Cost-Cutting Worked at Telecom Italia...

...But stiffer competition could dent its new profits

Cost-cutting is the corporate mantra of the moment. But some bosses wield the knife better than others. Telecom Italia (TI ) Chairman Marco Tronchetti Provera started slashing away last year, with more vigor than the rest of his European counterparts, and he's already reaping the benefits. On the heels of a $1.6 billion net loss in 2001, Telecom Italia is expected to log a profit of $1.7 billion this year, even without counting the income from its minority holdings. The carrier's $54 billion market capitalization now eclipses that of Deutsche Telekom (DT ) and France Télécom (FTE ). "Take all the fundamentals, from cash flow to profit margins, and you don't see many other [telecom] companies in this position," says Tronchetti.

The Milanese businessman who turned around the near-bankrupt cable and tiremaker Pirelli in the early 1990s has delivered on his promises to slash expenses and debt. Since taking control of the Telecom Italia group--which includes cellular unit Telecom Italia Mobile (TIM) and directory service Pagine Gialle--in September, 2001, Tronchetti has hived off $5.3 billion in noncore assets, including stakes in Spanish, French, and Austrian carriers, and whittled debt by nearly one-fifth, to $17.8 billion. To speed change at the ex-monopoly, Tronchetti, 54, installed his own lieutenants in 200 management jobs and cycled employees through 2 million man-hours of retraining programs aimed at improving customer service. Spurred by the strong performance at TIM, Telecom Italia is expected to post a 56% increase in net income--to $2.7 billion--in 2003, on revenues of $31.6 billion, according to Credit Suisse First Boston.

Producing top-line growth, however, will be harder than wringing efficiencies out of a former public utility. Telecom Italia still commands an 80% share of the fixed-line market. But that business, which provides slightly over half of overall revenues, is under threat as Italian regulators continue to pry open the market, giving households easier access to rival carriers. Telecom Italia's boss insists that new services enabled by the spread of broadband technology will compensate for the double blow of declining market share and falling fixed-line revenues. He hopes to beat the company's target of 1.4 million broadband customers by the end of 2004, up from 650,000 today. "By 2005, we should start to see a nice return on investment," says Tronchetti.

Tougher competition could take a bite out of TIM's lucrative mobile business, too. The unit currently boasts a leading 46% market share. But Hong Kong-based Hutchison Whampoa Ltd. (HUWHY ) is now in a position to claim a slice of the Italian market with the launch of its third-generation wireless service, H3G, in December. As the fourth--and newest--player in Italy, Hutchison may be willing to buy a critical market share by kicking off a price war. "We believe TIM's dominant position is vulnerable to material erosion," says John Karadis, wireless analyst for Commerzbank Securities in London.

Tronchetti shrugs off the threat. "We are ready to face any kind of competition. We have the most advanced technology in the market." Since taking control of Telecom Italia, Tronchetti has accelerated deadlines for getting new products to market. TIM was the first operator in the world to roll out new multimedia-messaging services last June. It recently launched a service that provides customers with live videos of soccer matches, accompanied by text and sound. What's more, TIM's margins are unrivaled. "They've managed to really set a benchmark in the mobile industry," says CSFB analyst Ottavio Adorisio.

That's small comfort for Pirelli's shareholders. The company controls a 27% stake in Olivetti, the holding company that controls Telecom Italia. Tronchetti clinched the deal in July, 2001, at $4.22 per share--a rich 80% premium--just weeks before the telecom shares took another nosedive. Meanwhile, Pirelli's investors have seen the value of their own shares halved over the past 12 months with the collapse of the global market for telecom equipment. "[Tronchetti] has burned a lot of shareholder value so far," says one Milan-based consultant.

Pirelli investors may be in for more pain next year. Olivetti is struggling under a $16 billion debt load and could face a cash crunch under a proposed new tax law. So Pirelli may have to inject fresh money into the holding company next year. Tronchetti the turnaround ace has Telecom Italia hitting its targets. But for Pirelli investors, value creation will be Tronchetti's ultimate test.

By Gail Edmondson in Milan

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