Update on takeover speculations of Credit Lyonnais and implications for BNP Paribas

US Stocks

• Recommendation update

Defence sector struggled last week. As we had mentioned, the Pentagon is going through its weapons programs and a few defence contractors such as Northrop Grumman Corp. (NOC, $91.23, CSFB: restricted), and Boeing Co. (BA, $31.40, CSFB: Outperform), received more funds than others. With regards to NOC, the US Air Force may buy no more than 36 F/A-22 fighters per year, down from 38 a year planned for 2007-2009. Furthermore, the Pentagon was reviewing whether to cut the program to 180 aircraft from as many as 339 (source: Bloomberg). Boeing is also under pressure. The Army was directed to reduce to 650 from 1207 the number of RAH-Comanche helicopters it plans to buy, and to focus its research on producing a reconnaissance helicopter rather than a dual-purpose, scout-attack chopper. Research funds for the Commanche would be cut by $450 million through 2003 and production funds by $725 million. Currently we have a buy rating on Boeing Co., believing current stock price does not reflect BA's fair-value of $45.00.

Northrop Grumman Corp. announced that its $11.8 billion acquisition of TRW was completed. TRW systems will be renamed Northrop Grumman Mission Systems, and TRW Space & Electronics will be renamed Northrop Grumman Space Technology. However, the U.S. Justice Department said it cleared the acquisition after NOC agreed to continue selling parts for military satellites to competitors like Lockheed Martin Corp. (LMT, $49.70, CSFB: Outperform), and Boeing Co. (BA, $31.40, CSFB: Outperform). Without the pledge, Defence Department officials raised concerns Northrop would have an incentive to stop selling sensors and other electronic gear that competitors need. With this acquisition, Northrop Grumman will acquire $2 billion in annual Pentagon sales. This acquisition is part of NOC's expansion strategy and follows the $2.6 billion purchase of Newport News Shipbuilding Inc. in last January, and the $5.2 billion acquisition of Litton Industries Inc. in May 2001. Based on military contracts last year, Northrop Grumman will remain the third-largest military contractor, behind Lockheed Martin and Boeing, with $13 billion in awards. LMT had about $14.7 billion in contracts, and Boeing had $13.3 billion. NOC's management expects that the acquisition of TRW will help lift profit to $7-$7.50 a share in 2003, and to $7.90-$8.40 in 2004, up from $6.10-$6.20 expected in 2002. Although these three acquisitions in a short period would take a couple of years to digest, we believe the expected increase in Northrop's EPS is not reflected in stock price. Hence we maintain our Buy on NOC.

There have been no significant news items out on our 2 tobacco stocks, Philip Morris Companies Inc. (MO, $40.98, CSFB: Not Rated) and Carolina Group (CG, $20.23, CSFB: Not Rated). CG recommended on the 3rd of December is up 9.3% and MO recommended on the 18th of November is up 7.7%. However, we would like to reiterate that both have been recommended principally for their high and safe dividend yields. MO and CG currently yield 6.3% and 8.8% respectively. We continue to view the stocks as attractively valued at current levels and maintain our BUY rating on both.

Europe

• We reiterate our buy call on DaimlerChrysler and Aventis. We consider the low 30s for DaimlerChrysler and low 50s for Aventis a very attractive entry level for an investor adopting a 12 to 18 months horizon

• Nokia's midquarter update

The European Central Bank cut at most its growth forecast for the region to 2.1 percent next year, down from a June estimate of as much as 3.1 percent. As mentioned several times before, we expect profit forecast for next year to slowly be adjusted downward. On a CSFB-adjusted pre-goodwill basis, consensus EPS growth rates for Europe are -4.4% for 2002 and +24.1% for 2003 - a figure, which appears still too optimistic. Since optimism has faded away somewhat we expect stock markets to head for some more consolidation in the weeks ahead.

The Western European aggregated autos data reported no new news as most countries have already announced, however the auto sector still headed lower. Western European car sales declined in November by 6.2% (decline of 6.9% in Germany, 9.4% in France and 6.8% in the U.K. Italian sales posted a gain of 1.3%, while Swedish sales increased 5.2% and Finnish sales gained 10%). DaimlerChrysler (DCX GY; EUR 31.22) fell below the EUR 32 mark, which we consider a very attractive level for investors with a 12-18 months horizon. We believe that the stock has a very good support in the low EUR 30s due to its attractive valuation and hence reiterate our buy rating. At current levels the risk/reward ratio looks very attractive with only limited downside risk and big upside potential. We expect the company to benefit from a well-executed restructuring plan and impressive product regeneration for both Mercedes Benz and Chrysler.

Credit Agricole (ACA FP; EUR 15.15) became once again the biggest shareholder of Credit Lyonnais (CL FP; EUR 52.75) holding 17.4%. Both Agricole and BNP Paribas (BNP FP; EUR 37.72) are keen to expand in consumer banking by taking over Lyonnais. Acquiring Credit Lyonnais would give BNP Paribas or Credit Agricole an additional six million customers and more than 1,800 branches in Europe's third-biggest financial market.
Agricole had held unsuccessful talks for months on a tie-up with Lyonnais and was even rejecting the government's stake at EUR 44 per share. After a management change Agricole seem to be following a different strategy. BNP recently increased its stake to 16.2% and asked regulators for approval to boost it to as much as 20%. After a management strategy meeting, Credit Lyonnais announced last week that it plans to form an alliance with Agricole.

In France, companies have to make a full takeover bid if their stakes reach 33%. As Credit Agricole is part of the 6 member group (Credit Agricole 10.5%, Allianz 6%, Axa 5.3%, Commerzbank 3.9%, BBVA 3.6% and Banca Intesa 2.7%) which controls Lyonnais as opposed to BNP, Agricole has a higher chance to acquire further stakes as any of the 6 member companies which decide to sell, need to offer their stakes first to the other members of the group before June 2003. As estimated synergies would be significantly higher in the case of a takeover by BNP Paribas (EUR 1.1-1.4bn) than by Credit Agricole (EUR 0.6-0.75bn), a hostile takeover bid by BNP Paribas cannot be ruled out. However, BNP Paribas announced it would be selling its stake if Credit Agricole makes an 'acceptable' bid. After some speculation over the weekend, it was just confirmed that Credit Agricole agreed to buy Credit Lyonnais for EUR 19.5bn in cash and stock which values Credit Lyonnais at about EUR 56 a share representing a premium of more than 6% to Friday's close. We believe this should be an 'acceptable' level for BNP Paribas. BNP Paribas looks attractively valued given its current discount to the industry (PER 9.66x vs industry 15.45x, 37% discount) and we would like to reiterate our buy on the stock.

The CEOs of Allianz (ALV GY; EUR 102.70) and Deutsche Bank (DBK GY; EUR 46.33) said that they would give up their seats on the board of Munich Re (MUV2 GY; EUR 130.14). While the CEO of Deutsche Bank left due to the fact that Deutsche Bank is not a shareholder anymore, Allianz's CEO left because of 'compliance with the corporate governance code'. We believe that this might prepare the way for Munich Re and Allianz to unwind their cross-holdings (Allianz has a 24.8% stake in Munich Re and will reduce this to 20% by end 2003; Munich Re holds 20% of Allianz). A potential reduction in their stakes would probably be done by a secondary placement in the market or the sale to a third party. We remain cautious on Allianz in the short-term due to industry specific reasons but also due to increased share supply. However, we stick to our view that the stock currently trades below its long-term potential and as such reiterate our Hold rating.

CSFB issued a note on Aventis (AVE FP; EUR 51.30) and the patent threat of its key drug Allegra. This is an interesting note and confirms our view that the stock is overly punished for this issue. At current levels Aventis looks very attractively valued and we reiterate our buy rating on the stock. Going into the new year Aventis should be in every equity portfolio in our view as we expect the concerns regarding Allegra to unwind during the course of the year. In addition, the company bought back 98.6% of a convertible bond into Rhodia in preparation to divest its 25% stake in Rhodia. We expect this to be done in the course of next year and believe once the issue is solved, the market will refocus on Aventis' attractive growth potential.

Nokia's (NOK1V FH; EUR 16.63) mid-quarter update once again disappointed, which led the stock almost 4% lower. For at least the third consecutive quarter Nokia reduced its sales guidance to 8.8-9bln from EUR 8.9-9.2bln and reiterated that it felt very comfortable with the earnings guidance of EUR 0.23-0.25 per share. Interestingly the company did not guide towards the top end of this range as they used to do in the last two quarters. The mobile phone 4Q02 operating margins are expected to exceed 3Q02's 22.8% while Networks operating margins are expected to be about 0%, which is significantly lower than the previous guidance of 5.20%. Nokia expects the ASP (Average Selling Price) to decline from 3Q02s EUR 152, which is seen as a product mix shift to the higher volume low-end phones. The company seems to indicate that this is the basis for the lower revenue guidance. Despite Nokia not disappointing on the earnings side it is disturbing that the company seems to adopt a pattern of setting expectations high and then gradually stepping back. In our view, this does no good for the management's excellent track record in the long run in our view. Within a week Nokia has disappointed twice, which does confirm our view that market expectations are still very high and that the stock is fully valued at EUR 20.