France Telecom's $53 Billion Burden

Michel Bon's spending spree put his company deep in debt, and soon he'll have to cough up more francs

When the going got tough, Michel Bon went shopping. Only a year ago, the chief executive of France Telecom, the French phone giant, was looking to rebound from a failed partnership with Deutsche Telekom. And rebound he did, leading France Telecom on a $50 billion spending spree that picked up wireless operator Orange, Internet service provider Freeserve, and data-network company Equant. To top it off, Bon's spending billions more on licenses to build next-generation mobile-phone networks. "It [cost] an amazing amount of money," Bon says. "But we have achieved what will essentially be our profile in the years to come."

Yet Bon now faces another daunting task: dispelling investor fears that he overpaid for operations that will never justify their price. Perhaps his biggest problem in this regard is Hans Snook, founder of the Orange network. When Bon dished out $40 billion to buy Orange last May, he was buying not only a strong foothold in key European markets, he was teaming up with Snook, perhaps the most respected marketing ace in the mobile industry.

It was Snook, an ex-hippie turned entrepreneur, who led Orange's wildly successful underdog challenge to British heavyweights Vodafone Airtouch PLC and British Telecommunications. Many speculated that when Bon bought Orange it would be Snook who would run all of France Telecom's mobile operations. Instead, Snook is relinquishing most of his management duties, apparently to dedicate himself to alternative medicine and other interests.

ORANGE ANYONE? People close to the situation say there is no rancor between Snook and Bon, and that Orange nowadays needs France Telecom's management skill more than Snook's creative spark. Maybe so. Yet his departure comes as debt-strapped France Telecom is planning to float Orange in February--in an equity market where investors are running pell-mell from phone stocks. Bon says he hopes to raise as much as $14 billion. Many analysts doubt he'll get that, and Standard & Poor's MMS warned recently that the company's credit rating could be lowered if the offering is delayed or raises less than is expected.

Of course, France Telecom isn't the only phone company taking a beating in the markets. But Bon is saddled with $53 billion in debt. And he soon will have to cough up more money to build next-generation wireless networks, even though profits from these projects are at least five years off. Mindful of these hazards, investors have driven down France Telecom shares almost 60% since last spring, to a recent $87 a share.

Bon, 57, needed to make some dangerous moves to keep his company in the game. Deregulation is shrinking France Telecom's fixed-phone business. And while the company's wireless and Internet operations are market leaders in France, France Telecom until recently had failed to gain a foothold elsewhere, while rivals such as Deutsche Telekom and Vodafone AirTouch PLC were gobbling up choice properties.

Buying Orange gave France Telecom a boost, turning it into Europe's second-largest cell-phone company, with more than 26 million customers, compared with Vodafone's 48 million. Likewise, the December acquisition of Britain's Freeserve propelled France Telecom to the front ranks of European Internet service providers, along with Deutsche Telekom's T-Online and Spain's Telefonica. To round out the picture, Bon is taking stakes in at least five of the next-generation wireless networks that are expected to deliver snazzy new online services starting in 2002.

How does the bulked-up France Telecom look against its competitors? Orange has a solid track record in Britain. And while T-Online has barely ventured outside Germany, Freeserve and France Telecom's Wanadoo Internet businesses now operate in more than a half-dozen countries and are aggressively building content, including lucrative online Yellow Pages sites in France and Spain. Overall, France Telecom earnings during the first half of 2000 were up 19.8%, to $1.2 billion, on sales of $14 billion. What's more, the company now gets more than 20% of its revenues from outside France, up from only 2% five years ago.

Investors want more proof. They note that cash flow from fixed-line services, which accounts for two-thirds of the company's revenue, declined in the first half of the year. The Internet is still not a huge revenue generator, while the cost of the new cell-phone networks clouds the future for the lucrative mobile-phone franchise. Thus, shares in Wanadoo, which trade separately from France Telecom, have fallen more than 50% since its listing last July. Most analysts reckon that if Orange was separately traded, its market value would be half what it was last summer.

STUNNING SUMS. The less Bon makes from the Orange IPO, the more he'll have to scramble to finance his next-generation wireless networks. Already, German phone company MobilCom, in which France Telecom took a 28.5% stake last spring for $3.5 billion, is struggling to raise money to build a new wireless network. If needed loans don't come through, France Telecom might have to inject more cash into the company to get the project going. Over lunch at France Telecom headquarters on Paris' Left Bank, Bon admits he has been stunned by the sums being spent on such projects. "It's frightening," he says. But, he adds, France Telecom expects to break even on its investments within four to seven years.

At first, Bon seems an unlikely combatant in the rough-and-tumble telecom arena. Tall and courtly, he boasts impeccable French Establishment credentials, including training at the elite Ecole Nationale d'Administration and a stint as a civil servant. He was picked to run France Telecom in 1995 after the government's Francois Henrot refused the job, citing a need for a freer hand to privatize and modernize the company.

Yet Bon--ironically aided by Henrot, who now represents France Telecom as an investment banker at Rothschild & Cie.--has quietly changed the giant into something more nimble. He oversaw a partial listing of the company in 1997, and as France's phone market was deregulated, he sharpened its competitive edge by slashing rates and improving customer service. He also has a flair for marketing, thanks partly to his seven years as an executive at French hypermarket chain Carrefour.

Could Bon take France Telecom to the next logical step, persuading the government to relinquish its 62% stake? The Socialists now running the government are loath to give up control of national champions such as France Telecom, Air France, and utility giant Electricite de France. But psychologically at least, Bon has already cut the cord. When the magazine Le Nouvel Observateur recently tried to organize a group portrait of the CEOs of France's seven major government-controlled companies, Bon was the only one who refused to pose. Then again, if the Orange offering fizzles and times get tough, Bon may end up grateful to have such a friendly shareholder.

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