France Télécom: Such Promise, but Zut Alors! Such Debt

At first glance, the job doesn't look half bad. Whoever replaces the deposed Michel Bon as CEO of France Télécom (FTE ) will run a European powerhouse that boasts $42 billion in revenues and leading positions in wireless and the Internet. Yet despite robust operations, the 55% state-owned France Télécom has seen its market capitalization plummet 97% in two years, to $8.2 billion--barely 1.4 times its annual cash flow. So it was no surprise at all when the board pushed out Bon on Sept. 12.

The problem is debt. Investors fret about France Télécom's crushing $70 billion in IOUs, the highest corporate debt in the world. These days FT, which borrowed the billions for a flurry of Internet and wireless investments, hasn't a prayer of refinancing. Only the prospect of state backing has kept its credit rating from falling to junk status.

Bon's successor must firm up the company's finances--but without selling the assets that could drive future growth. His big advantage: Unlike the Americans, most European telcos still dominate home markets. This spells higher margins. In fact, FT, like most leading phone companies in Europe, has reaped benefits from a funding collapse that wiped out legions of upstarts. Once again, FT rules the French market.

The challenge is to pay down debt without unloading its jewels. For FT, the most marketable divisions--Orange, a leader in wireless, and the Wanadoo Internet unit--account for all revenue and profit growth. Orange, Europe's No. 2 carrier after Britain's Vodafone (VOD ), posted first-half revenues up 14%, to $8 billion, and spun off $1.2 billion in operating income. It's no wonder Bon pleaded with the government before his ouster not to divest FT's 86% stake in the unit.

But something has to give. In the first half of this year, interest payments gobbled up $1.7 billion. On top of that, Télécom wrote down $10.6 billion in goodwill and other assets, dragging it to a net loss of more than $12 billion. And the company faces $15 billion in payments due in 2003. It can't possibly roll them over under current market conditions.

To pay this, the French government is planning a $15 billion stock-rights issue that will dilute current shares, including the state's, by two-thirds. If successful, this will stave off the near-term crisis but reduce debt only to $55 billion. To get France Télécom's balance sheet back to more normal ratios, the next CEO may have to venture into debt-for-equity swaps. If he can manage that without pawning off the crown jewels, he'll go down in history as a telecom hero.

By Andy Reinhardt in Paris

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