In Europe, the Search Is On for Other Enrons

Investor pressure may force a huge telecom write-off

Is there an Enron Corp. in Europe's future? That's what investors in European equities and bonds are desperate to know--whether some off-balance-sheet bomb will soon go off at one of the Continent's blue chips. So far, hordes of analysts, investors, and short-sellers have failed to come up with a European horror story on the scale of the Houston meltdown.

Make no mistake, though: Enronitis is having its effect. It's driving investors to demand action from companies that seem to have too much debt or too many overvalued assets on their books. Companies are responding. The biggest surprise: Analysts and consultants expect some of Europe's largest telcos to write down up to 90% of the value of their investments in third-generation wireless phone licenses. Such a write-down would be one of the biggest balance-sheet cleanups in European business. But the sheer size of the operation could still shake investor confidence.

A 3G write-down, massive as it could be, is not the only post-Enron drama unfolding in Europe. "Accounting issues and bankruptcy concerns are dominating the markets," says Richard G. Davidson, equity strategist at Morgan Stanley Dean Witter & Co. in London. And it's not only overoptimistic dealmaking that investors want to see redressed. Engineering giant ABB Ltd. (ABB ) is trying to clean the slate with $1.4 billion in charges to cover lurking asbestos liabilities and other problems. Board members at the Swiss engineering giant are even pressing once-revered Chairman and CEO Percy Barnevik to pay back some of his $80 million in severance benefits.

Europe's CEOs are definitely rattled by the turn of events, especially the pressure to deleverage. "There has been a completely brutal change from where debt was practically ignored to a [point] where everybody is looking at how much debt companies have," says Serge Tchuruk, chairman and CEO of French telecom equipment maker Alcatel (ALA ).

One effect of the focus on leverage is that preservation of a company's debt rating is of paramount importance. Take the case of British media company Pearson PLC (PSO ). On Christmas Eve, the company suddenly accepted a cash offer of $1.3 billion from Bertelsmann for its stake in Europe's largest broadcaster, RTL Group--about half what the property would have fetched in May. "We were amazed they accepted Bertelsmann's price," says a source close to the deal. Pearson won't publicly admit its arm was being twisted. But it is known that the company was going through a tough review by rating agencies Moody's Investors Service and Standard & Poor's and was at risk of a downgrade.

Pearson isn't the only media company feeling the heat. Rival Vivendi Universal (V ), a transatlantic conglomerate cobbled together by Jean-Marie Messier in the past two years, is being punished by investors who are feeling queasy over its acquisition hunger and complicated structure. Its debt rose more than 20% in the past year, to an estimated $26 billion, as Vivendi snapped up everything from television group USA Networks to publisher Houghton Mifflin. Another worry is the difficulty tracing cash flow. For example, when Vivendi issued quarterly operating results last year, it booked 100% of the operating profits generated by Cegetel--even though Vivendi owns only 44% of the fast-growing French phone company. Vivendi will strip out the 56% it doesn't own when it releases net earnings on Mar. 5. "We are not saying there are accounting irregularities," says Michael Nathanson, an analyst at Sanford C. Bernstein & Co. in New York. "But there is still a question: What is the earnings power of this company?"

No sector is taking as big a drubbing as the telcos--and it's not just 3G. Terry Smith, CEO of London brokerage Collins Stewart, pours scorn on mobile telco Vodafone Group PLC's (VOD ) pursuit of global domination. "They paid too much for their businesses and too much for their licenses," he says. Vodafone's net debt now stands at $13 billion. Smith figures its cash return on capital will be negative through March, 2003.

David E. Marcus, managing partner of Marcstone Capital Management, a New York-based hedge fund, says he's shorting Deutsche Telekom (DT ) because he doubts it can raise enough from asset sales to fulfill its pledge to cut debt to $43.5 billion, from $57 billion. "They are not going to be able to get the values they need to get [from the sales]," says Marcus.

France Télécom (FTE ) has spooked investors not only with its estimated $57 billion debt but with off-balance-sheet commitments. After the telco took a 25% stake in cable operator NTL Inc., it struck a deal with some banks that financed NTL's acquisition of a Swiss cable company. The banks got shares in NTL, with an option to sell them back to France Télécom later for a guaranteed $1.1 billion. Now NTL is in trouble and its shares are nearly worthless, but France Télécom is still on the hook for the $1.1 billion payment, due in March, 2003. Although France Télécom notified regulators of the arrangement at the time, investors are focusing anew on the risks involved in such commitments.

Yet the pressure to pare back debt and clean up balance sheets could carry its own risks. Europe's companies may seize every opportunity to issue stock--much as Vivendi did in early January, when it surprised the market with a sudden sale of $3 billion in treasury shares. The net result could well be an oversupply of equity, says George Hodgson, European equity strategist at ABN Amro (ABN ) in London. "That is going to keep a lid on European stock markets," he says. And keep a lid on companies' once vaulting ambitions.

By Stanley Reed with Kerry Capell in London, Andy Reinhardt and Carol Matlack in Paris, and bureau reports

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