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Long Rolls Royce Holdings plc (LSE:RR)

April 2016

Luis Sanchez

[email protected]

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(£ in millions) 2010 2011 2012 2013 2014 2015

Sales £10,866 £11,277 £12,209 £15,505 £13,864 £13,354

Growth % 6.4% 3.8% 8.3% 27.0% (10.6%) (3.7%)

Backlog £59,200 £57,630 £60,146 £71,612 £73,674 £76,399

% of sales 545% 511% 493% 462% 531% 572%

EBITDA £1,346 £1,574 £1,898 £2,367 £2,281 £2,105

Margin % 12.4% 14.0% 15.5% 15.3% 16.5% 15.8%

Free Cash Flow £714 £581 £548 £781 £254 £179

ROIC 12.8% 12.4% 14.9% 16.7% 13.3% 11.3%

Capitalization Financials Valuation

Market Cap £12,227 2015 Sales £13,354 EV/2015 EBITDA 5.9x

Cash £3,178 Backlog £76,399 EV/2016E EBITDA 8.5x

Debt £3,398 2015 EBITDA £2,105 EV/2016E Sales 0.9x

Enterprise Value £12,447 EBITDA Margin 15.8% Price/2016E EPS 24.6x

Projections based on analyst consensus estimates. Data as of 4/15/2016.

Company Overview

2

Business Description Business Segments

Rolls-Royce is a global producer of engines for

aerospace, maritime, and power generation

The company’s crown jewel is its Civil Aerospace

business where it is #2 in wide body engines

Rolls-Royce also has strong market positions in

defense aerospace and nuclear submarine engines

Rolls-Royce is based in the United Kingdom

Financial Summary

Civil

Aero

52%Defense

Aero

15%

Power

Systems

18%

Marine10%

Nuclear

5%

Civil

Aero

55%

Defense

Aero

26%

Power

Systems

13%

Marine

1%

Nuclear

5%

Sales Mix EBIT Mix

Civil Aerospace Defense Aerospace

Power Systems Marine Nuclear

Wide body jet engines Engines for military aircrafts

Back-up powerShips used in off-

shore oil

Royal Navy

submarines

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Investment Thesis

3

Summary Thesis

Rolls-Royce has the best wide body aircraft engines in production and

its Civil Aerospace business is expected to become the market leader

in wide body engines within the next 5 years

Excessively negative sentiment around Rolls-Royce’s stock has

developed due to short term earnings headwinds from a temporary

lull in engine shipments and complex accounting

The company’s massive £76 billion backlog highlights the significant

value of a predictable stream of future cash flow

The new CEO, Warren East, had a strong track-record of creating

shareholder value at ARM Holdings and is well positioned to affect

significant change at Rolls-Royce coming in as an outsider

A break-up of the company could result from the emergence of activist

investor ValueAct as the company’s largest shareholder

A sum-of-the-parts valuation approach implies 40% to 75% upside to

the current share price

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Marine Defense Aerospace Civ il Aerospace

Low High Low High Low High

2014 Revenue £1,709 £1,709 2014 EBITDA £385 £385 DCF Model Valuation £10,753 £12,281

2015 Revenue £1,324 £1,324 2015 EBITDA £416 £416 Assumptions:

Avg. Revenue £1,517 £1,517 Avg. EBITDA £400 £400 Discount Rate 10.0% 10.0%

Revenue Multiple 1.0x 1.5x EBITDA Multiple 8.0x 10.0x Long-term growth 3.0% 4.0%

Valuation £1,517 £2,275 Valuat ion £3,203 £4,003

Power Systems Nuclear Sum of the Parts Low High

Low High Low High Civil Aerospace £10,753 £12,281

2014 EBITDA £440 £440 2014 EBITDA £67 £67 Defense Aerospace £3,203 £4,0032015 EBITDA £361 £361 2015 EBITDA £86 £86 Power Systems £2,400 £3,200

Avg. EBITDA £400 £400 Avg. EBITDA £76 £76 Marine Systems £1,517 £2,275

EBITDA Multiple 6.0x 8.0x EBITDA Multiple 7.0x 9.0x Nuclear £534 £686

Valuation £2,400 £3,200 Valuation £534 £686 Enterprise Value £18,406 £22,445

Net Debt £811 £811

Equit y Value £17,595 £21,634

Current Market Cap £12,227 £12,227

Upside 43.9% 76.9%

Share Price on 4/15/16 £6.65 £6.65

Target Pr ice Range £9.57 £11.77

A Sum-of-the-Parts Model Implies Upside of 40% to 75%

4

Valuation Summary

Marine and Power Systems

operate in cyclical markets

without competitive

advantages. In a break-up

scenario, these two units

would be the first to go

Civil Aerospace is the crown jewel asset.

The Civil Aerospace business alone is

worth the company’s market cap

Defense Aerospace and

Nuclear are niche businesses

with attractive economics

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Civil Aerospace Segment Overview

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Business Description Segment Financials

Focuses on wide body engines for commercial

aircraft operators

Also sells engines for the corporate and regional jet

markets

Currently has the most efficient wide body engines

in production and is gaining market share

The wide body engine install base is expected to

grow by over 50% in the next 10 years as a result ofbusiness already won as the sole provider for

Airbus’s next generation aircraft frames

Beyond the current sales cycle, Rolls-Royce has a

strong pipeline of engines (Trent 1000/XWB/7000)

(£ in millions) 2010 2011 2012 2013 2014 2015

OE Revenue £1,892 £2,232 £2,934 £3,035 £3,463 £3,258

% OE 38.5% 40.1% 45.6% 45.6% 50.7% 47.0%

Services Revenue £3,027 £3,340 £3,503 £3,620 £3,374 £3,675

% Services 61.5% 59.9% 54.4% 54.4% 49.3% 53.0%

Total Revenue £4,919 £5,572 £6,437 £6,655 £6,837 £6,933

Growth % 9.8% 13.3% 15.5% 3.4% 2.7% 1.4%

Backlog £47,000 £48,490 £51,942 £49,608 £60,296 £63,299

% of sales 955% 870% 807% 745% 882% 913%

Gross Profit £1,675 £1,526

Gross Margin % 24.5% 22.0%

EBIT £392 £499 £743 £708 £942 £812

% of sales 8.0% 9.0% 11.5% 10.6% 13.8% 11.7%

EBITDA £626 £747 £1,027 £1,043 £1,227 £1,127

% of sales 12.7% 13.4% 16.0% 15.7% 17.9% 16.3%Capex & Intangibles £568 £620 £581 £891 £836 £668

% of sales 11.5% 11.1% 9.0% 13.4% 12.2% 9.6%

Note: segment financials have been adjusted for corporate overhead.

Over 80% of value is captured through aftermarket

maintenance service contracts (MRO)

Engines are sold at a loss with the expectation oflocking in MRO contracts with 10 to 25 year terms

Aircraft operators make quarterly subscription-like

payments for engine maintenance and service

The company collects engine performance data in

real time and alerts operators of service needs

Over the life of an MRO contract, each enginegenerates significant and predictable cash flows

Projected Ramp in Wide Body Engine Install Base

Source: Rolls-Royce company filings

Lucrative Aftermarket Engine Services

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Civil Aerospace has an Extremely Attractive Industry Structure

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Aircraft Engine Demand is Growing Strong Competitive Position

Air traffic is projected to grow 3% - 4% per year

over the next 30 years (1) Wide body is a duopoly between GE and Rolls-

Royce; Pratt & Whitney has a small presence

Industry participants are rational and predictable

Rolls-Royce’s market share of wide body is ~31%

and is expected to rise to over 50% within 5 years

Bears argue that Rolls’ smaller scale and lower

margins are evidence of competitive disadvantage

Rolls-Royce’s recent success in winning major

new engine contracts disproves the claim

Rolls’ competitive position could be strengthened

if cost reduction programs are successful

(1) “Global Air Transport Outlook to 2030”, International Civil Aviation Organization.

(2) “Gearing up for a fight,” The Economist, January 25, 2014.

(3) Represents total civil and defense aerospace platforms. Assumes $1.44 GBP / USD exchange ratio.

Barriers to Entry Are Prohibitively High

Developing an engine line requires over $1bn of

R&D and could take more than 10 years (2)

Multi-year contract bidding process is expensive

Operators are captive to long-term MRO contracts

and engines cannot be switched out once installed

For operators, switching costs include re-training

staff and investing in new servicing infrastructure

Total Aerospace Sales

and EBIT Margins(3)

Source: Boeing Current Market Outlook 2015.

Projected Aircraft Deliveries

$24 $15 $13

20.7%

13.8%10.2%

2014 2014 2014

Margin and scale

gap should be

viewed as an

opportunity

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0

50

100

150

200

250

300

350

2006 2008 2010 2012 2014 2016 2018 2020

E n g i n e D e l i v e r i e s ( u n i t s )

Trent 700 Trent 1000 Trent XWB Trent 7000

A Lull in Engine Deliveries and Complex Accounting Hides Value

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Segment Headwinds are Temporary Accounting Complexities Hide Value

• Rolls-Royce is transitioning from older engine lines

to newer models (Trent 1000 / XWB / 7000)

• The time lapse in between the transition has created

short-term headwinds for growth and earnings

• The lull is exacerbated by a change in accounting

whereby profits on new engines are recognized later

• Soft demand resulting from slowing global growth

has also contributed to recent market headwinds.Some older aircrafts have been retired early and

demand for corporate jets is down

• Rolls-Royce sells engines as “linked” or “unlinked”

Linked sales occur when the engine and MROcontract are sold as a package

Unlinked sales occur when the engine is sold first

and the MRO contract is added on

• Engines sold on new programs are primarily

unlinked because Airbus changed its sales process

• In unlinked contracts, losses from the sale of engines

below production costs are recognized sooner,

creating a headwind to earnings

• Both linked and unlinked contracts use percentage

of completion accounting for the MRO contract but

flow through different line items in the financials

• The various moving parts of the two methodologies

have created headaches for financial analysts

• The company recently responded to complaints by

increasing accounting disclosures, including detailed

schedules of Civil Aerospace segment cash flows

• Cash flow economics have not changed

Current lull in Rolls-Royce

Engine deliveries is temporary

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En te rp ri se Marke t 2016E 2016E ' 16 Sales 2016E

Company Name Value Cap EV / EBITDA P/E Growt h EBITDA %

BAE Systems £17,851 £16,414 8.3x 13.0x 8.7% 11.7%

Meggitt £4,249 £3,195 9.3x 12.5x 11.8% 24.8%

Safran £21,370 £20,177 8.1x 15.7x (0.9%) 18.4%

Honeywell £64,678 £61,235 11.1x 17.5x 5.2% 20.7%

Thales £11,512 £12,793 8.5x 18.3x 4.9% 11.7%

United Tec hnologies £71,412 £61,022 9.6x 16.2x 1.3% 18.9%

MTU Aero Engines £4,235 £3,378 9.1x 13.8x 6.0% 12.6%

Median £17,851 £16,414 9.1x 15.7x 5.2% 18.4%

Ro lls -Royc e (Wal l St .) £12,447 £12,227 8.5x 24.6x (3.1%) 11.0%

Source: Capital IQ, Wall Street consensus estimates. Data as of 4/15/2016.

Defense Aerospace

Low High

2014 EBITDA £385 £385

2015 EBITDA £416 £416

Avg. EBITDA £400 £400

EBITDA Multiple 8.0x 10.0x

Valuat ion £3,203 £4,003

Defense Aerospace’s Outlook and Valuation

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Defense Spending Outlook has Improved

The Congressional Budget Office projects the US

Defense budget to be flat from 2016 through 2020

~50% of Defense revenue is from US government

The threat of terrorism from ISIS in Europe has put

upward pressure on European defense budgets

Rolls-Royce has significant exposure to the UK

where the defense budget was just raised by 6.7%

Defense spending is expected to continue growing

in emerging market countries

Comparable Companies

Historical and Projected US Defense Budget

Source: US Congressional Budget Office.

Segment Valuation

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(£ in millions) 2010 2011 2012 2013 2014 2015

OE Revenue £236 £230 £251

% OE 35.4% 36.1% 36.5%

Services Revenue £431 £408 £436

% Services 64.6% 63.9% 63.5%

Total Revenue £667 £638 £687

Growth % (4.3%) 7.7%

Backlog £2,617 £2,499 £2,168

% of sales 392% 392% 316%

Gross Profit £119 £111


EBIT £50 £70

% of sales 7.8% 10.2%

EBITDA £67 £86

% of sales 10.5% 12.5%

Capex & Intangibles £23 £18

% of sales 3.6% 2.6%




Fincantieri £1,828 £479 18.4x NM 4.9% 2.9%

BWX Technologies £2,512 £2,403 12.1x 21.7x 3.2% 20.5%

ABB Ltd. £32,238 £30,975 10.3x 22.4x (2.0%) 12.9%

Curtiss-Wright £2,854 £2,392 9.9x 18.8x (0.2%) 18.9%

General Dynamics £29,968 £29,542 9.2x 14.6x 1.0% 14.8%

Huntington Ingalls £5,005 £4,742 7.8x 15.1x (0.5%) 13.2%

Median £3,929 £3,573 10.1x 18.8x 0.4% 14.0%



Nuclear Segment Overview

11


Sole provider for Great Britain’s submarine fleet

Also serves nuclear power plants with reactorsupport services and safety systems. Supplies

content on ~50% of global nuclear power plants

The monopoly on British nuclear submarines is an

attractive business that may not meaningfully grow,

but will continue to generate strong returns

The segment also enjoys a strong aftermarket

Rolls-Royce would likely be unable to divest its

submarine business due to political reasons

Comparable CompaniesSegment Valuation

Nuclear

Low High

2014 EBITDA £67 £67

2015 EBITDA £86 £86



Valuation £534 £686

Sales Mix

Subs

80%

Civil 20%

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Caterpillar £55,319 £32,515 16.1x 21.9x (12.6%) 12.0%

Cummins £14,052 £13,932 8.0x 15.1x (7.3%) 14.2%Siemens £72,524 £60,704 9.1x 14.7x 4.1% 12.5%

Med ian £55,319 £32,515 9.1x 15.1x (7.3%) 12.5%



Power Systems

Low High

2014 EBITDA £440 £440

2015 EBITDA £361 £361



Valuation £2,400 £3,200

Power Systems Segment Overview

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Provides propulsion systems for maritime and rail.

Also produces onsite power backup systems

Participates in cyclical and fragmented markets.

Rising competition from low-cost Asian producers

The segment is sub-scale and does not enjoy

meaningful competitive advantages

Recent financial performance has been weak due to

exposure to oil & gas

The business was formed out of a JV with Daimler

in 2011. In 2014, Daimler exercised a put option

and Rolls-Royce purchased the remaining stake for

€1.9bn (considered a bargain purchase)Comparable Companies

Segment Valuation

(£ in millions) 2010 2011 2012 2013 2014 2015

OE Revenue £1,938 £2,004 £1,893 £1,618

% OE 70.1% 68.8% 69.6% 67.8%

Services Revenue £827 £908 £827 £767

% Services 29.9% 31.2% 30.4% 32.2%

Total Revenue £2,765 £2,912 £2,720 £2,385

Growth % 5.3% (6.6%) (12.3%)

Backlog £1,823 £1,927 £1,971 £1,928

% of sales 66% 66% 72% 81%



EBIT £109 £296 £253 £194

% of sales 3.9% 10.2% 9.3% 8.1%

EBITDA £109 £561 £440 £361

% of sales 3.9% 19.3% 16.2% 15.1%Capex & Intangibles £11 £142 £144 £108

% of sales 0.4% 4.9% 5.3% 4.5%


Sales Mix

Rolls-Royce acquired Daimler’s 50% share of the

Power Systems business in 2014 for ~7x EBITDA.

Implies the business is worth £2.8 billion today

Marine

37%

Energy

30%

Industrial

21%

Defense

& Other

12%

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Company Name Value Cap EV/EBITDA EV/Sales Growth EBITDA %

Fincantieri £1,828 £479 18.4x 0.5x 4.9% 2.9%

SBM Offshore £6,510 £2,016 12.7x NM (12.6%) 31.1%

Wärtsilä £6,753 £6,412 11.1x 1.7x 1.8% 15.0%

Baker Hughes £15,393 £14,142 19.4x 2.0x (30.3%) 10.4%

Huntington Ingalls £5,005 £4,742 7.8x 1.0x (0.5%) 13.2%

Saipem £7,425 £2,977 7.3x 0.9x (8.6%) 12.2%

Alfa Laval AB £5,950 £4,919 10.7x 1.9x (10.1%) 18.0%

Median £6,510 £4,742 11.1x 1.3x (8.6%) 13.2%



Marine Segment Overview

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Provides propulsion and handling systems to

marine, offshore oil & gas, and naval markets

Operates in competitive markets and is sub-scale

Financial performance has deteriorated as a result

of exposure to offshore oil & gas

The business burned ~$100 million of cash in 2015

and is expected to continue burning cash

Announced a restructuring program to reduce

headcount and cut $65 million in costs by 2017

A divestiture of Marine would lift the value of the

overall company and free up management’s time

Comparable Companies

(£ in millions) 2010 2011 2012 2013 2014 2015

OE Revenue £1,719 £1,322 £1,288 £1,288 £1,070 £773

% OE 66.3% 58.2% 57.3% 63.2% 62.6% 58.4%

Services Revenue £872 £949 £961 £749 £639 £551

% Services 33.7% 41.8% 42.7% 36.8% 37.4% 41.6%

Total Revenue £2,591 £2,271 £2,249 £2,037 £1,709 £1,324

Growth % 0.1% (12.4%) (1.0%) (9.4%) (16.1%) (22.5%)

Backlog £2,977 £2,737 £3,954 £1,622 £1,567 £1,164

% of sales 115% 121% 176% 80% 92% 88%



EBIT £332 £287 £294 £233 £138 £15

% of sales 12.8% 12.6% 13.1% 11.4% 8.1% 1.1%

EBITDA £383 £335 £337 £292 £163 £116

% of sales 14.8% 14.7% 15.0% 14.3% 9.5% 8.8%Capex & Intangibles £65 £75 £101 £23 £36 £36

% of sales 2.5% 3.3% 4.5% 1.1% 2.1% 2.7%


Segment Valuation

Marine

Low High

2014 Revenue £1,709 £1,709

2015 Revenue £1,324 £1,324

Avg. Revenue £1,517 £1,517

Revenue Multiple 1.0x 1.5x

Valuation £1,517 £2,275

Sales Mix

Offshore

O&G 56%Merchant

24%

Naval

20%

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Newly Appointed CEO Warren East Brings an Outsider’s Perspective

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Track Record at ARM Plans at Rolls-Royce

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

ARM UK FTSE 100 Nasdaq Composite

ARM’s stock greatly outperformed

during East’s 12 year tenure

Warren East joined the Rolls-Royce Board in 2014

and was appointed CEO on July 1, 2015

After conducting a thorough operational review,

East noted the opportunity for significant cost cuts

Announced plans to layoff 20% of employees from

the top 2 levels of management

Announced plans to downsize the Civil Aerospace

manufacturing footprint by 20% to improveefficiency

+269%

+132%

+32%

ARM’s Stock Performance Under East

Warren East is an engineer by training

and has spent most of his career in

the semiconductor design industry

Mr. East served as CEO of ARM

Holdings from 2001 to 2013

Transformed ARM Holdings from a small firm with 1

product line to the world’s #1 mobile chip designer

During his 12 year tenure as ARM CEO, Warrengrew both revenue and EBITDA by 14% per year

Barron’s list of the world’s 30 best CEOs in ‘11 & ‘13

Described as a low-key operator who eschewed the

“rock star” persona adopted by other tech CEOs (1)

(1) “Warren East retires as ARM Holdings chief executive,” The Telegraph, March 19, 2013.

Is Warren East the Right Person to Lead?

Rolls-Royce is known for a spendthrift culture

where engineers run up research budgets on non-

revenue generating projects

Given the lack of financial accountability and

cultural change needed, a proven outsider is the

ideal candidate

Warren’s track-record managing a rapidly growing

global engineering business is extremely relevant to

the current challenges facing Rolls-Royce

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ValueAct’s Involvement Will Help Catalyze Change

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ValueAct Capital Overview ValueAct’s Investment in Rolls-Royce

ValueAct is known as one of the most successful

activist investors and has filed 66 13Ds since 2000

ValueAct runs a concentrated portfolio and focuses

on operational change and capital allocation

On average, ValueAct has generated 49% returns on

its 13D investments vs. 24% for the S&P 500 (1)

Announced its stake after Warren East became CEO

and is now the largest shareholder with 10%

Rolls-Royce is ValueAct’s second largest investment,

representing 14% of its portfolio

On March 2, 2016, Rolls-Royce appointed a

ValueAct representative to the Board

Rolls-Royce has a fragmented shareholder base and

lacks large insider ownership. This will helpValueAct swing its weight around the Board room

Likely Outcomes

It has been widely reported that ValueAct is

pushing for the divestiture of non-core assets,

although the company has publicly commented

that it is not exploring a break-up(2)

Beyond a break-up scenario, ValueAct will help

catalyze a deep restructuring of the firm’s cost base

and hold the management and Board accountable

ValueAct has an excellent track record of helping

companies improve operating margins and capital

allocation(1) According to 13D Monitor.

(2) “Rolls-Royce Names Activist Shareholder ValueAct to Board, Vows No Change to Strategy,” Wall Street Journal, March 28, 2016.

Recent Activist Investments

Microsoft

2013 - 2014

ValueAct took a Board seat and pushed the company

to buyback stock and focus on enterprise software

Oversaw replacement of CEO Steve Ballmer

Shares up over 80%; still owns shares 3 years later

Adobe

2011 - 2012 ValueAct took a Board seat and pushed company to

re-focus on mobile and SAAS products

ValueAct realized a 140% return on its investment(1)

Still owns shares 6 years later

Motorola

2011 - 2016

ValueAct took a Board seat and pushed the company

to divest noncore assets and buyback stock

ValueAct realized a 54% return on its investment(1)

Still owns shares 6 years later

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Issues Raised by Bears are Manageable

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Key Risks and Mitigants

Slow down in global GDP growth reduces demand

Long term air traffic demand growth has been consistent

Two of the worst periods for air travel were after 9/11

and during the 2008 financial crisis. In each of these

periods, air traffic declined by less than 3%

Most revenue is tied to maintenance which is less cyclical

Service contracts have minimum payment requirements

which are not much lower than projected levels

Lower profitability enables competitors to under-bid Rolls-

Royce on future Aerospace contracts

The oligopolistic industry structure has rational players

Recent platforms wins disprove the argument

Low margins should be viewed as an opportunity

Management team is unproven

Warren East had an excellent track record growing a

global business and delivering shareholder value

An outsider’s perspective is needed at Rolls-Royce due to

the need for significant change

Strong fundamentals make this business hard to screw-up

Failure to secure MRO contracts

The nature of “unlinked” contracts does not imply that

MRO contracts are at risk, it is purely accounting parlance

Virtually all Rolls-Royce engines are under contract

Rolls-Royce’s ability to monitor engine data in real time

and provide OEM replacement parts is uncontestable

Accounting is complex and based on estimates

The company’s accounting methods are in-line with howpeers treat long term service contracts and OE sales

The collection of engine data enhances estimate accuracy

Rolls-Royce bakes in a significant margin of error in its

projections of future profitability and cash flow

For example, the company does not bake in future

benefit from cost reductions until they are realized. In2014 and 2015, the company realized £203mm and

£323mm in profits for under-estimating contract values

Rolls-Royce could lose its technological edge in aerospace

The markets the company operates in (civil/defense

aerospace, nuclear) have multi-decade product cycles

The technology is evolutionary, not revolutionary. Rolls-

Royce has built upon its three-spool engine for decades

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Sum of the Parts Low HighCivil Aerospace £10,753 £12,281

Defense Aerospace £3,203 £4,003

Power Systems £2,400 £3,200

Marine Systems £1,517 £2,275

Nuclear £534 £686

Enterprise Value £18,406 £22,445

Net Debt £811 £811

Equit y Value £17,595 £21,634

Current Market Cap £12,227 £12,227

Upside 43.9% 76.9%

Share Price on 4/15/16 £6.65 £6.65

Target Price Range £9.57 £11.77

Conclusion: Rolls-Royce is a High-Quality Company Available at an Attractive Valuation

17

Investment Highlights Compelling Valuation

Exposure to growing markets insulated from

competitive forces

High barriers to entry and switching costs

Significant growth locked-in from backlog

Predictable stream of future cash flows

Attractive valuation misunderstood by

myopic sell-side analysts

Upside from operational improvements

Strong CEO in place

Potential to monetize from a break-up The significant discount to intrinsic value providesinvestors with a substantial margin of safety

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Appendix

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Long-Term Growth vs. Discount Rate Exi t Mu lt ip le vs. Discount Rate

3.0% 3.5% 4.0% 9.0x 10.0x 11.0x

9.0% £13,309 £14,357 £15,615 9.0% £12,369 £13,494 £14,618

10.0% £10,753 £11,458 £12,281 10.0% £11,322 £12,355 £13,38811.0% £8,853 £9,349 £9,916 11.0% £10,364 £11,314 £12,265

2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E Terminal Commentary

Sales 6,859 7,094 7,745 8,066 8,360 8,648 8,921 9,240 9,549 9,822 10,166 2016 - 2025 CAGR is 4%; below guidance and sell-side consensus

Growth % (1.1%) 3.4% 9.2% 4.1% 3.6% 3.4% 3.2% 3.6% 3.4% 2.9% 3.5%

EBIT 276 435 687 884 1,099 1,269 1,336 1,419 1,496 1,572 1,627 Terminal EBIT margin is consistent with current profitability of peers

Margin % 4.0% 6.1% 8.9% 11.0% 13.1% 14.7% 15.0% 15.4% 15.7% 16.0% 16.0%

D&A 450 550 675 772 871 971 1,068 1,063 994 913 813 D&A reflects amortization of CARs and depreciation of PP&E

% of Sales 6.6% 7.8% 8.7% 9.6% 10.4% 11.2% 12.0% 11.5% 10.4% 9.3% 8.0%

EBITDA 726 985 1,362 1,655 1,970 2,240 2,404 2,481 2,490 2,484 2,440

Margin % 10.6% 13.9% 17.6% 20.5% 23.6% 25.9% 26.9% 26.9% 26.1% 25.3% 24.0%

Tax Rate 26.0% 26.0% 26.0% 26.0% 26.0% 26.0% 26.0% 26.0% 26.0% 26.0% 26.0%

Taxes (72) (113) (179) (230) (286) (330) (347) (369) (389) (409) (423)

Δ Net Working Capital (412) (355) (310) (242) (167) (86) 0 46 95 147 152 Management has guided for NWC to become a source of cash

% of Sales 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% (0.5%) ( 1.0%) ( 1.5%) (1.5%)

Δ TotalCare Net Debtor (133) (71) (46) 26 67 114 118 121 122 138 102 As Linked contracts phase out, TotalCare becomes a cash inflow

% of Sales (1.9%) ( 1.0%) (0.6%) 0.3% 0.8% 1.3% 1.3% 1.3% 1.3% 1.4% 1.0%

CARs Additions (210) (280) (390) (420) (440) (450) (428) (400) (368) (330) (305) CARs additions rise with the sale of Unlinked engine contracts

% of Sales 3.1% 3.9% 5.0% 5.2% 5.3% 5.2% 4.8% 4.3% 3.8% 3.4% 3.0%

Capex (500) (500) (500) (500) (500) (500) (500) (500) (500) (500) (508) Conservative to guidance for capex to fall; maintenance capex rises

% of Sales 7.3% 7.0% 6.5% 6.2% 6.0% 5.8% 5.6% 5.4% 5.2% 5.1% 5.0%

Unlevered FCF (600) (334) (62) 290 644 987 1,248 1,380 1,452 1,532 1,458 The value of cash flow does is heavily weighted towards the back half

Period 0.25 1.25 2.25 3.25 4.25 5.25 6.25 7.25 8.25 9.25 of an engine's contractual life. Therefore, it is perfectly reasonable

Discount Factor 0.976 0.888 0.807 0.734 0.667 0.606 0.551 0.501 0.456 0.414 for the terminal value to be the largest component of value. This

PV of Cash Flow (586) (297) (50) 212 429 599 688 691 661 634 value would be captured if the DCF was extended into future periods

Ter minal Value Alt er nat ive Ter minal ValueSum of PV Cash Flows £2,982 Long-term growth 3.5% Exit Multiple 10.0x

Terminal Value £9,288 Enterprise Value £22,428 Enterprise Value £24,399

Enterprise Value £12,269 Present Value £9,288 Present Value £10,104

Net Debt £811

Equity Value £11,458 Discount Rate 10.0%

Civil Aerospace Segment Discounted Cash Flow Model

19

Civil Aerospace Segment Discounted Cash Flow Model

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Civ il Aero Rev enue Build 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

Wide body engine deliveries 224 275 282 308 330 370 425 530 562 600 630 650 670 690 700

Other engine deliveries 738 393 471 431 382 344 309 278 251 226 203 183 164 148 133Total engine deliveries 962 668 753 739 712 714 734 808 813 826 833 833 834 838 833

Original Equipment Revenue

Wide body linked revenue £1,766 £1,570 £1,610 £1,575 £1,610 £1,484 £1,400 £1,260 £1,225 £1,190 £1,155 £1,050

Wide body linked deliveries 223 267 282 232 208 230 225 230 212 200 180 175 170 165 150

Revenue / linked delivery 6.87 7.14 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00 7.00

Wide body unlinked revenue £392 £504 £595 £900 £1,425 £1,750 £2,000 £2,250 £2,375 £2,500 £2,625 £2,750

Wide body unlinked deliveries 1 8 0 79 100 140 200 300 350 400 450 475 500 525 550

Revenue / unlinked delivery 4.96 5.04 4.25 4.50 4.75 5.00 5.00 5.00 5.00 5.00 5.00 5.00

Other OE revenue £1,305 £1,184 £945 £851 £766 £689 £620 £558 £502 £452 £407 £366

Other engine deliveries 738 393 471 431 382 344 309 278 251 226 203 183 164 148 133

Revenue / other delivery 2.89 2.91 2.75 2.75 2.75 2.75 2.75 2.75 2.75 2.75 2.75 2.75

Total Civi l OE Revenue £2,232 £2,934 £3,035 £3,463 £3,258 £3,150 £3,326 £3,801 £3,923 £4,020 £4,068 £4,102 £4,142 £4,187 £4,166

Growth % 31.5% 3.4% 14.1% (5.9%) (3.3%) 5.6% 14.3% 3.2% 2.5% 1.2% 0.8% 1.0% 1.1% (0.5%)

Services Revenue

Wide body unlinked revenue £0 £300 £230 £370 £580 £825 £1,105 £1,420 £1,752 £2,102 £2,470 £2,855

Unlinked wide body install base 1 9 9 88 188 328 528 828 1,178 1,578 2,028 2,503 3,003 3,528 4,078

Revenue / installed engine 1.60 0.70 0.70 0.70 0.70 0.70 0.70 0.70 0.70 0.70 0.70

Wide body linked revenue £2,029 £2,071 £2,126 £2,189 £2,215 £2,209 £2,176 £2,175 £2,148 £2,157 £2,155 £2,145

Linked wide body install base 3,625 3,792 3,974 4,068 4,142 4,252 4,377 4,429 4,417 4,351 4,350 4,295 4,314 4,310 4,289Revenue / installed engine 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50

Other services revenue £1,345 £1,304 £1,353 £1,210 £1,150 £1,110 £1,060 £985 £919 £838 £738 £657

Other install base 10,520 10,589 10,535 10,190 9,648 9,021 8,068 7,669 7,397 7,065 6,568 6,125 5,589 4,919 4,379

Revenue / installed engine 0.13 0.14 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15

Total Civil Services Revenue £3,340 £3,503 £3,620 £3,374 £3,675 £3,709 £3,768 £3,944 £4,143 £4,340 £4,580 £4,818 £5,097 £5,362 £5,656

Growth % 4.9% 3.3% (6.8%) 8.9% 0.9% 1.6% 4.7% 5.0% 4.8% 5.5% 5.2% 5.8% 5.2% 5.5%

Total Civil Aerospace Revenue £5,572 £6,437 £6,655 £6,837 £6,933 £6,859 £7,094 £7,745 £8,066 £8,360 £8,648 £8,921 £9,240 £9,549 £9,822

Growth % 15.5% 3.4% 2.7% 1.4% (1.1%) 3.4% 9.2% 4.1% 3.6% 3.4% 3.2% 3.6% 3.4% 2.9%

Civil Aerospace Operating Model

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Civil Aerospace Revenue Build

Note: engine deliveries and engine install base were projected in a separate schedule. Historical engine deliveries were tracked from

1990 to present and engine life was mapped in a waterfall schedule. Engines were conservatively assumes to come offline after 20

years in service. Projected engine deliveries are based on management commentary and guidance.

l d l ( ’ )

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Civil Aero Expense Model 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

Original Equipment Revenue £2,232 £2,934 £3,035 £3,463 £3,258 £3,150 £3,326 £3,801 £3,923 £4,020 £4,068 £4,102 £4,142 £4,187 £4,166

Services Revenue £3,340 £3,503 £3,620 £3,374 £3,675 £3,709 £3,768 £3,944 £4,143 £4,340 £4,580 £4,818 £5,097 £5,362 £5,656

To tal Civi l Aerospace Reven ue £5, 572 £6,437 £6,655 £6,837 £6,933 £6, 859 £7, 094 £7,745 £8,066 £8,360 £8, 648 £8, 921 £9,240 £9,549 £9,822% Growth 15.5% 3.4% 2.7% 1.4% (1.1%) 3.4% 9.2% 4.1% 3.6% 3.4% 3.2% 3.6% 3.4% 2.9%

OE Gross Profit £866 £815 £788 £831 £950 £981 £1,005 £1,017 £1,026 £1,036 £1,047 £1,042

OE Gross Margin (Standard costing) 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%

Services Gross Profit £1,518 £1,654 £1,669 £1,696 £1,775 £1,864 £1,953 £2,061 £2,168 £2,294 £2,413 £2,545

Services Gross Margin (Standard costing) 45.0% 45.0% 45.0% 45.0% 45.0% 45.0% 45.0% 45.0% 45.0% 45.0% 45.0% 45.0%

Cost of Goods Fixed Costs £709 £942 £1,400 £1,300 £1,200 £1,100 £977 £1,006 £1,036 £1,067 £1,099 £1,132

Gross Profit £1,675 £1,526 £1,057 £1,227 £1,525 £1,745 £1,981 £2,072 £2,158 £2,262 £2,361 £2,455

Gross Margin 24.5% 22.0% 15.4% 17.3% 19.7% 21.6% 23.7% 24.0% 24.2% 24.5% 24.7% 25.0%

Administrative Costs £283 £296 £305 £314 £323 £333 £343 £353 £364 £375 £386 £398

% Growth 4.6% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%

Research & Development £461 £515 £480 £482 £519 £532 £543 £553 £562 £573 £583 £589

% of Segment Sales 6.7% 7.4% 7.0% 6.8% 6.7% 6.6% 6.5% 6.4% 6.3% 6.2% 6.1% 6.0%

Restructuring Costs £82 £7 £100 £100 £100 £100 £100 £0 £0 £0 £0 £0

JV Income £93 £104 £104 £104 £104 £104 £104 £104 £104 £104 £104 £104

% of Segment Sales 1.4% 1.5% 1.5% 1.5% 1.3% 1.3% 1.2% 1.2% 1.2% 1.1% 1.1% 1.1%

EBIT £942 £812 £276 £435 £687 £884 £1,099 £1,269 £1,336 £1,419 £1,496 £1,572

Operating Margin 13.8% 11.7% 4.0% 6.1% 8.9% 11.0% 13.1% 14.7% 15.0% 15.4% 15.7% 16.0%

Asset Depreciation and Other Amortization £344 £355 £385 £468 £550 £600 £650 £700 £750 £700 £600 £500

Amortization of CARs (Additions amortized straight line over 10 years) £37 £55 £65 £82 £125 £172 £221 £271 £318 £363 £394 £413

Total D&A £381 £410 £450 £550 £675 £772 £871 £971 £1,068 £1,063 £994 £913

% of Segment Sales 5.6% 5.9% 6.6% 7.8% 8.7% 9.6% 10.4% 11.2% 12.0% 11.5% 10.4% 9.3%

EBITDA £1,323 £1,222 £726 £985 £1,362 £1,655 £1,970 £2,240 £2,404 £2,481 £2,490 £2,484

EBITDA Margin 19.4% 17.6% 10.6% 13.9% 17.6% 20.5% 23.6% 25.9% 26.9% 26.9% 26.1% 25.3%Cash Flow Detail

Segment Capital Expenditures (Management guided capex to fall) £748 £502 £500 £500 £500 £500 £500 £500 £500 £500 £500 £500

% of sales 10.9% 7.2% 7.3% 7.0% 6.5% 6.2% 6.0% 5.8% 5.6% 5.4% 5.2% 5.1%

CARs Additions (Capitalized Asset Recoveries; unlinked engines losses) £86 £161 £210 £280 £390 £420 £440 £450 £428 £400 £368 £330

Unlinked wide body engine deliveries 79 100 140 200 300 350 400 450 475 500 525 550

CARs additions per delivery 1.09 1.61 1.50 1.40 1.30 1.20 1.10 1.00 0.90 0.80 0.70 0.60

TotalCare Net Debtor Balance (Net liability from linked MRO contracts) £1,955 £2,211 £2,344 £2,415 £2,461 £2,435 £2,368 £2,255 £2,136 £2,015 £1,892 £1,754

TC additions -£738 -£672 -£575 -£540 -£529 -£466 -£420 -£360 -£333 -£306 -£281 -£240

Linked wide body engine deliveries 232 208 230 225 230 212 200 180 175 170 165 150

TC additions per delivery 3.18 3.23 2.50 2.40 2.30 2.20 2.10 2.00 1.90 1.80 1.70 1.60

TC reductions 275 268 442 469 483 492 487 474 451 427 403 378

TotalCare Net Debtor Cash Flows -£463 -£404 -£133 -£71 -£46 £26 £67 £114 £118 £121 £122 £138

Segment Change in Working Capital £436 £484 £412 £355 £310 £242 £167 £86 £0 -£46 -£95 -£147

% of Segment Sales (Guided to be a future source of cash) 6.4% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% (0.5%) (1.0%) (1.5%)

Civil Aerospace Operating Model (con’t)

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Civil Aerospace Expense Build and Cash Flow Detail

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Thank You!

DISCLAIMER: THIS PRESENTATION IS NOT A RECOMMENDATION TO BUY OR SELL SECURITIES. PLEASE DO YOUR OWN RESEARCH.

EVERYTHING PRESENTED CONSISTS OF MY OWN OPINIONS AND DOES NOT REPRESENT ANY CURRENT OR FORMER EMPLOYERS.

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Rolls-Royce (RR) - 4.24.16