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Option Strategies for Power and Utilities Industries

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Actionable trade ideas for stock market investors and traders seeking alpha by overlaying their portfolios with options, other derivatives, ETFs, and disciplined and applied Game Theory for hedge fund managers and other active fund managers worldwide. Ryan Renicker, CFA

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Option Strategies for Power and Utilities Industries

  1. 1. EQUITY RESEARCHSeptember 19, 2006 North America Energy & PowerPower & Utilities Power & Utilities Daniel Ford, CFA Ryan RenickerIndustry Overview 1.212.526.0836 1.212.526.9425Derivative Strategy for Commodity Names daford@lehman.com rrenicke@lehman.comSector View:New: 3-NegativeOld: 3-NegativeInvestment conclusion We expect near-term downside for utilities names exposed to natural gas prices - EXC, D, TXU, and NRG. However, we are fundamentally bullish on these names over the medium term, on the basis of tightening U.S. power markets and Q406 shareholder events. This piece reflects our collaboration with the Ryan Renickers Equity Derivatives Team at Lehman Brothers.Summary We suggest two derivatives strategies that efficiently express this fundamental view with different risk-reward characteristics. Purchasing Oct puts and Jan call spreads lets investors gain from any near-term lows and provides participation to any upside in the fourth quarter and early next year. An alternative strategy involving higher risk would buy Oct puts and 1x2 call spreads expiring in January. This reduces the initial premium and provides greater leverage, but leaves investors short the upside beyond the near-term target price.Investment ConclusionWe expect near-term downside for utilities names exposed to natural gas prices - EXC, D, TXU, and NRG. However, we arefundamentally bullish over the medium term based on expected catalysts. We explore two derivatives strategies forexpressing this view using relatively cheap options on these names. The first strategy is to buy Oct puts and Jan 07 callspreads. A higher risk alternative is purchasing Oct puts and Jan 1x2 call spreads, with the higher strike close to the interimtarget.Fundamental ViewOur fundamental view is that these 4 companies are advantaged by tightening U.S. power markets coupled with shareholderevents in Q406 that should propel them at least halfway to our 12 month price targets by January. These catalysts include:EXC: a 12/12 analyst meeting where we expect a dividend hike, share repurchase and 2007/2008 EPS guidance. Our 12month target is $71 is premised upon applying a 15% premium to the integrated utilities group, or 14.3x our $4.97 estimate for‘08. However, our interim target is $65 which reflects ½ of the potential upside to our 12 month target.D: completion of strategic business review, potential structural changes announced. Our 12 month D price target of $79reflects an integrated multiple of 11.2x our 2008 EPS estimate of $7.12. However, our interim target is $78 which reflects ½ ofthe potential upside to our 12 month target.Our long-term rating on D is a 2-Equal weight as we are skeptical on the timeliness of recognizing the strategic upside of theassets, however, we believe that within the derivatives context detailed herein, particularly due to the near-term weakness ingas prices, there is a buying opportunity.Lehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors shouldbe aware that the firm may have a conflict of interest that could affect the objectivity of this report.Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companiescovered in this report, at no cost to them, where such research is available. Customers can access this independent research atwww.lehmanlive.com or can call 1-800-2LEHMAN to request a copy of this research.Investors should consider this report as only a single factor in making their investment decision. PLEASE SEE ANALYST(S) CERTIFICATION(S) ON PAGE 5 AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 6 1
  2. 2. EQUITY RESEARCHTXU: the likely air permit for a major power plant in Texas in mid-October followed by development company debt and equityfinancing in Q406. Our 12 month TXU price target is $69, however, our interim target is $65 which reflects ½ of the potentialupside to our 12 month target.More specifically, our 12 month target is premised upon the average of three valuation methodologies, which are: 14.9x theUtility business and 17.7x the Energy Business plus a value of the retail business of $1,178 per customer which yields $63;7.4x 07E EBITDA of $5.4B less $12.4B in debt which is $63; and a free cash yield of 7.9% on $2.8B in 07 which is $80.NRG: investor meeting on 10/17 to review a generation development program. Our 12 month target is $59, however, ourinterim target is $53 which reflects ½ of the potential upside to our 12 month target.More specifically, our 12 month target for NRG reflects the average of four valuation methodologies following and $2/share ofNOLs NPV including: IPP average 7.5x 2008 EBITDA of $1.72B less $5.9B of net debt and 144M diluted shares; free cashyield of 10.5% on $846M or $56; asset based values of $53 and Open EBITDA average of $2.35B 2008 EBITDA of 6.6x less$6.0B of net debt.Near-term this fundamental view is challenged by collapsing natural gas prices due to unprecedented storage levels, coupledwith lack of supply disruptions (hurricanes) and normal seasonal declines in usage. In similar past periods these stocks havetracked gas down and corrected 10-15% notably in 10/05 and 5/06. We believe this trough could last until winter heatingseason begins to ramp-up in November.Based upon past patterns, we posit that the stocks could see lows of $59-$57 for TXU, $46-$43 for NRG, $57-$54 for EXC,and $72-$68 for D. Figure 1 summarizes the key catalysts along with the expected downside and recovery target for each ofthese stocks.We would begin buying these stocks at the high end of the correction range and aggressively purchase at the bottom end.Our point of view is backed by a long-term view of gas and power prices outlined in "Just the Beginning" 8/21/06.Figure 1: Nat Gas Trade Milestones Interim Current RecoveryStock 9/18/06 Downside Positive Catalysts TargetD $76.87 $72-$68 Strategic review announcements $78EXC $58.73 $57-$54 Dividend hike, stock buyback, 07/08 guidance $65NRG $48.08 $46-$43 10/17 investor meeting in TX. $53TXU $62.29 $59-$57 Air permit for TX plant and devco financing. $65Source: Bloomberg, Lehman BrothersFigure 2: Average Implied Vol for EXC, D, TXU andNRG 30% 28% 26% 24% 22% 20% Avg 3m Implied Vol 18% Avg 1m Implied Vol 16% 06 06 06 6 06 06 06 06 06 l-0 p- - n- n- b- - g- r- ay ar Ju Ja Ju Fe Ap Se Au M MSource: Bloomberg, Option Metrics 2
  3. 3. EQUITY RESEARCHImplied Vols Still Fairly LowImplied volatility for Utilities names has been rising concurrently with the sell-off over the last two weeks. Figure 2 shows thataverage implied vols for these 4 stocks have been on the ascent over this period. However, these options are still tradingcheap relative to their vols since the beginning of the year. In the event of a near-term trough being attained, volatility couldrise even further, hence biasing us towards long option strategies.We suggest two possible options strategies with different risk-reward profiles that efficiently express our fundamental view.Strategy I: Oct Puts vs Jan Call Spreads • Expectations of a near-term pullback merit purchasing short-dated puts expiring in October. • Long call spreads expiring in January give participation to any potential upside in the later part of the fourth quarter and early next year. • We show the payoff from a strategy of buying TXU Oct 60 puts and TXU Jan 07 62.5-65 call spreads (Figure 3). • The trade benefits from any downside below $60 as of the October expiration and gains from TXU rising to $65 by the January expiration. • The up-front premium is $2.15, or approximately 3.5% of TXU’s closing price last night. This represents the maximum downside from the trade. • Figure 4 shows the expiration payoff of the strategy for TXU, for different underlying prices as of the October 20th and January 19th expirations. • Per our fundamental expectations, if TXU retreats to $57 by October 20 and rallies back to $65 by January 19, the trade stands to pay off $5.5 at expiration, over 250% of the initial premium.Figure 3: Puts vs Call Spreads Payoff – TXU 6 5 Payoff (9/18/06) 4 Benefit from Payoff (10/20/06) pullback till Oct Payoff (1/19/07) 3 Strategy Payoff 2 1 0 -1 -2 -3 50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 TXU PriceSource: Bloomberg, Lehman Brothers 3
  4. 4. EQUITY RESEARCHFigure 4: Strategy I P/L for TXU Under Different Scenarios Maximum downside limited to Max gain if TXU retracts in near-term premium paid and rallies before Jan TXU Price as of Jan 07 Expiration 50 52 54 56 58 60 62 64 66 68 70 50 7.9 7.9 7.9 7.9 7.9 7.9 7.9 9.4 10.4 10.4 10.4TXU Price as of Oct Expiration 52 5.9 5.9 5.9 5.9 5.9 5.9 5.9 7.4 8.4 8.4 8.4 54 3.9 3.9 3.9 3.9 3.9 3.9 3.9 5.4 6.4 6.4 6.4 56 1.9 1.9 1.9 1.9 1.9 1.9 1.9 3.4 4.4 4.4 4.4 58 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2 -0.2 1.4 2.4 2.4 2.4 60 -2.2 -2.2 -2.2 -2.2 -2.2 -2.2 -2.2 -0.7 0.4 0.4 0.4 62 -2.2 -2.2 -2.2 -2.2 -2.2 -2.2 -2.2 -0.7 0.4 0.4 0.4 64 -2.2 -2.2 -2.2 -2.2 -2.2 -2.2 -2.2 -0.7 0.4 0.4 0.4 66 -2.2 -2.2 -2.2 -2.2 -2.2 -2.2 -2.2 -0.7 0.4 0.4 0.4 68 -2.2 -2.2 -2.2 -2.2 -2.2 -2.2 -2.2 -0.7 0.4 0.4 0.4 70 -2.2 -2.2 -2.2 -2.2 -2.2 -2.2 -2.2 -0.7 0.4 0.4 0.4Source: Bloomberg, Lehman BrothersStrategy II: Oct Puts vs Jan 1x2 Call Spreads • A higher risk alternative to the previous strategy would be to purchase 1x2 call spreads expiring in January. • This reduces the initial premium and provides greater leverage but leaves the investor short the upside beyond the near-term target price. • The strategy makes more sense for stocks with an upward sloping term structure of implied volatility, such as NRG. • Figure 5 shows the payoff on different dates from a long position in NRG Oct 45 puts and NRG Jan 07 50-55 1x2 call spreads. • The initial cost of setting up the trade is $1.5, or about 3.1% of NRG’s closing price last night. • Figure 6 shows the suggested strikes and breakevens for the other stocks. The upper is the price above which the stock has to finish in order for the 1x2 call spreads to start losing.Figure 5: Puts vs 1x2 Call Spreads Payoff – NRG 10 8 1x2 call spreads start losing 6 beyond upper breakeven 4 Strategy Payoff 2 0 -2 -4 Payoff (9/18/06) -6 Payoff (10/20/06) -8 Payoff (1/19/07) -10 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 NRG PriceSource: Bloomberg, Lehman Brothers 4
  5. 5. EQUITY RESEARCHFigure 6: Puts vs 1x2 Call Spreads Payoff – Suggested Strikes Lower Upper Net Ticker Oct Leg Jan Leg Breakeven Breakeven Premium (Oct 06) (Jan 07)D B 75 Put B 75-80 1x2 Call Spread 1.7 74.3 81.6EXC B 60 Put B 60-65 1x2 Call Spread 3.05 58.1 71.35NRG B 45 Put B 50-55 1x2 Call Spread 1.5 44.4 58.1TXU B 60 Put B 60-65 1x2 Call Spread 0.9 59.1 66.3Source: Bloomberg, Lehman BrothersAnalyst Certification:We, Daniel Ford, CFA and Ryan Renicker, hereby certify (1) that the views expressed in this research Industry Note accurately reflect ourpersonal views about any or all of the subject securities or issuers referred to in this Industry Note and (2) no part of our compensation was,is or will be directly or indirectly related to the specific recommendations or views expressed in this Industry Note.Other Team Members:Orrill, Gregg 1.212.526.0865 gorrill@lehman.comMallick, Devapriya 1.212.526.5429 dmallik@lehman.com 5
  6. 6. EQUITY RESEARCHImportant Disclosures:Dominion Resources (D) US$ 77.16 (15-Sep-2006) 2-Equal weight / 3-NegativeRating and Price Target Chart: DOMINION RESOURCES As of 29-Aug-2006 Currency = USD 96.00 94.00 92.00 90.00 88.00 86.00 84.00 82.00 80.00 78.00 76.00 74.00 72.00 70.00 68.00 66.00 64.00 62.00 60.00 58.00 56.00 8-03 11-03 2-04 5-04 8-04 11-04 2-05 5-05 8-05 11-05 2-06 5-06 8-06 Closing Price Price Target Recommendation Change Drop Coverage Source: FactSetCurrency=US$Date Closing Price Rating Price Target Date Closing Price Rating Price Target03-May-06 74.46 84.00 03-Aug-05 77.90 88.0010-Mar-06 71.41 84.00 05-May-05 72.28 76.0009-Mar-06 71.65 93.00 24-Nov-04 66.73 71.0031-Jan-06 75.53 84.00 07-May-04 62.98 67.0008-Nov-05 75.76 83.0004-Nov-05 75.30 83.00 FOR EXPLANATIONS OF RATINGS REFER TO THE STOCK RATING KEYS LOCATED ON THE PAGE FOLLOWING THE LAST PRICE CHART.Lehman Brothers Inc. and/or an affiliate has managed or co-managed within the past 12 months a 144A and/or public offering of securitiesfor Dominion Resources.Lehman Brothers Inc. and/or an affiliate has received compensation for investment banking services from Dominion Resources in the past12 months.Lehman Brothers Inc. and/or an affiliate expects to receive or intends to seek compensation for investment banking services from DominionResources within the next 3 months.Lehman Brothers Inc and/or an affiliate trade regularly in the shares of Dominion Resources.Lehman Brothers Inc. has received non-investment banking related compensation from Dominion Resources within the last 12 months.Dominion Resources is or during the past 12 months has been an investment banking client of Lehman Brothers Inc. and/or an affiliate.Dominion Resources is or during the last 12 months has been a non-investment banking client (securities related services) of LehmanBrothers Inc.Risks Which May Impede the Achievement of the Price Target: Dominion is exposed to the electricity, natural gas, and oil commoditymarkets which can create earnings volatility.Other Material Conflicts: Lehman Brothers is acting as financial advisor to Equitable Resources in connection with the potentialacquisition of Dominion Peoples and Dominion Hope from Dominion Resources 6
  7. 7. EQUITY RESEARCHImportant Disclosures Continued:Exelon Corp (EXC) US$ 59.21 (15-Sep-2006) 1-Overweight / 3-NegativeRating and Price Target Chart: EXELON CORP As of 29-Aug-2006 Currency = USD 68.00 64.00 60.00 56.00 52.00 48.00 44.00 40.00 36.00 32.00 28.00 24.00 20.00 16.00 12.00 8.00 4.00 0.00 8-03 11-03 2-04 5-04 8-04 11-04 2-05 5-05 8-05 11-05 2-06 5-06 8-06 Closing Price Price Target Recommendation Change Drop Coverage Source: FactSetCurrency=US$Date Closing Price Rating Price Target Date Closing Price Rating Price Target01-Aug-06 58.92 66.00 28-Jan-04 33.14 39.5027-Apr-06 54.16 63.00 04-Dec-03 31.55 39.0009-Feb-06 55.51 66.00 24-Nov-03 30.93 38.0026-Jan-06 57.27 65.00 03-Nov-03 32.52 39.0025-Jul-05 52.28 1-Overweight 23-Oct-03 31.95 40.0025-Jul-05 52.28 65.00 03-Oct-03 32.06 39.5020-Dec-04 43.05 0.00 29-Sep-03 31.85 39.0017-Nov-04 41.11 45.00 18-Sep-03 31.45 38.5018-Oct-04 37.73 41.00 12-Sep-03 30.36 38.0007-May-04 32.34 40.00 13-Aug-03 29.79 36.5027-Apr-04 33.36 39.50 06-Aug-03 29.30 36.0029-Jan-04 33.33 40.50 FOR EXPLANATIONS OF RATINGS REFER TO THE STOCK RATING KEYS LOCATED ON THE PAGE FOLLOWING THE LAST PRICE CHART.Lehman Brothers Inc. and/or an affiliate has received compensation for investment banking services from Exelon Corp in the past 12months.Lehman Brothers Inc and/or an affiliate trade regularly in the shares of Exelon Corp.Exelon Corp is or during the past 12 months has been an investment banking client of Lehman Brothers Inc. and/or an affiliate.Risks Which May Impede the Achievement of the Price Target: Risks to the outlook include wholesale commodity prices, generationdevelopment market conditions, the outcome of regulatory proceedings, rating agency actions, interest rates, and access to the capitalmarkets.Other Material Conflicts: Lehman Brothers is currently acting as a financial advisor to Exelon Corp. with respect to its restructuring ofCommonwealth Edison. 7
  8. 8. EQUITY RESEARCHImportant Disclosures Continued:NRG Energy (NRG) US$ 47.30 (15-Sep-2006) 1-Overweight / 3-NegativeRating and Price Target Chart: NRG ENERGY As of 29-Aug-2006 Currency = USD 60.00 56.00 52.00 48.00 44.00 40.00 36.00 32.00 28.00 24.00 20.00 16.00 8-03 11-03 2-04 5-04 8-04 11-04 2-05 5-05 8-05 11-05 2-06 5-06 8-06 Closing Price Price Target Recommendation Change Drop Coverage Source: FactSetCurrency=US$Date Closing Price Rating Price Target Date Closing Price Rating Price Target02-Aug-06 48.85 59.00 12-Dec-05 44.81 55.0029-Dec-05 46.14 54.00 12-Dec-05 44.81 1-Overweight28-Dec-05 46.00 55.00 FOR EXPLANATIONS OF RATINGS REFER TO THE STOCK RATING KEYS LOCATED ON THE PAGE FOLLOWING THE LAST PRICE CHART.Lehman Brothers Inc. and/or an affiliate has received compensation for investment banking services from NRG Energy in the past 12months.Lehman Brothers Inc. and/or its affiliates beneficially owns 1% or more of any class of common equity securities of NRG Energy as of theend of last month.Lehman Brothers Inc and/or an affiliate trade regularly in the shares of NRG Energy.NRG Energy is or during the past 12 months has been an investment banking client of Lehman Brothers Inc. and/or an affiliate.Risks Which May Impede the Achievement of the Price Target: Key risks include power and gas prices, weather volatility, higherinterest rates and wider credit spreads, and power markets regulation. 8
  9. 9. EQUITY RESEARCHImportant Disclosures Continued:TXU Corp (TXU) US$ 61.45 (15-Sep-2006) 1-Overweight / 3-NegativeRating and Price Target Chart: TXU CORP As of 29-Aug-2006 Currency = USD 76.00 72.00 68.00 64.00 60.00 56.00 52.00 48.00 44.00 40.00 36.00 32.00 28.00 24.00 20.00 16.00 12.00 8.00 8-03 11-03 2-04 5-04 8-04 11-04 2-05 5-05 8-05 11-05 2-06 5-06 8-06 Closing Price Price Target Recommendation Change Drop Coverage Source: FactSetCurrency=US$Date Closing Price Rating Price Target Date Closing Price Rating Price Target02-Aug-06 65.72 72.00 25-Oct-04 30.63 36.0003-May-06 57.05 68.00 09-Sep-04 21.68 28.5019-Apr-06 47.57 67.00 01-Jul-04 20.55 Dropped12-Jan-06 51.34 70.00 14-Jun-04 18.47 25.0002-Dec-05 52.15 70.00 19-May-04 18.75 24.0007-Nov-05 50.62 35.00 18-May-04 19.02 22.5028-Oct-05 48.21 69.00 27-Apr-04 17.39 21.0005-Oct-05 53.77 71.00 24-Feb-04 13.63 17.5031-Aug-05 48.51 66.00 24-Feb-04 13.63 1-Overweight03-Aug-05 45.92 59.50 13-Feb-04 12.18 13.0018-Apr-05 41.31 48.00 27-Oct-03 11.49 2-Equal weight31-Mar-05 39.81 47.00 04-Aug-03 10.49 12.5021-Mar-05 39.91 44.50 04-Aug-03 10.49 1-Overweight03-Feb-05 36.74 41.50 FOR EXPLANATIONS OF RATINGS REFER TO THE STOCK RATING KEYS LOCATED ON THE PAGE FOLLOWING THE LAST PRICE CHART.Lehman Brothers Inc. and/or an affiliate has managed or co-managed within the past 12 months a 144A and/or public offering of securitiesfor TXU Corp.Lehman Brothers Inc. and/or an affiliate has received compensation for investment banking services from TXU Corp in the past 12 months.Lehman Brothers Inc. and/or an affiliate expects to receive or intends to seek compensation for investment banking services from TXU Corpwithin the next 3 months.Lehman Brothers Inc. and/or its affiliates beneficially owns 1% or more of any class of common equity securities of TXU Corp as of the endof last month.Lehman Brothers Inc and/or an affiliate trade regularly in the shares of TXU Corp.TXU Corp is or during the past 12 months has been an investment banking client of Lehman Brothers Inc. and/or an affiliate.Risks Which May Impede the Achievement of the Price Target: Key risks are Texas regulation, U.S. power and gas prices, interestrates, and credit rating downgrades. 9
  10. 10. EQUITY RESEARCHImportant Disclosures Continued:The analysts responsible for preparing this report have received compensation based upon various factors including the firms totalrevenues, a portion of which is generated by investment banking activitiesCompany Name Ticker Price (15-Sep-2006) Stock / Sector RatingDominion Resources D US$ 77.16 2-Equal weight / 3-NegativeExelon Corp EXC US$ 59.21 1-Overweight / 3-NegativeNRG Energy NRG US$ 47.30 1-Overweight / 3-NegativeTXU Corp TXU US$ 61.45 1-Overweight / 3-NegativeSector Coverage UniverseBelow is the list of companies that constitute the sector coverage universe:AES Corp (AES) Alliant Energy (LNT)Ameren Corp (AEE) American Electric Power (AEP)Aquila, Inc (ILA) CMS Energy (CMS)Consolidated Edison (ED) Constellation Energy (CEG)Dominion Resources (D) DPL Inc (DPL)DTE Energy (DTE) Duke Energy (DUK)Duquesne Light Holdings (DQE) Edison International (EIX)Empire District Electric (EDE) Entergy Corp (ETR)Exelon Corp (EXC) FirstEnergy Corp (FE)FPL Group (FPL) Great Plains Energy (GXP)Hawaiian Electric Inds (HE) ITC Holdings (ITC)Mirant Corp. (MIR) NiSource, Inc (NI)Northeast Utilities (NU) NRG Energy (NRG)OGE Energy (OGE) Ormat Technologies (ORA)Pepco Holdings (POM) PG&E Corp (PCG)Pinnacle West Capital (PNW) PPL Corporation (PPL)Progress Energy (PGN) Public Service Enterprise Gp (PEG)Puget Energy (PSD) Reliant Energy Inc. (RRI)Sempra Energy (SRE) Sierra Pacific Resources (SRP)Southern Co (SO) TECO Energy (TE)TXU Corp (TXU) Westar Energy (WR)Wisconsin Energy (WEC) Xcel Energy (XEL)Guide to Lehman Brothers Equity Research Rating System:Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2-Equal weight or 3-Underweight (seedefinitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industrysector (the “sector coverage universe”). To see a list of the companies that comprise a particular sector coverage universe, please go towww.lehman.com/disclosuresIn addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system.Investors should carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone.Stock Rating1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-monthinvestment horizon.2-Equal weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a12- month investment horizon.3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.RS-Rating Suspended - The rating and target price have been suspended temporarily to comply with applicable regulations and/or firmpolicies in certain circumstances including when Lehman Brothers is acting in an advisory capacity in a merger or strategic transactioninvolving the company.Sector View1-Positive - sector coverage universe fundamentals/valuations are improving.2-Neutral - sector coverage universe fundamentals/valuations are steady, neither improving nor deteriorating.3-Negative - sector coverage universe fundamentals/valuations are deteriorating.Distribution of Ratings:Lehman Brothers Equity Research has 1879 companies under coverage.44% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as Buy rating, 35% ofcompanies with this rating are investment banking clients of the Firm. 10
  11. 11. EQUITY RESEARCH40% have been assigned a 2-Equal weight rating which, for purposes of mandatory regulatory disclosures, is classified as Hold rating, 6%of companies with this rating are investment banking clients of the Firm.16% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as Sell rating, 67%of companies with this rating are investment banking clients of the Firm.This material has been prepared and/or issued by Lehman Brothers Inc., member SIPC, and/or one of its affiliates (“Lehman Brothers”) and has beenapproved by Lehman Brothers International (Europe), authorized and regulated by the Financial Services Authority, in connection with its distribution in theEuropean Economic Area. This material is distributed in Japan by Lehman Brothers Japan Inc., and in Hong Kong by Lehman Brothers Asia Limited. 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