Maybe Colaninno's Coup Wasn't Such a Great Idea

Heavy debt and slow markets are wounding Telecom Italia

Olivetti (OLVTY ) Chief Executive Roberto Colaninno was hailed as a new breed of entrepreneur in 1999 when he and a group of private investors pulled off Italy's first hostile takeover, snaring Telecom Italia (TI ) in a $51.4 billion unfriendly bid. Today, Colaninno heads Telecom Italia as well as Olivetti, which controls 55% of the telecom operator. But the embattled executive has little to crow about. Turin prosecutors are investigating a possible conflict of interest in Telecom Italia's purchase of phone-directory publisher Seat Pagine Gialle last year. Institutional investors complain that Colaninno has repeatedly run roughshod over minority shareholders. Olivetti's debt load is crimping investment, two board members have resigned, and Telecom Italia's plummeting share price has squashed a share-conversion scheme urgently needed to raise capital. To top it all off, antitrust authorities in April slapped Telecom Italia with a $60 million fine for abuse of its dominant market position.

Some of the problems may prove only temporary. But the 57-year-old CEO risks losing a battle against time in restructuring his prize. If a stalemate on debt rearrangements continues, his takeover could end up a major flop for Olivetti investors, whose shares are down some 25% since 1999. Colaninno has cut Telecom Italia's operating costs by more than $2 billion. But between them, Telecom Italia and Olivetti still shoulder debt of some $33 billion, which limits Telecom Italia's room to maneuver. "Cuts in capital spending could create a competitive gap in technology and networks," says Paolo Perrella, senior telecoms analyst at Fortis Bank in Milan.

Colaninno's managers insist they can reduce Olivetti's debt. They plan to trim $3 billion through refinancing, and figure that cash flow and additional cost cuts of $1.3 billion this year can fund needed investments. The problem is, competition is beginning to bite, and Telecom Italia's 89% market share in Italy could drop sharply in coming months. Says one insider: "There is no growth strategy; the entire focus is on cost-cutting."

The declining share price has temporarily thwarted Colaninno's plan to convert Telecom Italia's nonvoting shares into ordinary shares. The plan was designed to raise $8 billion in cash, partly to reduce Olivetti's debt. Meanwhile, profit softness could exacerbate Colaninno's dilemma. Although the company's sales are forecast to increase 12%, to $28 billion, net profit will fall 14%, to $1.5 billion, according to a June 15 report by Credit Suisse First Boston.

STICKING POINT. For the moment, Telecom Italia is safe from a takeover because of the lock Olivetti has on the company; publicly traded Olivetti is itself controlled by a holding company called Bell. This complex structure, a throwback to the opaque governance that dominated corporate Italy for decades, insulates Colaninno and his private investors from shareholder wrath. "Corporate governance is a sticking point in Italy that keeps valuations lower than in the rest of the world," says Marc Gabelli, portfolio manager at Gabelli Asset Management Inc. in New York.

The only pressure for change this year could come from the courts. In their investigation of the Seat acquisition, prosecutors are looking for signs that Colaninno, who benefited from an indirect personal investment in Seat, violated conflict-of-interest laws. Colaninno has released Telecom Italia board-meeting documents showing that he met all legal requirements for revealing his own potential conflict of interest the day the board voted on the purchase, and that he refrained from voting himself. He now admits that he should have notified shareholders as well. "We are honest, we are hardworking, but we are not infallible," Colaninno told investors on June 12.

Meanwhile, insiders say that the core Olivetti investors Colaninno persuaded to back the hostile bid are fuming. They expected a two-year restructuring of the inefficient ex-monopoly followed by a hugely profitable sell-off. Instead, their shares are languishing, and there are no buyers in sight. They are obliged to hold on to the shares until 2002 but could well decide to bail out then if Colaninno doesn't turn things around. This takeover tale isn't over yet.

Corrections and Clarifications A photo caption in the article on Telecom Italia ("Maybe Colaninno's coup wasn't such a great idea," Italy, July 2) erroneously stated that Roberto Colaninno is being investigated on conflict of interest questions. Italian prosecutors are investigating transactions made by Telecom Italia but have not cited Colaninno personally. BusinessWeek regrets the error.

By Gail Edmondson in Rome

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