The day David bought Goliath

Olivetti's conquest of Telecom Italia owed much to a new Europe where financiers are awash with cash and any company, however big, can be put into play
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The Independent Online
Franco Bernabe, the chief executive of Telecom Italia, had a question for Roberto Colaninno, chief executive of Olivetti, when they met at a conference on 13 January. The day before, the Telecom chief had read what seemed like an incredible report in La Repubblica. The Rome-based newspaper said Colaninno's Olivetti was preparing a bid for Telecom, a company seven times its size.

"What's this about?'' asked Bernabe.

"Totally absurd,'' Colaninno shot back. "Pure fantasy. I wouldn't worry about it.''

Colaninno was being - as the 50-year-old Bernabe would learn soon enough - less than candid. The 55-year-old Olivetti chief executive had already enlisted three US banks and an Italian one to plan what would become Europe's biggest-ever takeover bid. He had also surreptitiously begun to approach senior politicians - the Italian government owned 3.4 per cent of Telecom and held veto power over changes in ownership - entreating them to stay out of his way.

The exchange between the corporate leaders marked a start to what would become a 60.4bn euro (pounds 40bn/$63bn) takeover battle. It was a transaction that would stand European financial conventions on their heads and set benchmarks for audacity.

But Colaninno was accustomed to confounding people's expectations. He had transformed Olivetti from an also-ran computer maker into Europe's No 2 mobile-telephone service in just two years.

Telecom, the former state monopoly, earned 1.98bn euros on revenue of 23.48bn euros in 1998. Olivetti netted just 128m euros on revenue of 3.7bn euros. Olivetti had only recently recovered from a brush with bankruptcy. The former manual typewriter maker lost 4,700bn lire ($2.5bn) between 1991 and 1996.

At the time of the conference on 13 January, Telecom's market value was 50bn euros and its stock was rising. Bernabe figured Colaninno wouldn't be able to raise that kind of money. Plus, Bernabe had good reason to think he had shareholders' confidence. His turnaround of Eni, once an unprofitable and corrupt state-owned energy company, had been hailed in a Harvard Business School study. Since the government had named Bernabe as Telecom's boss in November, the stock had risen 25 per cent.

In Italy, takeovers had long been private affairs arranged by powerful industrial families - like the Agnellis and Pirellis - with the help of the bankers who sat on their boards and the government officials with whom they socialised. Colaninno, as a provincial upstart, wasn't bound by the niceties of doing business the old-fashioned way.

It was the euro, adopted by Italy and 10 other countries in January, that made Colaninno's takeover of Telecom possible. The new currency has contributed to the build-up of a huge pool of cheap capital in Europe.

To be eligible to use the new currency, European governments had to cap their budget deficits at 3 per cent of economic output - a tall order for Italy, which had a deficit equivalent to 6.6 per cent of gross domestic product in 1996. To get that ratio down, the Italian government sold stakes in companies like Telecom, raising 60bn euros between 1993 and 1998 - a quarter of the total of all such asset sales in Europe.

Partly because European governments no longer have to borrow as much, the benchmark interest rate set by the new European Central Bank is now 2.5 per cent. Italy's benchmark rate was 9 per cent as recently as 1996.

Europe, in short, is awash with money, much in the hands of asset managers who control $6,000bn in funds, twice what they managed three years ago. With all this cash looking for a home, virtually any European company can, with the right cast of characters, be put into play. Olivetti's conquest of Telecom has made the unthinkable thinkable.

"For the right deal, previously unfathomable sums can be raised," says Don McCree of Chase Manhattan, Olivetti's main banker.

Colaninno, who declined to be interviewed for this story, broached the idea of the Telecom bid last autumn with Ruggero Magnoni and Vittorio Pignatti Morano of Lehman Brothers Holdings, Olivetti's main investment bank for the past decade.

The chief executive, who'd invested millions of euros of his own money in Olivetti, told the bankers he felt constrained. In his two years at the helm, he'd quit the computer business and bolstered Olivetti's position in telecommunications. Its Omnitel unit was Europe's No2 mobile-phone network, and its Info-strada business was Italy's No2 fixed-line service.

Now, though, he had no place to grow. Olivetti's arrangement with major Omnitel shareholders - Mannesmann of Germany and Bell Atlantic and AirTouch Communications of the US - restricted the company's ability to expand abroad. Buying Telecom was the best option, Colaninno concluded.

It was a tempting target, one with 80 per cent of Italy's $28bn market for fixed and mobile phone services. It had too many workers, generated 8bn euros in cash annually and suffered from bad managers and restless shareholders.

Turmoil in the executive suite had reduced Telecom's share price by 44 per cent in the 11 weeks to 9 Oct-ober, making it attractive to a would-be raider. In October, the stock traded for five times cash flow per share, half the ratio of AT&T or British

Telecommunications. And Telecom had 7.9bn euros in debt, just 14 per cent of its total capitalisation.

Colaninno and his bankers agreed that Telecom was ripe for a leveraged buy-out (LBO) - a takeover in which the acquirer borrows money and uses the target company's own cash flow to repay it.

Colaninno sounded out Chase bankers Frederico Imbert and James B Lee. They said it was possible. Encouraged, Cola-ninno asked James Cantwell - top European telecommunications banker at Donaldson, Lufkin & Jenrette (DLJ) - and Magnoni and Pignatti of Lehman to devise a plan.

Speed was essential. Telecom investors, anticipating Bernabe's arrival as chief executive, were pushing up its stock price. The higher the stock went, the more cash Colaninno had to raise. He'd need to float a loan of as much as $25bn - far larger than anything ever done in Europe. The Continent's biggest syndicated loan at that point was the $8bn Zurich Insurance had raised to buy BAT Industries' financial units in 1997.

For a loan of this magnitude, Colaninno would need Chase, the world leader in syndication. On 22 December, Chase's Imbert telephoned Colaninno to wish him a merry Christmas.

"I was just about to call you," Colaninno told the banker.

On Christmas Eve, Lee - the Chase vice chairman - called the Olivetti chief executive from his home in Darien, Connecticut. Chase would consider arranging the jumbo loan only if the New York bank alone would be the lead manager. Colaninno agreed.

DLJ, Chase and Lehman bankers gathered in London on 8 January and hatched a plan. To avoid having to borrow so much, they would offer Telecom investors interest-bearing notes that would have to be exchanged after one year for shares in Telecom Italia Mobile, a cellular company 60 per cent owned by Telecom Italia.

Gerardo Braggiotti, a senior Lazard Group banker, offered Bernabe a defence. At a 15 January meeting with the Telecom chief executive, he dusted off an old idea to convert Telecom's 2 million non-voting savings shares to ordinary stock - a move that would have increased the amount of voting equity by 12bn euros and probably made Telecom too big for Olivetti.

But Bernabe, who had been at Telecom for just two months, hadn't yet hired his management team and took no action.

Colaninno, by contrast, was hyperactive. In late January, at a meeting with his advisers in Geneva, he told them he'd asked Mediobanca, the well-connected Italian investment bank, to help with the offer. "No one understands Italian finance like Mediobanca," he said.

Mediobanca's head of investment banking, Matteo Arpe, 34, wasted no time trying to shape the deal. He scoffed at the exchangeable securities the US banks planned to issue, calling them too new and complicated. Massimo Capuano, chief executive of Borsa Italiana, also told Olivetti the exchangeables couldn't be listed on the Italian exchange.

Colaninno sent his bankers back to the drawing board. In early February, the bankers proposed to offer cash, debt and stock in a ratio that would work out to 6 euros a share in cash, 2.6 euros in floating-rate notes and 1.4 euros in shares of Tecnost, an Olivetti lottery equipment-making unit with sales of just 83m euros in 1998.

Officially, it would be Tecnost, not Olivetti, that would make the bid. Using Tecnost would let Colaninno offer stock to Telecom shareholders without diluting his control of Olivetti.

But Colaninno's advisers from DLJ and Lehman were so peeved at Chase's insistence that it - and it alone - manage the jumbo loan that they banned representatives of the New York bank from their meetings. The investment bankers approached Barclays to discuss the possibility of replacing Chase.

On 12 February, Colaninno took guarantees from his bankers that they could raise the necessary money to show the prime minister, Massimo D'Alema.

The next day, Colaninno told his advisers that the government "won't be an obstruction". He didn't elaborate, but the bankers worked out the reason themselves. D'Alema, a former Communist who had been prime minister only since November, didn't want to be seen interfering in a free-market battle - plus he knew the alternative to an Olivetti takeover of Telecom might be a purchase by a foreign company, something that wouldn't sit well with the electorate.

Having squared the government, Colaninno concentrated on doing the same with his bankers. He ordered them to split the fees and glory equally.

On 15 February, Pignatti of Lehman, Arpe of Mediobanca, Cantwell of DLJ and McCree of Chase worked out a peace treaty. Mediobanca would raise cash from Italian banks and underwrite a 3bn euro share sale. Chase agreed to accept Lehman and DLJ as co-lead managers for the 22.5bn euro loan. All four would run an 18bn euro bond issue.

Bernabe, meanwhile, finally heeded his colleagues' pleas and began assembling his own team of bankers. On 18 February, Bernabe hired CSFB, the investment banking unit of Credit Suisse Group, and San Paolo-IMI, Italy's biggest bank. Both were Telecom shareholders.

By now, Italian newspapers were saying a bid was imminent. Consob, the agency that regulates securities trading, asked Olivetti to address the rumours. The company issued press releases saying its board would meet on Sunday 21 February to discuss a "strategic operation" involving Telecom.

Bernabe called an emergency Telecom board meeting for Saturday. Olivetti then brought its meeting forward to Saturday as well - to prevent Telecom from taking defensive moves. It would be the first time Colaninno would tell most of his board that he intended to buy Telecom.

If the bid succeeded, he told the directors, Olivetti would sell its own telephone businesses to Mannesmann for 7.9bn euros. Olivetti would offer Telecom shareholders an 11 per cent premium, he said. After Magnoni and Pignatti briefly explained the financing, Cola-ninno told the board to vote.

No one questioned the need for urgency. Everyone knew Telecom's board was meeting 300 miles away in Rome. The Olivetti board unanimously endorsed the bid.

For Olivetti, the next few hours were critical. Once a bid was delivered, Italian takeover law would limit Telecom's ability to take defensive moves like paying massive dividends or issuing new shares.

But there had been no need to rush. Because Telecom's board had been summoned at the last minute, the law required all 13 members be present for any binding votes. Gianfranco Gutty, chief executive of Assicurazioni Generali, an insurance company whose biggest shareholder is Mediobanca, didn't attend. He sent a letter saying any move made in his absence would be void.

The directors who did attend were split over what to do. Bernabe wanted to fight, as did two others. Telecom chairman Berardino Libonati, a lawyer, scanned the bid and declared it so vague as to be legally invalid.

After four hours of discussion, the board recommended that Bernabe hire advisers who weren't shareholders. That weekend, Bernabe signed up Lazard and JP Morgan. These firms eventually would earn 12m euros each.

As David Mulford - CSFB's international chairman and a former assistant secretary of the US Treasury - and the other advisers rattled off defensive options, Bernabe rejected them one by one.

Forget borrowing money to bid for TIM, the mobile-phone company, or Olivetti. Forget a share buy-back. Bernabe knew that a buy-back would soak up cash the raiders were counting on to repay their debts, but he wouldn't mortgage Telecom. He hated debt. He'd inherited 28.4 trillion lire of it at Eni and recalled how it had hobbled him.

"I don't want to do anything that I wouldn't do in the normal course of business," he repeatedly told his bankers. Bernabe also wanted cash on hand for acquisitions abroad.

Meanwhile, opportunity was slipping by. Consob had, as Libonati expected, rejected Olivetti's offer as too vague. Olivetti's lawyers rewrote it to conform to the law, but that took three days. In that time, Telecom was free to adopt whatever defence it desired. It did nothing. On 10 March, almost two weeks after Olivetti had refiled its bid, Bernabe settled on a defence meant to make Telecom too big to buy.

Telecom proposed to convert its savings shares to common, buy back 10 per cent of its stock for up to 15 euros a share and offer to acquire the rest of TIM, the mobile phone company, for more than 20bn euros.

But Bernabe was again foiled by his aversion to debt. He insisted on paying for TIM with Telecom stock. His shareholders, who would have to approve the plan, didn't like using Telecom - which they said was undervalued - to buy TIM stock, which they thought overpriced.

The Olivetti team was trying to win over its own sceptics. Even with generous terms, Chase couldn't enlist the banks at the top of its list. UBS, Credit Suisse Group, JP Morgan, Citicorp and others declined because they were already working for Telecom or because Telecom threatened to blackball them if they helped Olivetti. Others said their policies forbade lending to highly leveraged hostile bids.

Olivetti's own banks had pledged 10bn euros and Mediobanca had enrolled Banca di Roma and Monte dei Paschi di Siena, but it wasn't enough. On 8 March, McCree, Chase's director of acquisition finance, flew to Milan to warn Colaninno that the loan was in trouble.

Three days later, Colaninno boarded a chartered jet for a weeklong blitz of 30 banks in London, Amsterdam, Paris, Brussels, Frankfurt and Madrid; 25 signed on. By 26 March, the loan deadline, Olivetti had pledges of 33bn euros, a third more than it had thought it could get - and five times what it would need.

While Colaninno celebrated the success of his loan, Bernabe was trying to recover from a disastrous meeting with London fund managers, who had shot down his idea of buying TIM with stock. Belatedly heeding his bankers' advice, he announced a 22bn euro all-cash offer for TIM.

Olivetti's advisers were worried. They thought the all-cash offer for TIM would succeed in putting Telecom out of reach. They urged Colaninno to increase his bid immediately. Emboldened by the success of the loan, he raised the offer to 11.5 euros a share.

As Olivetti's board was approving the higher bid on 29 March, its bankers committed an almost fatal error. They sold 24 million Telecom shares. When Consob realised Olivetti had done this, its president Luigi Spaventa warned Colaninno that manipulating shares was grounds for suspending an offer. Colaninno said the sale was a mistake that grew out of an effort to raise cash.

Consob officials decided that suspending the bid would be too harsh. Instead, the agency recommended that the Treasury fine Colaninno 200m lire ($107,000) - a step it has yet to take.

Bernabe, meanwhile, was trying to placate 70 restive shareholders at the New York Palace Hotel. Hedge fund manager Richard Perry and veteran mutual fund investor Mario Gabelli urged Bernabe to be more aggressive in defence. Bernabe declined to take any new measures.

Telecom failed to attract a quorum of investors - representing at least 30 per cent of common shares - to an extraordinary meeting on 10 April called to vote on converting the savings shares.

Bernabe, though, was nursing a secret, last-ditch defence: a $96bn merger with Deutsche Telekom, Europe's biggest phone company.

He and Telekom chief executive Ron Sommer announced the proposal in London on 22 April. It was another all-stock transaction, involving a company that was still 72 per cent owned by the German government. Shareholders scoffed.

"It would be a very bizarre combination, merging with a company that is even less efficient than Telecom Italia and letting the German state run it," Corrado Berlenda, who manages 5.7m euros in Telecom shares at Euroconsult, said.

The Italian government tipped the balance on 20 May, the night before the tender closed, by informally prodding reluctant major shareholders to sell. D'Alema wanted to avoid a court battle if Olivetti didn't get clear control.

By 9pm the next day, Colaninno knew he'd won. Investors, including the so-called core shareholders that controlled Telecom's board, tendered 52 per cent of the company. Even San Paolo-IMI, Telecom's defence adviser, sold.


Date Target Acquirer Status Value ($bn)

18 April Telecom Italia Deutsche Telekom Withdrawn 91.5

18 January Air Touch Vodafone Completed 74.4

20 February Telecom Italia Olivetti Completed 34.8

1 April Arco BP Amoco Pending 27.2

23 February Telecom Italia Mobile Telecom Italia Withdrawn 24.8

17 May Hoechst Rhone Poulenc Pending 21.9

1 February Paribas Societe Generale Pending 19.9

9 March Paribas BNP Pending 18.9

9 March Societe Generale BNP Pending 18.7

21 March Banca Commerciale Unicredito Italiano Withdrawn 16.6

Source: Securities Data