK GDP                                2011-12: main spending/tax changes and our
growth to slow in 2011. The deficit (as a percentage of GDP)                             estimated potential effect on GDP (using OBR
is likely to decline by more than 2pp in fiscal year 2011/12. In                         ‘short-run’ multipliers)
real terms, departmental budgets are set to be cut by 4% in                                                                            2011-12       % of                      -ve effect
fiscal year 2011-12. In an accounting sense – the contribution                                                                          (£ bn)*      GDP      Multiplier         on GDP
to GDP growth from changes in government spending on
                                                                                         Welfare spending                                   1.6        0.1            0.6              0.1
goods and services and in government investment – the OBR
                                                                                         Departmental expenditure
estimate is that reduced government spending will subtract
around 0.5pp from real GDP growth in 2011 (Exhibit 5). Our                                 resource DEL                                    -0.1        0.0            0.6              0.0

forecast for the GDP deflator is higher than the OBR’s, so we                              capital DEL                                      8.1        0.6               1             0.6
estimate a stronger effect (i.e., around 0.8pp).                                         VAT rise                                         12.1         0.9          0.35               0.3
                                                                                         Incr. in personal tax allowance                   -3.5       -0.3            0.3             -0.1
Exhibit 5
                                                                                         Total                                                                                         0.9
OBR estimate of direct effect of government                                              OBR multipliers from the June 22 Budget; * +ve implies deficit reduction measure.
                                                                                         Source: HM Treasury, OBR, Morgan Stanley Research estimates
consumption and investment cuts on GDP growth
 PP           OBR estimate of contribution of real government
              spending to real GDP growth                                                We expect CPI inflation in 2011 to remain significantly above
                                                                                         target (Exhibit 7). January 2011’s VAT rise (from 17.5% to
                                                                                         20%) should help to keep inflation above the BoE’s 2% target
                                                                                         throughout 2011. We then expect a sharp decline in early
                                                                                         2012 as the VAT rise drops out of the y-o-y comparison. But,
                                                                                         as a central case, we don’t have inflation moving below target
                                                                                         at that point (in contrast to the BoE’s ‘central’ forecast).
 -0.8       We estimate a contribution closer to -0.8pp, reflecting our
   -1       higher GDP deflator forecast                                                 The inflation outlook for 2012/13 is effectively what will matter
            2010        2011        2012         2013         2014        2015           for next year’s monetary policy decisions. There are four
Note: ‘Government spending’ includes government consumption and government investment.
                                                                                         reasons why inflation doesn’t move below target at that point
Source: OBR, Morgan Stanley Research.                                                    in our forecast:
But of course, some of this will result in an offsetting reduction
                                                                                         Less spare capacity in firms: We take seriously the
in imports (some of those government purchases will come
                                                                                         information from survey-based estimates of spare capacity,
from abroad, for example). And, it isn’t just spending on
                                                                                         which suggest that it is shrinking rapidly (Exhibit 8).
government goods and services that will change – there will be
other tax and benefit changes, notably January’s VAT rise.                               Exhibit 7
                                                                                         Our inflation forecasts compared
To take into account those wider effects, forecasters generally
                                                                                           4                                                  Year on year central inflation
assume that a 1% of GDP worth of fiscal consolidation will have                                %
                                                                                                                                              forecasts (CPI)
an effect of -X% on GDP; they assume a ‘multiplier’.
Unfortunately, there is quite a lot of disagreement in the                                 3
literature on what is an appropriate multiplier. We break down
                                                                                                                                                      Morgan Stanley
the consolidation into categories, using data in the Spending                              2                                                                                     OBR
                                                                                                 BoE inflation target
Review and Budget, and apply a different multiplier to each.                                                            Consensus                        BoE (Nov.)
Using the OBR’s multipliers (from the June Budget) and our                                                                                    BoE (Aug.)
calculations of the size of 2011/12 consolidation in each of                                                                                           BoE forecasts assume market
these categories, again, we think this could subtract nearly 1pp                                                                                       interest rate expectations and are
                                                                                                                                                       the mode of their projection
from GDP growth over the coming 12-24 months (Exhibit 6).                                  0
                                                                                           Sep-10         Mar-11        Sep-11       Mar-12        Sep-12          Mar-13

                                                                                         Source: BoE, OBR, HM Treasury, Morgan Stanley Research estimates

                                                                                             MORGAN STANLEY RESEARCH

                                                                                             December 8, 2010
                                                                                             Investment Perspectives — Europe

Strategy and Economics
Exhibit 8                                                                                    Why do we expect the BoE to raise rates at all? This is a
Surveys suggest spare capacity is shrinking rapidly                                          reasonable question, given our rather weak 2011 GDP growth
    2.0     Standard deviations from average, %                                              forecast. Our forecast is based on a number of assumptions:
                                                                   A rise indicates
    1.5                                                                 less spare              Spare capacity is being relatively accurately reflected in
                                                                           capacity              the survey data and continues to shrink.
    0.5                                                                                         The UK economy does not record negative GDP growth in
    0.0                                                                                          any quarter next year.
                                                                                                ‘Contagion’ from the euro area periphery debt markets
    -1.0                                                                                         doesn’t spread significantly into the UK in 2011.
    -1.5              Survey Measure of Spare Capacity
                                                                                                In August 2011, the MPC will effectively be looking at
                                                                                                 inflation prospects in 2013 to guide its decisions. By that
           90   92    94     96     98      00     02     04     06     08      10     12
                                                                                                 point, we expect the BoE’s central forecast to be showing
Note: We have constructed a measure of the output gap, based on survey indications of            inflation above target, assuming unchanged monetary
spare capacity. These use data from the BCC, BoE, CBI and OECD on capacity utilisation
and capacity constraints in services and manufacturing. These are then weighted to reflect       policy, at the end of the forecast horizon.
the higher share of services in GDP.              Source: Morgan Stanley Research.
                                                                                                MPC members become increasingly worried about risks to
     Wage settlements: We expect wage growth to pick up to                                      their inflation-targeting credibility over 1H11 and one or
      more normal levels over the next two years, reflecting                                     two more MPC members join Sentance in 1H in voting for
      sustained above-target inflation and increased firm                                        a rate increase.
      profitability. However, we expect the rise to be capped by
      higher unemployment (see The UK Labour Market: A                                          Sterling does not appreciate significantly on a trade-
      Second Softening, November 25, 2010). We expect unit                                       weighted basis in 2011.
      wage cost inflation to pick up (although to levels below                                  Wage settlements pick up in 2011 and inflation
      2.0% on average in 2012).                                                                  expectations rise in 1H11.
     Inflation expectations: Household medium-term inflation                                We would regard a rate rise from 0.5% to 1.0% in 2011 as
      expectations have been drifting upwards. We expect a                                   ‘taking the foot off the accelerator a bit’ rather than ‘putting on
      pick-up in medium-term inflation expectations in 2011,                                 the brake’ to borrow an analogy from Governor King. 1.0%
      reflecting sustained above-target inflation.                                           would be well below what we would consider a ‘neutral rate’.
     Global inflation pressures: According to research by our                               We would also not expect such a gradual rate rise profile to
      Global Economics Team (see Inflation Goes Global,                                      derail recovery, partly because we would expect banks to
      July 16, 2007, Joachim Fels and Manoj Pradhan), a 1pp                                  compress their mortgage margins somewhat, offsetting part of
      increase in global inflation raised UK inflation by 1.6pp                              the impact.
      over the past 45 years (compared to only a 0.6pp effect in
      the US). In addition, the team found that national inflation                           Can we rule out further QE? We still cannot rule out further
      has become more sensitive to its relationship with global                              QE, although it is clearly not our central case. In particular,
      inflation since the mid-90s.                                                           there are risks that fiscal tightening could dampen GDP growth
                                                                                             more than we expect. In addition, we of course cannot rule out
Monetary policy                                                                              contagion from euro area periphery debt markets spreading
                                                                                             significantly to the UK (the UK has a relatively high budget
Our forecast has been that the MPC would increase interest                                   deficit, strong banking and trade linkages to the euro area and
rates in 2011, starting at the May meeting. However, we have                                 an outsized banking sector). That would likely prompt an
long acknowledged that the balance of risks to this forecast                                 extension of QE from the BoE. Ultimately, however, we would
lies firmly in the direction of rates remaining low for longer.                              expect any such contagion to manifest itself in increased
We take some of those risks into our central case and push                                   inflation risks through looser monetary policy, some sterling
out our expectation of a first rate increase (of 25bp) to the                                depreciation and a likely interpretation by many investors that
August meeting. We now expect the policy rate to end 2011                                    the MPC was aiming to help the UK inflate its way out of trouble
at 1% and 2012 at 2% (with risks still skewed towards ‘low for                               and ‘monetising government debt’ (rather than interpreting the
longer’, given the relatively weak recovery we envisage).                                    MPC’s actions as reacting to increased downside risks to the
                                                                                             economy and therefore inflation).

                                                                      MORGAN STANLEY RESEARCH

                                                                      December 8, 2010
                                                                      Investment Perspectives — Europe

Strategy and Economics
December 2, 2010                                                      Exhibit 1
                                                                      5y Gilt Sharpe Ratios No Longer So Attractive
UK Interest Rate Strategy                                                                 1.5                                    2Y        5Y        10Y         30Y

UK Rates: 2011: A Year of Two                                                             1.0


Morgan Stanley & Co.   Anthony S O'Brien

                                                                           Sharpe Ratio
International plc+     Anthony.O'                                  0.0

The outlook for gilt yields looks as uncertain in 2011 as it did                          -0.5
in 2010, with political and fiscal policy concerns being
replaced by risks of contagion from peripheral Europe                                     -1.0

threatening to hamper the UK economic recovery, while
inflation is likely to remain above target for the whole of the                           -1.5
                                                                                            Nov-01   Nov-02   Nov-03    Nov-04   Nov-05    Nov-06   Nov-07     Nov-08    Nov-09     Nov-10
year. No wonder Governor King continuously refers to large
                                                                      Source: Morgan Stanley Research
upside and downside risks to inflation in MPC minutes and
Inflation Reports and how the MPC “will watch the incoming            Exhibit 2
data carefully, ready to adjust policy in either direction”.          Insufficient Risk Premia Discounted in Front End
However, in 2010, as the Sharpe ratios in Exhibit 1 show,                                                                                            Sonia 1y vs 1y1y spread

investors were compensated for the high level of uncertainty
by an attractive carry/rolldown profile, particularly in the 5y                           150

sector. Unfortunately, this has moderated as we approach
                                                                         Spread (bp)

2011, with measures of vol-adjusted carry well off their 2010
highs (the Sharpe ratio here is defined as 1-year roll+carry
less 1-year financing, all divided by rolling volatility).

In addition, although inflation continues to surprise on the
upside, the SONIA curve continues to push the first rate hike
by the MPC further into the future, with the spread between 1y                              Nov-09             Feb-10             May-10              Aug-10                   Nov-10

and 1y1y SONIA 120bp lower than it was at the beginning of            Source: Bloomberg

2010 – see Exhibit 2. These factors make investing decisions
in the front end precarious.
                                                                      Our favourite long position is extending out of 5y into 10y gilts
                                                                      cash-for-cash or receiving GBP 5y5y in swaps between 4.75
If all goes well, 2011 is likely to be divided into two periods for
                                                                      and 5%. GBP 5y5y swaps rose as high as 5.6% in 2007 when
gilt investors. Euro peripheral concerns and the uncertainty
                                                                      the bank rate was at 5.5%, but we think that any tightening by
surrounding the economic impact of the upcoming VAT hike
                                                                      the MPC will be ‘measured’ in the next few years. As we have
and fiscal consolidation should cap yields in the first half of
                                                                      discussed in previous publications, it is very likely that the
the year. However, yields should start pushing higher in 2H,
                                                                      neutral rate of interest has fallen, given that the marginal
discounting a rise in the bank rate by year-end. The timing of
                                                                      funding cost for banks has risen from 25bp above the bank
when yields start adjusting to upcoming monetary tightening is
                                                                      rate to around 175bp according to the BoE. This rise has
difficult to say with any certainty, so for duration
                                                                      naturally been passed onto borrowers, hence our belief that
recommendations we favour investing in the higher yields
                                                                      the natural rate of interest has been reduced, probably to
further out the curve, rather than the assets with the greater
                                                                      below 4%. This makes GBP 5y5y above 4.75% attractive, and
carry/rolldown offered in the 2-5y sector. The high yields
                                                                      with rolldown of 0.5bp/week (we also recommend GBP 5y5y
should give some protection in the event of stronger economic
                                                                      risk-reversals, as the structure takes advantage of richness in
growth (and hence less spare capacity), meaning that the
                                                                      the payer skew relative the receive skew – see European
MPC raises rates earlier than expected, but also provides
                                                                      Interest Rate Strategist: Responding to Higher Risks,
attractive upside if growth slows and yields fall.
                                                                      November 26, 2010). Additionally, switching out of 2025s

                                                                    MORGAN STANLEY RESEARCH

                                                                    December 8, 2010
                                                                    Investment Perspectives — Europe

Strategy and Economics
into 2040s (cash for cash at 4.70%) also looks appealing to         banks as the SLS is withdrawn from April 2011, which should
us, as the long yields should remain supported by pension           widen credit spreads as banks compete for investors.
funds and insurers if yields rise, in comparison to the 15-20y
                                                                    Exhibit 3
sector.                                                             Gilt Asset Swap Spreads to Continue to Richen
                                                                                                                        % Deficit to GDP                -110
One may consider hedging these long duration positions by                                                               30y a/s spread
selling UKT 2y (paying GBP 2y). With 2y yields below 1%, it

                                                                                                                                                               A/s spread (bp) inverted
strikes us as a cheap way to have long positions further out                                                                                            -70

                                                                      Deficit to GDP (5)
the curve. With only 25bp priced in the SONIA curve by the                                  0

end of 2011, and another 50bp for 2012, there is insufficient
risk premia priced into the front end. Indeed, one has to be                                -4
reasonably certain that the UK economy will slow dramatically
to support such market levels. We believe that 2-5y yields                                  -8
should cheapen to reflect the two-way risks expressed by the
MPC. On the curve we recommend selling 5s as part of a
                                                                                           -12                                                           50
UKT 5s10s20s barbell (carry/roll is flat) as the fly is near its                             Dec-00   Dec-03   Dec-06        Dec-09        Dec-12   Dec-15
highs. The highs in 1Q were arguably artificially generated,
                                                                    Source: Morgan Stanley Research, OBR
with the BoE buying gilts and hence providing a stronger bid
to the UKT 20y sector than is normally the case. Hence, we          Cross-currency spreads
believe that the 10y sector offers good value on the fly. 10y       With the growing risk of peripheral credit stresses migrating to
yields have suffered the most in the sell-off in the past three     the euro-zone’s core, we favour 10y gilts versus Bunds, as
months (hence the underperformance of the 5y5y), a trend            gilts offer a relatively ‘safer haven’. The 5y CDS differential
which should not persist in the event that the market begins to     has tightened to an 18-month low, and we think the 10y
price in a higher bank rate. In addition, if the gilt market        gilt/Bund spread should converge too. European government
begins to discount the economy heading towards a Japan-like         issuers tend to ‘front-load’ their auctions at the beginning of
scenario of low inflation and bank rates, the 10y belly should      the year, when 1Q is rather light in terms of gilt supply.
also fare well as it did in the summer.                             According to our FX strategists, the GBP is significantly
                                                                    undervalued against the EUR, and so we expect to see
Asset swap spreads
                                                                    continued gilt buying from overseas investors. We
The OBR Autumn Forecasts suggested that the government
                                                                    recommend the GBP/Euro 5y5y spread and UKT 10y versus
was on course to achieve its fiscal austerity objective of a 1%
                                                                    Bunds. The carry/roll dynamics also favour gilts.
deficit to GDP ratio in 2015/16. This continues to bode well for
gilt asset swap spreads in 2011. Exhibit 3 plots the                Significant risks surround our forecasts, as contagion may
percentage deficit to GDP ratio and 30y asset swap spreads          spread from the European peripheral banking sector into the
since 2000. We also include the deficit-reduction path laid out     large UK banking sector, adversely affecting the sovereign
in the OBR Autumn Forecasts, which implies that 30y spreads         credit. In addition, although it appears that the government
should test zero in 2012. As core European governments take         has set the economy on the path to fiscal austerity, the UK’s
on more peripheral exposure (through the EFSF, etc.),               deficit to GDP ratio is still an imposing 10% of GDP, which
peripheral weakness could transfer to the core, and so gilts        only shrinks gradually to 7.6% in 2011/12. There is a risk that,
potentially represent one of a declining number of flight-to-       at some stage, a fearful investor community may not deem
quality assets. We believe that the risks from owning asset         this fast enough, leading to higher yields, steeper curves,
swap spreads are limited as either the government remains           tighter asset swap spreads and cheapening versus Bunds
on course to achieve its fiscal objectives, which should be         (although the German banking sector would probably be
positive for spreads, or growth disappoints under the weight of     affected too). Of course, under such circumstances, the MPC
spending cuts; thus, the market prices in a greater likelihood of   could extend QE to temper the rise in yields. However, the
an extension of QE. Again, this would be positive for spreads.      inflationary consequences of such action would again lead to
                                                                    steeper curves.
We favour short-end asset swap spreads as the £18.5 billion
redemption of UKT 4Q11 on March 7 will cover around 35% of          One thing is certain – 2011 is bound to be an eventful year;
the whole of next year’s short issuance. In addition, markets       but we have reason to believe that the gilts market will stay
permitting, we could see a plethora of front-end issuance from      under the radar.

                                                                   MORGAN STANLEY RESEARCH

                                                                   December 8, 2010
                                                                   Investment Perspectives — Europe

Strategy and Economics
December 2, 2010                                                   around 8% looking ahead. Within that framework, Qing sees:
                                                                   1) a secular boom in consumer spending, underpinned by
Global Equity Strategy                                             rising labour share of national income; 2) a rapid expansion of
                                                                   the service sector, and 3) manufacturing shrinking as a share
$7,000 Question                                                    of GDP (while still growing in absolute terms).
Morgan Stanley Australia   Gerard Minack
Limited+                  Exhibit 1
                                                                   Growth Before and After US$7K Per Capita
It’s been right to be a secular optimist on China, but the story
may be changing structural shape: toward slower growth, but
with a consumer focus. This won’t signal the end of the
commodity super-cycle, in our view, particularly if India
continues its structural rise.

My colleagues Qing Wang and Chetan Ahya are bullish on
China and India, but see changes in the structural stories.
(This is beyond a one-year view. For their 2011 outlooks, see
China Economics: 2011 – A Year of Reflation, and Asia
Pacific Economics: 2011 – Yes to Rebalancing, No Inflation
Risks and Asset Bubbles).
                                                                   Exhibit 2
China has just passed an important growth milestone:               The Engine Shifts Gear
exceeding average income of US$7,000. As Qing explains
(see Chinese Economy Through 2020), this is an income level
that has often marked a turning point for developing
economies. First, this event typically precedes a material
slowdown in trend growth. Exhibit 1 shows the growth record
in 40 economies that have reached this income level. The
vertical axis shows GDP growth in the decade prior to the $7K
level, the horizontal axis the growth in the decade after.
Trend growth in 31 of the 40 economies slowed – by an
average of 2.8% per year – after breaking through the $7K
income level.

This sample stretches back a century, and the pattern also
                                                                   Exhibit 3
holds in Asia. Exhibit 2 shows GDP growth in China, South
                                                                   China Turns to Consumers
Korea and Japan before and after reaching $7K. Asian
countries have not avoided the slowdown.

A second change also occurs around the $7K income level:
Consumers become the engine of growth. Exhibit 3 shows
how consumption typically shrinks in the development phase,
but then rises once $7K is exceeded. The decline and then
rise in consumer spending (as a share of GDP) is mirrored in
investment spending, which switches from GDP-plus to GDP-
minus growth around the $7K income threshold. (These
charts use official data. Qing and Jonathan Garner have
argued that consumer spending is understated in China.)

Qing’s conclusion is that China’s trend growth will probably
                                                                   Source: Qing Wang, Steven Zhang, Ernest Ho, Chinese Economy Through 2020, 8
slow from a 10.3% annual average over the past decade to           November 2010; Morgan Stanley Research

                                                                   MORGAN STANLEY RESEARCH

                                                                   December 8, 2010
                                                                   Investment Perspectives — Europe

Strategy and Economics
While China’s trend growth seems set to slow, Chetan               Exhibit 4
expects India’s to accelerate. In fact, as outlined in India and   India Another China?
China: New Tigers of Asia, Chetan expects India to grow
faster than China over the coming decade.

India started economic liberalization almost 20 years after
China did. Since then, it has seen a similar increase in export
share of GDP (Exhibit 4). There has likewise been a
significant trend increase in infrastructure spending (although
as a lower share of GDP compared with China).

Chetan argues that three factors point to structurally higher
Indian growth: 1) improving demographics (a decline in the
dependency ratio); 2) structural reforms, and 3) globalization,
reflected in the rising share of exports and direct investment
                                                                   Source: Chetan Ahya and Tanvee Gupta, India and China: New Tigers of Asia, 13 August,
(which now exceeds China’s as a share of GDP) and in               Morgan Stanley Research

reduced tariff barriers. Chetan expects Indian growth of 9-
                                                                   Exhibit 5
10% by 2013-15 – higher than China’s new trend growth of
                                                                   Coal Consumption

China has been an increasingly important influence on
commodity markets over the past decade. The prospect of
slower, more consumer-focused growth in China implies
slower Chinese demand for commodities. India’s prospective
acceleration, however, provides an important offset.

Jonathan Garner has looked at the implications of this switch
in growth rates for several important commodities, taking into
account the different intensity of use in China and India.
Exhibit 5 shows coal as an example (for detail, see his 2011
Outlook: Slowing Growth, Rising Inflation and Higher Policy
Rates = Less Bullish Than Consensus).                              Source: Jonathan Garner, Pauline Yeung, 2011 Outlook: Slowing Growth, Rising Inflation
                                                                   and Higher Policy Rates = Less Bullish Than Consensus, 1 December, Morgan Stanley
The conclusion is that aggregate demand from China and
India will remain solid, but with some variation across
commodities. Coal demand may slow on a five-year view, to
8% per year from 9¼% over the past five years; steel will
likely slow to 10½% from 13%. These remain high growth
rates. In contrast, demand growth for cement is expected to
slow from 10¾% to 1¼%. Perhaps the most important
forecast is that oil demand will accelerate from 4¾% growth to
7½%. This is driven by rising consumer demand as per
capita income reaches levels where auto density surges,
underlining the potential for energy prices to become a
serious issue in the next few years.

                                                                      MORGAN STANLEY RESEARCH

                                                                      December 8, 2010
                                                                      Investment Perspectives — Europe

Strategy and Economics
December 7, 2010                                                      Our estimates of the impact on growth of the deal, if enacted,
                                                                      rest heavily on our baseline assumptions. Our estimates may
US Economics                                                          vary from those of other analysts who may have assumed
                                                                      more or fewer of these provisions in their baseline. Moreover,
Tax Deal Could Boost Growth to                                        there could be two intangible benefits from such a deal that
4%+ Next Year                                                         are hard to quantify. First, it would reduce the uncertainty
                                                                      around the tax issue; clarity could be a plus for growth.
Morgan Stanley & Co.    Richard Berner
                                                                      Second, it could boost investors’ risk appetite, which would
                        David Greenlaw                                further ease financial conditions.
                                                                      Tax cuts and EUC benefits likely to be extended. While
Breakthrough tax deal? President Obama has announced a                the outlook for enactment of this deal is unclear, we think that
“framework” agreement with Republican Congressional                   the tax cuts for all income groups and unemployment benefits
leaders that could, if enacted, boost growth over the four            are highly likely to be extended. Ironically, many Democrats
quarters of 2011 by 1 to 1.2 percentage points relative to our        have strong reservations about the proposal, while many
baseline forecast of 3%. Some of the provisions would last            Republicans have expressed support. As a result, the
two years, but others would expire after 2011 and thus would          prospects for the deal will only become clearer after
pull growth forward into 2011 at the expense of 2012. As a            Congressional representatives caucus and work on a strategy
result, following a significant boost to growth in 2011, this         to move key elements toward legislation.
package could reduce growth in 2012 by about half a
percentage point.                                                     Shift in policy mix: Monetary policy implications. Such a
                                                                      deal, if enacted, would shift the burden of policy stimulus from
Framework details. While many details have yet to be                  monetary to fiscal policy, exactly what Fed officials have
announced, the deal involves:                                         hoped. Conditional on the outcome, this deal or one broadly
                                                                      similar to it has implications for monetary policy. While the
     A two-year extension of all expiring tax cuts, including        Fed is committed to complete the $600 billion Large-Scale
      those for upper-income taxpayers;                               Asset Purchase program announced in November (QE2), the
     A two-year extension of other expiring tax provisions,          shift to fiscal stimulus — and the expected improvement in the
      including a fix for the alternative minimum tax;                economic outlook over the next few quarters — imply that
     A new 12-month, 2% payroll tax cut for employees;               officials would be less inclined to extend the current LSAP
     100% expensing of business investment outlays in                program beyond Q2 2011.
      2011; and
     A 13-month extension of emergency unemployment                  Exhibit 1
      benefits.                                                       Framework Fiscal Agreement
                                                                      (effects on revenue, billions of $, calendar years)                              Included
The deal does not include an extension of the Making Work                                                                                                 in our
                                                                                                                                     2011         2012 baseline
Pay tax credit; it substitutes the payroll tax cut for that credit.   Extend expiring tax cuts                                       -105         -199
The table below provides estimates for the revenue impact of           for those with incomes below $250K                             -89         -132       yes
                                                                       for those with incomes above $250K                             -16          -67        no
these provisions, which add up to more than $1 trillion over
two years.                                                            Extend other expiring provisions                                -187         -214        most

                                                                      Extend unemployment benefits                                     -56            0         half
As noted in the table, in our baseline outlook published last
                                                                      New initiatives                                                 -190         -100
Friday, we assumed that tax cuts would be extended for lower           2% payroll tax cut for employees                               -120            0          no
and middle-income taxpayers, that EUC unemployment                     Business expensing                                              -70         -100        50%

benefits would be extended for six months, that business              Total                                                           -539         -512
expensing would be allowed for 50% of investment outlays,             Note: Other expiring provisions include two-year extensions of the estate tax under the Kyl-
                                                                      Lincoln proposal ($5 million exemption and 35% rate), marriage penalty relief, current law for
and some other expiring provisions, such as the AMT fix,              capital gains and dividend taxes, an increase in the AMT exemption amount, the combined
would be extended. Thus, this proposed deal includes                  interaction from extending EGTRRA and AMT provisions, and other expiring credits and
significant new stimulus from the payroll tax cut, expanded           Source: Congressional Budget Office, Morgan Stanley Research

business expensing, the longer EUC benefits extension, and
tax cuts for upper-income taxpayers.

                                                                    MORGAN STANLEY RESEARCH

                                                                    December 8, 2010
                                                                    Investment Perspectives — Europe

Strategy and Economics
Budget and financing implications. If the proposal based            Of course, the higher budget deficit would imply some
on the agreement reached between the White House and                associated impact on the volume of Treasury borrowing. This
Congressional Republicans were enacted, we would take our           would likely take the form of a delay in the anticipated
FY 2011 deficit forecast up by $160 billion, to $1.295 trillion     reduction in coupon auction sizes and a smaller cutback in bill
(or 8.6% of GDP). And we would adjust our FY 2012 deficit           issuance than in our current baseline. In that baseline, we
estimate up by a similar amount, to $1.11 trillion (or 7% of        expect issue sizes for the 2-, 3- and 5-year notes to begin to
GDP).                                                               move modestly lower by mid-2011. Under the proposal, we
                                                                    would anticipate that these cutbacks would not occur until
These changes largely reflect the impact of three proposed          later in the calendar year. Overall, in FY 2011, we would
measures — the payroll tax cut, business expensing, and             boost expected coupon issuance by about $60 billion and bill
extended unemployment benefits. Most of the payroll tax             issuance by about $100 billion relative to current estimates.
effect hits in FY 2011, while we are assuming that the bulk of      So, if the proposal were enacted we would look for gross
the impact associated with the expensing provisions would hit       coupon issuance of $2.06 trillion in FY 2011 – implying net
in FY 2012. Also, it’s important to note that the near-term         issuance of about $1.4 trillion. We would still anticipate a net
outlays associated with the proposed expensing provision            paydown in bills over the course of the coming year, but less
merely represent a timing shift – the total $150 billion or so of   than in the baseline outlook.
estimated tax breaks during the FY 2011-12 period would be
entirely recouped by 2020.

                                                                                                                                                                MORGAN STANLEY RESEARCH

                                                                                                                                                                December 8, 2010
                                                                                                                                                                Investment Perspectives — Europe

Strategy and Economics
December 3, 2010                                                                                                                                                Positioning: Bond-fund inflows have run at a record pace in
                                                                                                                                                                2009 and 2010 (Exhibit 1), although this may reverse direction
Global Interest Rate Strategy                                                                                                                                   in 2011. This indicates vulnerability for higher yields, sparked
                                                                                                                                                                even by modest expectations of rising inflation, as an unwind
Outlook 2011: Bonds to Adjust for                                                                                                                               of two years’ worth of long bond positions can exacerbate the
Rising Growth and Inflation Risks                                                                                                                               sell-off. Essentially, bond flows may shift from buying on
                                                                                                                                                                weakness to selling on strength, which will likely inflate the
Morgan Stanley & Co.            Jim Caron                                                                                                                       level of yields.
                                                                                                                                                                Quantitative easing: QE will be a source of volatility in 2011.
Has the secular decline in interest rates ended? As we                                                                                                          It stems from conflicting views on whether the Fed will fulfill
approach the start of 2011, this is the one fundamental                                                                                                         intended purchases of $600 billion US Treasuries by end-
question that developed-market bond investors need                                                                                                              2Q11, or if it will succumb to political pressures and fall short.
answered. If it has, then investment decisions are made easy                                                                                                    QE2 adds a bimodal risk to bond markets in that the market
for bond investors: Look to sell strength and reduce long-                                                                                                      will likely price its conclusion well before it ends. If economic
duration exposure. But the consequences extend beyond just                                                                                                      conditions are improving in the US, then the end of QE
rate markets. There is a high-beta relationship between                                                                                                         represents the loss of one of the biggest buyers of US
changes in rate levels and performance across many other                                                                                                        Treasuries in the market; a risk for higher yields that will be
asset classes, especially spread products. This beta is                                                                                                         priced perhaps in late 1Q11. Conversely, if economic data
amplified as public sector risk rises, which introduces political,                                                                                              disappoint, then the end date of QE2 represents the loss of a
policy and regulatory externalities. Thus, risk becomes less                                                                                                    substantial market support facility; a risk for yields to decline
idiosyncratic, which creates a greater ‘risk-on/risk-off’ profile                                                                                               that may also be discounted in 1Q11.
that makes beta a higher component of returns. The critical                                                                                                     Political risks: Politics and policy will play intensified roles in
linkage is that interest rate markets are a primary source of                                                                                                   the markets in 2011. There are many variables to consider —
that beta for 2011. As we see it, this will hinge on five key                                                                                                   monetary policy, capital controls, currency policy, financial
themes in 2011:                                                                                                                                                 regulation, tax policy, fiscal austerity versus fiscal autonomy,
Inflation: This will be the main driver of asset allocation                                                                                                     and a resurgence of nationalism and protectionism. They are
decisions in fixed income. The initial conditions of low yields                                                                                                 likely to add to risk premiums and reduce market efficiencies.
and low inflation expectations in developed market bond                                                                                                         Nevertheless, navigating these risks will be a key part of
markets have yields running near secular lows. This has                                                                                                         investment decisions in 2011, in our view.
been helped by investor demand for the safety of fixed returns                                                                                                  European sovereign crisis: Our central case is that core
and deleveraging forces driven by the US financial crisis in                                                                                                    Europe will continue to provide support to peripherals, but at
2008. But if the investor mindset shifts toward rising inflation                                                                                                a price of fiscal tightening and reform. In this context: 1)
risks, reducing fixed income exposure will be a more thematic                                                                                                   peripheral markets will be buffeted by bouts of uncertainty,
trade in 2011.
Exhibit 1
Initial Conditions: Bonds Are Historically Overbought as an Asset Class
                                                                                                                                                          Bonds are More popular now than Stocks Ever
                                                                                                                                                          Bonds Are more Popular Now Than stocks ever
                                2 Years of Record Inflows into Bonds
                                2-Years of Record Inflows into Bonds                                                                                                  Peak        equity Bubble in
                                                                                                                                                          Were at the peak of the Equity bubble in 2000

                                                                                                                                                                Bonds win the popularity contest
                                                                                            Rolling 12M Aggregate Flows To US Mutual Funds $bn .

                                                                                                                                                   400          over the past 25-years

                                                                    Inflow into                                                                    200

                                                                    Bond Funds                                                                     100



                                                                Outflow from                                                                       -200          Equities

                                                                Equity Funds                                                                                     Bonds

                                                                                                                                                          85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Source: The Investment Company Institute (ICI) is the national association of US investment companies. Members of ICI manage total assets of $9.8 trillion. ICI's weekly estimates for mutual fund
flows cover 95% of the industry. YTD 2010 is as of Nov 17, 2010 while YTD 2009 is as of Nov 10, 2009. Morgan Stanley Research

                                                                     MORGAN STANLEY RESEARCH

                                                                     December 8, 2010
                                                                     Investment Perspectives — Europe

Strategy and Economics
while 2) core curves will remain under steepening pressure           Observe in Exhibit 2 the sharp decline in UST 10y yields
due to both the cost to core countries of supporting                 (proxy), while credit spreads remained low and stable in 2010.
peripherals and to increasing perception of inflation risks.         This means that the positive performance in spread products
                                                                     has vastly more to do with the decline in yields than the
2011: The Year of Beta Amplified
                                                                     performance of spreads. For instance, in the case of
Easy developed-market (DM) central bank policies over the
                                                                     investment-grade credit, which has returned on average
past two years have been pre-conditions for bond market
                                                                     ~10% in 2010 YTD, over 90% of its returns are due to
returns to become highly dependent on falling interest rates
                                                                     duration (interest-rate sensitivity, or beta). This ‘beta’
(beta) and encouraged investors in spread products to accept
                                                                     relationship should not only spill over into 2011, but it could be
significantly higher duration risks. Thus, bond market
                                                                     amplified since we are coming off two years of record inflows
performance in 2011 will have an amplified beta relationship
                                                                     in bond fund funds, and we now see inflation risks rising as
to rising rates mainly due to historically low yield levels in
                                                                     DM growth appears to be stabilizing. Reconciling overweight
spread products in concert with the relatively narrow level of
                                                                     positions in bonds with rising inflation risks and economic
spreads. Reconciling this with the risk of rising yields will be a
                                                                     stability should be a key theme in 2011.
central theme in 2011, as unwinding two years’ worth of
overweight bond positions and a greater discounting for              In 2011 investors may feel that the worst of the credit
inflation may dominate the landscape of risk.                        crunch has passed. Many of the central risks associated
Exhibit 2
                                                                     with the fallout from the subprime crisis, such as recession,
Beta Unveiled: Changes in Rate Levels to Drive                       deflation and delivering, have shifted toward being tail risks.
Returns in 2011                                                      Similarly, the prior tail risks of inflation, economic recovery
                                                                     and stability have become central risks. Europe stands out as
                                                                     the notable exception, and the risk of contagion remains an
                                             Beta: Sharp Fall        unknown variable. Nevertheless, we do not see growth as an
                                             in Rates Amid
                                             Stable Spreads          issue for 2011; we expect neither a boom nor a recession.
                                                                     The question is whether growth will be high enough to provide
                                                                     escape velocity for DM economies to reduce unemployment
               2006: Record                                          and generate enough income to reduce public-sector debt
               Tight Spreads
                                                                     and improve their fiscal balance sheets. As we see it, DM
                                                                     growth may put us on a trajectory toward a long, slow path to
                                           Crisis                    recovery, but lackluster growth may only barely tilt the scales
                                                                     toward fiscal and economic recovery.
                                                                     But this does not mean yields can’t rise. We believe that
                                                                     yields are most at risk of rising in 1H11. This will be a period
Source: Morgan Stanley Research
                                                                     when the asset allocation and two years’ worth of overweight
                                                                     bond positions re-adjust to reconcile the removal of
The beta of bond market returns unveiled – a risk for                deflationary tail risks in favor of growth stability and inflation
2011. Changes in rate levels may matter most in 2011 for             tail risks. Bond investors may therefore shift from buyers on
performance across many asset classes; this is especially            weakness to sellers on strength in 1H11, despite the longer-
true for spread products. To understand this better, we look         term economic estimates that argue for yields to remain low
back to a time when DM central banks were hiking rates to            and steady. We believe that it will be difficult for yields to rise
slow growth – the year was 2006 (see Exhibit 2). At that time,       beyond a certain threshold, say UST 10y 3.50%/3.75% as a
interest rates were high but spreads were at record tights,          proxy, because it may attract longer-term value buyers based
which kept the cost of credit low. Spreads reversed to wider         on expectations of a long, tepid recovery. But that doesn’t
levels with the onslaught of the subprime crisis in 2008, but        mean that yields can’t rise to reach those levels.
DM central banks countered this with cuts in interest rates to
                                                                     A year of two halves. We recommend that investors reduce
historically low levels. While that may have been part of the
                                                                     duration exposure at the outset of 2011 and wait for an
solution in the 2008-09 subprime crisis because it kept the
                                                                     opportunity for yields to rise and for spreads to possibly widen
market flush with liquidity and buffered the increasing cost of
                                                                     to gain a more tactical entry point to buy bonds. Positioning
credit, it has become part of the problem in its aftermath.
                                                                     defensively at the outset of 2011 may enable investors to
Here’s what we mean:
                                                                     pounce on this opportunity when it arrives.

                                                                     MORGAN STANLEY RESEARCH

                                                                     December 8, 2010
                                                                     Investment Perspectives — Europe

Strategy and Economics
December 8, 2010                                                     Exhibit 1
                                                                     Index Targets for Year-End 2011
China Strategy                                                                                   2011YE index target                        Up-/Down-side

2011 Outlook: A Year of Re-rating                                    Index        Current        Base             Bull      Bear        Base            Bull     Bear

Morgan Stanley Asia    Jerry Lou                                                        67.6      94.5          111.5      73.2         39.8%       65%               8%
                       Allen Gui
                                HSCEI        12,922        17,682     20,541        13,965         36.8%       59%               8%
                       James Cao
                                Source: Morgan Stanley Research estimates
                       Corey Ng, CFA
                                 Exhibit 2
                                                                     Monetary Leading Indicator Implies Downward
We are optimistic on the 2011 outlook for Chinese equities.          Trend of CPI in 2011: Assuming Rmb7 Trillion New
We see several positive themes: mild inflation, normalized           Loans
liquidity, modest tightening, good growth, strong currency,
                                                                                                          Monetary Leading Indicator (6M-Lag)
cheap valuation, humble relative performance in 2010, and             8%                                  Consumer Price Index(RHS)                              10%
mild consensus outlook.                                               7%
We set our new year-end 2011 index targets for MSCI                   5%

                                                                      4%                                                                                         4%
China at 94.5 and for HSCEI at 17,682. These targets imply
                                                                      3%                                                                                         2%
40% and 37% upside potential, respectively. We favor high-
beta, cheaply valued and deep cyclical industries, including          1%

banks, property, insurance, steel, cement and energy. We              0%

underweight all consumer sectors as we are not comfortable            -1%                                                                                        -4%
                                                                         2001    2002    2003   2004     2005     2006   2007    2008     2009   2010     2011
with their lofty valuations and high earnings expectations.
                                                                     Source: CEIC, Morgan Stanley Research
Loan quota is the key domestic risk and G3 growth is the key
external risk. We are using our economist’s forecast of Rmb7         for the full year 2011 – if we assume Rmb 7 trillion new loans
trillion new loans in 2011. If the actual quota turns out to be      to be allocated across the 12 months in 2011 in the same
much less than this, we expect that stocks would fall due to         proportion as they have been in 2010.
over-tightening. If economies in the developed world surprise
on the upside and recover quickly in 2011, oil and food prices       Policy makers’ change in tone has also confirmed this
would rise globally, forcing China to tighten aggressively. In       view. At the regular Working Meeting of the Politburo that
that scenario, stocks would fall.                                    just concluded, the tone for 2011 fiscal policies was
                                                                     “appropriately accommodative” (same as 2010); monetary
Liquidity, inflation and policies: Not a vicious spiral.             policies shifted to “stable and healthy” (from appropriately
Liquidity, inflation and policies interact with each other, but we   accommodative in 2010). This implies a balance between
do not envision a vicious spiral that would derail growth, as        remaining pro-growth and tackling inflation risk.
China’s money supply already decelerated in 2H2010.
                                                                     Finally, Rmb7 trillion in new loans is a very loose level of
Indeed, our Greater China economist, Qing Wang, forecasts a          liquidity to fuel growth. Indeed, it represents 16% of GDP in
new loan quota of Rmb 7 trillion and 4.5% inflation in 2011,         2011, which is still well above the 13% “normal” new loans to
with CPI peaking by the middle of the year. This is a very           GDP ratio before the financial crisis (2005~2007 average).
mild inflation picture for 2011, with good growth.                   Clearly, this would not derail growth.

We, the strategy team, also see the possibility that CPI could       In conclusion, we can build a bull case on our economist’s
peak even sooner in 1Q2011. Our monetary leading indicator           inflation and liquidity view in 2011, as CPI peaking by 2011
(constructed by M1 and M2 information) shows clear downward          will be good news for equities. If CPI actually peaks earlier
trend pressure on CPI in the coming months and                       than that, as suggested by our monetary leading indicator,
                                                                     then it could trigger market re-rating in the next few months.

                                                                   MORGAN STANLEY RESEARCH

                                                                   December 8, 2010
                                                                   Investment Perspectives — Europe

Strategy and Economics
Growth expectations: Moderate, with upside risk. In the            This implies strong re-rating potential in market valuation,
past 10 years, MSCI China’s EPS growth has averaged                given the close correlation between Rmb appreciation
15.5% YoY, compared to current consensus forecast of               expectations and Chinese market valuation.
14.9% for 2011. We think there are upside risks in consensus
earnings forecasts, especially in the large-cap groups such as     From a relative performance perspective, we think it is also
banks and energy.                                                  quite unlikely that MSCI China would underperform the
                                                                   regional market for a third consecutive year – unless
The market is pricing in little expansion in banks’ net interest   fundamentals were exceptionally weak. Between 1993 and
margin next year. However, we think this implies earnings          1995, China underperformed AXJ for three consecutive years
upside for the industry, since we envisage interest rate           because the “Asian tigers” were booming amid an asset
normalization next year. Assuming average NIM rebounds to          bubble, while China’s domestic economy suffered a hard
the 2007 level of 3% (our analysts now expect just 2.4%), the      landing after severe inflation and the bursting of an asset
big five banks would net about Rmb125 billion extra after-tax      bubble in Hainan Island property.
profit on top of the current estimate of Rmb620 billion. That
would dramatically lift their 2011 earnings growth from 18.7%      Today’s relative fundamental outlook is exactly the opposite:
to 42.7% on average.                                               China’s economic strength and corporate fundamentals are
                                                                   probably the strongest in the region, yet it has
For the energy industry, every US$1 rise in oil prices would       underperformed the region continuously for two years. We
also add roughly 1% to the oil companies’ combined earnings        think a third year of such mispricing is highly unlikely against
growth in 2011 – currently the oil price assumed by our            this fundamental backdrop.
analysts is US$95.
                                                                   Index targets: 37% and 40% upside. We set our new index
For other smaller industries such as capital goods, steel and      targets for MSCI China and HSCEI at 94.5 and 17,682,
cement, we believe the solid execution and delivery of social      implying 40% and 37% upside respectively, mainly driven by
housing projects in 2011 (see Qing Wang’s report 2011: A           2011 earnings growth of 14.9% and 16.4% from 2010, and
Year of Reflation, November 22, 2010) could also prompt            P/E multiple expansion of 20% from current market levels.
increased earnings estimates.
                                                                   Assuming real GDP growth of 9% in 2011, our model
Valuation attractive, currency should support. MSCI                indicates a forward earnings multiple of 14.58x, based on the
China is trading at P/E multiples of 14.0x for 2010e and 12.2x     historical relationship between growth and valuation.
for 2011e, based on consensus estimates. This is attractive        Assuming 6.5% Rmb appreciation in 2011, our model
compared to the historical average in the past decade of           indicates 19x, based on the historical relationship between
13.8x FY1 P/E. A 2011e P/E of 12.2x is also very close to          Rmb appreciation and valuation. We believe the achievable
half a standard deviation line below the long-term average – a     market forward P/E should settle between these two. We
historically strong support level. Also considering the humble     thus use the median, 16.79x, as the target multiple for 2011.
performance of MSCI China in 2010 (up 4.3% year-to-date),
we think that overall, the market’s downside risk in 2011          Asset allocation strategy: We are contrarians. Reviewing
should be very limited.                                            our 2010 asset allocation, we employed a low-beta strategy in
                                                                   1H2010 and turned to a high-beta strategy since mid-2010.
The A-share market is trading at a discount to its H-share
counterpart – which is very rare (only the third time in 10        We are carrying forward our high-beta strategy into 2011.
years). This also suggests strong performance over the next        We have a great focus on value, as we believe deep value
12 months in both the A-share and H-share markets.                 and highly cyclical sectors can beat the market significantly
                                                                   throughout the process of re-rating.
Our economist also believes that Rmb strengthening will
continue in 2011 at an annualized rate of 6.5% (see Qing           Our favored industries are banks, properties, insurance, steel,
Wang’s report 2011: A Year of Reflation, November 22,              cement and energy. We underweight transportation, auto,
2010). Clearly this is not what the market is now pricing in       durables, staples, and technology.
(RMB 12-month NDF premium to spot rate is only 2.4% now).

                                                              MORGAN STANLEY RESEARCH

                                                              December 8, 2010
                                                              Investment Perspectives — Europe

Strategy and Economics
December 8, 2010                                              Exhibit 1
                                                              Index Targets for 2011
Hong Kong Strategy                                                                                           2011YE index target                                                           Up-/Down-side

2011 Outlook: Extending the Asset                             Index              Current                      Base                       Bull                 Bear                   Base                       Bull           Bear
Price Cycle to Equities                                       Seng               23,428                 29,399                    33,917               23,012                      25.5%                       45%                -2%
Morgan Stanley Asia   Jerry Lou
Limited+                                       8,750                    9,361                10,182                  7,891                      7.0%                      16%            -10%
                      Corey Ng, CFA
                          Source: Morgan Stanley Research
                      James Cao
                         Exhibit 2
                                                              2011 GDP forecasts for Hong Kong and China imply
We believe Hong Kong stocks will keep rising in 2011.         good earnings growth in Hong Kong
Despite the HSI’s 7.1% YTD gain in 2010, Hong Kong
                                                                 12%                                                                                                                                                         100%
equities have been lagging property prices. We believe this
                                                                 10%                                                                                                                                                         80%
trend should reverse in 2011, according to past patterns.
We set our new year-end 2011 index targets for HSI at                                                                                                                                                                        40%
29,399 and for MSCI Hong Kong at 9,361. These targets                                                                                                                                                                        20%
imply 26% and 7% appreciation potential. The Chinese                                                                                                                                                                         0%
components in the HSI are the key source of upside relative
to MSCI Hong Kong, a pure local index.
                                                                                                                                                 Weighted Average HK/China GDP(YoY)                                          -40%
                                                                                                                                                 MSCI Hong Kong EPS(YoY,RHS)
                                                                  -6%                                                                                                                                                        -60%
We prefer banks and consumer stocks and underweight
residential properties and utilities.
                                                              Note: Weighted Average HK/China GDP (YoY) is weighted by market cap of China related
                                                              stocks listed in HKex.
A weak US economy and strength in China can fuel Hong         Source: IBES, CEIC, HKex, Morgan Stanley Research
Kong asset prices. Hong Kong is a unique play on the
divide between emerging markets and developed markets. It     Under these two assumptions, it is very likely that Hong
follows the US Fed on monetary policies while its economic    Kong’s asset price cycle will be sustained in 2011.
fundamentals track China’s growth. This unique combination    Looking at Hong Kong’s property market, however, this is
means that a weak US economic cycle and a strong Chinese      hard to believe – the ratio of residential property value to GDP
economic cycle can together push asset prices to very high    has already reached the previous peak in 1997. We think
levels in Hong Kong (remember, there are no independent       there is a way for both an extended asset price cycle and
monetary policies to tackle asset bubbles). This theory was   peaking property prices to work – equities rise and properties
confirmed again in 2010 by the property market, as seen in    lag. The Hong Kong government has already used anti-
many other past cycles.                                       speculative policies to prevent further extension of the
                                                              property bubble. While global liquidity remains ample and
The big question – will this remain in force? We think so:    Chinese growth remains robust, property prices are unlikely to
                                                              crash – they just get stuck at a high level, waiting for the next
1) Our global economics team still portrays the global        catalyst to trigger a fall – and this catalyst has to be a Fed rate
   liquidity cycle as AAA (ample, abundant and augmenting),   hike, which is not visible in 2011.
   against the backdrop of BBB (bumpy, below-par and
   brittle) recovery in G10 economies.                        On the other hand, we think Hong Kong’s stocks, especially
                                                              those China-related plays such as the banking and consumer
2) Our Greater China economist, Qing Wang, still sees 9%      groups, can rise further in 2011.
   real GDP growth in China for 2011.
                                                              It is not rare in history for stocks to underperform properties in
                                                              a single year in Hong Kong. However, it is quite rare that
                                                              stocks underperform properties for two years or longer.
                                                              Indeed, it has happened only twice in the past 20 years

                                                                   MORGAN STANLEY RESEARCH

                                                                   December 8, 2010
                                                                   Investment Perspectives — Europe

Strategy and Economics
(2001~2002 and 2004~2005). In other words, historical              Exhibit 3
trends suggest a 90% chance that stocks will beat properties       Residential Property Bubble in Full Perspective
in 2011, according to the relative performance pattern over        (Value of Residential Property to GDP)
the past 20 years.                                                   350%                                                                                     180

                                                                     300%                                                                                     150
Index targets: Bullish on the Hang Seng. We have raised
our year-end 2011 HSI target by 12% to 29,399, implying 26%          250%                                                                                     120
upside – driven mainly by our new MSCI China target. The
new target suggests a price/book value multiple of 1.84x for         200%                                                                                     90

the Hong Kong local component and 16.8x 2011e earnings
                                                                     150%                                                                                     60
multiple for the Chinese component in the HSI, based on the
consensus outlook for earnings growth.                               100%
                                                                                                        Residential Property Value to GDP
                                                                                                        Property Price Index (RHS)

                                                                      50%                                                                                     0
Both GDP growth and Rmb appreciation drive Hong Kong’s                  Jan-83     Jan-87    Jan-91    Jan-95        Jan-99    Jan-03      Jan-07    Jan-11
valuation. Using our Hong Kong and China economists’               Source: Rating and Valuation Department, CEIC, Morgan Stanley Research
assumptions, the P/BV multiple implied by projected
aggregate GDP growth of 7.2% next year is 1.69x; assuming          Exhibit 4

6.5% Rmb appreciation, the multiple is 2.04x. The median is        Stocks have been underperforming properties in
1.865x, implying little upside in local stocks’ valuation.         2010, which is rare in history
However, given our more bullish Chinese index targets (see           120%                                              Property Price
our note Outlook 2011: A Year of Re-rating), the Chinese             100%
                                                                                                                       HSI Rel to Property Price
components in the HSI raise the 2011 target by 21%.                   80%
Our new target for MSCI Hong Kong has much less upside
because it is a pure Hong Kong local stock index, heavily
dominated by property stocks. We see only 7% upside in this           -20%
index, to 9,361 by year-end 2011, using the prevailing 1.84x          -40%
P/BV multiple.                                                        -60%



                                                                          10 9


                                                                        20 200
Sector preference - Banks and consumers, Underweight
property and utilities. Within the Hong Kong local stocks,         Source: Factset, CEIC, Morgan Stanley Research
there are four main sectors: banks and consumers (which we
                                                                   Exhibit 5
overweight) and properties and utilities (which we
                                                                   Property Valuation Already Holding at High Levels
                                                                     350%                                                                                     3.0
                                                                                 Residential Property Value to GDP
We believe continued economic growth fueled by China and                         HSI Property PBV (RHS)
                                                                     300%        HSI Property PBV - Average (RHS)                                             2.5
low cost of capital will eventually lead to NIM expansion in the
banking sector, which can help banks to outperform. We also          250%                                                                                     2.0
believe the property sector’s valuation will be capped because
property prices have already peaked. Therefore we expect             200%                                                                                     1.5

these stocks should underperform.
                                                                     150%                                                                                     1.0

The consumer sectors in Hong Kong should continue to                 100%                                                                                     0.5
benefit from both high asset prices and strong tourist flow
from China. Utilities are a defensive sector and we                   50%                                                                                     0.0
                                                                        Jan-83     Jan-87    Jan-91     Jan-95       Jan-99     Jan-03      Jan-07   Jan-11
underweight it because we are bullish on the market.
                                                                   Source: Rating and Valuation Department, CEIC, Morgan Stanley Research

Our Hong Kong Focus List, a short list of stocks we like, is
carried forward into 2011, based on this asset allocation

                                                                 MORGAN STANLEY RESEARCH

                                                                 December 8, 2010
                                                                 Investment Perspectives — Europe

Strategy and Economics
December 3, 2010                                                 repositions itself as a premium market for Chinese growth
                                                                 given proven product quality, a productive labor force, and
Taiwan Strategy                                                  strong management execution.
2020 Vision – Taiwan Super-Cycle                                 Risk factors
Morgan Stanley Taiwan   Frank A.Y. Wang                          1) Rate hike cycle reflects improved confidence of
Limited+                economic recovery as inflation is in check (please refer to
                        Angel Lin                                Morgan Stanley’s Taiwan economist Sharon Lam’s research).
                        Philip Yang                              In the last rate hike cycle, TAIEX had a bull market rally
                          during late 2004 to late 2007 until the US financial crisis hit.
                                                                 Sharon forecasts a rate hike of 12.5bp per quarter to 2.125%
Why buy Taiwan in 2011? 1) The Government should stay            through to end-2011.
market friendly with more ‘cross-straits’ policies coinciding    2) Currency appreciation will not be a negative to TAIEX
with global economic recovery ahead of the 2012 Presidential     in 2011 as technology stocks will be more driven by an
election. 2) China and Tech are dual engines of growth           earnings recovery from the cyclical technology upcycle (such
based on: a global tech upgrade cycle; and Taiwan re-            as TFT and semiconductors) that have larger pricing
positioning itself as a premium market for Chinese growth, no    volatilities than currency movements, and non-technology
longer facing a hollowing out of its manufacturing sector. 3)    companies will benefit from the currency appreciation trend
Re-rating and earnings upside potential - 2011 ROE sustains at   that will support the index on increased weightings, in our
15% as in 2010 with upside potential from our 10% EPS growth     view.
forecast on economic recovery. Taiwan has been de-rated in
the past 10 years on concerns of a hollowing out effect to       2011 Taiwan Focus list: This consists of: 1) branded
China, at an average forward P/B of ~1.6x despite higher         companies that can scale up in China’s market; 2) technology
ROE. With a return in confidence from cross-straits trade-       companies with global competitive advantages that China
driven growth, we see Taiwan re-rating to above 2x fwd P/B       lack; and 3) asset reflation beneficiaries from secular growth
with improved ROE.                                               in Chinese visitors.

Our 2011 TAIEX index target is 10,000 (~20% upside               Exhibit 1
potential), or 15x forward P/E and 2x forward P/B based on       2011 Taiwan Focus List
15% ROE and 10% EPS growth for 2011. The market will             Stock                             Key Drivers
recognize fair value in back-to-back years where Taiwan          AU Optronics (2409.TW,            China market-share gain; global TFT LCD
sustains 15% ROE, in our view. Our bull case value, with a       NT$30.8)                          upcycle

10% probability for a re-rating, of 11,000 implies ~30%          Acer (2353.TW, NT$92.8)           Global PC brand scaling up in China

upside; our bear case value, with 20% probability for double-    WPG (3702.TW, NT$55.1)            China distribution network; semiconductor
dip risk, of 7,000 implies ~15% downside.
                                                                 Yulon Motor (2201.TW,             Next ECFA beneficiary; China auto growth
In past years, when TAIEX hit the 10,000 mark, Taiwan had        Taiwan Fertilizer (1722.TW,       Assets reflation
lower ROE and was on higher multiple despite higher interest     NT$112.5)
rates and inflation. We believe our 2011 TAIEX target will be    Yuanta (2885.TW, NT$18.6) Taiwan stock market rally key beneficiary
realized by National Day 2011 (October 10, 2011) on capital      Cathay FHC (2882.TW,              New rate rise cycle; NT$ appreciation
                                                                 NT$46.1)                          demand
repatriation with increased confidence. 2011 is 100th year
                                                                 Epistar (2448.TW, NT$104)         LED leader in Greater China; secular
since the foundation of the Republic of China (ROC).                                               growth in lighting replacement
                                                                 Ralink (3534.TW, NT$109)          Wireless fabless leader in Greater China;
We believe Taiwan will re-rate as a ‘premium’ market for                                           secular growth on foundry expansion
Chinese growth given: 1) after going through cycles in global    Richtek (6286.TW,                 Fabless analog design leader in Greater
competition, surviving companies now have stronger balance       NT$264.5)                         China
sheets, higher earnings quality, and greater shareholder focus   Huaku (2548.TW, NT$87.2)          Property developer leader in Taiwan
(i.e., a good cash dividend) with global competitiveness. 2)     President Chain Store             Retailer leader in Taiwan
                                                                 (2912.TW, NT$121)
Improved confidence that Taiwan will scale up in China’s         Source: Morgan Stanley Research
market using its ‘cultural advantage’ and ECFA benefits. 3)
With expected China-driven volume growth, Taiwan

                                                                                         MORGAN STANLEY RESEARCH

                                                                                         December 8, 2010
                                                                                         Investment Perspectives — Europe

Strategy and Economics
Exhibit 2
2020 Vision: Mega Trends for the Next Decade
Mega trend                        Market view                       Our view                                          Where we could be wrong
Economic Cooperation              Market views ECFA on an           ECFA is a secular trend, not just an event.       Taiwan or China delays ECFA discussions due
Framework Agreement               event basis for trading           More opportunities expected for cross-strait      to a political leadership change or further cross-
is secular, not an event          opportunities around the key      trade. Taiwan leads on IP protection and          straits trade agreements are made beyond the
                                  milestone dates                   technology product management, which it           investment horizon. Article 16 of ECFA states
                                                                    can leverage to scale up in China. With the       Taiwan or China can stop ECFA unilaterally
                                                                    'peace dividend', Taiwan is in a super-cycle      without the other side’s consent. Taiwan’s 2012
                                                                    benefiting from China’s secular growth trend.     Presidential Election and China’s next country-
                                                                                                                      level leadership change in 2013 will be
                                                                                                                      important watch points.

‘Brand in Taiwan’                 Taiwan is mainly a                The Taiwanese market is small so                  Taiwan completely misses the branding
matters                           manufacturing hub; there is       Taiwanese companies focus on ODM/OEM              opportunity in China to scale up, as it doesn't
                                  little brand value for Taiwan     business of US, European and Japanese             change the OEM/ODM mindset of treating
                                  companies.                        brands for export growth. As Taiwan               China as a low-end market. Taiwan companies
                                                                    products have been quality proven for             fail to understand Chinese consumers’ unique
                                                                    developed markets, Taiwan now has a               purchasing behavior and don't build their own
                                                                    unique opportunity to cultivate brands as         logistics networks to capture growth. Taiwan
                                                                    premium products for the Chinese market.          loses in the secular Rmb appreciation trend vs.
                                                                    Over time, Taiwan companies will scale up in      the US$ as its manufacturing cost is mostly
                                                                    China by understanding Chinese consumer           Rmb while most products are priced in US$.
                                                                    demand requirements and building logistics
                                                                    networks amid Rmb appreciation.

Tourism a big factor              Market is bullish on improving    Tourism is in a super-cycle that will lead to a   1) The government fails to invest in core
                                  cross-straits relationship        long-term sustainable retail, infrastructure      infrastructure to accommodate Chinese visitor
                                  leading to strong appreciation    and property boom (e.g., hotels, food and         demand. 2) Tourism agencies treat Chinese
                                  in tourism stocks.                beverage) with new service opportunities          travelers as one-time visitors and fail to gain
                                                                    (e.g., healthcare).                               repeat business due to poor treatment, which
                                                                                                                      may hurt new Chinese visitor demand due to
                                                                                                                      bad publicity. 3) Residents find increased
                                                                                                                      Chinese visitors make an unwelcome impact
                                                                                                                      on daily life, thus Taiwan deliberately decides
                                                                                                                      to keep Chinese visits at a hurdle rate that
                                                                                                                      slows tourism driven economic growth.

Greater China R&D                 Global companies set up R&D       Given the infrastructure investment and           Taiwan falls behind on basic science and
center                            centers directly in China that    strong IP protection awareness, Taiwan is         technology developments, losing out to tier-1
                                  marginalize Taiwan’s growth       well positioned as a Greater China R&D            cities in China that have strong universities and
                                  opportunity given Taiwan is a     Center. Taiwan and China’s IP protection          thus good R&D centers.
                                  much smaller market               agreement gives global companies an R&D
                                  compared to China.                foundation base in Taiwan, as not all countries
                                                                    have IP protection agreements with China.

TSE becomes Asia’s                Taiwan's market is just about     Taiwan is technology-savvy and will be an         Taiwan fails to attract global technology
Nasdaq                            technology and Taiwanese          important technology development center for       companies, regional mid/small cap companies,
                                  technology companies are          China market backed by strong IP protection.      and all Taiwanese-run companies globally for
                                  being marginalized as             Taiwan's tech-focused stock market is a           direct or dual listing on TAIEX despite the
                                  ODM/EMS makers with a lack        good funding vehicle for global technology        strong market appetite. TAIEX falls behind the
                                  of branding are losing global     companies expanding in China, and thus we         likes of Shenzhen's Venture Board in capturing
                                  competitiveness to Korea,         expect them to leverage TAIEX as the main         more listings.
                                  which has stronger brands and     funding source for TDR and direct listings.
                                  larger scale.

‘Treasure island’ from            On improved Taiwan-China          Taiwan is being re-landscaped through the         Taiwan falls behind on execution of its urban
the wealth effect                 cross-straits trade and a low     urban renewal subsidy program. The five           renewal plan given the lengthy process. The
                                  interest rate environment,        new Municipal Cities are effectively an           sharp interest rate rise to curb inflation delays
                                  Taiwan's stock market             administrative re-zoning that help to improve     urban renewal projects. City governments
                                  valuation will improve and        government efficiency by reducing duplication.    approve irrational urban plans for social
                                  property prices will stay on an   The urban renewal subsidy program will            housing locations that negatively affect the
                                  uptrend.                          improve the cities' landscapes allowing for a     property market.
                                                                    more sustainable property market uptrend,
                                                                    as it provides economic incentives to
                                                                    renovate 30+ year old low-end properties.
Source: Morgan Stanley Research

                                                                   MORGAN STANLEY RESEARCH

                                                                   December 8, 2010
                                                                   Investment Perspectives — Europe

Industry Analysis
December 8, 2010                                                   What’s changed?
                                                                   7 Dec 2010                                                                                    PT                                                                        Rating
Charting the Skies; resuming                                       AF-KLM                                                            From €17.2 to €19.9                                                                                                       Overweight
                                                                   BA                                                                              NA to 350p                                                                                 NA to Overweight
coverage of BA (OW), lowering                                      Lufthansa                                                         From €16.5 to €20.0                                                                 From OW to Equal-weight
LHA to EW                                                          Source: Morgan Stanley Research estimates

Morgan Stanley & Co.   Suzanne Todd                                Exhibit 1
International plc              Risk-reward distribution of select carriers
                       Penelope Butcher
                       Pené                   100%
                                                                                                                                                                                     Bull Case                                    Bear case                                    PT
                       Menno Sanderse                                                    80%

                                                                                         40%                                                           28%                                                                                                            27%
                                                                                                             39%                                                                              14%                                 17%
Legacy leverage preferred – yield and volume trends in                                   20%

4Q support our view.                                                            current

We think investors underestimate the ability of network                         -20%

carriers to leverage exposure to 1) the robust uplift in                        -40%
passenger volumes and yields, particularly on long-haul                         -60%
routes; 2) better than expected development of the peak air                     -80%
cargo season; and 3) the potential impact of medium-haul
restructurings and saving programmes. We forecast a return                                               AF-KLM                                        BA                                     LHA                                 EZJ                                 RYA
to peak profitability levels within 12-18 months, yet the legacy   Source: Morgan Stanley Research estimates
shares trade at 25-65% discounts to their prior peaks in 2007.
                                                                   Exhibit 2

Air France-KLM – attractive valuation makes our top-pick,
                                                                   BA is leading the yield momentum in Europe
remain OW with a new PT of €19.90. We think investors                                    25%
                                                                                                                       Air France -KLM                                    British Airways                         Lufthansa                         Iberia
continue to underestimate AF-KLM’s ability to leverage its                               20%

exposure to the robust uplift in yields and underappreciate the                          15%

full savings potential of new cost programmes                                            10%
                                                                    % YoY Yield Growth


British Airways – resuming with Overweight: Ahead of the                                  0%

creation and listing of the new IAG Group on January 24,                                 -5%

2011, we resume interim coverage of BA (including IAG pro                                -10%

forma estimates) at Overweight with a price target of 350p.                              -15%                                       3Q10 yield growth divergence
                                                                                                                                    across peers ranging from 5.9%
                                                                                         -20%                                       (IBLA) to 20.1% (BA)

Lufthansa – a solid play on volume and fare recovery but                                 -25%



















we see few near-term catalysts; downgrade to EW.
Full-year guidance uplifts and strong German macro data
                                                                   Source: Company data, Morgan Stanley Research
have driven share price momentum. We see modest upside
still to come, but the c.15% lift to our PT is less compelling
than AF-KLM (39%) and BA (28%).                                                          Industry View: Attractive
                                                                                         We think passenger and cargo trends will remain favourable in
                                                                                         4Q10 and into 2011 with yield uplift remaining robust,
                                                                                         particularly on long-haul routes. Medium-haul restructurings
                                                                                         and gains from cost saving programmes should further
                                                                                         enhance profitability and support our preference for the major
                                                                                         legacy names. Market share gains and strong load factor
                                                                                         performance should support the low-cost carriers.

                                                                                                             MORGAN STANLEY RESEARCH

                                                                                                             December 8, 2010
                                                                                                             Investment Perspectives — Europe

Industry Analysis

Air France - KLM                                                                                             Lufthansa
Ahead of the Game: Stay OW                                                                                   Into a Hold: Move to EW
Earnings power greater than consensus expects.                                                               FY guidance uplifts and strong German macro data have
We raise our FY11 EBIT forecast to €465 million versus                                                       driven share price momentum. We see modest upside
company guidance for EBIT in excess of €300 million. We are                                                  still to come, but the c.15% lift to our PT is less
30% ahead of consensus for FY12 EBIT (MSe €1,204                                                             compelling than AF-KLM (39%) and BAY (28%). Therefore
million). This equates to delivery of peak profits within 18                                                 we move our recommendation on LUFT back to Equal-weight.
months yet the share price is 65% below the level achieved at
                                                                                                             We think Lufthansa is a solid play on volume and fare
the peak of profitability.
                                                                                                             recovery but we see few near-term triggers for further
Very attractive valuation. AF-KLM delivers 4.3x                                                              outperformance. We see three headwinds into 2011 – capacity
calendarised 2012 PE reduced to 3.4x on removal of the                                                       growth ambitions, German Eco tax absorption and expansion
Amadeus stake. This is significantly cheaper than the peer                                                   of competition at the primary hub of Frankfurt in October
group average of 8.5x. P/BV for FY12e of 0.65x trades at a                                                   2011. Relative to its more leveraged peers AF-KLM and BAY,
32% discount to LHA and BA ratios of 0.94x and 0.98x.                                                        LUFT also faces earnings drag from higher price competition
                                                                                                             in MRO and restructuring efforts in its Systems division.
ROCE target ahead of pre-crisis performance. AF-KLM
now targets a return on capital employed of 8% in year to end                                                These headwinds are balanced by the opportunity to
FY14, higher even than the pre-crisis peak of 7%. We believe                                                 leverage the new base of revenues from SWISS, Austrian
the full cost saving potential of the medium-haul restructure is                                             and bmi into the next up cycle. We outline that LUFT has
underappreciated. Coupled with yield recovery in medium                                                      the opportunity to leverage the purchased ~€6bn of revenues
haul as a result of disciplined capacity, we expect the ROCE                                                 since 2007. Assuming the acquired businesses can return to
target to be exceeded and reach 10% ROCE during FY13.                                                        their previous peak margins, there is around €600m of
                                                                                                             potential EBIT upside from the prior peak in 2007.
Risks to our OW view: 1) slower-than-expected recovery in
passenger business revenues; 2) failure to execute on the                                                    Our new price target of €20.00 per share reflects assumed
achievement of non-fuel unit costs savings at the levels we                                                  growth of 8% in passengers in 2011 as well as modest 2%
assume; and 3) a rapid shift in fuel prices or FX movements                                                  yield increase. We believe this is fair in the context of the
beyond our base case assumptions ($90/bbl and 1.30                                                           above-mentioned headwinds. We look for catalysts on trading
EUR/USD in FY12e) that affects cash flow and leverage.                                                       in January, as well as the first perspective on summer at the
                                                                                                             FY10 results on March 17.
Valuation methodology: Weighted average of discounted
cal 2012 EPS at 10x (based on historical network carrier avg,                                                Valuation methodology: Weighted average of discounted
discounted at CoE (12.6%); DCF and NAV with distressed                                                       2012 EPS, DCF and NAV with distressed asset sale (20%
asset sale (20% discount to fleet value).                                                                    discount to fleet value).

See our report, Air France-KLM – Ahead of the Game: Stay                                                     See our note, Deutsche Lufthansa AG – Into a Hold: Move to
OW, published today.                                                                                         EW, published today.
Exhibit 3                                                                                                    Exhibit 4
Revenues drive recovery: we forecast return to                                                               LUFT returning to peak levels of operating earnings
peak profitability in FY12                                                                                   in FY11
        € 1,281                                                                                                                               1,600
                                                                                           € 1,204                                                                                                                                  1,421
                                                                                                                                                                                                        1,378 1,354

                                                                            € 465                                                             1,200

                                                                                                     € 160
                                                                                                                     perating result (€m

                  € 39                                                              € 50                                                      1,000                                                                          924
                                                                                                                                               800                   718

                         -€ 193     -€ 207                                                                                                                                                577
                                                            -€ 436                                                                             600

                                                                                                                                               200                                                                    130
                                                   -€ 1,632                                                                                      0
            FY08                  FY09                    FY10                FY11e           FY12e                                           (200)
                                             Total EBIT    Cargo Division                                                                             2000    2001   2002   2003   2004   2005   2006   2007   2008   2009   2010   2011

e = Morgan Stanley Research estimates               Source: Company data, Morgan Stanley Research            Source: Company data, Morgan Stanley Research estimates for FY10 and FY11

                                                                                MORGAN STANLEY RESEARCH

                                                                                December 8, 2010
                                                                                Investment Perspectives — Europe

Industry Analysis

British Airways
                                                                                financials of the new company and estimate the group will be
Long delay, now time to play                                                    able to return EBIT margins approaching 8.7% by calendar
                                                                                2012. Based on the combined market caps today, this would
Ahead of the creation and listing of the new IAG Group on                       indicate the group is trading on 7x earnings (assuming 30%
January 24, 2011, we resume interim coverage of BAY                             tax rate).
(including IAG pro forma estimates) at Overweight with a
PT of 350p. The key drivers of our view include:                                Valuation methodology: Weighted average of discounted
                                                                                2012 EPS, DCF and NAV with distressed asset sale (20%
(1) Increased scale drives opportunity: We believe there                        discount to fleet value).
are benefits a network airline can derive from operating at a
large size – most notably, in corporate travel. In addition,                    Exhibit 5
further progress on productivity and volume-driven cost                         BA – Steps to 40p in FY2012
savings present an opportunity to expand margins, in our
(2) Leveraging the ATI partnership with American:                                 50p

Revenue opportunities have been quantified at ~£125m to                                                              24p         24p
BAY. Given the market shares held on key routes such as                                                                                        8p
LHR-JFK we expect there is room for upside to these targets.                      30p
In addition, medium-term opportunities may also arise from                                              14p
ability to co-locate facilities (at JFK) and joint purchasing                     20p                                                                      40p

initiatives (fuel, IT, equipment).
                                                                                  10p       18p
(3) Balance sheet structure improves, but retains some
vulnerability: Capex is rising for BAY, absorbing a large                           p
                                                                                        FY11e EPS     One-offs    Yield + Vol    Fuel     Other Costs   FY12e EPS
portion of cash flow generation. Earnings power will need to
be maintained at least at our estimates to avoid risk of capital                Source: Morgan Stanley Research estimates

injections in the medium term.
                                                                                See our note, British Airways – Long delay, now time to play,
We review the potential pro forma P&L of the new                                published today.
International Airlines Group. We merge the calendarised
Exhibit 6
Pro forma International Airlines Group P&L, 2009-12e
Proforma International Airline Group P&L (in Euros)
                                 FY09     FY10e      FY11e              FY12e
Passenger Revenues             11,958    12,705     14,152             15,264
RPKs                          161,262  161,458    169,979             177,518
  Growth                                    0.1%      5.3%               4.4%   Modest traffic growth assumptions in line with market
Yield per RPK (cents)             7.42      7.87      8.33               8.60

Other Revenues                       2,343       2,527       2,556     2,652
Est. IB Revenue Synergies                                                  67   Assuming pricing power sufficient to cover fuel costs
Total Revenues                     14,301       15,231      16,708    17,983

Fuel Costs                          4,210        4,111       4,729     5,113
Other Costs                        10,830       10,752      10,993    11,497
Est. IB Cost Synergies                                                    133   Additional EBIT leverage by assuming half €400m synergies are achieved
Total Costs                        15,039       14,863      15,722    16,476

EBIT                                  (738)        369         986     1,506    Assumes joint business reaches 8.4% EBIT margin in 2012
                                                                                below prior peak levels reached by BAY and IBLA of 10-11%
Net Interest                          (265)       (198)       (125)      (88)
Other                                  (28)        (39)         17        35
                                                                                Attractive forward PE relative to historic standalone levels
PBT                                 (1,030)        132         878     1,453    ----- was around 10x for BAY and 14x for IBLA
Tax at 30%                             309         (40)       (263)     (436)
Net                                   (721)         92         614     1,017

Current Joint Market Cap (Euros)                                       6,856
Implied FY12 PE                                                           6.7

Source: Company data, Morgan Stanley Research estimates (FY10-12)

                                                                                                   MORGAN STANLEY RESEARCH

                                                                                                   December 8, 2010
                                                                                                   Investment Perspectives — Europe

Industry Analysis

 Our airline universe

                                                                                                     Investment Consideration                                                       Potential Catalysts

                                                                Bull   26.80                   Diversified route exposure relative to peers                         + Revenue gain through ATI partnerships with Delta
      AF-KLM                                       OW           Base   19.90                Onerous fuel hedges limit cost reduction potential                      + Success in unit cost reduction from "Challenge 12"
                                                                Bear   9.20                 Lowest exposure to premium seats of peer group                         -/+ Alitalia turnaround could be driver of equity income
                                                                Bull   550                ATI & merger open new route and cost opportunities                   + Approval of American ATI should enhance transatlantic yields
         BA                                        OW           Base   350                   Most leveraged to UK/US economic recovery                        + Revenue growth through network connectivity via Iberia merger
                                                                Bear   45       Pending increases in costs related to passenger and emissions taxation                 - High mid term capex and pension obligations
                                                                Bull   6.90                    Superior scale and cost base versus peers                                +/- Announcement of fleet replacement order
        RYA                                        OW           Base   4.85        Improving market shares with particular strength in Italy and Spain       + Route maturisation and inc sector length potential boost to yields
                                                                Bear   2.80                Yield moderisation likely as capacity growth slows                 +/- Near term impact on yields of currency movements GBP/EUR
                                                                Bull   1.30             Capacity growth increases LCC penetration in UAE region                   +/- Announcements regarding competitors' capacity plans
        AIRA                        EW                          Base   1.00            Base openings in Africa and Asia will bring price competition                + Evidence of improving control on non-fuel cost base
                                                                Bear   0.53        Little detail on allocation of cash to UAE private equity investments                 +/- Updates on value of investment portfolio
                                                                Bull   6.60       Agreement to join oneworld in 2012 may benefit connecting business          + Opportunity to leverage synergies from Oneworld membership
        AB1                         EW                          Base   4.05          Exposure to long haul subscale & charter faces declining share          + Limited exposure to weak UK market and well placed for E Europe
                                                                Bear   0.00       Balance sheet a risk but manageable if yields don't deteriorate further                  + Updates on impact of NIKI acquisition
                                                                Bull   6.30    Support from fleet valuation in USD, resolution of main shareholder dispute         + Significant opportunity for cost cutting in FY11 and 12
        EZJ                         EW                          Base   5.10              Cost reduction potential in fleet, labour & procurement                        - Main shareholder dispute remains ongoing
                                                                Bear   3.00             Market share upside from competitor capacity reductions                            -/+ Turnaround in ancillary performance
                                                                Bull   28.45           Non-passenger divisions more immune to economic cycle                        + Potential valuation creation from asset divestment
        LHA                         EW                          Base   20.00   Compelling €1bn cost saving programme & potential acquisition synergies        - Exposure to competition on Asia and ME routes highest of peers
                                                                Bear   10.70     Strong Balance Sheet position, although investment capex growing                       - Potential impact of German Eco tax in 2011
                                                                Bull   7.09       Successful establishment of Istanbul as hub; further fleet expansion            +/- Announcements regarding competitors' capacity plans
       THYAO                        EW                          Base   4.64       Robust passenger growth driven by domestic and international traffic         +/- Near term impact on yields of currency movements TL/EUR
                                                                Bear   1.66           Risk that low yields cannot offset expansion strategy costs                           - PT highly sensitive to oil price swing
                                                                Bull   15.30               Company has expanded unrestricted cash balance                          - Return to capacity growth will likely see yield pressure
        VLG                         EW                          Base   10.90              Yield trends impacted by RYA moves in near term                    + Balanced by improving business share & weaker local competitors
                                                                Bear   7.70           Opportunity from potential adjustments at Iberia and Spanair              - High exposure to leases heighten impact of a demand shock
                                                                Bull   31.00         Yield stability and potential return of capacity and traffic growth         - Capacity growth returning while yield pressure is negative
        SAS           UW                                        Base   18.00            Persistent weakness in yields main source of concern                            - Remaining potential asset spinoffs minimal
                                                                Bear   0.00       Continued poor revenue evolution leads to significant B/S weakness          - Weak balance sheet and short haul exposure drag on earnings
                                                                Bull    NA                ATI & merger open new route and cost opportunities                   + Approval of American ATI should enhance transatlantic yields
        IBLA                        NA                          Base    NA           Continued growth in market share and yields on Latam routes               + Revenue growth through network connectivity via BA merger
                                                                Bear    NA             Preservation of yields on domestic and European routes                 - Growing competition from high speed rail and LCC competitors

 Valuation cases stated in local currency. For valuation methodology and risks associated with any price targets above, please email with a request for valuation methodology and risks
 on a particular stock
 Source: Morgan Stanley Research estimates

                                                                        MORGAN STANLEY RESEARCH

                                                                        December 8, 2010
                                                                        Investment Perspectives — Europe

Industry Analysis
December 7, 2010                                                        We firmly believe the opportunities are there for Big Oil to
                                                                        re-rate. If the industry’s track record is anything to go by, if
Oil & Gas                                                               one or two companies take the lead, others will follow.
                                                                        Unfortunately for equity investors today, the key questions of
2011: The Big Oil Scorecard                                             ‘if, when and who’ remain unanswered. The track record and
Morgan Stanley & Co.     Theepan Jothilingam, CFA                       our conversations with management make us believe it may
International plc+          take a little longer for Big Oil to react. With the backdrop of a
                         James R Hubbard, CFA                           bullish call on oil, our preference for 2011 would therefore
                         Matthew P Lofting, CFA, Sasikanth              remain the more leveraged sub-sectors including the Oilfield
                         Chilukuru, Albina Sadykova                     Services and the UK E&Ps.

Since our September note How Big Can Be Beautiful: Oil                  Who’s likely to embrace what of Oil 1.01-1.04 and
1.01-1.04, we have updated our models to incorporate recent             what’s the prize?
portfolio changes – the winners next year will accelerate
restructuring and emphasise exploration and medium-term                 We understand a one-strategy-fits-all approach will not
growth. BP is our best idea among the mega-caps for 1H11.               necessarily be the right one – nonetheless we believe those
We prefer the UK majors to Europe as we upgrade Shell and               companies that embrace change where necessary will be the
lower Total in our order of preference.                                 industry winners.

We review the key themes, recent strategic moves by the                 It would be wrong to say that there has been no response from
companies and outline further potential opportunities for the           the industry in the last 18 months. Since our September report,
European Energy heavyweights during 2011.                               we have seen a number of moves that suggest that the group is
                                                                        willing to consider some of the issues raised by Oil 1.01-1.04.
        Exploration: There has been a clear recognition of
         underinvestment in exploration and its growing                 A more radical approach to restructuring through Oil 1.01 to
         importance – please see our report Get Offshore                close the ‘gap’ to fair value (based on NAV) would favour Shell
         Exploration Exposure, 2 December, 2010.                        or Eni on a purely mathematical approach. However, in terms of
                                                                        actually delivery of Oil 1.01-1.04 – of successfully embracing a
        Restructuring: The view as to how aggressive a
                                                                        more radical approach to portfolio management – BP is the
         restructuring and disposal program should be is mixed.
                                                                        most likely to move furthest and fastest, in our opinion.
         Most management teams are reluctant to embrace a
         ‘shrink to grow’ strategy, albeit recent news flow             Exhibit 1
         suggests a pick-up in activity from Big Oil – since            Growth of 3-5% post Oil 1.01-1.04 would justify a
         September we have seen c.$30 billion of disposals.             40-50% multiple re-rating
        M&A: Remains a selective tool – contrary to our                                                                      Justified P/E, assuming Ke = 10%
         opinion, IOCs view ‘Wall Street’ barrels as expensive                            18

         with the emphasis firmly on early play openers rather                            16

         than large-scale deals. Increasingly on the deal front,                          15
                                                                          Justified P/E

         the IOCs are being squeezed out by resource hungry                                                                                     sector post 1.01-1.04
         NOCs. In aggregate, since September we have seen                                 12

         c.$90 billion of acquisitions.                                                   11
                                                                                                                                                                                     re-rating opportunity

        The dividend: Reducing the payout is not appealing                                9
                                                                                                             sector today
         and the least likely measure in our four-point plan to be



















         embraced. With the exception of BP, European large















                                                                                                                                                       LT growth

         caps are reluctant to rebase the dividend payout.                                                                               ROE=14%        ROE=16%             ROE=18%

        Ratings changes and top pick: We upgrade Shell                 Note: P/E = (roe-g) / (roe * (ke – g)). Roe = return on equity. Ke = cost of equity. g = long-
                                                                        term growth. Source: Morgan Stanley Research;
         and downgrade Total to reflect our thesis. Our best
                                                                                          Industry View: Attractive
         idea for 2011 is BP – alongside depressed valuation, it
                                                                                          Oil & Gas
         is probably best positioned to ‘re-invent’ itself to offer a                     Our view is supported by inexpensive valuation (on an
         better balance of growth and income. We leave ENI on                             absolute and relative basis) and a positive view on medium-
                                                                                          term oil prices.

                                                                                                                                                                         MORGAN STANLEY RESEARCH

                                                                                                                                                                         December 8, 2010
                                                                                                                                                                         Investment Perspectives — Europe

Industry Analysis
Exhibit 2                                                                                                                                                                BP: The road to redemption … top pick of the mega-
Eni would have the highest disposal potential on a                                                                                                                       caps for H1
relative basis, on our selection criteria; however,
the critical question is who is more likely?                                                                                                                             BP – Overweight, PT 555p
                                                                                                                                                                         Has the incentive and track record of embracing change.
                                                                                                                                                                         And is delivering.
                                                  30%                                                                                                                    BP is, in our opinion, the most likely to embrace change for
                  Disposals as a % of group NAV

                                                                                                                                                                         two simple reasons – first, it needs to following Macondo; and
                                                                                                                                                                         second it is a company with a cultural DNA that has risen to
                                                  20%                               19%
                                                                                                                                                 18%                     major challenges and embraced difficult changes time and
                                                  15%                                                                                                                    time again over the last 30 odd years. In reality, with good
                                                                                                                                                                         progress on disposals and the dividend already cut, BP is
                                                                                                                                                                         already some way towards delivering on Oil 1.01 and 1.04.

                                                                                                                                                                               BP – the starting point is valuation: On our new
                                                                ENI                 TOT                  BP                  RDS                Group                           estimates, BP is trading on 6.4x 2012e PE, a c.15%
                                                                       Upstream     Downstream      Midstream     Non-core assets/ investments
                                                                                                                                                                                discount to the sector, a c.20% discount to Shell and a
* Note that the companies have not given any indication that they intend to pursue such a
strategy                 Source: Morgan Stanley Research                                                                                                                        45% discount to its 10-year average multiple. In
                                                                                                                                                                                addition, it is inexpensive in absolute terms at a 26%
‘Upside Case’ – multiple re-rating back to 10-year average                                                                                                                      discount to our base case SOTP valuation – which
We would argue an accelerated portfolio rationalisation                                                                                                                         incorporates an estimated $40bn (post-tax) charge
process for Big Oil is more about portfolio ‘repositioning’ than                                                                                                                relating to Macondo and a 30% devaluation of the
portfolio ‘liquidation’. In that context, the alternative way to                                                                                                                deepwater US GoM portfolio.
look at this is that effective delivery underpins a multiple
re-rating back towards the 10-year average – reversing the                                                                                                                     Production, EPS and cash flow concerns from
progressive de-rating of the past decade.                                                                                                                                       disposals overstated: Our volume and EPS impact is
                                                                                                                                                                                c. 8% for the $20bn of asset sales, which suggests
We believe the ‘upside case’ in this scenario is also material –                                                                                                                concerns BP is losing core cash flows is overdone.
albeit we risk the re-rating at BP at 75%, to account for the                                                                                                                  Increasingly ‘investable’: Dividend restoration in H1
extreme de-rating of the past decade (a premium multiple for                                                                                                                    (we est. 7c / quarter) will invariably attract income funds
much of the first half of the last decade was eroded first by                                                                                                                   and potentially force investors that are underweight or
operational issues at Texas City, Thunderhorse and then                                                                                                                         run neutral positions to reconsider the risks.
Macondo). Even so, we estimate a re-rating of these
proportions carries a prize of between 30-80%, with BP at the                                                                                                                  Perceptions of Macondo liabilities fall: BP raised its
upper-end of the group and ENI at the lower.                                                                                                                                    provision with the Q3 results to c.$40bn (pre-tax). This
                                                                                                                                                                                incorporates fines for the Clean Water Act and no
Exhibit 3                                                                                                                                                                       partner recovery. A reduction in the liability of $5bn
The ‘Upside Case’ – embracing Oil 1.01-1.04 drives                                                                                                                              (post-tax) adds c. 20p/sh (or 4%) to the share price.
a multiple re-rating back toward the 10-yr average…                                                                                                                            Accelerating disposal program: BP has already
                                                  90%                                                                                                    14.0
                                                                                       BP: Re-rating
                                                                                                                                                                                delivered $20bn of its current target of $25-30bn. We
                                                                                       risked at 75%
                                                                                                                                                                                see scope for a target upgrade to nearer $50bn.
 Upside from PE multiple expansion

                                                                                                  The re-rating                                                                Global settlement/Panel Reviews: Increasingly, we
                                                  60%                                             opportunity                                            10.0
                                                                                                                                                                                expect BP and the industry to consider potential
                                                                                                                                                                                settlements in 2011. There are also a number of
                                                                                                                                                                PE ($)

                                                                                                                                                                                ongoing reviews – including the President’s
                                                  30%                                                                                                    6.0                    Commission, which is expected to outline
                                                  20%                                                                                                                           recommendations before 12 January. The market will
                                                  10%                                                                                                                           also look for updates from the US Dept of Justice and
                                                  0%                                                                                                     2.0                    the Marine Board (pencilled in for the Spring).
                                                                  BP                      Total                   Shell                   Eni
                                                  Upside from PE multiple expansion to 10-Yr avg (LHS)     10-Yr Avg PE multiples (RHS)    Current 2012e PE (RHS)

Source: Factset, Morgan Stanley Research estimates

                                                                   MORGAN STANLEY RESEARCH

                                                                   December 8, 2010
                                                                   Investment Perspectives — Europe

Industry Analysis
      Bob Dudley’s first investor presentation – 1 Feb:           Translating capex into a material CFO expansion: We have
       Smaller base, higher growth rates and a change in           remodeled our cash flow projections and have a renewed
       upstream reporting have been outlined. An upside case       confidence that not only will the targeted CFO expansion be
       emerges if BP can persuade investors it can grow            delivered, but FCF expectations exceeded. Importantly, we
       quicker than its peers off a smaller base and that the      think there is risk that perceptions of cash flow expansion will
       underlying safety track record is being addressed.          be accelerated in 2011, with group capex likely to be at the
                                                                   lower end of the $25-30bn guidance range. The latter point is
      Raising PT to 555p/sh: We remove the previous
                                                                   underpinned by risks of lower spend next year on US gas
       small discount to base DCF. Our SOTP is 586p/sh.
                                                                   (currently $3-3.5bn p.a.), the decision to hold off on exploration
Deterioration in GoM volumes a key risk: GoM barrels are           in the Chukchi Sea (Alaska) and uncertainty in the GoM.
high margin – if the lack of activity persists and decline rates
accelerate, BP is disproportionately exposed to an erosion in      E&P momentum: After c.3.5% volume growth this year, we
profitability.                                                     anticipate continued growth and estimate an upper quartile
                                                                   2% 2010-12e CAGR – underpinned by ramp-ups at Pearl
Shell – EW, PT £23.00                                              GTL & Qatargas (both Qatar). On exploration, we sense a
Showing signs of managing the portfolio more                       heightened appetite and think the budget could rise to $4-5bn
aggressively – perhaps closer to Oil 1.01-1.04 than we             p.a. – while the program for 2011 looks interesting and
thought.                                                           includes Brazil, French Guiana and Chinese tight gas.
Under Peter Voser, Shell has regrouped and focused on
execution and delivery of its megaprojects, most notably in        Valuation – inexpensive in absolute terms but less
the deepwater, Qatar and Canada. Increasingly, the company         compelling on a relative basis: Shell is trading at a notable
appears willing to adjust its strategy and, in particular, its     25% discount to our base case SOTP (LT $90/bbl) and is
approach to portfolio management – the part sale of its stake      inexpensive versus consensus EU market multiples.
in Woodside last month was evidence of this. We sense a            However, a 7.9x 2012e PE multiple leaves the shares trading
sea-change at Shell – historically at least, it has proved         at a c.25% and c.10% premium to BP and Total respectively –
slower and less nimble in navigating periods of material           and we are concerned this premium combined with relative
industry change. However, with increasing confidence around        outperformance could constrain performance during 1H11.
its cash generation, we think there is potential for the
company to embrace our four-point plan more aggressively.          Total – Equal-weight, PT €44
                                                                   Time to embrace change again, after nine years’ slumber.
Upgrading to Equal-weight – limited downside, but                  Total is probably the sleeping giant of the three mega-caps,
relative valuation less compelling                                 with material upside possible from Oil 1.01-1.04, but little
Please refer to our note Delivery and Restructuring Catalysts      evidence to support a view that it will wholeheartedly embrace
Offset by Valuation for more details. We acknowledge that          such radical change.
after recent relative outperformance we are somewhat ‘late to
the party’. However, in addition to being incrementally            Downgrading to Equal-weight – limited potential to
comfortable that a free cash flow expansion can materialise in     unlock value
2011/12, we also see material upside to Shell’s $7-8bn             Please refer to our note Limited Potential to Unlock Value –
disposal program, an E&P division well positioned to exhibit       Downgrade to EW for more details. Whilst Total is relatively
continued momentum and a stronger appetite for exploration.        inexpensive (both in relative and absolute terms), the company
                                                                   appears unlikely to embrace more radical portfolio restructuring
Scope to increase the $7-8bn disposal program threefold:           (as we advocate under Oil 1.01-1.04) in the immediate term.
Our analysis suggests Shell could triple its existing $7-8bn       With 2011 also a quieter year in terms of catalysts and volume
disposal target, with the recent partial sale of Woodside          growth (expected to be flat y/y), we therefore downgrade to EW.
highlighting an appetite to rationalise the portfolio. We
estimate a program of this magnitude could be worth c.£1/sh        Total unlikely to embrace Oil 1.01-1.04 near term:
unrisked and see Shell as the most likely within European Big      We believe EU 'Big Oil' is at a crossroads and needs to adopt a
Oil to exceed our expectations around delivery on our four-        more radical approach to portfolio repositioning to unlock value.
point ‘Oil 1.01-1.04’ plan in 2011.                                Whilst we see material restructuring upside at Total (c.$29bn of
                                                                   potentially disposable assets), we detect only a limited appetite
                                                                   to date and see greater potential for change at both BP and Shell.

                                                                                                   MORGAN STANLEY RESEARCH

                                                                                                   December 8, 2010
                                                                                                   Investment Perspectives — Europe

Industry Analysis
Rising spot gas exposure limiting Total’s ability to translate                                     unconventionals (where Big Oil’s technological expertise can
operational momentum into financial performance:                                                   come to the fore); 2) Relatively smaller positions in refining and
Total’s exposure to weak spot gas markets has risen over the                                       chemicals; 3) Substantial balance sheet capacity and flexibility.
last 12m (ramp-up of Middle East LNG, entry into US shale gas
and higher Syrian gas volumes). We estimate portfolio gearing                                      Oil 1.02 – Re-gearing to exploration: Increased balance
to US spot gas has gone from negligible levels to 6-7% – which                                     sheet strength should help convince management teams to
has had a negative drag on earnings. We therefore adopt a                                          take on more risk. This should come in two (organic) ways:
more conservative stance on gas earnings, and lower medium-                                        1.02 (a) Increase exploration budgets by two or three times,
term group EPS forecasts by c.7% p.a.                                                              drill more frontier exploration and increase market disclosure;
                                                                                                   and 1.02 (b) Increase growth spend, with a clear emphasis
Catalysts now appear more limited: After relatively strong                                         that incremental dollars are being spent on growth projects
operational progress over the last 12m, visible share price                                        (as opposed to maintenance).
catalysts now appear more muted on a 6-12m view –
particularly with 2011 volume growth set to be broadly flat.                                       Oil 1.03 – Take the M&A road – more aggressively:
                                                                                                   Management teams need to be bolder and put a greater
ENI – Underweight, PT €18                                                                          emphasis on upstream M&A that genuinely ‘moves the dial’. In
Longer-term upside in selling non-core companies.                                                  particular, we think Big Oil should seek exploration assets
ENI’s upside within Oil 1.01-1.04 clearly lies in its significant                                  offering exposure to frontier regions, access to legacy projects
non-core holdings in associated companies, rather than                                             where the group can bring its technological skill-set to the table
upstream reserve sales. Whilst it is hard to see material                                          and assets that reinforce differentiated geographical hubs.
disposals occurring over the next six months, if we take the
longer-term view and look towards a potential longer-term                                          Oil 1.04 – Then cut the payout – gives more money to
change in strategy, the potential sales and ensuing removal of                                     spend: If Big Oil wants to be seen as something other than
today’s material conglomerate discount could well make ENI                                         income stocks, it needs to do something about it. The group
one of the stronger 3-5 year investment cases                                                      gets little credit for its above average payout, which we do not
                                                                                                   believe particularly underpins the rating of Big Oil today. We
                                                                                                   argue that if the group can outline a credible logic for growth
A summary of Oil 1.01-1.04 … a four-point plan
                                                                                                   (Oil 1.01 to 1.03), then there is an opportunity to reduce the
to narrow the valuation discount for Big Oil                                                       payout (and re-invest cash savings). We estimate lowering
                                                                                                   the average yield to 5% would generate aggregate savings of
Oil 1.01 – ‘Shrink to grow’: An accelerated company-wide
                                                                                                   c.US$13bn and lower cash breakeven by c.$5/bbl.
divestment program, leaving: 1) An upstream business with
substantially better growth prospects, which is more exposed to                                    Prices for stocks mentioned: Shell 2,000p, Total €38.06, Eni €15.75, BP 435p

Exhibit 4
Relative risk-reward profiles – BP is clear winner in our order of preference

        40%                   28%
                                                               15%                              16%                                14%
        20%                                                                                                                                                        BASE
       -60%                                                                                                                                                        BEAR
                                BP                           RD Shell                            Total                             Eni
For valuation methodology and risks associated with any price targets above, please email with a request for valuation methodology and risks on a
particular stock.                                                                                                                             Source: Morgan Stanley Research estimates

                                                                   MORGAN STANLEY RESEARCH

                                                                   December 8, 2010
                                                                   Investment Perspectives — Europe

Industry Analysis
December 8, 2010                                                   What’s changed?

Telecom Services                                                   Rating changes                                        New                             Old

                                                                   Iliad                                                  EW                            OW
Stocks for 2011                                                    COLT                                                   EW                            OW
                                                                   TPSA                                                   UW                             EW
Morgan Stanley & Co.    Nick Delfas
International plc
                                                                   TeliaSonera                                            UW                             EW
                        Luis Prota, Frederic Boulan,
                        Terence Tsui, Ryan Fox

Flat 2010, Flat to up 2011. Telecoms have been flat relative
in 2010. Our DCF-driven price targets suggest 20% upside in        Price Target Changes                                  New                             Old
2011 (similar to Morgan Stanley’s strategists’ market view of
                                                                   Belgacom                                           €28.50                         €28.00
+15%), so our industry view remains ‘In Line’, and importantly
                                                                   Bouygues                                           €38.00                         €38.00
telcos do have downside protection due to dividends providing
                                                                   BT Group                                            £2.00                          £1.55
nearly half the return – this improves the risk return. We
                                                                   Deutsche Telekom                                   €11.00                         €11.00
would upgrade to ‘Attractive’ at prices 10% below current          France Telecom                                     €20.00                         €20.00
levels, as current FCFE yields merely fairly reflect the cost of   KPN                                                €15.00                         €15.00
equity plus some shrinkage in telco FCFE.                          OTE                                                €11.50                          €7.50
                                                                   Swisscom                                         SFr 493                        SFr 466
Stock selection. We suggest investors build their portfolio “à     Tele2                                          SKr 155.0                      SKr 145.0
la carte” from the following categories:                           Telecom Italia (Ords)                               €1.20                          €1.20
                                                                   Telecom Italia (Savs)                               €1.00                          €1.00
           Growth. Our top pick in the sector this year is        TEF                                                €21.00                         €22.00
            Telenor for value plus growth – last year was BT       Telekom Austria                                    €13.00                         €12.50
            and in 2008 Telefonica. We also remain OW KDG          Telenor                                        NKr 127.0                      NKr 120.0
            and Telenet.                                           TeliaSonera                                     SKr 58.0                       SKr 58.0
                                                                   Vodafone                                            £1.90                          £1.75
           Out of consensus calls: OTE; ultimately TI? OTE        TEF O2 CR                                       CZK 450                        CZK 510
            could double (or halve) from current levels – an       TPSA                                            PLN 17.0                       PLN 19.0

            attractive risk reward. TI could see some earnings     CWC                                                 £0.57                          £0.72
                                                                   CWW                                                 £0.70                          £0.85
            risk – but could offer value thereafter.
                                                                   Colt                                                £1.50                          £1.70
                                                                   Freenet                                            €13.00                         €12.00
           Basic FCF exposure. FT, KPN, Telefonica.
                                                                   Iliad                                            €100.00                        €107.00
                                                                   Inmarsat                                            £7.60                          £8.05
In the short term we also expect Vodafone (EW) to perform
                                                                   Kabel Deutschland                                  €41.00                         €36.00
well due to asset sales / agreement with VZ.                       TalkTalk                                            £1.90                          £1.60
                                                                   Telenet                                             €30.0                          €27.5
Mobile data – overhyped. We are not mobile data bulls.             For valuation methodology and risks associated with any price targets above, please email
                                                          with a request for valuation methodology and
Pricing power will remain weak due to over-capacity; revenue       risks on a particular stock.                           Source: Morgan Stanley Research
growth consists of “hire purchase” of handsets; sector
EBITDA is clearly still falling; returns are too high. Some
good news is Apple’s falling share of smartphones: this
redresses the balance of power (slightly) in favour of

Key risk: voice pricing. The biggest risk will be how
                                                                       Industry View: In-Line
challengers use lower MTRs in Germany and Belgium – we                 We see more limited absolute upside for European telecom
reiterate our UWs on DT and Belgacom for this reason among             stocks in 2010. Higher prices and slightly lower forecasts
others.                                                                mean much of the previous value gap has been extinguished.

                                                                                                                                                              MORGAN STANLEY RESEARCH

                                                                                                                                                              December 8, 2010
                                                                                                                                                              Investment Perspectives — Europe

Industry Analysis
Exhibit 1                                                                                                                                                     Exhibit 2
Cable valuation converges towards Telcos by 2014                                                                                                              Organic Growth Remains Rare
                      14                                                                                                                                                                                Revenue                         EBITDA
                                                                                                                                  2011e                                                            Organic       Reported        Organic        Reported
                                                                                                                                  2014e                       BT (%)                                   -2.8            -2.8            2.8              2.8
                                                                                                                                                              DT (%)                                   -2.1            -4.1           -8.2              -9.2
                                                                                                                                                              FT (%)                                   -0.6            -8.3           -3.5              -7.3
  EV/OpFCF multiple


                                                                                                                                                              KPN (%)                                   0.6            1.4             3.2              5.9
                                                                                                                                                              OTE (%)                                  -8.3            -7.8         -14.5              -14.9
                       9                                                                                                                                      PT (%)                                    0.3             0.3           -3.8              -3.8
                                                                                                                                                              Swisscom (%)                              3.6            0.7             2.8              0.6
                                                                                                                                                              TEF (%)                                   3.5            6.9            -2.3              2.7
                       7                                                                                                                                      Tele2 (%)                                 6.0            2.6           17.0              12.7
                                                                                                                                                              Telenor (%)                               5.7            5.8             8.0              7.4
                           KDG   Liberty   Telenet     VMED                    ZON         European                         European                          TeliaSonera (%)                           4.3            -1.1            4.0              0.1
                                 Global                                                     Cable                           Telecoms
                                                                                                                                                              TI (%)                                   -4.4            0.0            -2.0              -8.0
Source: Morgan Stanley Research estimates                                                                                                                     TKA (%)                                  -3.8            -3.8           -8.3              -8.3
                                                                                                                                                              VOD (%)                                   2.3            2.9            -1.2              -2.8
                                                                                                                                                              Source: Company data, Morgan Stanley Research

Exhibit 3
Morgan Stanley European Telecoms: Our Order of Preference
                                                     Valuation                                                                                       Com m ents
                                                                                                                                    2011E FCFE tax
                                                                                                               ex licence amort
                                                                                            Total return (%)
                                                                         (downside) (%)

                                                                                                               Modelware P/E
                                                          Price Target

                                                                                                                                    adj. (%)


                                                                                                                                                     Key elements of view
Overw eight
Telenor                                                  127               35.6           39.5                          9.7            9.8           Best combination of grow th and value.
France Telecom                                          20.0               27.2           36.1                          8.8           13.0           Attractive valuation; concerns on Iliad launch, fixed and mobile pricing pressure priced in.
KPN                                                     15.0               36.4           43.7                          7.7           13.7           Solid cash return the engine of value creation. Some cable / management uncertainty.
Kabel Deutschland                                       41.0              14.0            14.0                          NM            7.0            Strongest grow th profile in European cable/telcos: 7% top-line grow th, 10% EBITDA grow th.
OTE                                                     11.5              54.4            56.9                        18.5           11.3            FCF stabilising, more rational pricing environment, macro situation already priced in.
TalkTalk                                                1.90              17.5            20.9                        10.4            7.5            Compelling cost-cutting story and beneficiary of consolidation in UK broadband.
Telenet                                                 30.0               -0.9           12.3                        22.0            6.6            Strong divi (13%) but harder to see rating upside.
Telefonica                                              21.0              23.4            31.6                         7.9           12.0            Combination of Latam / Europe exposure. We think our Spanish numbers look achievable.
Freenet                                                 13.0              73.3            86.6                        12.3           21.9            Cheap valuation, but also potential for grow th via pivotal role in the German contract market.
Equal-w eight
Bouygues                                               38.0               22.2            27.3                        10.9             3.7           Consensus ests still too high, but significant upside to mark-to-market.
Telekom Austria                                        13.0               21.9            28.9                        17.3            10.5           Profit w arning suggests very limited immediate dow nside. Valuation and dividend attractive.
British Telecom                                        2.00               12.7            17.0                         9.6            10.0           Restructuring, improving regulation including content, GS upside, positive new sflow from pensions.
Vodafone                                               1.90               15.2            21.8                         7.8            11.2           Better earnings momentum, plus disposal / dividend upside.
Colt Telecom                                           1.50               16.3            16.3                        15.9             5.7           High current FCFE yield plus scope to grow in managed services. M&A accretive given tax.
Iliad                                                 100.0               27.4            27.9                        15.4             4.8           Optionality on mobile business is very significant, and w e think success is likely.
Sw isscom                                               493               19.4            24.9                         9.2             9.4           Defensive proposition; headline grow th trimmed by MTR cuts, some pricing risk.
Inmarsat                                               7.60               14.1            17.6                        14.3             8.2           Core business fairly valued, upside from spectrum, but potential new capex in Ka-band.
Cable & Wireless Communications                        0.57               18.6            29.2                        10.0             8.5           Attractive dividend, but too early to call a Caribbean recovery
Telecom Italia (Savers)                                1.00               23.4            30.9                         6.7            21.2           Cheap valuation, domestic mobile should stabilise, Brazil still providing strong grow th
Telecom Italia (Ords)                                  1.20               22.3            27.4                         8.1            17.5           Cheap valuation, domestic mobile should stabilise, Brazil still providing strong grow th
Telefonica O2 Czech Rep                                 450               15.6            25.9                        13.2            11.7           Well supported dividend, but challenging economic environment.
Tele2                                                   155                5.4             9.5                        16.5             4.6           Positive momentum in Russia and Sw eden
Underw eight
TP                                                      17.1               -0.5            8.3                        20.1             8.4           Discounted value hidden by fibre investment plan. Current earnings momentum still -ve how ever.
Belgacom                                                28.5                8.9           17.2                         9.3            10.5           Competition fine issues, plus MTR creating price w ar risk in mobile.
TeliaSonera                                             58.0                7.0           12.0                        10.8             8.1           Expensive considering w here it is operating; Turkcell facing challenges.
Cable & Wireless Worldw ide                             0.70                7.3           14.2                         8.8             8.4           Gross margin expectations likely to be disappointed and/or higher capital intensity.
Deutsche Telekom                                        11.0               11.7           18.8                        10.7            10.7           Declining FCFE; tough US and domestic fixed.
Source: Morgan Stanley Research

                                                                    MORGAN STANLEY RESEARCH

                                                                    December 8, 2010
                                                                    Investment Perspectives — Europe

Industry Analysis
Stocks for 2011
Telecoms have been flat relative in 2010 – a total shareholder            Out of consensus calls: OTE; ultimately TI? OTE
return of 9.6% versus 9.8% for the STOXX 600.                              could double (or halve) from current levels – an
                                                                           attractive risk reward. TI could see some earnings risk
Our DCF-driven price targets suggest 20% upside in 2011                    – but could offer value thereafter.
(similar to Morgan Stanley’s strategists’ market view of
+15%), so our industry view remains ‘In Line’, and importantly            Basic FCF exposure. FT, KPN, Telefonica. These
telcos do have downside protection due to dividends providing              stocks benefit from low valuations, high cash returns
nearly half the return – this improves the risk return. Relative           and stable or stabilizing core businesses.
performance could be slightly better in 2011.
                                                                    In the short term we also expect Vodafone (EW) to perform
We would upgrade to ‘Attractive’ at prices 10% below                well due to asset sales / agreement with VZ (covered by
current levels, all else equal. One way to rationalize this is      Simon Flannery).
that current FCFE yields merely fairly reflect the cost of equity
plus some shrinkage in telco FCFE. Assuming a cost of               Recommendation changes are Telia to UW on valuation; Iliad
equity of 9.5%, the sector average FCFE yield of 11.1%              down to EW; Colt down to EW; TPSA down to UW. Our order
compensates for a 1-2% annual erosion in the FCFE of the            of preference is shown in Exhibit 3.
sector into perpetuity. Given declining returns in mobile and
continuing EBITDA decline at major operators (FT, DT,               Our price target changes are principally due to roll-forwards to
Telefonica, Vodafone) this seems merely fair rather than            end 2011. Other significant drivers are:
cheap. 2010 was a good year for opFCF progression for the
sector (flat) but had the benefit of an easier comp due to the            TEF O2 Czech: Deterioration in mobile trends in Q3,
financial crisis.                                                          together with an accelerated MTR decline of -40% in
                                                                           H2'11 from -30% in 2010;
Mobile data – overhyped. We are not mobile data bulls for
developed Europe, and in general continue to prefer                       Colt: Slightly weaker cash generation and data growth
fixed/cable exposure. Pricing power will remain weak due to                during 2010;
over-capacity; revenue growth consists of “hire purchase” of
handsets; sector EBITDA is clearly still falling; returns are too         CWC: Lower estimates in Panama (following H1
high. Some good news is Apple’s falling share of                           warning on enterprise contracts), together with
smartphones: this redresses the balance of power (slightly) in             continued underperformance vs. Digicel in the
favour of operators (Apple is covered by Katy Huberty).                    Caribbean;

Key risk: voice pricing. The biggest risk will be how                     CWW: Lower gross margin growth following H1
challengers use lower MTRs in Germany and Belgium – we                     results;
reiterate our UWs on DT and Belgacom for this reason among
others.                                                                   TalkTalk: Higher medium term MSe EBITDA margin
                                                                           from 16% to 19% following company guidance of a
Stock selection                                                            20% EBITDA margin;

We suggest investors build their portfolio “a la carte” from the
                                                                    TPSA: We are 4.1% below consensus EBITDA for 2011,
following categories:
                                                                    8.5% for 2012 given current trends.

      Growth. Our top pick in the sector this year is Telenor
       for value plus growth – last year was BT and in 2008
       Telefonica. Telenor screens well due to top line
       growth (currently 6%, 3% expected 2011); rising
       EBITDA margins and falling capex, plus a FCFE yield
       of 13% excluding Indian losses. We also remain OW
       KDG and Telenet.

                                                                                                            MORGAN STANLEY RESEARCH

                                                                                                            December 8, 2010
                                                                                                            Investment Perspectives — Europe

Industry Analysis

 Exhibit 4
 European Valuation Comparables
                                              Price  Price     Bull   Bear Upside to       Total Mkt Cap             Ppt EV / Ppt EBITDA           Modelw are P/E adj lic. Am ort     Adjusted FCFE Yield (%) ex spectrum           Ppt EV/OpFCF
                                Rating Curr. 07-Dec Target    Case    Case Target (%) Return (%) EUR mn      2009       2010e      2011e   2012e   2009   2010e     2011e       2012e    2009    2010e     2011e     2012e   2009   2010e    2011e   2012e
  Belgacom                          U EUR     25.8     28.5    37.1    18.3      10.4      18.9     8,417      5.2         5.1       5.1     5.1    8.2       8.8      9.2       9.0     11.3       9.8     10.7      10.1    6.8      7.4     7.3     7.3
  Bouygues                          E EUR    31.57     38.0    54.0    19.0      20.4      25.4    11,185      3.8         3.8       3.8     3.5    9.1      11.4     11.0       9.2     20.9       4.0      3.6       8.4    5.4      6.4     6.7     6.1
  BT Group                          E GBP     1.78     2.00    2.55    1.20      12.4      16.6    16,334      4.8         5.1       4.9     4.6   12.1       9.0      8.5       8.2     10.9       9.4     10.5      10.9    8.7      9.2     8.7     8.2
  Deutsche Telekom                  U EUR     9.86     11.0    13.4     8.0      11.6      18.7    42,917      5.1         5.4       5.4     5.2    9.9       9.9     10.7      10.5     12.1      11.7     10.8      10.7    9.8     10.4    10.6    10.3
  France Telecom                    O EUR    15.84     20.0    22.3    14.0      26.3      35.1    42,060      4.9         5.0       5.0     5.0    9.9       9.1      8.9       9.2     13.0      13.1     12.9      11.9    7.8      8.0     8.6     8.8
  KPN                               O EUR    11.06     15.0    18.2     8.4      35.6      42.9    18,017      6.0         5.3       5.2     5.0    7.7       8.5      7.8       7.2     13.2      13.2     13.6      14.3    9.1      8.0     8.3     8.0
  OTE                               O EUR     7.52     11.5    15.0     5.5      52.9      55.5     3,685      4.8         4.4       4.6     4.5   11.0      15.3     18.6      17.8     11.8       9.9     11.2      12.3    8.3      7.9     8.3     8.0
  Portugal Telecom                  ++ EUR   10.12      ++      ++      ++         ++        ++     8,864      8.4         5.8       4.5     4.2   12.7      17.2     14.3      12.6      2.2       2.2      5.9       6.7   19.9     12.4     9.2     7.8
  Sw isscom                         E CHF       413    493     589     367       19.3      24.9    16,517      6.4         6.6       6.4     6.3    9.0       9.3      8.9       8.6     10.2       8.7      9.8       9.8   10.9     11.1    10.4    10.3
  Tele2                             E SEK    148.4     155     190     125        4.4       8.5     7,232      7.2         6.3       6.2     5.8   13.8      11.2     15.5      15.3      6.9       7.7      4.2       6.2   13.4     10.3    13.4    10.5
  Telecom Italia (Ords)             E EUR     0.98     1.20    1.70    0.85      22.8      27.9    17,978      4.9         4.5       4.0     3.8    8.6       8.2      7.8       7.9     12.9      15.0     17.6      18.8    8.5      7.5     6.5     6.4
  Telecom Italia (Savs)             E EUR     0.81     1.00    1.42    0.72      22.9      30.3    17,978      4.9         4.5       4.0     3.8    7.2       6.8      6.5       6.6     15.4      18.0     21.1      22.6    8.5      7.5     6.5     6.4
  Telefonica                        O EUR    17.03     21.0    26.4    13.7      23.3      31.5    77,708      5.7         4.7       5.2     5.0    9.0       6.1      8.1       7.9     10.2      10.6     11.8      12.3    8.0      5.7     6.7     7.0
  Telekom Austria                   E EUR    10.69     13.0    15.5     8.7      21.6      28.6     4,828      4.5         5.1       5.0     4.8   13.2      17.6     17.3      14.4     13.4      -0.4     10.4      10.9    7.4      9.4     9.8     9.2
  Telenor                           O NOK     93.4    127.0   137.0    95.0      36.0      39.9    19,427      NM          6.0       5.0     4.5   12.4      13.0      9.6       8.4      NM       10.7     10.8      10.2    NM       9.1     7.8     7.4
  TeliaSonera                       U SEK     54.5     58.0    63.0    48.0       6.4      11.4    26,786      7.5         5.4       5.2     5.0   11.6      11.2     10.9      11.0      6.9       7.8      8.1       8.4   12.2      7.5     7.3     7.1
  Vodafone                          E GBP     1.65     1.90    2.20    0.02      15.0      21.7   103,948      5.4         5.4       5.1     4.8    8.1       8.1      7.9       7.6     11.1      11.1     11.2      11.2    7.9      7.5     7.4     6.9
  Total Average for the Telecom s Sector                                         21.3      27.4                5.6         5.2       5.0     4.8   10.2      10.6     10.7      10.1     11.4       9.6     10.8      11.5    9.5      8.6     8.4     8.0
  Total Weighted Average for Telecom s sector                                    19.7      26.4                5.3         5.1       5.0     4.8    9.4       8.9      9.1       8.8     11.1      10.9     11.5      11.9    8.4      7.8     7.9     7.7
  TEF O2 Czech                      E CZK    386.5    450.0   540.0   310.0      16.4      26.9     4,956      5.0         4.7       4.9     5.2   10.8      12.6     13.1      13.7      6.9      13.0     11.8      11.0    7.2      5.9     6.1     6.5
  TPSA                              U PLN    17.15     17.0    21.0    13.0      -0.9       7.9     5,692      4.3         6.3       5.4     5.6   17.4     115.9     20.1      19.8     16.9      10.7      8.4       9.8    6.6     14.3    11.1    11.1

  Cable & Wireless Communications   E GBP     0.48     0.57    0.75    0.37      18.2      28.6     1,485      NM          2.9       2.9     3.0   10.6      10.0     10.1       9.8      NM        7.9      8.4      10.8    NM       3.9     3.9     4.0
  Cable & Wireless Worldw ide       U GBP     0.66     0.70    1.05    0.50       6.5      13.4     2,063      5.7         3.3       3.5     3.3    8.0       9.4      8.8       8.3      7.9       6.9      8.3       8.5   16.0      9.1    10.1     9.5
  Colt                              O EUR     1.31     1.50    1.90    0.70      14.7      14.7     1,385      3.2         3.5       3.1     2.8   19.3      23.6     16.2      15.3      7.8       3.1      5.6       7.1   10.0     12.8    11.8    14.3
  Freenet                           O EUR       7.8    13.0    16.0     6.0      66.8      79.6      998       5.5         5.1       4.3     4.2   12.1      13.7     12.8      11.4     29.5      22.4     21.1      20.7    5.8      5.8     4.9     5.0
  Iliad                             E EUR     78.7     100     171      53       27.1      27.6     4,606      8.9         6.9       6.9     6.9   26.2      14.3     15.4      17.8      0.3       1.1      4.8       5.9   30.0     18.0    22.3    28.7
  Inmarsat                          E GBP     6.74     7.60    9.80    4.55      12.8      16.2     3,849     11.3         9.4       7.1     7.7   32.1      21.8     13.1      15.4      7.3       6.6      8.5       7.5   14.5     14.4    16.1    19.4
  Kabel Deutschland                 O EUR     36.0     41.0    65.0    16.0      13.9      13.9     3,240      7.2         8.3       7.1     6.4    NM        NM       NM       14.3      4.3       3.5      7.0       9.5   14.2     16.0    12.6    10.6
  TalkTalk                          O GBP     1.64     1.90    3.50    0.70      15.9      19.2     1,779      NM          7.0       6.1     5.0    NM       11.4     10.6       8.7      NM        6.9      7.4       9.3    NM      11.5     9.5     7.3
  Telenet                           O EUR     30.2     30.0    37.0    23.0       -0.8     12.4     3,471      7.7         9.1       8.7     8.6   49.7      46.4     22.0      21.3      0.8       5.0      6.6       7.4   16.3     15.9    14.0    13.0
  Virgin Media                      O USD     27.0     29.0    38.0    17.0       7.4       7.8     4,132      6.8         7.5       6.8     6.3    NM        NM      34.7      19.7      3.9       6.6      4.9       6.0   11.9     13.2    12.2    10.8
  Total Average for Altnets                                                      14.8      19.5                6.8         6.2       5.6     5.3   21.3      18.0     15.3      13.7      7.2       6.4      8.7       9.6   14.7     11.9    11.5    11.8
 ++ Rating and price target for this company have been removed from consideration in this report because, under applicable law and/or Morgan Stanley policy, Morgan Stanley may be precluded from issuing such information with
 respect to this company at this time.
 e = Morgan Stanley Research estimates, NM = Not meaningful

                                                                   MORGAN STANLEY RESEARCH

                                                                   December 8, 2010
                                                                   Investment Perspectives — Europe

Industry Analysis
December 7, 2010                                                   Top/bottom picks

Utilities                                                          6 Dec 2010                                  Price                                                     PT              Up/

Staying Cautious into 2011                                         Top picks
                                                                   Centrica                                    316p                                                 360p                     14%         Overweight
Morgan Stanley & Co.   Emmanuel Turpin
                                                                   EDF                                         €31.6                                                €45.0                    42%         Overweight
International plc
                       Bobby Chada, Antonella Bianchessi           Enagas                                      €14.9                                                €17.8                    20%         Overweight
                       Nicholas Ashworth, Sean Lee, Igor Kuzmin    ENEL                                         €3.7                                                 €5.0                    36%         Overweight
                                                                   Suez Environ.                               €13.9                                                €15.5                    12%         Overweight
Challenges aplenty – focus on defensive names + self-help
stories: We retain our Cautious stance on the sector, in the
                                                                   Bottom picks
context of 1) the enduring oversupply situation and an
                                                                   Drax                                        373p                                                 380p                      2% Underweight
operating environment as challenging as ever; 2) some further
                                                                   E.ON                                        €22.3                                                €25.5                    15% Underweight
downside to consensus estimates, we believe; and 3) sector
                                                                   Gas Natural                                 €11.2                                                 €9.4                   -16% Underweight
valuation does not yet reflect the subdued growth outlook and
                                                                   Iberdrola                                    €5.4                                                 €5.4                     0% Underweight
risky environment. We would advise focusing on capital
                                                                   RWE                                         €48.3                                                €65.5                    36% Underweight
preservation and the more defensive regulated names, as            Source: FactSet (share price data), Morgan Stanley Research estimates
well as specific self-help growth stories.

Our top picks for 2011: Centrica, EDF, Enagas, ENEL, and
Suez Environnement.                                                Dissection of growth: Invested capital vs. NOPAT

                                                                                                                                  Growth in NOPAT (10e-13e)
Our bottom picks: Drax, E.ON, Gas Natural, Iberdrola and
                                                                     70.0%                                                  ACC                                                                             EDPR
Exhibit 4 shows our order of preference for the sector.                                                                                                                                IBR


Lowest earnings growth: The sector will have the lowest              50.0%                                                SEV

earnings growth outlook among all industries over the next           40.0%             Turnaround Stories
                                                                                                       PNN                                                                           Capex-fuelled Growth

three years, at just c.3% EPS CAGR, on consensus                     30.0%
                                                                                                                                                              REE                            CNA
estimates. Our analysis shows there is still downside to             20.0%
                                                                                                                                                                    UU                NG

consensus.                                                           10.0%

                                                                                                  EDF                 FUM SVT
                                                                                                              GAS                                                              IBE
                                                                                                                                EDP                                  TRN
                                                                     0.0%                ENEL           ELE

Divergence of business models: We believe that 2011 will                 -10%    A2A      0%                          10%                                                20%                 30%               40%
highlight striking differences in capital allocation strategies,
with some companies adopting a downsizing strategy and              -20.0%               EDN

others continuing to expand – we prefer turnaround stories, i.e.    -30.0%                        Downsizing
                                                                                                                                              Growth in Capital Invested (10e-13e)

companies delivering earnings growth at below average              Source: Morgan Stanley Research estimates
capital expansion.

Balance sheet strengthening and financing should still
prove a key topic in 2011, with attention turning to rising
rates. In this report, we offer a matrix of companies’ exposure
to the main macro risks to help steer investment decisions in
the New Year.

Commodity markets still uncertain: We retain our view that
oversupply is here to stay in Europe, implying weak power
prices and weak generation spreads.
                                                                      Industry View: Cautious

                                                                     MORGAN STANLEY RESEARCH

                                                                     December 8, 2010
                                                                     Investment Perspectives — Europe

Industry Analysis
Growth: the lowest earnings growth outlook over the next             Exhibit 1
3 years … still downside to consensus                                Oversupply will continue in Europe as significant
Utilities offer the lowest earnings growth over the next three       new generation capacity continues to come online …
years, according to Morgan Stanley’s European Strategy
team, which estimates that the 2009-12 EPS CAGR for the                                                                                    21%
                                                                                                                               16,000                                   % is capacity as proportion of 2009 peak
sector should not exceed c.3%, compared to an average of                                                                                                                demand
c.24% for Europe as a whole.                                                                                                                           21%

                                                                        Capacity MW
                                                                                                                               10,000                                  45%
Interestingly, utilities is one of only two sectors to offer less                                                                                                                    15%
growth than it has done for the past 10 years. According to                                                                                                                                                        14%
the same analysis, the sector delivered 7.8% CAGR in net
earnings over 2000-10. This should be borne in mind when
looking at historical valuation metrics, and implies utilities                                                                      -
should now trade on lower multiples relative to the market                                                                               Germany        UK       Netherlands         Italy       France            Spain

than has been the case historically.                                                                                                                  Began operation since Jan'09      Under construction

                                                                     Note: This excludes renewables’ capacity additions
We see some downside to 2011 consensus estimates,                    Source: UCTE, Company data, Morgan Stanley Research

especially for integrated companies. Although we see less            Exhibit 2
downside to consensus estimates than a year ago, we still            … which explains why there appears to be no real
see c.4-5% downside on average for 2011-13. It is still too          correlation between Industrial Production and the
early to call for a positive inflexion point in consensus            dark green spread
estimates as the commodities environment remains weak and
uncertain, and balance sheet repair exercises could add fresh                                                                  120                                                                                 16

                                                                                                                                                                                                                        2 Year Forward Dark Green Spread
pressure to EPS.                                                                                                               115                                                                                 14
                                                                            Industrial Production Index

Dissection of growth: Invested capital vs. NOPAT                                                                               105

In a capital intensive sector like utilities, earnings growth                                                                  100
should be looked at in conjunction with trends in capital                                                                       95
invested (CI), in our view. As we move into 2011, the trend                                                                     90

we expect for CI and NOPAT over the next three years allows                                                                     85                                                                                 4

us to split the sector into three categories.                                                                                   80                                                                                 2
                                                                                                                                     Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep
                                                                                                                                      07 07 08 08 08 08 09 09 09 09 10 10 10
(i) Capex-fuelled earnings growth stories: return on                                                                                                              IP         DGS
reinvestment and access to capital are key drivers of value
                                                                     Source: Datastream, Bloomberg, Morgan Stanley Research
creation. We highlight Snam, Enagas and Centrica as
attractive stocks in this category: their growth is highly visible   Exhibit 3
and supported by strong balance sheets and attractive                UK and German power prices – UK back to start of
valuations. IBE remains among our bottom picks. Net                  year levels but German prices remain weak
debt/EBITDA is in line with regulated names but its risk profile
                                                                                        German and UK Baseload Power EUR/MWh

is higher, and it trades at a premium to its peers.

(ii) Downsizing companies: below average earnings growth                                                                       62
can coincide with below average growth in CI, or even a
decline in CI. Free cash flow strength and attractiveness +
sustainability of dividend payments are key. We highlight                                                                      52

ENEL as our top pick among these players: While growth is                                                                      47
poor, its 8.5% dividend yield is covered by free cash flow
generation. We highlight Underweight rated E.ON and RWE:                                                                        Jan 09 Mar 09 May 09 Jul 09 Sep 09 Nov 09 Jan 10 Mar 10 May 10 Jul 10 Sep 10 Nov 10
not only is the decline in NOPAT relevant but their dividends                                                                                          2011 German Power              2011 UK Power
are either not covered by free cash flow (RWE) or are below                                                                                            2012 German Power              2012 UK Power

the sector average (E.ON).                                           Source: Bloomberg, Morgan Stanley Research

                                                                     MORGAN STANLEY RESEARCH

                                                                     December 8, 2010
                                                                     Investment Perspectives — Europe

Industry Analysis
(iii) Turnaround stories: these companies appear to be in a          Those companies with a high proportion of refinancing due in
sweet-spot of above-average earnings growth, but below               the next 24 months, and a high exposure to variable rates,
average growth in CI. Implementation risks for the turnaround        include EDP, IBE, ACC, A2A, EL, REE, EDN, EDFEN.
need to be considered, as well as growth discounted in
valuation multiples. We highlight SEV and EDF as attractive          Credit ratings and the return of hybrid issuances:
stocks in this category, offering a recovery of NOPAT not            With 50% of companies in our coverage universe on negative
depending on capital expansion. We highlight GAS as UW –             outlooks from at least one of the credit rating agencies, we
despite a subpar return on invested capital (40% below               expect more hybrid issuances to materialise, market
average), the stock trades at a modest discount on EV/IC             conditions permitting. IBE, GN and DONG have announced
(20%).                                                               plans in this respect. This would help credit ratings but cost
                                                                     more than plain debt (for more details, see our report Hybrids
Further balance sheet repair needed, some tension exists             or the cost of credit metrics enhancement, dated 4 October,
A year ago we dubbed 2010 the year of balance sheet repair.          2010).
We focused our analysis on the tension that could arise on
companies’ earnings from the inverse trends of falling variable      Exposure to an uncertain macro environment
rates but rising cost of new debt.                                   With the economic environment uncertain as we go into 2011,
                                                                     we have updated our screens for European utilities’ exposure
For 2011, we see the situation changing materially, with the         to three types of macro parameters: interest rates, foreign
outlook being for variable rates to rise, while refinancing could    exchange and inflation. In the full report (P38-39) we give a
still prove expensive, as long as credit markets are pricing in      matrix detailing companies’ exposure to these macro risks.
elements of sovereign risk in parts of Europe.
                                                                     Inflation hedges: Regulated utilities across Europe have
There has been no improvement in net debt/EBITDA over the            links to inflation to varying degrees. These stocks should
past year despite capital strengthening initiatives: A number of     benefit in a higher-for-longer inflationary environment, in our
companies in the sector have adapted to the tough economic           view, as inflation is passed through to asset values, as well as
conditions and strengthened their balance sheets through             to revenues, earnings and, ultimately, dividends. The other
capital increases (NG, Verbund), disposals (approximately            winners from higher-for-longer inflation in the sector should be
€28bn this year alone, as we go to print). However, due to a         environment stocks, where contract revenues are linked to an
deterioration in the operating environment for the sector, the       inflation basket.
average Net debt/EBITDA has not improved, at 3.9x at the
end of 2010 compared to 3.8x a year ago.                             Gas and power market: Oversupply is here to stay, weak
                                                                     power prices, weak generation spreads
Refinancing: The average debt maturity has increased to 7.9
                                                                     Although the demand outlook is recovering in line with the
years on average but tension points still exist, we believe.
                                                                     broader economy, we believe that new capacity additions and
Corporates have continued their efforts that started in 2009
                                                                     the impact of energy policy will drive enduring oversupply.
and issued new debt with a view to increasing the average
                                                                     Although the demand recovery so far is decent, we expect it
maturity of their debt portfolio. A cluster of companies still has
                                                                     to look less robust in 4Q10 and 2011 as broader economic
large refinancing needs (in absolute terms or compared to
                                                                     growth slows.
their size) to address in the next 24 months.

                                                                     Conversely, capacity additions of thermal power plants
Exposure to variable rates: We have seen a trend of
                                                                     (mostly planned pre-crisis) are continuing as planned, and
companies locking in currently low interest rates and
                                                                     renewables’ capacity additions are robust. Capacity additions
increasing the proportion of their debt at fixed rates (on a
                                                                     in Europe, excluding renewables, since January 2009
straight average 63% at end-2010, on our estimates). In
                                                                     (i.e. from January 2009 to 3Q10) were 23GW and over the
contrast, a cluster of companies has kept a high degree of
                                                                     next two years a further 54GW of capacity additions has been
exposure to variable rates. In some cases, this exposure has
                                                                     in construction. In total, these new capacity additions alone
increased since last autumn.
                                                                     are sufficient to more than meet German peak demand, on
                                                                     our estimates.

                                                                                                    MORGAN STANLEY RESEARCH

                                                                                                    December 8, 2010
                                                                                                    Investment Perspectives — Europe

Industry Analysis
Exhibit 4
Utilities: Our order of preference

Prices as of December 6, 2010.
For valuation methodology and risks associated with any price targets above, please email with a request for valuation methodology and risks on a
particular stock
Source: Morgan Stanley Research estimates

                                                                    MORGAN STANLEY RESEARCH

                                                                    December 8, 2010
                                                                    Investment Perspectives — Europe

Company Analysis
December 6, 2010
                                                                    Stock Rating: Overweight        Reuters: HNKG_p.DE Bloomberg: HEN3 GR

Henkel                                                              Price target
                                                                    Shr price, close (Dec 3, 2010)§
                                                                    52-Week Range                                             €48.59-34.16
Valuation Catching up, Take                                         Mkt cap, curr (mn)                                             €18,678
                                                                    § = Intraday share price at 3.30pm Monday Dec 6.
Profits, Moving to EW
                                                                    Fiscal Year ending                                   12/09           12/10e              12/11e         12/12e
Morgan Stanley & Co.   Mark A Christensen                           ModelWare EPS (€)                                     1.91             2.86                3.38           3.72
International plc+         P/E                                                   19.1             17.0                14.4           13.0
                       Michael Steib, Erik Sjogren, CFA             Div per shr (€)                                       0.59             0.66                0.74           0.82
                                                                    Div yld (%)                                            1.6               1.4                 1.5            1.7
Strong fundamentals increasingly in the price – EW.                 e = Morgan Stanley Research estimates

Henkel has stood out among global staples stocks for some           Price Performance
time, with outperformance driven by continuous earnings
                                                                           He nk el AG & Co. KGaA Nv tg P rf (Le ft, E uro)
upgrades. Management was initially bold in setting its 2012                Re la tiv e to GE RMANY DAX (TR) (Right)
                                                                           Re la tiv e to MS CI W orld Inde x /Hous e hold & P e rs onal P roducts (Right)
financial targets and has since been clinical in their execution.
After initially doubting the targets set in November 2008, the                                                                                                         %
                                                                                                                                                                           2 20
consensual view has evolved from “how far short of their                                                                                                                   2 00
target will Henkel fall” to “how far beyond can it go”. We think                                                                                                           1 80
this shift in the debate is a reflection of the change in             35                                                                                                   1 60
sentiment for the shares more generally, with the stock having        30                                                                                                   1 40
transitioned from a consensual underweight 18 months ago to           25                                                                                                   1 20
the consensus overweight it is today.                                 20                                                                                                   1 00

                                                                                    06                 07                 08                09                  10
                                                                    Source: FactSet Research Systems Inc
While the c.30% increase in the shares year to date can be
attributed almost entirely to earnings upgrades – which have
                                                                           Company Description
risen more than any other large-cap global HPC stock this                  Henkel operates in three business areas: Laundry & Home Care
year – our SOTP analysis indicates that current valuation is               (brands include Persil, Purex, Bref), Cosmetics/Toiletries
increasingly approaching a level we would consider                         (Fa, Schwarzkopf, Dial) and Adhesive Technologies (Pritt, Loctite,
                                                                           Pattex). Based in Dusseldorf and employing ~50,000 people worldwide,
appropriate for the mix of Henkel’s businesses. The                        it is a leading player in European personal care and a global leader in
Adhesives business, however, deserves a premium to global                  adhesives, sealants and surface treatments.
peers, in our view, given its dominant market leadership,                  Household & Personal Care Products/Germany
superior technology in many sectors, and accelerating profit               Industry View: In-Line
momentum at a time when many specialty chemical peers are
                                                                           GICS Sector: Consumer Staples
rolling over recent peak margins. See our full report for detail.          Strategists' Recommended Weight: 12.4%
                                                                           MSCI Europe Weight: 12.4%
We believe arguing for further outperformance from this point
would therefore require more meaningful earnings upgrades
to come, which may prove difficult given a number of external       continue to play the Henkel margin story may consider
pressures such as supply shortages in Adhesives, ongoing            investing in the ordinary shares (see below) or, alternatively,
promotional pressure in Consumer and input cost inflation           we would recommend switching into Reckitt Benckiser in HPC
across the business. Henkel is well placed to manage these          or Unilever in Food.
pressures. However, we think upgrades to earnings from this
point are unlikely to replicate those witnessed in 2010.            Consensus now factors in 14% for 2012 as base case
                                                                    A discussion on Henkel without reference to the 14% margin
Downgrading to Equal-weight                                         target in 2012 has become the exception rather than the rule.
Based on our view that the preference shares are unlikely to        When Henkel CEO’s Kasper Rorsted delivered his plan in
maintain their outperformance in the medium term, we                November 2008, the majority view was one of disbelief, with
downgrade to Equal-weight. We expect ongoing strong                 consensus setting expectations at ~11.5%, before lowering to
operational momentum and would continue to recommend                ~10.7% in mid-2009. However, from 3Q09 margin initiatives
investors hold the shares, but would look for a more attractive     began to gain traction, investors started to realise the
entry point to add to existing positions. Investors wishing to      potential for improvement and estimates began their rapid

                                                                                                                   MORGAN STANLEY RESEARCH

                                                                                                                   December 8, 2010
                                                                                                                   Investment Perspectives — Europe

Company Analysis
ascent. While the official consensus estimate remains slightly                                                     Exhibit 1
below at 13.7%, the majority of larger brokers are either in line                                                  Consensus among larger brokers already at 14%
or above 14% (see Exhibit 1). We believe that management is                                                              15.0%                                Current 2012 Margin Estimate

well placed to achieve its target (we look for 14.2% in 2012).                                                                                                January '10 2012 Margin Estimate

However, with two years and a further 150-200 bps to go, we                                                              14.0%
                                                                                                                                                                                                      Management 2012 Target

feel the balance of risk is now shifting towards its execution,
with little margin for error in consensus estimates.

Recommend considering a switch to the ordinary shares
Henkel preference shares have historically traded at a 10%
premium to the ordinary shares, due principally to the slightly
higher dividend and the higher trading liquidity. In the last 18
months, as interest in Henkel has reached new highs, investors
                                                                                                                                                                                                 NA       NA
have chosen to invest more in the prefs than the ordinary                                                                10.0%
shares. As a result, the premium has expanded to ~20%. We
                                                                                                                   Graph shows expectations for 12 major brokers. Source: FactSet, Morgan Stanley Research
believe the ordinary shares remain undervalued in absolute
terms and relative to the prefs. We would therefore recommend                                                                          Competitive pressure in Consumer – a continuing
that investors wishing to continue to play the Henkel margin                                                                            headwind. Henkel is one of few global players to have
story, and able to manage the lower liquidity, consider taking                                                                          taken share from P&G over the last 18 months. More
some profits from the prefs and invest in the ords.                                                                                     recently, however, this outperformance has come under
                                                                                                                                        pressure. We believe heightened competition may
Upgrade cycle may be limited by near-term headwinds                                                                                     threaten profitably for all players, including Henkel.
Our estimates remain slightly above consensus and we
                                                                                                                                       Rising raw material costs. Around one third of Henkel’s
therefore expect forecasts to continue to rise in the near term.
                                                                                                                                        raw materials are based on some form of oil derivative,
That said, we believe the magnitude of upgrades may be
                                                                                                                                        and with crude oil continuing to rise, we expect input
limited by near-term headwinds such as:
                                                                                                                                        cost headwinds to challenge Henkel’s cost base
                                                                                                                                        throughout 2011. We believe management will continue
           Supply shortages in Adhesives. Henkel has recently
                                                                                                                                        to deliver on cost initiatives, and therefore do not expect
            had some difficulty in sourcing some raw materials. We
                                                                                                                                        this to result in a collapse of profits or margins. Rather,
            still expect a strong performance from the Adhesive
                                                                                                                                        we see it as a limiting factor to upside surprise in 2011.
            business in the coming quarters, but believe the scope
            for material upside surprise may be limited.
Exhibit 2
Recent outperformance has led to a more neutral risk-reward outlook
    €60                                                                                                                                      BULL CASE €55: Faster paced volume recovery allows
                                                                                                    €55 (+13%)                               management materially to exceed 2012 targets. Organic
       55                                                                                                                                    growth momentum maintained into 2011, with Consumer growing
                                                                                                                                             +4.5% and adhesives +7%. Additional volume leverage and
       50                                                            € 48.56                     €50.00 (+3%)
                                                                                                                                             delayed recovery of input costs through pricing drive a further
                                                                                                                                             125 bps of margin gains in 2011 and management achieves a
                                                                                                                                             2012 EBIT margin of 14.7%, ahead of the current target.
                                                                                                    €43 (-11%)
                                                                                                                                             BASE CASE €50: Volume recovery in 2010 resulting in
                                                                                                                                             improved capacity utilisation – progress made from
                                                                                                                                             restructuring. 2010 organic growth of 3% for the consumer
       30                                                                                                                                    business and +11% for Adhesives assuming ongoing industrial
                                                                                                                                             recovery globally, resulting in 6.7% for the group.
                                                                                                                                             BEAR CASE €43: Adhesive and Laundry volumes decline
                                                                                                                                             again in 41Q0, increased input cost pressure limits margin
                                                                                                                                             gains in FY. 4Q volumes return to negative trends in adhesives
       15                                                                                                                                    and declines accelerate in Laundry, while continued promotional
        Dec-08            Jun-09      Dec-09           Jun-10             Dec-10        Jun-11                                               pressure in Consumer limits growth to 4% for the group.
            Price Target (Dec-11)         Historical Stock Performance             Current Stock Price

                                                                                                                                             PRICE TARGET METHODOLOGY: Set at our base-case
                                                                                                                                             valuation, which is derived from our residual income fair value.

Source: FactSet (historical share price data), Morgan Stanley Research estimates

                                                                    MORGAN STANLEY RESEARCH

                                                                    December 8, 2010
                                                                    Investment Perspectives — Europe

Company Analysis
December 2, 2010
                                                                                                                         Reuters: NG.L Bloomberg: NG/ LN ADR:

National Grid                                                       Stock Rating: Equal-weight
                                                                    Price target
US disappointment to outweigh                                       Shr price, close (Dec 1, 2010)
                                                                    52-Week Range
UK growth                                                           Mkt cap, curr (mn)                                                                   £19,144

                       Bobby Chada                                  Fiscal Year ending                                     03/10    03/11e    03/12e         03/13e
Morgan Stanley & Co.
International plc+                ModelWare EPS (p)                                       56.5      47.7      49.2           49.3
                       Nicholas J Ashworth, CFA                     P/E**                                                   11.6      11.5      11.2           11.2
                                                                    Div per shr p)                                          33.7      36.4      39.3           41.3
                                                                    Div yld (%)                                              5.8        6.5       7.0            7.4
                       Arsalan Obaidullah
                                                                    ** = Based on consensus methodology
                                                                    e = Morgan Stanley Research estimates

We expect the US earnings recovery to disappoint, the               Price Performance
NY rate case to be tough and restructuring hopes to
                                                                           Na tional Grid P LC (Left, British P ounds )
disappoint. The shares offer little upside, and we see                     Re la tiv e to FTS E UK ALL-S HARE (GBP ) (Right)
                                                                           Re la tiv e to MS CI W orld Inde x /Utilitie s (Right)
better value elsewhere in the regulated names. As such,                    £
we resume coverage with Equal-weight and 575p PT.                                                                                                       %
                                                                                                                                                            1 70
                                                                                                                                                            1 60
Following the rights issue, and in the face of some                                                                                                         1 50

                                                                     6.5                                                                                    1 40
disappointing US regulatory newsflow, National Grid (NG)
                                                                      6                                                                                     1 30
shares have performed surprisingly well and now trade at a                                                                                                  1 20
relatively small discount (4%) to our revised fair value of 575p.                                                                                           1 10
Within this price target we have revisited in detail how the US                                                                                             1 00
business should be valued.                                                          06                  07                  08        09         10
                                                                    Source: FactSet Research Systems Inc

Recent developments in the most important US rate case,
                                                                           Company Description
in New York, have been very disappointing. It now                          Formed from the merger between National Grid and Lattice Group in
appears that NG will only receive c.$100m of revenue                       October 2002, National Grid owns and operates the electric transmission
                                                                           system in England and Wales, and four of the eight gas distribution
increases, around 25% of that requested, and that NG will
                                                                           networks in the UK following the sale of four in 2005. In the US, it owns
significantly under-earn its allowed ROE and its targeted 10%              three electric and gas utilities in the North-east region.
ROE, assuming a typical regulatory capital structure, in its               Utilities/United Kingdom
biggest US business. This New York development                             Industry View: Cautious
                                                                           The sector growth outlook remains subdued, both in absolute and
substantially outweighs the decent progress made elsewhere.
                                                                           relative terms, and valuations are not yet attractive overall. We advise
If we look at the six main rate cases settled so far, and include          focusing on capital preservation in more defensive regulated names, as
the latest New York recommendation, then we assess that                    well as specific self-help growth stories.
                                                                           GICS Sector: Utilities
NG has been granted a weighted average ROE of 9.8% – but
                                                                           Strategists' Recommended Weight: 1.5%
whether it can earn this is quite another matter.
                                                                           MSCI Europe Weight: 5.5%

The speed of the US recovery is likely to disappoint.
In New York, for example, we believe that delivering a              believe a US restructuring therefore is unlikely in the medium
satisfactory ROE could be very difficult if NG does not resolve     term. This is partly because management is keen to turn this
the differences of opinion between itself and the NYPSC on          business around and partly because a full or partial sale of the
cost allocation methodology. We expect it to be at least three      US business could create as many issues as it resolves, on
years before NG can report a satisfactory ROE                       our analysis.
(i.e. about 10% minimum) across its US businesses.
                                                                    Selling the US is earnings dilutive and creates financial
Restructuring hopes are also too optimistic. In addition,           issues. For example, a US disposal, especially a full
the last six months have seen rising market expectations of a       disposal, is substantially earnings dilutive, and could put the
rapid US turnaround or a major US restructuring. A quick            current dividend policy under pressure. Although the US
turnaround is now unlikely, as recent rate cases show. We           business does not generate cash – it is “self-funding” – it does

                                                                                                      MORGAN STANLEY RESEARCH

                                                                                                      December 8, 2010
                                                                                                      Investment Perspectives — Europe

Company Analysis
generate a decent earnings stream, partly due to the high                                             Exhibit 1
leverage of this business unit. Even a partial IPO, possibly                                          National Grid: Sum of the parts valuation
the best solution from a financial structure perspective, raises                                                                                             £mn                p per share
issues of making the business more complex and potentially                                            UK Electricity TO                                      8,523              246
introducing a conglomerate discount.                                                                  UK Electricity SO                                      219                6
                                                                                                      UK Gas TO                                              4,813              139
UK offers good returns and growth, but consumes cash.                                                 UK Gas SO                                              599                17
The UK business remains a very good performer. Here we                                                UK Gas Distribution                                    7,385              213
are confident that NG can produce good returns and good                                               UK TO RAVs                                             20,722             598
growth. But the UK business remains highly cash consumptive,                                          Premium to RAV                                         2,072              60
as the RAV grows, and to a large extent this influences the                                           UK SO Incentives                                       818                24
overall group strategy in ways that may hinder the share price                                        UK utility sub-total                                   23,612             658
– for example, it effectively rules out a full US disposal even if                                    US T&D Assets                                          12,451             359
coupled with a decent-sized share buyback. The scale of the                                           US Stranded Costs                                      160                5

UK business also effectively caps the valuation as it means                                           US utility sub-total                                   12,611             364

that NG will never trade on the M&A multiples that smaller                                            Metering                                               2,005              58

regulated assets sometimes command. And the increasing                                                Property                                               500                14
                                                                                                      BritNed                                                266                8
leverage and increasing absolute debt levels mean that NG
                                                                                                      LNG & Interconnectors                                  349                10
will likely always offer a higher dividend yield than other
                                                                                                      Grain LNG                                              1,330              38
regulated assets that have started the deleveraging cycle.
                                                                                                      Other Activities sub-total                             4,450              128
                                                                                                      Enterprise Value (£m)                                  40,674
Debate will continue over long term capital structure
                                                                                                      Adjusted Debt                                          (20,659)           (596)
We have now analysed the likely financial profile of NG over a
                                                                                                      Pension Liability                                      (114)              (3)
much longer timeframe – attempting to forecast the next
                                                                                                      Equity Value (£m)                                      19,901
decade, rather than the next five years. It now appears clear                                         Shares in issue                                        3,465
to us that if NG’s capex remains close to current projected                                           Equity Value (p)                                       574
levels (around £5bn per annum), there could be the                                                    Source: Morgan Stanley Research estimates
requirement to strengthen the balance sheet with disposals –
although this is not straightforward and may need a revisit of
the dividend – or further equity issuance.

Exhibit 2
A balanced risk-reward, although poor US sentiment is expected to drive the shares in the next 12 months
    p700                                                                                                                              BULL CASE 660p: UK regulation stable, best in class US
                                                                                                                                      performance UK Valuation: 20% Premium to RAV
                                                                                                                                      US Valuation: 1.4x Rate Base.
                                                                                                   660p (+19%)
                                                                                                                                      BASE CASE 575p: UK regulation stable, US recovery

                                                                                                                                      UK Valuation: 10% Premium to RAV
                                                                                                                                      US Valuation: 1.3x Rate Base
                                                                                                   575p (+4%)
                                                                                                                                      BEAR CASE 460p: Tougher UK regulation, US recovery falters
                                                                                                                                      UK Valuation: 0% Premium to RAV
                                                                                                                                      US Valuation: 1.1x Rate Base
                                                                                                                                      PRICE TARGET METHODOLOGY: Sum of the parts (see
                                                                                                                                      details above)
                                                                                                   460p (-17%)
       Dec-08              Jun-09       Dec-09            Jun-10           Dec-10         Jun-11                  Dec-11
            Price Target (Dec-11)           Historical Stock Performance            Current Stock Price

Source: FactSet (historical share price data), Morgan Stanley Research estimates

                                                                  MORGAN STANLEY RESEARCH

                                                                  December 8, 2010
                                                                  Investment Perspectives — Europe

Company Analysis
December 8, 2010
                                                                  Stock Rating: Overweight                       Reuters: OTEr.AT Bloomberg: HTO GA

OTE (Hellenic Telecoms.)                                          Price target
                                                                  Shr price, close (Dec 3, 2010)
                                                                  52-Week Range                                                          €10.80-5.16
5 Reasons to Turn Positive on                                     Mkt cap, curr (mn)                                                          €3,626

OTE: Upgrading to OW                                              Fiscal Year ending                             12/09         12/10e         12/11e         12/12e
                                                                  ModelWare EPS (€)                               0.68           0.49           0.40           0.42
Morgan Stanley & Co.   Luis Prota
                                                                  Prior EPS (€)*                                     -           0.46           0.39           0.44
International plc+
                                                                  P/E*                                            15.2           15.1           18.5           17.6
                       Nick Delfas                                Div per shr (€)                                 0.19           0.19           0.19           0.19
                           Div Yld (%)                                      1.8             2.6            2.6            2.6
                       Frederic Boulan, CFA, Terence Tsui,        * = Based on consensus methodology
                       Ryan Fox                                   e = Morgan Stanley Research estimates

OTE now offers deep value – >50% to our PT and >100%              Price Performance

to our bull case, which we see crystallising with further               Hellenic Telecommunications Organization S.A. (Left, Eur o)
                                                                        Relativ e to GREECE ATHEX COMPOSITE (Right)
macro improvements – raising to Overweight.                             Relativ e to MSCI W orld Index /Telecommunication Serv ices (Right)
We are upgrading OTE from Equal-weight to Overweight with               €
a new price target of €11.5, up from €7.5. The stock has                                                                                                    160
clearly been affected by the macro environment in Greece,          25
but also by a very aggressive competitive and regulatory           20                                                                                       120

environment. This has given rise to close to 45%                                                                                                            100
underperformance relative to the sector since the beginning of                                                                                              80
2009 (see Exhibit 1), with the stock coming down 35% in                                                                                                     60

absolute terms in that period. We see deep value in the stock       5                                                                                       40
                                                                                06              07               08               09             10
and feel comfortable that now is the time to turn more positive   Source: FactSet Research Systems Inc
on OTE shares. Why? We have five key reasons:
                                                                        Company Description
1. Macro environment: Structural reforms on track                       OTE is the incumbent and leading telecom operator in Greece, with
                                                                        operations abroad in Romania (wireline and wireless), Bulgaria
Before turning more positive on the stock, we wanted to hear            (wireless) and Albania (wireless). Cosmote is the wireless subsidiary
about the revised public deficit and debt to GDP metrics for            holding all the group mobile assets. OTE is 20% owned by the Greek
2009 and the potential implications on further austerity                State and 30% by Deutsche Telekom.

measures in the country. These revised metrics were                     Telecommunications Services/Greece
                                                                        Industry View: In-Line
announced in early November, with new austerity measures                We estimate an average upside for the sector that is exactly in line with
announced on November 19 for the 2011 budget. However,                  our strategists’ expectations for the broader market
these new measures should have little impact on OTE, in our             GICS Sector: Telecom Services
view, as they do not involve new telecom taxes or material              Strategists' Recommended Weight: 8.7%

changes to the country’s disposable income. Also, the EMU               MSCI Europe Weight: 6.7%

and IMF second review approved the third tranche of the loan
granted to Greece on November 30 and our macro team has           position and revolving facility, OTE expects to need a
stressed that Greece is ahead of schedule on the structural       maximum of €500-700 million to cover the €2.1 billion
front and in fiscal reforms. Finally, the Eurogroup on            maturities in 2011, which could be raised by tapping the
November 28 also suggested that the maturities of the             markets, or could be provided by DT.
financing for Greece could be aligned with Ireland, which
could extend loan repayment from 2015 to 2021.                    3. FCF stabilising in 2011e and up 60% by 2013e
                                                                  We expect EBITDA to come down 5% in 2011 and we are 4%
2. No refinancing issues for OTE                                  below consensus now. Despite this, we expect FCF to go up
Despite debt concerns around Greece, OTE bonds are well           12% in 2011 thanks to lower taxes, capex and restructuring
within the sovereign yield, with 2015 bonds trading close to      payments. On top of this, we also expect the end of special
par. Also, the fact that Deutsche Telekom (DT) will act as        taxes on profitable companies by 2012 to allow for a 60%
lender of last resort for OTE eliminates any potential issues     higher FCF in 2013e than in 2010e.
for OTE’s refinancing needs. In addition to its current cash

                                                                                                          MORGAN STANLEY RESEARCH

                                                                                                          December 8, 2010
                                                                                                          Investment Perspectives — Europe

Company Analysis
4. Attractive absolute valuation with our bull case                                                       Exhibit 1
implying above 100% upside potential                                                                      OTE relative performance to the sector (2 years)
Our price target implies 55% upside potential, but our realistic
bull case implies over 100% upside potential. This offers a
very attractive risk to return ratio as we only estimate a 26%
potential decline to our bear case. When looking at 2013-14
metrics i.e. once special taxes come to an end, the stock is
trading at a 16-17% FCF yield and still growing after that to
levels close to 19% by 2015e.

We calculate our new price target of €11.50 as the simple
average (rounded up) between:

i)        €11: our fair value for December 2011, already implying
          48% upside, more than double the sector average and
          the highest individual upside in the sector, on our
          numbers; and                                                                                    Source: FactSet

ii)       €11.7: rising FCF visibility leads the market to start                                          per share. A 5% put option was also exercised by the Greek
          looking to 2013e FCF yield metrics and targeting a similar                                      Government for a €27.5 per share price. Now DT owns 30%.
          FCF yield than that implied in our sector fair value. This                                      Another 10% put option could be executed in 2011 at a 15%
          value would exceed €12 if we used 2014/15 FCF instead.                                          premium to the previous 20-day average price. However, in
                                                                                                          our view, the key element is that, under the agreement signed
5. DT could buy OTE shares in the market from 2012                                                        with the Greek Government, DT could buy more shares in the
DT acquired a 20% stake in OTE from MIG at €26 per share,                                                 market from 2012 without asking for approval. DT has not
2% from the market and another 3% from the State at €29.75                                                made any public comment that we are aware of in this regard.

Exhibit 2
Very positively skewed risk-reward profile with substantial upside potential from FCF growth and a more
stable macro environment
      €                                                                                                                 BULL CASE €15.5: Hidden value crystallising with reduced
                                                                                                                        sovereign risk: 4% line loss 09-12e. 90% b’band penetration,
                                                                                                                        retail share 53%. Mobile data 16% of total mobile revs by 12e.
                                                                                                                        TV/DSL products mean RT grows fixed lines by 1% pa 09-12e.
                                                                                                                        €1 from real estate; €1 from DT synergies. RF rate 5.5% = €1.5.
                                                                                                  €15.5 (+109%)
                                                                                                                        BASE CASE €11.0: More stable macro environment. 9% line
                                                                                                                        loss, fixed revs 09-12e CAGR -5.5%;30% 12e EBITDA margin.
                                                                                                €11.50 (+55% )          Greek service revs 09-12e CAGR -4%, 35% 12e margin; data
          10                                                                                                            revs 11% of total. RT 1150 DSL/1250 TV customers by 12e with
                                                                           € 7.40                                       4% line loss in 09-12e. RF rate 6.5% = yield for LT OTE bonds.
                                                                                                                        BEAR CASE €6.0: Factoring in EE risk and weaker operating
                                                                                                    €6.0 (-19%)
                                                                                                                        performance: Wireline revs -6.5% in 09-12e. Greek service revs
                                                                                                                        09-12e CAGR -5.5% with 12e 34% margin; data revs 11% of
                                                                                                                        total. RT only 85% of base case DSL/TV customers by 2012e.
                                                                                                                        20% reduction in value in OTE’s EE assets due to currency
          0                                                                                                             depreciation. RF rate 12%, as 10y Gov bond yield = €3.3 /share.
          Dec-08             Jun-09    Dec-09            Jun-10            Dec-10        Jun-11               Dec-11
               Price Target (Dec-11)        Historical Stock Performance            Current Stock Price                 PRICE TARGET METHODOLOGY: Average of i) base case
                                                                                                                        SOTP DCF*; and ii) €11.7 valuing at sector target 13e FCF yield.

Source: FactSet (historical share price data), Morgan Stanley Research estimates; *WACC 9.1% and long-term growth 1% for Fixed Telephony and Greek Mobile

                                                                   MORGAN STANLEY RESEARCH

                                                                   December 8, 2010
                                                                   Investment Perspectives — Europe

Company Analysis
December 6, 2010                                                                                                   Reuters: UNc.AS Bloomberg: UNA NA
                                                                   Stock Rating: Overweight                                                          ADR UN.N
Unilever NV                                                        Price target                                                                           €27p
                                                                   Shr price, close (Dec 3, 2010)                                                        €22.39
The New “Unilever Model” –                                         52-Week Range                                                                   €24.11-20.68
                                                                   Mkt cap, curr (mn)                                                                   €64,890
Double Upgrade to OW
                                                                   Fiscal Year ending                              2009         2010e       2011e         2012e
Morgan Stanley & Co.   Michael Steib                               ModelWare EPS NV (€)                             1.08          1.36       1.59          1.74
International plc+             ModelWare P/E NV                                 20.7          16.4        14.1         12.9
                       Erik Sjogren, CFA, Audrey Borius,           Div per shr €)                                   0.47         0.83        0.89          0.96
                       Mark A Christensen                          Div yld NV (%)                                    2.1           3.7         4.0           4.3

A new ‘Unilever Model’ emerging, de-rating overdone,                                         Reuters: ULVR.L Bloomberg: ULVR LN ADR UL.N
many concerns priced in, risk/reward now more attractive           Price target                                                     2,300p
                                                                   Shr price, close (Dec 3, 2010)                                   1,855p
than it has been in three years – double-upgrading to OW           52-Week Range                                              2,024-1,662p
                                                                   Mkt cap, curr (mn)                                              £55,131
The potential emergence of a new “Unilever Model”.
In 2009, investors initially got very excited about the prospect   Fiscal Year ending                             2009`         2010e       2011e         2012e
                                                                   ModelWare EPS plc (p)                           96.2          117.0      136.1         149.2
of change and, more tangibly, the prospect of accelerating
                                                                   ModelWare P/E plc                               19.3           15.9        13.6         12.4
volume growth in 2010. While volume growth did pick up             Div per shr (p)                                    1              1           1             1
substantially, negative pricing meant like-for-like sales growth   Div yld (%)                                      3.4            3.8         4.0           4.3
                                                                   e = Morgan Stanley Research estimates
remained well below its peers. As pricing will now turn positive
(a function of rising input costs and the comparison base          Price Performance
effect), it appears that many investors are concerned about
                                                                         Unilev er N.V . (Left, Euro)
volume growth slowing right down again. While some slowing               Relativ e to NETHERLANDS AE X INDEX (Right)
                                                                         Relativ e to MSCI W orld Index /Food Bev erage & Tobacco (Right)
is inevitable, we think the strong emerging market (EM)                  €

exposure (52% of group sales) should limit this effect. We see      26

this as more of an issue in developed markets (DM), however,        24                                                                                   160
particularly in the more commoditised food categories.              22
                                                                    20                                                                                   130
We think the likelihood of Unilever delivering more consistent      18                                                                                   120

4-6% sales growth and steady, mix-driven (not restructuring         16
driven) margin improvement has improved considerably                14
given: (i) a renewed focus on the global and higher margin                       06              07               08               09         10
                                                                   Source: FactSet Research Systems Inc
categories in which Unilever’s EM footprint can be leveraged,
as we elaborate below; (ii) the potential for further portfolio          Company Description
changes in DM; and (iii) a tightening of management control              Unilever is a global leader in both Food (55% of group sales) and HPC
procedures.                                                              (45%), with a portfolio spanning categories such as Spreads & Cooking
                                                                         Oils (Flora, Rama), Savoury & Dressings (Knorr, Bertolli), Beverages
                                                                         (Lipton), Ice Cream (Wall’s), Personal Care (Sunsilk, Lux) and
Challenges still formidable but the way Unilever appears to              Household care (Persil, Omo). Its products are distributed globally, with
increasingly reshape its growth strategy is encouraging.                 the company having leading positions in many developing regions. The
                                                                         stock has a dual listing – in the Netherlands and London.
Elements of this were clearly articulated for the first time at
                                                                         Food Producers/Netherlands
the company’s recent investor seminar in Singapore. Rather               Industry View: In-Line
than trying to make Food in EM as big a business as HPC
already is (which has been the strategy for some time), we               GICS Sector: Consumer Staples
welcome the company’s renewed focus on its core strength:                Strategists' Recommended Weight: 12.4%
focusing on global categories in HPC (particularly Personal              MSCI Europe Weight: 12.4%
Care) and Ice Cream/Beverages, while pursuing a more
local/regional strategy in the core food categories (mostly
spreads, dressings and savoury). It also appears that
Unilever is more committed to matching the rhetoric with
capital allocation decisions – management clearly stated that

                                                                                                                                         MORGAN STANLEY RESEARCH

                                                                                                                                         December 8, 2010
                                                                                                                                         Investment Perspectives — Europe

Company Analysis
Exhibit 1                                                                                                                                De-rating is overdone, in our view. While the 2009 change
We expect Unilever to deliver annual organic                                                                                             agenda was initially greeted with near-unanimous
growth of 5-6%                                                                                                                           enthusiasm, this has now given way to a more balanced view.
                                 Unilever Organic Growth (2005-2014e)                                                                    The share price has materially underperformed over the past
                                                                                2011-14 average organic
                                                                                                                                         12 months and the de-rating suggests that investors take the
                Volume          Pricing
    7%                                                                               growth: 5.6%                                        view that nothing has changed at the company since the new
    6%                                                                                                                                   management took charge. The share price appears to
                                                                                                                                         discount no improvement in the medium-term growth outlook,
                                                                                                                                         no improvement in the potentially more consistent delivery of
                                                                                                                                         margin and cash flow growth, and no improvement in the way
                                                                                                                                         the company overall is run – we think this is far too bearish
                                                                                                                                         and hence upgrade our rating for the first time in three years.
   -1%                     2005-10e average
                         organic growth: 4.5%                                                                                            Many concerns now priced in. We think that competitive
                                                                                                                                         pressures (e.g. in Laundry) are unlikely to ease but, equally,










                                                                                                                                         unlikely to get worse. Input costs are rising, but we argue
e = Morgan Stanley Research estimates Source: Company data, Morgan Stanley Research                                                      Unilever is better equipped to deal with this. That said, the
                                                                                                                                         company still needs to improve its ability to turn R&D into
the global categories and the higher margin categories would
                                                                                                                                         sustainable commercial success for better growth in DM.
be over-resourced going forward compared to the more local
businesses in food. This is important to drive the overall group
                                                                                                                                         Potentially huge rewards: successful execution could
mix improvement both at the top line and the margin level. We
                                                                                                                                         mean a sustainable 2-3 PE multiple point re-rating.
think that, historically, mix has been a drag on earnings; going
                                                                                                                                         If Unilever executes on the model that we see emerging, we
forward, we expect this to be a positive driver of earnings
                                                                                                                                         believe the shares have substantial potential to re-rate from
                                                                                                                                         13.5-14.0x currently to 15.5-16.0x.
We still see potential for Unilever to either improve profit
                                                                                                                                         We raise our EPS estimates by 6-8% for 2011-13, primarily on
levels in some of the more mature businesses (particularly
                                                                                                                                         better top-line growth and margin outlook from 2011. Our new
in European and US food divisions), or to ultimately dispose
                                                                                                                                         price targets of €27 (up from €21) and 2,300p (up from
of at least some of them – and the small disposals in the past
                                                                                                                                         1,900p) imply a forward multiple of earnings of around 15.5x
two years have been completed at surprisingly attractive
                                                                                                                                         on a 12-18 month basis, up from just 13.5–14.0x currently.
valuation levels.

Exhibit 2
We see the risk/reward profile as more attractive now than at any point in the last few years
    € 35                                                                                                                                            UPSIDE SCENARIO €30: Continuously grows at upper end
                                                                                                                                                    of the 4-6% range we think is realistic. Organic growth of close
                                                                                                                                                    to 6% from 2011 as volume growth holds up despite recovering
     30                                                                                                                           €30 (+34%)        pricing, 40bps underlying margin progression pa as profitability in
                                                                                                                                                    European and US food businesses improves despite input cost
                                                                                                                              €27.00 (+21% )        headwinds.
                                                                                                 € 22.39
                                                                                                                                                    BASE CASE €27: An emerging new “Unilever Model”: Organic
                                                                                                                                                    growth of 3.9% in 2010e should accelerate in 2011 to over 5.5%
                                                                                                                                                    with a longer-term growth potential of 4-6%. Underlying margins
     20                                                                                                                           €20 (-11%)
                                                                                                                                                    improve by 20-30bps p.a., driven by operational leverage and
                                                                                                                                                    improving mix, i.e. not by restructuring savings as in the past.

     15                                                                                                                                             DOWNSIDE SCENARIO €20: Sustainable change fails to
                                                                                                                                                    materialise. Volume growth slows materially in coming quarters
                                                                                                                                                    despite higher investment as pricing picks up to offset input cost
     10                                                                                                                                             pressure. Organic growth of 4% in 2011-12, well below peers
      Dec-08                  Jun-09                 Dec-09                 Jun-10               Dec-10                  Jun-11           Dec-11    such as Nestle, Danone or global HPC companies.
            Price Target (Dec-11)                         Historical Stock Performance                         Current Stock Price
                                                                                                                                                    PRICE TARGET METHODOLOGY: Derived from our Base case
                                                                                                                                                    – 15.5x 2012e EPS.

Source: FactSet (historical share price data), Morgan Stanley Research estimates

                                                                                                         MORGAN STANLEY RESEARCH

                                                                                                         December 8, 2010
                                                                                                         Investment Perspectives — Europe

European Industry Valuations and Economic Forecasts
European Industry Valuations
                                                                Price/Earnings (Pre-Goodwill)                 Price/Sales                               EV/EBITDA                           Dividend Yield (%)
Updated as of 06/12/2010 Close                                            2011e       2012e                2011e          2012e               2011e              2012e                     2011e                 2012e
Automobiles & Components                                                  10.6          8.4                 0.46              0.44                4.1                 3.7                   2.4                   3.0
Banks                                                                      8.7          7.0                        -             -                  -                   -                   3.8                   4.9
Capital Goods                                                             13.2         11.5                 0.72              0.68                7.1                 6.2                   3.0                   3.3
Commercial Services & Supplies                                            14.6         12.7                 0.81              0.76                8.0                 6.9                   2.7                   3.0
Consumer Durables & Apparel                                               17.8         15.3                 1.47              1.38                8.4                 7.3                   1.9                   2.1
Diversified Financials                                                    13.8         12.0                 0.76              0.73                7.8                 6.9                   2.8                   3.3
Energy                                                                     9.0          7.8                        -             -                  -                   -                   3.0                   4.1
Food & Staples Retailing                                                   9.2          8.2                 0.62              0.58                3.9                 3.5                   4.5                   4.7
Food Beverage & Tobacco                                                   12.4         11.0                 0.33              0.31                6.0                 5.4                   3.6                   4.0
Health Care Equipment & Services                                          14.0         12.7                 1.39              1.33                8.1                 7.4                   3.2                   3.5
Consumer Services                                                         15.5         13.8                 1.06              1.01                8.1                 7.2                   1.6                   1.8
Household & Personal Products                                             17.2         15.6                 2.06              1.96               10.7                 9.5                   2.4                   2.6
Insurance                                                                  7.9          7.3                        -             -                  -                   -                   5.5                   6.0
Materials                                                                 10.9          9.8                 1.15              1.09                5.7                 5.0                   2.3                   2.6
Media                                                                     11.9         10.7                 1.10              1.06                6.2                 5.6                   4.2                   4.5
Pharmaceuticals & Biotechnology                                           10.3          9.9                 2.18              2.12                6.9                 6.4                   4.2                   4.5
Real Estate                                                               17.5         15.9                        -             -                  -                   -                   4.4                   4.7
Retailing                                                                 15.3         13.6                 0.94              0.89                8.0                 7.1                   3.4                   3.8
Semiconductors & Semiconductor Equipment                                  14.0         12.9                 1.60              1.52                6.2                 5.3                   1.4                   1.7
Software & Services                                                       14.0         12.3                 1.47              1.39                7.9                 6.8                   2.1                   2.3
Technology Hardware & Equipment                                           12.6         10.9                 0.81              0.79                5.8                 5.1                   3.4                   3.7
Telecommunication Services                                                10.2          9.7                 1.18              1.17                5.4                 5.2                   6.8                   7.2
Transportation                                                            12.3         10.5                 0.59              0.56                5.4                 4.8                   2.8                   3.2
Utilities                                                                 11.3         10.4                 0.75              0.72                6.5                 6.1                   5.5                   5.8

MSCI Europe (Coverage)                                                    11.0          9.7                 0.89              0.85                6.1                 5.5                   3.7                   4.1

Economic Forecasts
`                           GDP (%)                       CPI Inflation                  3-Month Euro Rates (%) (E)                10-Year-Bond Yields (%) (E)                  Exchange Rates
                 2009    2010e   2011e   2012e   2009   2010e   2011e       2012e   07-Dec     Dec-10    Mar-11     Jun-11     07-Dec   Dec-10   Mar-11      Jun-11         07-Dec   Dec-10 Mar-11                Jun-11

US               -2.6     2.9     2.9     3.2    -0.3    1.7      2.1        2.2     0.28         0.45      0.45       0.55     3.17      3.00          3.00   3.50                -              -          -           -
Canada           -2.5     3.3     2.9     2.3     0.3    1.5      1.7        1.8     0.98         1.50         -          -     3.23      3.00            -      -          1.01                  -          -           -

EU-15            -4.2     1.8     1.5     1.8     0.6    1.9      1.9        1.9       -                                          -
EMU              -4.0     1.7     1.4     1.7     0.3    1.7      1.8        1.9     1.03         0.90      0.95       1.00     2.89      2.75          2.90   3.00         1.33           1.46       1.45        1.43
Austria          -3.5     1.4     1.5     1.8     0.4    1.6      1.6        1.6     1.03         0.90      0.95       1.00     3.36      3.18          3.39   3.46         1.33           1.46       1.45        1.43
Belgium          -2.7     1.7     1.5     1.9     0.0    1.9      1.5        1.6     1.03         0.90      0.95       1.00     4.01      3.50          3.69   3.90         1.33           1.46       1.45        1.43
Denmark          -4.7     1.9     1.8     2.4     1.3    1.8      1.6        2.3     1.21         1.25      1.05       1.10     3.06      2.87          3.03   3.14         7.45           7.46       7.46        7.46
Finland          -8.1     0.7     2.0     2.3     0.0    0.9      1.2        1.4     1.03         0.90      0.95       1.00     3.16     2.87        3.03       3.14        1.33           1.46       1.45        1.43
France           -2.5     1.6     1.8     2.0     0.1    1.6      1.8        1.8     1.03         0.90      0.95       1.00     3.31     3.25        3.44       3.58        1.33           1.46       1.45        1.43
Germany*         -4.9     3.4     1.7     2.0     0.3    1.1      1.4        1.7     1.03         0.90      0.95       1.00     2.89     2.75        2.90       3.00        1.33           1.46       1.45        1.43
Greece           -2.0    -5.0    -3.5     1.0     1.3    4.5      0.6        -0.1    1.03         0.90      0.95       1.00    11.66     10.75      10.75      10.70        1.33           1.46       1.45        1.43
Ireland          -7.6     0.1     0.9     2.0    -1.7   -1.5      -0.1       0.6     1.03         0.90      0.95       1.00     7.93     6.00        5.84       5.63        1.33           1.46       1.45        1.43
Italy            -5.1     1.2     1.4     1.6     0.8    1.5      1.7        1.8     1.03         0.90      0.95       1.00     4.41     4.50        4.90       4.50        1.33           1.46       1.45        1.43
Netherlands      -3.9     1.9     1.4     1.7     1.2    1.3      1.5        1.6     1.03         0.90      0.95       1.00     3.15     2.92        3.06       3.15        1.33           1.46       1.45        1.43
Portugal         -2.6    1.3      -1.3    0.8    -0.8    1.5      0.9        0.5     1.03         0.90      0.95       1.00     5.98     5.75        5.70       5.60        1.33           1.46       1.45        1.43
Spain            -3.7    -0.3     1.0     1.5    -0.3    1.7      1.8        1.7     1.03         0.90      0.95       1.00     5.20     5.00        5.15       5.00        1.33           1.46       1.45        1.43
Sweden           -5.3     4.6     3.4     3.2    -0.3    1.2      1.9        2.5     1.79         1.45      1.70       2.20     3.14     2.85        3.08       3.25        9.14           9.10       8.80        8.70
UK               -5.0     1.7     1.6     2.0     2.2    3.2      3.0        2.1     0.80         0.75      0.80       0.95     3.52     3.35        3.60       3.70        0.84           0.90       0.88        0.87
                                                                                                                                                                            1.58           1.62       1.65        1.64
CEEMEA           -4.8     3.6     3.8     3.8     7.7    5.7      6.0        5.9       -             -         -          -       -                                           -        -
Japan            -5.2     3.7     1.0     1.7    -1.3   -1.0      -0.3       -0.2    0.34         0.23      0.23       0.24     1.17      0.90          1.40   1.70          83            81         84           85
Asia ex-Japan     6.2     9.1     7.9     8.0     2.4    5.0      4.7        3.7       -                       -          -       -                       -      -            -             -          -            -
Latin America    -2.0     6.3     4.1     4.4     6.3    6.6      6.9        6.7       -                       -          -       -                       -      -            -             -          -            -
 European exchange rates are against the euro, except where noted. * Not work-day adjusted.
Source: National Statistical Offices & Morgan Stanley Research, e = Morgan Stanley Research estimates

                                                                                                       MORGAN STANLEY RESEARCH

                                                                                                       December 8, 2010
                                                                                                       Investment Perspectives — Europe

European Model Portfolio
                                                                                 Portfolio                                                                                              Portfolio
                                            Price         Benchmark            Over- (+) /                                                         Price          Benchmark           Over- (+) /
Total Portfolio: 48 Stocks             07/12/2010         Weight (%)     Under- (-) weight                                                    07/12/2010          Weight (%)    Under- (-) weight

Note: Industries ranked from greatest Overweight to greatest Underweight

OVERWEIGHTS                                                                                            UNDERWEIGHTS
Materials                                                         10.8                +4.0             Consumer Discretionary                                             9.2                 -4.0
Rio Tinto (RIO.L)                         £ 45.05                                                      Adidas (ADSG.DE)                           €49.87
Xstrata (XTA.L)                           £ 14.61                                                      Fiat (FIA.MI)                              €14.05
Akzo Nobel (AKZO.AS)                       €42.72                                                      SES (SESFd.PA)                             €18.10
BASF (BASF.DE)                             €61.15                                                      IHG (IHG.L)                                £ 12.30
Linde (LING.DE)                           €111.65                                                      Utilities                                                          5.3                 -4.0
Insurance                                                          4.6                +2.0             EDF (EDF.PA)                                €31.76
Legal and General (LGEN.L)                 £ 0.98                                                      National Grid (NG.L)                         £ 5.48
Aegon (AEGN.AS)                             €4.47                                                      Health Care                                                        9.7                 -2.0
AXA (AXAF.PA)                              €11.91                                                      AstraZeneca (AZN.L)                        £ 30.28
Energy                                                            10.7                +2.0             GlaxoSmithKline (GSK.L)                    £ 12.42
BG (BG.L)                                    £ 0.98                                                    Sanofi-Aventis (SASY.PA)2                   €48.55
Tullow Oil (TLW.L)                         £ 12.15
BP (BP.L)                                   £ 4.55                                                     Totals                                                           100.0
Saipem (SPMI.MI)                            €34.02
Repsol (REP.MC)                             €20.36                                                     Asset Allocation (%)3                     Equities              Bonds                Cash
Petrofac (PFC.L)                           £ 15.17                                                     Recommended Allocation                      52                    37                   11
Telecommunication Services                                         6.6                +2.0             Benchmarks                                  50                    40                   10
KPN (KPN.AS)                               €11.06
BT Group (BT.L)                            £ 1.78
Telefónica (TEF.MC)                        €17.03
France Telecom (FTE.PA)                    €15.84

Consumer Staples                                                  12.4                 0.0
Diageo (DGE.L)                          £ 11.45
Danone (DANO.PA)                         €47.12
Imperial Tobacco (IMT.L)                £ 19.05
Reckitt Benckiser (RB.L)                £ 34.84
British American Tobacco (BATS.L)       £ 23.60
Industrials                                                       11.2                 0.0
Lufthansa (LHAG.DE)                      €17.48
Siemens (SIEGn.DE)                       €91.59
TNT (TNT.AS)                             €19.76
EADS (EAD.PA)                            €17.93
Atlantia (ATL-IT)                        €15.33
SKF (SKFb.ST)                        SEK 190.90
Information Technology                                             2.9                 0.0
Cap Gemini (CAPP.PA)                     €34.00
Dassault Systems (DAST.PA)               €55.42
Diversified Financials & Real Estate                               5.0                 0.0
ING (ING.AS)                              €7.42
Schroders (SDR.L)                       £ 17.57
British Land (BLND.L)                    £ 5.10
Banks                                                             11.8                 0.0
Credit Agricole (CAGR.PA)                €10.04
Barclays (BARC.L)                        £ 2.63
Danske (DB.CO)                       DKK 147.90
SocGen (SOGN.PA)                         €38.90
DnB NOR (DNBNOR.OL)                   NOK 78.45
1. This stock is currently not covered in Europe by a Morgan Stanley industry analyst. 2. Although the shares of this company remain on the model portfolio, Morgan Stanley & Co. International
Limited policy precludes the exercise of investment management discretion or the rendering of investment advice on the shares at this time by the strategist and/or the Morgan Stanley analyst who
follows the shares. 3. The equity position is allocated as the European Equity Model Portfolio. Bonds are allocated equally between France, Germany, the Netherlands and the UK. The bond
position is invested in ten-year paper of these countries. Source: MSCI/Exshare, Morgan Stanley Research

                                                                                           MORGAN STANLEY RESEARCH

                                                                                           December 8, 2010
                                                                                           Investment Perspectives — Europe

Events Diary
Monday 13 December to Sunday 26 December 2010
Date       Company Results                                               Other Company Events                                                        Economic Data
Mon 13 Dec Air Liquide - Strategy Report - 2015                          Air Liquide - Investor Day                       UK - Rightmove house price index, nsa - Dec
           Bank Saint-Petersburg - Q3 Results (IFRS) - 2010              Amplifon - OGM                                    UK - Nationwide Consumer confidence - Nov
           Burgenland Holding - Annual Results - 2009/10                 Bank Hapoalim - Investor Conference
           GiFi - Annual Results - 2009/10                               Bank Saint-Petersburg - Conference Call, Web Cast
           Marseille-Kliniken - Q1 Results - 2010/11                     Bank Vozrozhdenie - Investor Conference
           Unique (Flughafen Zürich AG) - Nov Traffic fig - 2010         Hannover Rueckversicherung - Investor Conference
           Wichford - Preliminary Results - 2009/10 (T)                  Marseille-Kliniken - Press Conference
                                                                         Systar - Industry Conference
                                                                         Volta Finance - AGM

Tue 14 Dec Aurubis - Preliminary Results - 2009/10                       Aedes Immobiliare - General Meeting                       UK - RICS house price balance - Nov
           Carpetright - Interim Results - 2010/11                       Air Liquide - Shareholders Meeting                                FRA - Consumer prices - Nov
           Clas Ohlson - Q2 Results - 2010/11                            Aixtron - Investor Conference                              SWE - Real GDP, 2nd estimate - 3Q
           Domino Printing Sciences - Preliminary Res - 2009/10          Bilfinger Berger - Investor Conference                                 UK - CPI Inflation - Nov
           Drax Group - Trading Statement - 2010                         DeA Capital - Investor Conference                                       UK - RPI Inflation - Nov
           ESI Group - Q3 Sales - 2010/11                                Electricite de France - EDF - Shareholders Meeting         EMU - Industrial production, sa - Oct
           European Nickel - Trading Statement - 2010/11                 Exel Industries - Analysts Briefing                     GER - ZEW Economic Sentiment - Dec
           Exel Industries - Annual Results - 2009/10                    Folli-Follie - Investor Conference            EMU - ECB publishes Consolidated Financial Stmt
           Exel Industries - Q1 Sales - 2010/11                          Frigoglass - Investor Conference                                           US - FOMC meeting
           Go-Ahead Group - Trading Statement - 2010/11                  GEK Holding & Real Estate - Investor Conference
           Harboes Bryggeri - H1 Results - 2010/11                       GiFi - Analysts Briefing
           Imagination Technologies Group - Interim Res - 2010/11        Greek Organisation of Football Prognostics - OPAP - Investor Conference
           Interbulk Group - Preliminary Results - 2010                  Hellenic Bank - Investor Conference
           Lafuma - Annual Results - 2009/10                             Hellenic Exchanges - Investor Conference
           Renovo - Preliminary Results - 2009/10                        Imagination Technologies Group - Analysts Briefing
           Scott Wilson Group - Interim Results - 2010/11                Intralot - Investor Conference
           Societe Sucriere de Pithiviers le Vieil - Final Res - 09/10   KBC Group - Investor Conference
           Solar Millennium - Preliminary Results - 2009/10 (T)          Linde - Roadshow
           Tonnellerie Francois Freres - H1 Results - 2011               L'Oreal - Shareholders Meeting
           TUI - Annual Results - 2010                                   Marfin Popular Bank - Investor Conference
           Vienna Airport - Flughafen Wien - Nov Traffic fig - 2010      Motor Oil (Hellas) - Investor Conference
           Viking Line ABP - Annual Results - 2009/10                    Mytilineos Holdings - Investor Conference
           Whitbread - Interim Management Statement - 2010               Orascom Construction Industries - Investor Conference
                                                                         PGS - Petroleum Geo-Services - Capital Markets Day
                                                                         Prysmian - Investor Conference
                                                                         Renovo - Analysts Briefing, Web Cast
                                                                         RSM Tenon Group - AGM
                                                                         SABAF - General Meeting
                                                                         SAF-Holland - EGM
                                                                         Sanofi-Aventis - Shareholders Meeting
                                                                         Sanoma - Information Meeting
                                                                         Sarantis - Investor Conference
                                                                         Sevan Marine - Industry Conference
                                                                         Sorin - Investor Conference
                                                                         Tottenham Hotspur - AGM
                                                                         TUI - Analysts Briefing, Press Conference
                                                                         Vaahto Group - AGM
                                                                         Weatherly International - AGM
                                                                         Wincor-Nixdorf - Investor Conference
                                                                         Yara International - Industry Conference

Wed 15 Dec Bank of Moscow - Q3 Results (IFRS) - 2010 (T)                 Befimmo - AGM                                               SPA - Consumer prices (final) - Nov
           Centralschweizerische Kraftwerke - Annual Res - 2010          Beiersdorf - Investor Day                              SWE - Riksbank Monetary Policy Report
           Compagnie des Alpes - Annual Results - 2009/10                BowLeven - AGM                                       SWE - Riksbank Monetary Policy Decision
           Dalsvyaz Telecom - Q3 Results (IFRS) - 2010                   Centralschweizerische Kraftwerke - Press Conf         UK - Claimant count unemployment - Nov
           Hennes & Mauritz - H&M - Nov Sales - 2010                     Coloplast - Roadshow                              UK - Average earnings - headline (3M/Y) - Oct
           IGE + XAO - Q1 Turnover - 2010/11                             Compagnie des Alpes - Analysts Briefing                      UK - Unemployment rate, sa - Oct
           Inditex - Q3 Results - 2010                                   Dalsvyaz Telecom - Conference Call                      EMU - ECB Governing Council Meeting
           LVL Medical - Annual Results - 2009/10                        Dassault Systemes - EGM                           NOR - Norges Bank Monetary Policy Decision
           North West Telecom - Q3 Results (IFRS) - 2010                 General Bank of Greece - EGM                                         EMU - Eurogroup Meeting
           Novolipetsk Steel - Q3 Results (US GAAP) - 2010 (T)           GOL Linhas Aereas Inteligentes - Investor Day
           OGK-1 - Q3 Results (IFRS) - 2010 (T)                          InfoVista - AGM
           Rosinter Restaurants - Nov Trading Statement - 2010           Jeronimo Martins - EGM
           Sberbank - Nov Turnover - 2010                                LaCie - AGM
           Senior - Trading Statement - 2010                             Michelin - Shareholders Meeting
           Sistema-Hals - Q3 Results (US GAAP) - 2010 (T)                Novolipetsk Steel - Conference Call (T)
           Smiths News - Annual Report Published - 2009/10               PureCircle - AGM
           SuperGroup - Interim Results - 2009/10                        Total - Shareholders Meeting

                                                                                    MORGAN STANLEY RESEARCH

                                                                                    December 8, 2010
                                                                                    Investment Perspectives — Europe

Events Diary
Date         Company Results                                      Other Company Events                                                                Economic Data
             Uralsvyazinform OAO - Q3 Results (IFRS) - 2010 (T)
             Volga Telecom - Q3 Results (IFRS) - 2010
             Volvo - Nov Operations Report - 2010
             Wimm Bill Dann Foods - Q3 Results - 2010 (T)
             WSP Group - Trading Statement - 2010

Thu 16 Dec Aeroports de Paris ADP - Nov Traffic figures - 2010    Advfn - AGM                                                      EMU - ECOFIN Council Meeting
           Begbies Traynor Group - Interim Results - 2010         Ambu - AGM                                                     ITA - Consumer prices (final) - Nov
           BEKO Holding - Annual Results - 2009/10                Carl Zeiss Meditech - Analysts Briefing                       UK - Retail sales, volumes, sa - Nov
           Carl Zeiss Meditech - Annual Results - 2009/10         CGGVeritas - Capital Markets Day                                      EMU - HICP final, nsa - Nov
           Chrysalis - Preliminary Results - 2009/10              China Goldmines - AGM                                                EMU - HICP, core, nsa - Nov
           Danisco - Q2 Results - 2010/11                         Danisco - Conference Call                                            EMU - Trade balace, sa - Oct
           EGL AG - Annual Results - 2009/10                      EADS - Shareholders Meeting                                        SWI - Monetary Policy Meeting
           Euromedis Groupe - Q1 Sales - 2010/11 (T)              Edenred - Shareholders Meeting                          EMU - European Council Meeting (1st day)
           EVN - Annual Results - 2009/10                         EGL AG - Analysts Briefing
           Greentech Energy Systems - Nov Prod Rpt - 2010 (T)     Gabriel Holding - AGM
           Iberia - Nov Traffic figures - 2010                    Irish Life & Permanent - Industry Conference
           Isra Vision - Preliminary Results - 2009/10 (T)        KWS SAAT - AGM
           Manutan International - Annual Results - 2009/10       LVL Medical - Analysts Briefing
           Omega Navigation Enterprises - Q3 Results - 2010 (T)   Monrif - EGM
           Punch Taverns - Q1 Interim Mngt Stmt - 2010/11         Novorossiysk Commercial Sea Port - EGM
           Sanochemia Pharmazeutika – Prelim Res - 2009/10 (T)    Olympique Lyonnais Groupe - AGM
           Sports Direct - Interim Results - 2010/11              Outotec - Information Meeting
           Wood Group (John) - Trading Statement - 2010           Poligrafici Editoriale - EGM
           Zhaikmunai L.P. - Q3 Results - 2010                    Punch Taverns - AGM
           Zodiac Aerospace - Q1 Revenues - 2010/11               Severn Trent - Investor Day
                                                                  Zhaikmunai L.P. - Conference Call

Fri 17 Dec   DTZ - Interim Results - 2010 (T)                     Brit Insurance Holdings - EGM                   FRA - INSEE Mfg survey (synth. Index) - Dec
             Fenner - Annual Report Published - 2009/10 (T)       MJ Maillis Group - EGM                                  GER - Ifo Business climate, sa - Dec
             Grainger - Annual Report Published - 2009/10 (T)     Petrolia Drilling - EGM                                      EMU - Trade balance, sa - Oct
             Keller Group - Trading Statement - 2010              Sportingbet - AGM                                 EMU - European Council Meeting (2nd day)
             Petrofac - Trading Statement - 2010                  Telekom Austria - Capital Markets Day
             Renew Holdings - Annual Report Published - 2009/10   Theolia - OGM
             Wolford - H1 Results - 2010/11                       UFF - Union Financiere de France Banque - General Meeting
                                                                  Vilmorin & Cie - AGM
Sun 19 Dec                                                        ANEK Lines - EGM

Mon 20 Dec Character Group - Annual Rpt Published - 2009/10 (T)   Acergy - EGM                                                      GER - Producer prices, nsa - Nov
           Immoeast - H1 Results - 2010/11                        Aicon - AGM                                               UK - Trends in Lending data series - Dec
           Immofinanz - H1 Results - 2010/11                      Aktiv Kapital - EGM                            UK - CBI Industrial trends survey (total orders) - Dec
           Marston's - Annual Report Published - 2009/10          Arques Industries - EGM                         EMU - Consumer confidence (flash estimate) - Dec
           Per Aarsleff - Annual Results - 2009/10                Baltic Oil Terminals - General Meeting
           Tetragon Financial Group - Nov Fin stmt - 2010 (T)     D Ieteren - EGM
                                                                  ILA Group - AGM
                                                                  Severstal - EGM
                                                                  USG People - EGM

Tue 21 Dec Gfk - Dec Business Outlook - 2010                      Gemfields - AGM                                    UK - GfK consumer confidence survey - Dec
           Hornbach Holding - Q3 Results - 2010/11                Kuzbassenergo - EGM                               GER - GfK consumer confidence survey - Jan
           HORNBACH-Baumarkt - Q3 Results - 2010/11               Nutreco - EGM                                    SWE - NIER Business Sentiment Survey - Dec
           Mittel - Annual Results - 2009/10                      Peninsular Gold - AGM                          SWE - NIER Consumer Confidence Survey - Dec
           SkiStar - Q1 Results - 2010/11                         Serabi - General Meeting                            UK - Public sector net borrowing, nsa - Nov
                                                                  Sistema - EGM                            EMU - ECB publishes Consolidated Financial Statement

Wed 22 Dec KappAhl - Q1 Results - 2010/11                         Aeroflot - Analysts Briefing (T)                           ITA - ISAE Consumer confidence - Dec
           Novorossiysk Commercial Sea Port - Q3 Res - 2010 (T)   Central African Gold - AGM                                            ITA - Retail Sales, sa - Oct
           Rostelecom - Q3 Results (IFRS) - 2010 (T)              Lancashire Holdings - General Meeting                                    UK - MPC minutes - Dec
           Zotefoams - Trading Statement - 2010 (T)               Olmix - AGM                                                               UK - GDP (details) - 3Q
                                                                  VM Materiaux - EGM                                      BEL - BNB Business Survey, Monthly - Dec
                                                                                                                            GRE - Deadline for final budget approval

Thu 23 Dec                                                        Ciments Francais - General Meeting                      FRA - Consumption mfg goods - Nov
                                                                  Comstar United Telesystems - EGM                   NET - GDP release, sa (2nd estimate) - 3Q
                                                                  Hellenic Telecommunications Organisation - OTE - EGM EMU - PMI manufacturing (flash) - Dec
                                                                  Mobile TeleSystems - EGM                            UK - BBA loans for house purchase - Nov
                                                                  Specialist Energy Group - AGM

                                                                                 MORGAN STANLEY RESEARCH

                                                                                 December 8, 2010
                                                                                 Investment Perspectives — Europe

Events Diary
Date         Company Results                                     Other Company Events                                                      Economic Data
Fri 24 Dec   Federal Grid Company - Preliminary Results - 2010   Gestevision Telecinco - EGM                                  Christmas Eve - ATH - Closed
                                                                                                                              Christmas Eve - COP - Closed
                                                                                                                              Christmas Eve - FRA - Closed
                                                                                                                              Christmas Eve - HEL - Closed
                                                                                                                               Christmas Eve - ITX - Closed
                                                                                                                              Christmas Eve - MDD - Closed
                                                                                                                              Christmas Eve - STO - Closed
                                                                                                                              Christmas Eve - SWX - Closed
                                                                                                                              Christmas Eve - VNA - Closed

Sat 25 Dec                                                                                                          UK - CBI distributive trades survey – Dec

 (T) = Tentative /provisional dates to be confirmed sa = seasonally adjusted nsa = not seasonally adjusted Note: Morgan Stanley cannot guarantee the
accuracy of these dates, which may be subject to change.
Source: Columba Systems (Company Results, Other Company Events, market close dates in Economic Data), Morgan Stanley Research (Economic Data
except market close dates)


               December 8, 2010
               Investment Perspectives — Europe


                                                                                  MORGAN STANLEY RESEARCH

                                                                                  December 8, 2010
                                                                                  Investment Perspectives — Europe

                                                        Options Disclaimer

Options are not for everyone. Before engaging in the purchasing or writing of options, investors should understand the nature and extent of their
rights and obligations and be aware of the risks involved, including the risks pertaining to the business and financial condition of the issuer and the
underlying stock. A secondary market may not exist for these securities. For customers of Morgan Stanley & Co. Incorporated who are purchasing
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statement entitled “Risks of Option Writers.” That publication, which you should have read and understood prior to investing in options, can be
viewed on the Web at the following address: Spreading may also entail substantial
commissions, because it involves at least twice the number of contracts as a long or short position and because spreads are almost invariably
closed out prior to expiration. Potential investors should be advised that the tax treatment applicable to spread transactions should be carefully
reviewed prior to entering into any transaction. Also, it should be pointed out that while the investor who engages in spread transactions may be
reducing risk, he is also reducing his profit potential. The risk/ reward ratio, hence, is an important consideration.
The risk of exercise in a spread position is the same as that in a short position. Certain investors may be able to anticipate exercise and execute a
"rollover" transaction. However, should exercise occur, it would clearly mark the end of the spread position and thereby change the risk/reward ratio.
Due to early assignments of the short side of the spread, what appears to be a limited risk spread may have more risk than initially perceived. An
investor with a spread position in index options that is assigned an exercise is at risk for any adverse movement in the current level between the
time the settlement value is determined on the date when the exercise notice is filed with OCC and the time when such investor sells or exercises
the long leg of the spread. Other multiple-option strategies involving cash settled options, including combinations and straddles, present similar risk.
Important Information:
         Examples within are indicative only, please call your local Morgan Stanley Sales representative for current levels.
         By selling an option, the seller receives a premium from the option purchaser, and the purchase receives the right to exercise the option
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          shares to/from the option buyer at the strike price. If the option seller does not own the underlying security while maintaining the short
          option position (naked), the option seller is exposed to unlimited market risk.
         Spreading may entail substantial commissions, because it involves at least twice the number of contracts as a long or short position and
          because spreads are almost invariably closed out prior to expiration. Potential investors should carefully review tax treatment applicable
          to spread transactions prior to entering into any transactions.
         Multi-legged strategies are only effective if all components of a suggested trade are implemented.
         Investors in long option strategies are at risk of losing all of their option premiums. Investors in short option strategies are at risk of
          unlimited losses.
         There are special risks associated with uncovered option writing which expose the investor to potentially significant loss. Therefore, this
          type of strategy may not be suitable for all customers approved for options transactions. The potential loss of uncovered call writing is
          unlimited. The writer of an uncovered call is in an extremely risky position, and may incur large losses if the value of the underlying
          instrument increases above the exercise price.
         As with writing uncovered calls, the risk of writing uncovered put options is substantial. The writer of an uncovered put option bears a risk
          of loss if the value of the underlying instrument declines below the exercise price. Such loss could be substantial if there is a significant
          decline in the value of the underlying instrument.
         Uncovered option writing is thus suitable only for the knowledgeable investor who understands the risks, has the financial capacity and
          willingness to incur potentially substantial losses, and has sufficient liquid assets to meet applicable margin requirements. In this regard,
          if the value of the underlying instrument moves against an uncovered writer’s options position, the investor’s broker may request
          significant additional margin payments. If an investor does not make such margin payments, the broker may liquidate stock or options
          positions in the investor’s account, with little or no prior notice in accordance with the investor’s margin agreement.
         For combination writing, where the investor writes both a put and a call on the same underlying instrument, the potential risk is unlimited.
         If a secondary market in options were to become unavailable, investors could not engage in closing transactions, and an option writer
          would remain obligated until expiration or assignment.
         The writer of an American-style option is subject to being assigned an exercise at any time after he has written the option until the option
          expires. By contrast, the writer of a European-style option is subject to exercise assignment only during the exercise period.

                                                                                     MORGAN STANLEY RESEARCH

                                                                                     December 8, 2010
                                                                                     Investment Perspectives — Europe

                                                          Morgan Stanley ModelWare is a proprietary analytic framework that helps clients
                                                          uncover value, adjusting for distortions and ambiguities created by local accounting
                                                          regulations. For example, ModelWare EPS adjusts for one-time events, capitalizes
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                                                          a FIFO basis. ModelWare also emphasizes the separation of operating performance of a
                                                          company from its financing for a more complete view of how a company generates earnings.

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As of October 29, 2010, Morgan Stanley beneficially owned 1% or more of a class of common equity securities of the following companies covered in Morgan
Stanley Research: ABB, Acer Inc., Akzo Nobel, AU Optronics, Barclays Bank, British American Tobacco Plc, British Land, Cable & Wireless Communications
PLC, Capgemini, Credit Agricole S.A., Danone, Danske Bank, Deutsche Bank, Deutsche Lufthansa AG, Diageo, Drax, E.ON, Enagas, Iberdrola, Imperial
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Financial Holdings, Centrica, CEZ, Colt Group S.A., Credit Agricole S.A., Danone, Danske Bank, Dassault Systemes SA, Deutsche Bank, Deutsche

                                                                                     MORGAN STANLEY RESEARCH

                                                                                     December 8, 2010
                                                                                     Investment Perspectives — Europe

Lufthansa AG, Diageo, DnB NOR, Drax, E.ON, EADS, EDF, Edison, EDP, Enagas, Endesa, ENEL, Eni SpA, FIAT, Fortum, France Telecom, Freenet AG,
Gas Natural, GKN Plc, Henkel, Iberdrola, Iliad, Imperial Tobacco, ING, Inmarsat, InterContinental Hotels Group, Invensys, Kabel Deutschland Holding AG,
KPN, Legal and General, Linde, Lloyds Banking Group, Marks & Spencer, National Grid plc, Nokia, Northumbrian Water Group, Novartis, OTE (Hellenic
Telecoms.), Pennon Group, PGE Polska Grupa Energetyczna S.A., Reckitt Benckiser, Red Electrica, Repsol-YPF, Rexam PLC, Rio Tinto Plc, Royal Bank of
Scotland, Royal Dutch Shell, RSA, RWE AG, Saipem, sanofi-aventis, Schroders, Scottish & Southern, Serco Group plc, SES, Severn Trent, Siemens, SKF,
Smiths Group, Snam Rete Gas, Societe Generale, Suez Environnement, Swisscom, Tele2, Telecom Italia, Telefonica, Telefonica O2 Czech Republic,
Telekom Austria, Telenor, TeliaSonera, Terna, ThyssenKrupp, TOTAL, TPSA, TUI Travel, Tullow Oil, Unilever NV, Unilever PLC, United Utilities, Verbund,
Vodafone Group, Wolseley plc, Xstrata PLC, Yuanta Financial Holding Company.
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Nobel, Aviva, AXA, BAE SYSTEMS, Barclays Bank, BG Group, BP plc, British Airways, Cathay Financial Holdings, Centrica, CEZ, Credit Agricole S.A.,
Danske Bank, Deutsche Bank, Deutsche Lufthansa AG, Diageo, DnB NOR, E.ON, EADS, EDF, EDP, Endesa, ENEL, Eni SpA, FIAT, Fortum, France
Telecom, Gas Natural, Iberdrola, Imperial Tobacco, ING, Legal and General, Linde, Lloyds Banking Group, Marks & Spencer, National Grid plc, Novartis,
Petrofac, Repsol-YPF, Rio Tinto Plc, Royal Bank of Scotland, Royal Dutch Shell, RWE AG, Schroders, Scottish & Southern, SES, Siemens, Smiths Group,
Societe Generale, Telecom Italia, Telefonica, Telenor, Terna, TOTAL, Unilever NV, Unilever PLC, Verbund, Vodafone Group, Xstrata PLC, Yuanta Financial
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Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.

                                                                                      MORGAN STANLEY RESEARCH

                                                                                      December 8, 2010
                                                                                      Investment Perspectives — Europe

Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight, Not-Rated or Underweight (see definitions below). Morgan
Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of
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Global Stock Ratings Distribution
(as of November 30, 2010)

For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our
ratings of Overweight, Equal-weight, Not-Rated and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover.
Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see
definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond
Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively.
                           Coverage Universe    Investment Banking Clients (IBC)
                                          % of                   % of % of Rating
Stock Rating Category         Count       Total     Count Total IBC Category
Overweight/Buy                 1121         40%           417        44%          37%
weight/Hold                    1175         42%           410        43%          35%
Not-Rated/Hold                  119          4%            26         3%          22%
Underweight/Sell                392         14%           105        11%          27%
Total                         2,807                       958

Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances
(such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley received
investment banking compensation in the last 12 months.
Analyst Stock Ratings
Overweight (O). The stock's total return is expected to exceed the average total return of the analyst's industry (or industry team's) coverage universe, on a
risk-adjusted basis, over the next 12-18 months.

Equal-weight (E). The stock's total return is expected to be in line with the average total return of the analyst's industry (or industry team's) coverage universe,
on a risk-adjusted basis, over the next 12-18 months.

Not-Rated (NR). Currently the analyst does not have adequate conviction about the stock's total return relative to the average total return of the analyst's
industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months.

Underweight (U). The stock's total return is expected to be below the average total return of the analyst's industry (or industry team's) coverage universe, on a
risk-adjusted basis, over the next 12-18 months.

Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.
Analyst Industry Views
Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad
market benchmark, as indicated below.

In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad
market benchmark, as indicated below.

Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad
market benchmark, as indicated below.

Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe -
MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index.

                                                                                              MORGAN STANLEY RESEARCH

                                                                                              December 8, 2010
                                                                                              Investment Perspectives — Europe

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                                                                                           MORGAN STANLEY RESEARCH

                                                                                           December 8, 2010
                                                                                           Investment Perspectives — Europe

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Additional information on recommended securities/instruments is available on request.                                                                            L19346

                                                                                            MORGAN STANLEY RESEARCH

                                                                                            December 8, 2010
                                                                                            Investment Perspectives — Europe

Director of Research                        Tobacco                                          MEDIA
Rupert Jones         +44 (0)20 7425 4271    Toby McCullagh           +44 (0)20 7425 6636                                                   MIDDLE EAST NORTH AFRICA
Associate Director of Research              ENERGY/UTILITIES                                 Media & Internet
Juliet Estridge      +44 (0)20 7425 8160                                                     Patrick Wellington      +44 (0)20 7425 8605   Head of Research
Matthew Ostrower     +44 (0)20 7425 8560    Oil & Gas                                        Edward Hill-Wood        +44 (0)20 7425 9224   Sean Gardiner             +971 4 709 7120
Mitzi Frank          +44 (0)20 7425 8022    Theepan Jothilingam +44 (0)20 7425 9761             Julien Rossi         +44 (0)20 7425 9755   Economics
Product Development & SSC                   James Hubbard          +44 (0)20 7425 0749                                                     Mohamed Jaber             +971 4 709 7105
Ben Britz            +44 (0)20 7425 3055       Matthew Lofting     +44 (0)20 7425 5915       PROPERTY                                      Financials
Fergus O’Sullivan    +44 (0)20 7425 6404       Jamie Maddock       +44 (0)20 7425 4405                                                     Dan Cowan                 +971 4 709 7165
                                                                                             Property                                        Suha Urgan              +971 4 709 7240
Management                                     Albina Sadykova +44 (0) 20 7425 7502          Bart Gysens             +44 (0)20 7425 5862
Sarah Waugh          +44 (0)20 7425 8154       Sasikanth Chilukuru +44 (0)20 7425 3016                                                     Infrastructure
                                                                                             Chris Fremantle         +44 (0)20 7425 5761   Muneeba Kayani            +971 4 709 7117
Sharon Reid          +44 (0)20 7677 6101    Matt Thomas            +44 (0)20 7425 5387          Bianca Riemer        +44 (0)20 7425 2646   Saul Rans                 +971 4 709 7110
Media Relations                                Marina Zavolock     +44 (0)20 7425 5354
Sebastian Howell     +44 (0)20 7425 5324    Oil Services                                                                                     Nida Iqbal              +971 4 709 7103
                                                                                             RETAIL                                        Telecoms
                                            Martijn Rats             +44 (0)20 7425 6618
MACRO                                                                                                                                      Sean Gardiner         +971 4 709 7120
                                              Rob Pulleyn            +44 (0)20 7425 4388     Retailing/Brands
                                            Utilities                                                                                      Cesar Tiron        +44 (0)20 7425 8846
Equity Strategy                                                                              Louise Singlehurst      +44 (0)20 7425 7239
                                            Bobby Chada              +44 (0)20 7425 5238                                                     Madhvendra Singh    +971 4 709 7122
Ronan Carr           +44 (0)20 7425 4944                                                        Emily Tam            +44 (0)20 7425 4055
   Matthew Garman    +44 (0)20 7425 3595    Nicholas Ashworth        +44 (0)20 7425 7770        Pallavi Verma        +44 (0)20 7425 2644
Graham Secker        +44 (0)20 7425 6188        Arsalan Obaidullah   +44 (0)20 7425 4267     Retailing                                     RUSSIA
   Chris Sellers       +44 20 7425-4013     Igor Kuzmin              +44 (0)20 7425 8371     Geoff Ruddell           +44 (0)20 7425 8954   Economics
Economics                                   Emmanuel Turpin          +44 (0)20 7425 6863     Fred Bjelland           +44 (0)20 7425 3612      Alina Slyusarchuk   +44 (0)20 7677 6869
Joachim Fels         +44 (0)20 7425 6138        Sean Lee             +44 (0)20 7425 6230     Edouard Aubin           +44 (0)20 7425 3160
                                            Antonella Bianchessi     +44 (0)20 7425 7857
                                                                                                                                           Metals & Mining
   Manoj Pradham     +44 (0)20 7425 3805                                                        Charlie Muir-Sands   +44 (0)20 7425 5207
                                                Carolina Dores       +44 (0)20 7677 7167                                                   Dmitriy Kolomytsyn        +7 495 589 9942
   Spyros Andreopoulos                                                                                                                       Timur Salikhov          +7 495 287 2118
                     +44 (0)20 7677 0528    Clean Energy                                     TECHNOLOGY
                                            Allen Wells              +44 (0)20 7425 4146                                                   Oil & Gas
Elga Bartsch         +44 (0)20 7425 5434
                                                                                             Technology                                    Matt Thomas            +44 (0)20 7425 5387
   Olivier Bizimana  +44 (0)20 7425 6290    Andrew Humphrey          +44 (0)20 7425 2630
                                                                                             Patrick Standaert       +44 (0)20 7425 9290     Marina Zavolock      +44 (0)20 7425 5354
Melanie Baker        +44 (0)20 7425 8607    FINANCIALS                                       Adam Wood               +44 (0)20 7425 4450   Telecommunications Services
   Cath Sleeman      +44 (0)20 7425 1820
                                            Banks/ Diversified Financials                       Ashish Sinha         +44 (0)20 7425 2363   Sean Gardiner      +44 (0)20 7425 2175
Daniele Antonucci    +44 (0)20 7425 8943
                                            Huw van Steenis           +44 (0)20 7425 9747       Guillaume Charton    +44 (0)20 7425 2686     Polina Ugryumova    +7 495 589 9944
   Alina Slyusarchuk +44 (0)20 7677 6869
Pasquale Diana       +44 (0)20 7677 4183       Alice M. Timperley    +44 (0)20 7425          Francois Meunier        +44 (0)20 7425-6603   Utilities
                                            9094                                                Sunil George         +44 (0)20 7425 3436   Bobby Chada            +44 (0)20 7425 5238
Tevfik Aksoy         +44 (0)20 7677 6917
                                            Steven Hayne             +44 (0)20 7425 8332                                                     Igor Kuzmin          +44 (0)20 7425 8371
Mohamed Jaber           +971 4 709 7105
Michael Kafe            +27 11 507 0891     Bruce Hamilton           +44 (0)20 7425 7597     TELECOMS
                                                                                                                                           SOUTH AFRICA -
   Andrea Masia         +27 11 507 0887        Anil Sharma           +44 (0)20 7425 8828
                                            Chris Manners            +44 (0)20 7425 3917     Telecommunications Services                   RMB MORGAN STANLEY
Derivatives and Portfolios                                                                   Nick Delfas             +44 (0)20 7425 6611
Neil Chakraborty     +44 (0)20 7425 2571    Hubert Lam               +44 (0)20 7425 3734
                                            Francesca Tondi          +44 (0)20 7425 9721
                                                                                             Luis Prota                 +34 91 412 1217    Head of Research/Strategy
Praveen Singh        +44 (0)20 7425 7833                                                     Frederic Boulan         +44 (0)20 7425 6830   Vaughan Henkel            +27 11 282 8260
SRI                                            Wouter Janssens       +44 (0)20 7425 2138
                                            Maxence Le Gouvello      +44 (0)20 7425 6942        Terence Tsui         +44 (0)20 7425 4399   Economics
   Kristina Obrtacova +44 (0)20 7425 6107                                                       Ryan Fox             +44 (0)20 7425 5413   Michael Kafe              +27 11 507 0891
                                               Thibault Nardin       +44 (0)20 7677 3787
                                                                                                                                              Andrea Masia           +27 11 507 0887
                                            Magdalena Stoklosa       +44 (0)20 7425 3933     TRANSPORTATION
Sectors                                        Hadrien de Belle      +44 (0)20 7425 4466                                                   Financials
                                                                                             Transport                                     Magdalena Stoklosa        +27 11 282 1082
CONSUMER DISCRETIONARY/                        Samuel Goodacre       +44 (0)20 7677 0759
                                                                                             Menno Sanderse          +44 (0)20 7425 6148      Derinia Chetty         +27 11 282 8553
                                            Henrik Schmidt           +44 (0)20 7425 8808
INDUSTRIALS                                 Insurance                                        Jaime Rowbotham         +44 (0)20 7425 5409   Greg Saffy                +27 11 282-4228
Aerospace & Defence                         Jon Hocking          +44 (0)20 7425 2307         Penny Butcher           +44 (0)20 7425 6698   Industrials
                                                                                                Suzanne Todd         +44 (0)20 7425 8316   Anthony de la Cour        +27 11 282 8139
Rupinder Vig         +44 (0)20 7425 2687    Farooq Hanif         +44 (0)20 7425 6477
                                                                                                Doug Hayes           +44 (0)20 7425 3831   Roy Campbell              +27 11 282 1499
  Ovunc Okyay        +44 (0)20 7425-8754       Adrienne Lim      +44 (0)20 7425 6679
Autos & Auto Parts                             Maciej Wasilewicz +44 (0)20 7425 9104            Daniel Ruivo         +44 (0)20 7425 5816   Retail
                                                                                                                                           Natasha Moolman           +27 11 282 8489
Stuart Pearson       +44 (0)20 7425 6654       Damien Kingsley-Tomkins
                                                                 +44 (0)20 7425 1830
                                                                                             EMERGING MARKETS                              Danie Pretorius           +27 11 282 1082
   Edoardo Spina     +44 (0)20 7425 0664
                                                                                                                                              Qaqambile Dwayi        +27 11 282 4146
   Laura Lembke      +44 (0)20 7425-7944    HEALTHCARE                                       Equity Strategy (Global)
Business & Employment                                                                                                                      TMT
                                                                                             Jonathan Garner         +44 (0)20 7425 9237   Peter Takaendesa          +27 11 282 8240
Services                                    Biotech & Medical Technology                     Equity Strategy (CEEMEA)
Jessica Alsford       +44 (0)20 7425 8985   Michael Jungling         +44 (0)20 7425 5975                                                   Mining
                                                                                             Economics                                     Simon Kendall             +27 11 282 4932
David Hancock         +44 (0)20 7425 3752   Karl Bradshaw            +44 (0)20 7425 6573     Pasquale Diana          +44 (0)20 7677 4183   Leigh Bregman             +27 11 282 8969
   Simone Porter Smith+44 (0)20 7425 3893      Andrew Olanow         +44 (0)20 7425 4107     Banks/ Diversified Financials
Capital Goods                                  Valerie Rinecker      +44 (0)20 7677-0209                                                   Food Producers
                                                                                             Magdalena Stoklosa      +44 (0)20 7425 3933      Qaqambile Dwayi        +27 11 282 4146
Ben Uglow            +44 (0) 20 7425 8750   Pharmaceuticals                                    Samuel Goodacre       +44 (0)20 7677 0759
Guillermo Peigneux   +44 (0)20 7425 7225    Andrew Baum              +44 (0)20 7425 6647       Hadrien de Belle      +44 (0)20 7425 4466   TURKEY
Vidya Adala          +44 (0)20 7425 2044    Peter Verdult            +44 (0)20 7425 2244     Telecommunications Services
   Robert Davies     +44 (0)20 7425 2057       Liav Abraham          +44 (0)20 7425 8273     Sean Gardiner              +971 4 709 7120    Sayra Can Altuntas     +44 (0)20 7425 2365
Leisure/Hotels                                 Simon Mather          +44 (0)20 7425 3227     Consumer                                      Erol Danis             +44 (0)20 7425 7123
Jamie Rollo          +44 (0)20 7425 3281       Matt Hartley          +44 (0)20 7425 2272     Daniel Wakerly     +44 (0)20 7425 4389           Batuhan Karabekir - +44 (0)20 7425
Vaughan Lewis        +44 (0)20 7425 3489                                                       Maryia Berasneva +44 (0) 20 7425 7502       3346
   Alex Davie        +44 (0)20 7425 9867    MATERIALS                                                                                      Economics
   Andrea Ferraz     +44 (0)20 7425 7242                                                                                                   Tevfik Aksoy           +44 (0)20 7677 6917
                                            Building & Construction
CONSUMER STAPLES                            Alejandra Pereda            +34 91 412 1747                                                    Banks
                                               Michael Watts         +44 (0)20 7425 7515                                                   Magdalena Stoklosa     +44 (0)20 7425 3933
Beverages                                   Chemicals                                                                                      Telecommunications Services
Michael Steib        +44 (0)20 7425 5263                                                                                                   Sean Gardiner             +971 4 709 7120
                                            Paul Walsh               +44 (0)20 7425 4182
   Eveline Varin     +44 (0)20 7425 5717
                                            Peter J. Mackey          +44 (0)20 7425 4657
Food Producers/HPC                             Amy Walker            +44 (0)20 7425-0640
Michael Steib        +44 (0)20 7425 5263
Toby McCullagh       +44 (0)20 7425 6636
                                            Metals & Mining
                                            Ephrem Ravi              +44 (0)20 7425 2127
Mark Christensen     +44 (0)20 7425 5392
                                            Hannah Kirby             +44 (0) 20 7425 6014
Erik Sjogren         +44 (0)20 7425 3935
                                              Carsten Riek           +44 (0)20 7425 3075
    Audrey Borius    +44 (0)20 7425 7242
                                              Markus Almerud         +44 (0)20 7425 9870
                                              Alain Gabriel          +44 (0)20 7425 8959

                                                                                    MORGAN STANLEY RESEARCH

                                                                                    December 8, 2010
                                                                                    Investment Perspectives — Europe

Fixed Income Research - Global
Global Cross-Asset Strategy               Currency Strategy                       Interest Rate Strategy                     Credit Research
Gregory Peters           1+212 761-1488   North America                           North America                              Europe – Financials
Jason Draho              1+212 761-7893   Gabriel de Kock        1+212 761-5154   Jim Caron                 1+212 761-1905   Jackie Ineke                 41+44 220-9246
Credit Strategy                           Ron Leven              1+212 761-3413   Subadra Rajappa           1+212 761-2983   Marcus Rivaldi              44+20 7677-1464
North America                             Yilin Nie              1+212 761-2886   Bill McGraw               1+212 761-1445   Lee Street                  44+20 7677-0406
Gregory Peters           1+212 761-1488   Christine Tian         1+212 761-5970   Janaki Rao                1+212 761-1711   Fiona Simpson               44+20 7677-3745
Rizwan Hussain           1+212 761-1494   Europe                                  George Azarias            1+212 761-1346   Asia Pacific – Financials
Adam Richmond            1+212 761-1485   Stephen Hull          44+20 7425-1330   Igor Cashyn               1+212 761-1696   Desmond Lee                  +852 2239-1575
Michael Zezas            1+212 761-8609   Tim Davis             44+20 7677-1692   Zofia Koscielniak         1+212 761-1307
Maya Abdurahmanova       1+212 761-1470   Calvin Tse                                                                         Commodities Strategy
                                                                                  Jonathan Marymor          1+212 761-2056
                                                                                                                             Hussein Allidina            1+212 761-4150
Europe                                    Asia Pacific                            Europe                                     Chris Corda                 1+212 761-6005
Andrew Sheets           44+20 7677-2905   Stewart Newnham        852+2848-5320    Laurence Mutkin          44+20 7677-4029   Tai Liu                     1+212 761-3585
Phanikiran Naraparaju   44+20 7677-5065   Emma Lawson            852+3963-3190    Anthony O’Brien          44+20 7677-7748
Carlos Egea             44+20 7425-6247                                                                                      Bennett Meier               1+212-761-4967
                                          Yee Wai Chong          852+2239-7117    Mayank Gargh             44+20 7677-7528
Serena Tang             44+20 7677-1149                                                                                      EM Fixed Income and Foreign
                                          Economics                               Anton Heese              44+20 7677-6951
Jonathan Graber         44+20 7425 0577                                                                                      Exchange Strategy
                                          North America                           Owen Roberts             44+20 7677-7121
Japan                                                                                                                        North America
                                          Richard Berner         1+212 761-3398   Elaine Lin               44+20 7677-0579
Hidetoshi Ohashi         81+3 5424-7908                                                                                      Rogerio Oliveira             1+212 761-1204
                                          David Greenlaw         1+212 761-7157   Corentin Rordorf         44+20 7677-0518
Tomoyuki Hirose          81+3 5424-7912   Ted Wieseman           1+212 761-3407                                              Vitali Meschoulam            1+212 761-1889
                                                                                  Rachael Featherstone     44+20 7677-7764
Asia Pacific                              David Cho              1+212 761-0908                                              Juha Seppala                 1+212 761-1949
                                                                                  Japan                                      Rosa Velasquez               1+212 761-8278
Viktor Hjort             +852 2848-7479   Europe                                  Takehiro Sato             81+3 5424-5367
Kelvin Pang              +852 2848-8204   Joachim Fels          44+20 7425-6138                                              Europe
                                                                                  Le Ngoc Nhan              81+3 5424-7698
Nishant Sood             +852 2239-1597   Arnaud Marès          44+20 7677-6302                                              Rashique Rahman             44+20 7677-7295
                                                                                  Miho Ohashi               81+3 5424-7904
Structured Credit Strategy                Manoj Pradhan         44+20 7425-3805                                              Paolo Batori, CFA           44+20 7677-7971
                                                                                  Asia Pacific                               Vanessa Barrett             44+20 7677-9569
Sivan Mahadevan          1+212 761-1349   Spyros Andreopoulos   44+20 7056-8584
                                                                                  Pieter Van Der Schaft     +852 3963-0550
Ashley Musfeldt          1+212 761-1727                                                                                      Regis Chatellier            44+20 7677-6982
                                          Emerging Markets Economics              Rohit Arora               +852 2848-8894
Vishwanath Tirupattur    1+212 761-1043                                                                                      Chuan Lim, CFA              44+20 7677-7597
                                          Tevfik Aksoy          44+20 7677-6917
James Egan               1+212 761-4715   Pasquale Diana        44+20 7677-4183                                              James Lord                  44+20 7677-3254
Oliver Chang             1+415 576-2395   Alina Slyusarchuk     44+20 7677-6869                                              Robert Tancsa               44+20 7677-6671
Richard Parkus           1+212 761-1444   Mohamed Jaber          971+4 709-7105
Andy Bernard             1+212 761-7880   Michael Kafe           27+11 507-0891
Srikanth Sankaran       44+20 7677-2969   Andrea Masia           27+11 507-0887

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