Europe's Sell Off To End All Sell Offs

Huge stakes are riding on the fate of Deutsche Telekom's November offering

It was supposed to be a sure thing. In February, 1987, with the Tokyo stock market skyrocketing, the Japanese government sold 1.9 million shares of Nippon Telegraph & Telephone Corp. at $10,720 a pop. Armies of brokers went door to door, pitching the stock to housewives and retirees as a must-have piece of Japan Inc. By October, 1988, they had sold 35% of the company. But two years later, the Tokyo stock market plunged, exposing NTT for what it was: an overpriced colossus far less profitable than the global competition. Its market value has since halved, and many small investors lost their life savings.

A decade later and half a world away, the NTT debacle is haunting a new army of brokers. State-owned German giant Deutsche Telekom aims to raise up to $10 billion by issuing as many as 500 million new shares, making it the world's second-biggest initial public offering after NTT. Lead managers Deutsche Bank, Dresdner Bank, and Goldman Sachs, as well as dozens of others in a sprawling consortium, are hitting the road to pitch the stock. Chief Executive Ron Sommer and other company officials will then make their own 17-nation tour and will set the price just before trading starts on Nov. 18.

The success of the T share, as it's called in Germany, will determine more than the company's near-term finances. German Chancellor Helmut Kohl wants Telekom stock to sow the seeds of a shareholder culture. If it's a flop, Bonn will have a hard time unloading other state-owned companies, such as the railroad and the rest of airline Lufthansa. Without a vibrant equity market, Frankfurt will lose status as a European financial capital. And unless the public is persuaded that stocks are a good long-term investment, private pension funds will never fill the gap left by dwindling public benefits. "The real measure [of Telekom's success] will be if investors make real, hard money out of it," says Vicky K. Sleddon, fund manager at Mercury European Privatization Trust in London. "That depends on how it is priced."

Indeed, pricing the T share will be the most important decision Sommer has made since taking over 18 months ago. Analysts are estimating a range of $13.07 to $19.60. If Telekom gets too greedy and pushes its bankers to go for the high end, the issue could face the same fate as NTT. Telekom needs a good record with this first offering to be able to sell a second tranche, possibly in 1998, and for the government to put its own shares on the block in 2000.

FREE SHARES. The trouble is, Telekom wants a rich share price to help pay off its $64 billion debt, the highest corporate debt in Europe. But its bankers think it is more important to place the maximum number of competitively priced shares than to worry about the balance sheet. Consortium members say that over the past several months, Telekom execs have been arguing for the higher end of the range, leading to some heated conversations and slammed doors.

Complicating the decision is that Telekom has to satisfy one set of investor expectations at home and another abroad. Risk-averse German fund managers tend to look at yield. Accustomed to the security of bonds, Germans want high dividends to beat the 6% they can get for 10-year government debt. They also get a tax credit on dividend income. So they're willing to pay more for high-yielding stocks. U.S. and British investors focus more on growth. As a result, early soundings show that Germans are willing to pay in the $16 to $19 range, while British and American investors are leaning toward $13 to $16.

Telekom execs are going all out to convince the German public that T shares are a great deal at any price. Bankers and analysts estimate that the company aims to place 40% of the new shares with domestic individual investors. So the marketing press has been formidable. The popular star of a TV detective series urges viewers not to miss out. Banks have waived or reduced fees for account holders who buy T shares. The 2 million people who have filled out forms to get more information from Telekom will get priority over other retail investors in case the offering is oversubscribed. And the company is promising a free share per 10 purchased shares to investors who hold the stock until 1999.

Besides such incentives, marketers are going overboard to make stock-buying as comfortable as possible. Commerzbank, for one, is trumpeting a product called the Safe T, which guarantees against any capital losses until 2002. In return, investors hand their dividends over to Commerz. Such gimmicks are meant to appeal to conservative investors who are more terrified of losing their capital than they are greedy for gains.

DEBT-LADEN. But fostering the notion that stocks are risk-free could backfire in the wake of a downturn, especially if T shares are perceived as overpriced. Even if they're not, investors who aren't prepared for volatility would be loath to dip into equities a second time. That has happened in Britain. Although the number of people holding shares has jumped from 9% to 22% since British Telecom was privatized in 1984, stock ownership remains thin. More than half of British shareholders own stock in only one company.

In addition to investor skepticism, Telekom faces a tough investment climate. The DAX index of 30 blue-chip shares is at all-time highs. Interest rates at record lows have nowhere to go but up, which would make government paper even more attractive. Furthermore, some $40 billion more worth of new privatization shares are expected to flood the market in the next two years.

Global institutional investors, meanwhile, who are expected to take at least 40% of the offering, are scrutinizing Telekom's performance. Among their biggest worries is the company's debt, incurred as Telekom rushed to bring eastern Germany up to speed. Robert Mocatta, a telecom analyst with BZW, one of the few banks outside the selling consortium, noted in a provocative report that Telekom's debt is higher than Turkey's. He worries that Telekom has spent too much of its cash flow on acquisitions in Asia and Eastern Europe. Mocatta, who compares the stock offering to a leveraged buyout, thinks a competitive price range would start at $6.50.

GERMAN PROXY. Potential investors have also put CEO Sommer in the spotlight. The issue's success among money managers depends largely on whether they trust his ability to keep his promises. These include cutting Telekom's debt by a third by 2000, defending against new competitors when Germany's telecom market is deregulated in 1998, and cutting back labor costs and other legacies of a state-owned bureaucracy. Michael J. Mahoney, who manages more than $3 billion for the GT Global Telecommunications Fund, says his assessment of Sommer will weigh heavily in his decision on T shares. "Leadership is crucial," he says.

Some institutional investors won't be quite such a hard sell. For example, managers of specialized Germany funds can't ignore that Telekom will account for up to 4.5% of the DAX index. Even people such as Gary L. Bergstrom could be game. The head of Acadian Asset Management in Boston, who normally doesn't like initial public offerings, admits that he will have to consider buying Telekom just because its size could make it a proxy for the German market. But most global investors are likely to stack it up against other telecom shares. There are plenty to choose from, especially in regions such as Latin America and Asia with more room for growth.

Certainly, Europe in 1996 is not Japan in 1988. Already, Telekom is up against fierce competition in such areas as private networks and mobile phones and is preparing for full deregulation. It has powerful cash flow and state-of-the-art technology. But the lessons of NTT are clear. All the marketing in the world won't help--unless the price is right.

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