MORGAN STANLEY RESEARCH

November 29, 2010

European Strategy

Overall transparency and visibility of the Spanish banking 3. Long IBEX. This strategy is riskier than the first two trades,
system is relatively high. but would offer more upside if this ‘surprise’ were to
materialises.
- Funding position of banks improving. Spanish banks’
reliance on ECB funding is falling (Exhibit 72). This represents Exhibit 72

an important difference to Ireland, Greece and Portugal. The Spanish banks’ reliance on ECB funding is falling
share of banking assets funded by the ECB has halved in 20%
Greece €92.4bn, 17.5%

Spain to 2.1% and remains far below Greece, Ireland and 18%

Percentage of banking assets funded by ECB

16%
Portugal (17.9%, 9.9% and 7.2% respectively). Spanish bank
14%
CDS remain below the Q2 wides despite the sovereign CDS
12%
hitting new highs last week. So far, the market is more Ireland €130bn, 9.9%
10%
sanguine about Spanish banks than in May/June (again unlike
8%
other peripherals). Portugal
6% €40bn, 7.2%

4%
- Growth expectations more realistic now. While they Spain
2%
remain cautious about short- and medium-term prospects, our €71.3bn, 2.1%

0%
economists’ forecasts for Spain in 2011-12 are now above Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10

consensus (Exhibit 73), having been below earlier in the year. Spain Portugal Greece Ireland Italy
Germany Belgium France Austria Netherlands
They see some signs of life from exports, manufacturing and Source: ECB, Central Bank of Ireland. Note: Time lags on data releases from central banks
even house price declines (moderating). They also argue that mean that latest data are not available for all countries.

the policy landscape – from the 2011 budget approval to some

structural reforms under way – has turned for the better.
Exhibit 73
- Spanish equities are cheap and under-owned. Multiples MS vs consensus GDP expectations for Spain
relative to MSCI Europe are the cheapest of all European
markets (being 1.8-2.0SD cheap on P/E, PBV and DY). Spain 2.0
Morgan Stanley
is one of the most under-owned markets too – the average fund
being 1.6 percentage points below benchmark in our EPFR 1.5
Consensus
positioning data (Exhibit 74).
1.0

Trade implications. We have three suggested trades to play 0.5

this surprise.
0.0

1. Long Spanish senior bank bonds and sovereign debt. Given

-0.5
the weak domestic growth outlook and high leverage of many Spain Euro area
Spanish corporate, the lower-risk way to play this theme may -1.0
2010 2011 2010 2011
well be in credit, particularly as we think default risk is below
Source: Consensus Economics, Morgan Stanley Research estimates
current market expectations.

2. Long a basket of high-quality Spanish stocks. Another

lower-risk way to play Spain would be to focus on those
companies that are in sectors other than financials, have a high
proportion of non-domestic sales and preferably have strong
balance sheets and profitability. Stocks meeting those criteria
include Ebro Foods, Inditex, Repsol, Tecnicas Reunidas and
Telefonica 4.

4
Ebro Foods is not covered; Inditex is covered by Fred Bjelland,
Repsol by James Hubbard, Tecnicas Reunidas by Rob Pulleyn and
Telefonica by Luis Prota.

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 MORGAN STANLEY RESEARCH

November 29, 2010

European Strategy

Exhibit 74
Countries – relative valuations and ownership
compared to the historical norm

4.0
Expensive and Overowned Cheap and Overowned
Consensus country weights - % Point Deviation From

3.0 Holland

2.0
Germany

1.0 France
Ireland
Denmark Belgium
Norway Finland
Benchmark

0.0 Austria Portugal

Nordic Greece

-1.0 Peripheral
Italy
Sweden Swiss
Spain
-2.0

-3.0

-4.0 UK

Expensive and Underowned Cheap and Underowned

-5.0
2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5
Relative valuations compared to 10-year moving average (z-score) - the lower the cheaper

Source: MSCI, EPFR, Morgan Stanley Research

Note: Country rotation model based on relative valuations and consensus sector position. We
explored many different valuation measures, including P/E, P/BV, P/CE, P/Dividend, and
combinations thereof. Austria (P/CE & P/BV), Belgium (P/CE & P/D), Denmark (P/BV), Finland
(P/D), France (P/CE & P/D), Germany (P/BV, P/CE & P/D), Greece (P/BV & P/D), Ireland
(P/CE & P/D), Italy (P/CE, P/BV & P/D), Netherlands (P/E, P/CE & P/D), Norway (P/CE & P/D),
Portugal (P/D), Spain (P/E & P/D), Sweden (P/BV), Switzerland (P/E, P/BV, P/CE & P/D), UK
(P/E, P/BV & P/D), peripheral Europe (P/BV & P/D) Nordic (P/BV & P/CE). Peripheral Europe is
made up of Greece, Ireland, Spain and Portugal.

Exhibit 75
Spanish stocks with foreign sales at least 30% of total and market cap >€1bn
Dividend Net International sales % of total sales from
Market ROE Yield Debt / as % of total outside Developed
Cap PE % % EBITDA (Worldscope) Europe (MS) MS
Name Sector Price $ 2011 2011 2011 2011 2009 2009 Rating
ACERINOX Materials 11.60 3,951 10.0 15.3 3.9 1.9 89 56 Underweight / I
ABENGOA Industrials 17.73 2,191 7.3 18.7 1.2 6.6 81 - -
TECNICAS REUNIDAS Energy 42.97 3,281 14.2 37.2 3.4 -4.9 78 - Overweight / I
EBRO FOODS Consumer Staples 15.53 3,345 14.8 10.5 3.0 -0.2 75 - -
NH HOTELES Consumer Discretionary 3.47 1,167 173.3 0.4 0.0 5.5 71 - -
BBVA Financials 8.26 50,752 6.7 14.0 5.5 - 70 55 ++ / I
GAMESA CORP TECNOLOGICA Industrials 5.29 1,775 19.6 4.0 1.2 1.7 69 40 Equal-Weight / N
INDITEX Consumer Discretionary 60.00 51,094 19.9 26.4 2.9 -1.4 67 28 Equal-Weight / C
TELEFONICA Telecommunication Services 18.13 113,042 9.6 33.3 8.6 2.2 65 40 Overweight / I
FERROVIAL Industrials 7.90 7,912 65.8 3.3 5.0 9.4 65 61 Equal-Weight / I
OBRASCON HUARTE LAIN Industrials 22.58 3,077 10.8 18.2 2.3 5.1 59 - -
IBERDROLA Utilities 5.88 43,210 11.1 9.7 5.7 3.7 59 32 Underweight / C
IBERDROLA RENOVABLES Utilities 2.48 14,317 20.7 4.2 1.6 3.7 58 40 Overweight / N
GRIFOLS Health Care 9.61 2,798 13.4 20.5 3.0 1.9 54 52 ++ / A
ABERTIS INFRAESTRUCTURAS Industrials 13.20 13,327 13.6 16.1 5.0 5.3 50 3 Equal-Weight / I
REPSOL YPF Energy 19.83 33,074 9.3 11.3 5.2 1.7 49 34 Overweight / A
MAPFRE Financials 2.20 9,061 6.9 13.4 7.3 - 47 35 Underweight / I
VISCOFAN Consumer Staples 26.32 1,676 13.7 20.0 3.3 0.0 43 - -
CONSTRUCCIONES Y AUX FER Industrials 388.70 1,820 10.2 19.3 3.2 -2.3 42 - -
PROSEGUR Industrials 44.81 3,778 14.4 25.3 2.4 0.3 42 - -
INMOBILIARIA COLONIAL Financials 0.06 1,759 - - 0.0 - 42 - -
ALMIRALL Health Care 6.81 1,545 9.3 13.4 4.4 -0.8 38 5 Equal-Weight / A
INDRA SISTEMAS A Information Technology 13.14 2,946 10.5 18.4 5.1 0.3 36 16 Equal-Weight / I
BANCO SANTANDER Financials 8.53 97,061 7.1 13.0 7.3 - 32 46 Equal-Weight / I
++ The rating for this company has 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. For important disclosures regarding companies that are the subject of this screen, please see the Morgan Stanley Research Disclosure Website at
www.morganstanley.com/researchdisclosures Source: MSCI, IBES, FactSet, Worldscope, Morgan Stanley Research

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 MORGAN STANLEY RESEARCH

November 29, 2010

European Strategy

Morgan Stanley is currently acting as financial advisor to Talecris Biotherapeutics Holdings Corp ('Talecris') in connection with their
acquisition by Grifols S.A, as announced on 7 June 2010.
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the information herein are not intended to serve as an endorsement of the proposed transaction.
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Morgan Stanley & Co. Limited is acting as financial adviser and corporate broker to International Power plc on the proposed
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Morgan Stanley & Co. Limited, an affiliate of Morgan Stanley, is acting as financial adviser to Portugal Telecom SGPS S.A. in relation
to the potential acquisition of a direct and indirect stake of Telemar Norte Leste SA and on specific matters in connection with the
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