Italy's breakthrough deal

Glover, John

The wide distribution of Telecom Italia shares is finally creating the retail equity market that the country needs.

In the words of the local press, it was "la madre di tutte le privatizzationi," the mother of all privatizations. That seeming hyperbole was a tribute to the slew of records clocked up at the end of October by the privatization of Telecom Italia, Italy's national phone operator.

It was not an initial privatization: 55.3% of the company (formerly called STET) already traded on the Milan, London, and New York exchanges. But Italy's treasury sold virtually all of the remaining 44.7% in two parts, a L5.4 trillion ($3.2 billion) private placement of 9.02% to core strategic shareholders (including Italian banks, insurers, and an Agnelli family investment vehicle), followed by a L18.93 trillion flotation that lured nearly 2.1 million normally equity-shy Italians into banks, brokerage houses, and post offices in the hope of booking shares.

The total $14.9 billion take made the sale the largest privatization ever outside Japan-bigger even than Deutsche Telekom's $13.3 billion sale last year. The private tranche was the largest private placement ever carried out, notes Marco Taricco, vice president of investment banking at Morgan Stanley Dean Witter, one of the treasury's advisers. And the "greenshoe" overallotment provision-225 million shares worth some $1.5 billion"dwarfed most offerings," says Charles Kirwan-Taylor, co-head of equity capital markets at London's Barclays de Zoete Wedd, one of the two global coordinators. In a new index produced by Milan investment bank Mediobanca that weights stocks by float, or the shares available for trading, Telecom Italia now accounts for 20.6% of the Milan borsa.

To pull off the sale, BZW and Mediobanca, the other global coordinator, had to cope with extraordinary obstacles, including a worldwide stock market plunge, the (temporary) resignation of Italy's prime minister, Romano Prodi, and the news that BZW's equity operations were being put up for sale by its parent, Barclays Bank. As it turned out, Mediobanca, in its first effort honchoing a privatization, did such a good job placing shares domestically that BZW wound up with only 50 million shares for international buyers.

But more than money was riding on the Telecom deal. Mario Draghi, director general of Italy's treasury, to whom the ministry's privatization team reports, points to three public policy objectives at the heart of Italy's privatization program. "First, we needed to remove the state from the running of businesses," Draghi says. "Second, we wanted to develop a retail shareholder culture in Italy. Third, we wanted to ensure the accountability of company management to shareholders."

The Telecom sale, the high point of this plan so far, mostly achieved these objectives, except for a few qualifications. The treasury did not exit the company entirely; it retains a so-called "golden share" giving it continued influence over management. Mario Monti, the European Union's single-market commissioner, has opened infraction proceedings against Italy (as well as Britain and Portugal) over the use of golden shares. And Telecom Italia chairman Guido Rossi resigned in November, apparently over continued political interference. Now running the company is group managing director Tomaso Tommasi di Vignano, who is close to the Prodi government.

But in winning huge numbers of retail investors, the deal was unquestionably a triumph. They had no trouble ponying up the minimum investment of L10,908,000, or roughly $6,270. To meet demand, the size of the retail offer had to be doubled to 1.45 billion shares, while institutions, which had booked 800 million shares, wound up with only 280 million.

Italy needs to encourage widespread share ownership both to sell off the rest of its huge state-owned companies and to begin shifting to a private pension system. "For us, [Telecom Italia] is the dramatic change you had in Britain with Mrs Thatcher," says one of the Italian bankers involved in the deal. The success set the stage for the sale of Banca di Roma in December and augurs well for the privatization of Enel, the national electricity supplier, in 1998-a deal that may be even bigger than the Telecom Italia sale. In short, in the words of the title of a recent book by Massimo D'Alema, secretary of the Democratic Party of the Left and the power behind Romano Prodi's center-left government, Italy is finally becoming "un paese normale"-a normal country.

In selling companies, as in comedy, everything is in the timing. For the treasury, the timing of the Telecom sale was pure serendipity. The offering price was set as the shares' closing price on the bourse on Friday, October 24, the day the booking period closed, minus a 3% discount for retail investors-with a maximum price of L11,200. And a 10% bonus issue of shares was set aside for retail investors who hold their shares for at least a year.

Savers such as Benito Castelmagno, a Milan clerk, advised and encouraged by a friend who works at Banca di Roma, was one of thousands who saw a chance to turn a quick buck. With most of his savings in government bonds, he was making his first foray into the equity market. As he explained to friends and colleagues, the shares would be delivered on Monday, October 27. He figured he could sell them and have the money by the time he had to pay for them on October 29.

But October 27 turned out to be Gray Monday, the day when Asian jitters sent world stock markets plunging. Telecom slumped below its offer price-and stayed there. Benito paid, but he was stuck with the shares. "My wife told me to stay in treasury bonds," he commented sourly. Not until early December did the shares rise above the discounted offering price. But by then Castelmagno, like countless other Italians, decided he rather liked owning Telecom shares and chose to keep them.

Though somewhat chagrined by the price decline, treasury mandarins put their best spin on it. "You've got to remember that the fall in the market is not a Telecom Italia event, it's a worldwide event," says Vittorio Grilli, the dapper 40-year-old former academic who heads the treasury's privatization team. "These things occur every once in a while. It's unfortunate it occured the day after the offer." Adds one of the deal's bankers: "We really didn't want to bring in people who just wanted to sell the day after for a quick profit."

Four years into a privatization program that has brought more than $38 billion flowing into its coffers, Italy's treasury has tested all sorts of selling techniques-from private trade sales to initial public offerings and secondary flotations, single- and multitranche deals, shorter and longer bookbuilding periods, as well as the use of convertible bonds. In tough markets, such as 1995, it promised to reimburse investors' losses. In strong markets, such as 1996 and 1997, it has offered bonus shares to those holding on to their shares for more than a year.

About the only technique the treasury hasn't tried is selling shares on an installment payment schedule, a gambit used several times by Britain in its massive 1980s privatizations. In Italy the technique would require special legislation, meaning delays. But it's not really necessary. "There is a stronger case for it when interest rates are in double digits than when they're at 6%," says Grilli. "But there isn't a problem of cash-constrained retail investors in Italy. They have plenty of cash, if they want to use it." A full 16.2% of disposable income, he points out; "the household savings rate here is huge."

A sale of Telecom Italia has been in the air ever since the 1992 currency crisis and magistrates' corruption investigations swept away the political order that had ruled the republic since the end of World War II. With the arrival of a series of technocratic governments, the idea of selling state assets ceased to be regarded as heresy and entered the political mainstream.

But selling Telecom Italia entailed problems. For one thing, it didn't exist as such. It was a spezzatino telefonico, a telecom stew, of separate companies for international traffic, for domestic traffic, satellite traffic, and so on, many of them with their own listings on the bourse but all controlled by Italy's largest, most heavily indebted state industrial holding company, Istituto per la Ricostruzione Industriale (IRI), through a sub-holding called STET. Thanks to the cash flow from its monopoly of Italian telecoms, and a highly centralized, authoritarian management enjoying its own political sponsorship, STET was one of the most powerful companies in the country. "Who runs Italy?" asked Karel Van Miert, the EU competition commissioner, after one of his many run-ins with the company. "STET or the government?"

The telecom stew was merged in 1994 to form Telecom Italia, with STET holding 64% of the company. Early the next year IRI, under heavy pressure from the EU competition authorities to cut its crippling and potentially dangerous L70 trillion-plus debt load, appointed first Morgan Stanley and then Milan's Euromobiliare to advise on the sale of STET/Telecom. Grilli stresses the importance of knowing the local market in a sale of Telecom's size. "What we've seen here is that the importance of getting the Italian retail and institutional parts right is paramount. They are the engine of the transaction," he says. "A local expert is very important for local knowledge." As a bonus, he adds, local institutions gain experience and expertise and make international contacts.

Naming the advisers didn't mean the sale was going to come quickly. "Between February 1995 and the end of 1996 it was all stop and go," says Rita Gastaldi, who heads corporate finance and primary markets at Euromobiliare. One stumbling block was that legislation setting up a regulatory office had to be in place before the state could exit telecoms. By blocking the law, opponents of privatization blocked the sale. Also, IRI and STET's top managers (led by managing director Ernesto Pascale) seemed to be dragging their heels. "Privatization would have meant a loss of power for STET managers," points out a Milan analyst. "It also meant IRI losing power-what would it do if it didn't own STET?" Adds Alberto Rolla, telecom analyst at Pasfin Sim in Milan: "Pascale felt strongly that the company should invest heavily in raising the barriers to entry to the Italian market. But private investors would probably prefer dividends or a share buyback."

Under an Italian-EU agreement, IRI was supposed to reduce its debt-equity ratio to 1-to-1 by the end of 1996. Selling STET by the deadline was impossible, so the treasury, under former Bank of Italy governor Carlo Ciampi, transferred STET to the ministry. The move was, Ciampi said in an interview, "a clear signal we are serious about privatization." STET finally set about merging with Telecom last January. But the government, fed up with the slow pace, fired management and brought in Guido Rossi, a wealthy corporate lawyer and a veteran of the 1993 salvage of Montedison, to be chairman and see the privatization through. Tomaso Tommasi di Vignano of Telecom Italia, a career Telecom executive, became group managing director.

The merger was rammed through various decision-making bodies in March. "It was like Bre'r Rabbit shouting, `Don't throw me in the briar patch,' says a former Telecom executive. "The people who did not want to sell were pushing for the merger as a way of buying time. They were surprised when it happened."

Completed in July, the reorganization was peculiar. Telecom, clearly the financial engine with 90,000 employees, was absorbed by tiny STET and its 500 employees-which then changed its name to Telecom Italia. "There were marginally more advantages this way," says Morgan Stanley's Taricco. "STET was already quoted in the United States, plus there were tax considerations pushing in this direction."

Another vital step in preparing the company for privatization came in July, when Telecom Italia signed a memorandum of understanding to link up with AT&T and its international alliance Unisource. That was a crucial move to prepare the company for deregulation, when it will have to contend with a slew of new competitors-the most worrisome of which may be Enel, which announced a joint venture with Deutsche Telekom and France Telecom. At the same time, Italy's parliament finally approved legislation setting up a regulatory office. "That was the final piece of the jigsaw allowing the operation to go forward," says BZW's Kirwan-Taylor.

Given Italy's lack of a tradition of public companies owned by the market, the treasury and its advisers decided to create a stable shareholder base (azionariato stabile) of strategic investors. Each would have a small stake in the company, to be retained for at least three years. "In the Italian context it made a lot of sense," notes Euromobiliare's Gastaldi. Adds Grilli: "If the equity market is large enough, with enough institutional investors, the need for an azionariato stabile is much less."

Then the plot thickened. The Prodi government was the driving force behind getting the privatization done. But suddenly Prodi lost a confidence vote and handed in his resignation after his allies in the Communist Refoundation party withdrew their support for his budget. "That added complexity to something that was complicated enough already," sighs Grilli. Then BZW's parent, Barclays Bank, decided to sell its equity operations, which might have caused a hitch. But the treasury crossed its fingers and pressed ahead. "We felt that the demand was there and that Telecom could be sold on the basis of its own merits," Grilli says.

The complications didn't end there. Shortly after the sale Rossi stalked out of a board meeting and resigned. The reason: a spat over corporate governance. Rossi, it transpired, wanted the closest possible oversight of management; executives, led by Tommasi di Vignano, resisted the move. Suspicions that Tommasi had government backing for his stand raised the specter of an uncontrolled fiefdom being recreated in the newly privatized company. Meanwhile, a report from Confindustria, the powerful employers' association, complained that the privatization of Telecom was a step forward "only in so far as it leads to the real liberalization and opening to competition of the Italian telecom industry."

"Tommasi is not a Bernie Ebbers," says a Milan analyst who complains of Tommasi's "lack of vision." But Ebbers's Worldcom is planning an Italian investment next year, as are such other players as British Telecom. In that tougher environment, what counts at Telecom Italia will not be political clout but business acumen. And that will be the real measure of success of continental Europe's largest-ever privatization.

Copyright Global Finance Media Inc. Dec 1997/Jan 1998
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