That Sinking Feeling at Suez

Can the utility giant come back from its recent pounding?

Ever since he brokered one of the largest industrial mergers in French corporate history six years ago by combining Compagnie Financière de Suez -- the builder of the Suez Canal -- with the giant utility Lyonnaise des Eaux, Gérard Mestrallet has been considered one of the most reliable and steady managers in his country, if not all Europe. The congenial, 53-year-old CEO of mighty Paris utility group Suez (SZE ) seemed to be emblematic of everything going right in the Continent's boardrooms as he churned out profits from water, gas, and electricity -- real businesses you could put your hands on.

Mestrallet aggressively expanded those businesses on a global scale, from Manila and Jakarta to Buenos Aires and Atlanta. But his methods were worlds apart from those of brash corporate chieftains such as Vivendi Universal's (V ) Jean-Marie Messier, a fellow French utility executive whose multibillion-dollar shopping forays into media ended in disaster. In the late 1990s, when investment bankers pressed Mestrallet to sell off hard assets to concentrate on Enron-style trading operations, which were highly valued back then, they were politely shown the door. And he resisted the feeding frenzy that prompted many French managers, including Messier, to bid on France's expensive licenses for third-generation mobile phones, which will take years to pay off.

But these days, even the affable Mestrallet is feeling the heat. In early March, the company, which has $43.3 billion in sales, confirmed that huge write-offs on stock holdings and some emerging-market businesses -- $550 million for Argentina alone -- would result in more than $955 million in net losses in 2002, the first red ink after a long period of stellar earnings. Suez, which once boasted one of the largest market capitalizations in France, has seen its share price plunge almost 60% over the past year. Suez shares lost a fifth of their value in just one week in late February, after rumors about accounting problems, which Suez says are completely unfounded, hit the markets. "These last few days have not been the easiest time," says Mestrallet in his art-filled office in central Paris.

The way he tells it, Suez has been battered by one business storm after another. First, world growth stalled, dampening demand for power. Then, certain emerging markets where Suez had placed huge bets, such as Argentina and the Philippines, slipped into an economic tailspin. In the U.S., the Enron scandal made any kind of energy trading look suspect -- and Suez, through its European electricity and gas businesses, had become an important trader. Finally, the relentless bear market has hurt Suez because it still carries plenty of equity holdings on its books, including big blocks of insurer Axa (AXA ) and oil giant Total Fina Elf (TOT ). "There has been a quite exceptional accumulation of crises," says Mestrallet.

He has a point, and he has company. Suez is not Vivendi Universal, which all but collapsed early last year. And it's a far cry from Dutch retailer Royal Ahold (AHO ), now reeling from accusations of false accounting. But the current travails of Suez -- heavy debt, troubles in emerging markets, and a hard-to-understand balance sheet -- are shared by more than a few of Europe's biggest and best corporations. Growth in domestic European markets has been anemic, so they expanded aggressively abroad.

Mestrallet probably waited too long to hit the brakes. While other companies across Europe began to retrench two years ago by selling off noncore operations and cutting overhead, Suez was still in full expansion mode around the globe, despite a debt pile that had grown to $30 billion by the end of 2001.

Things came to a head at a tense Suez board meeting last November in New York. Directors such as David Simon, the former chairman of BP (BP ); Gerhard Cromme, chairman of the supervisory board of Germany's ThyssenKrupp; and Felix Rohatyn, former Lazard partner and U.S. Ambassador to France, were increasingly unhappy with how things were going at the company. They had an ally in Belgian tycoon Albert Frere, whose sale of Brussels power producer Tractebel to Suez in 1996 made him the biggest individual shareholder. All worried about the deteriorating financial position of the group and the possibility that the Suez credit rating, cut twice by Standard & Poor's since 1999, would fall below A. Such a downgrade would be a blow to Suez' image and raise its borrowing costs.

The group directed Mestrallet to launch a strategic review of Suez' business lines. First, they ordered him to slash exposure to risky emerging markets. Second, they told him to cut debt levels by speeding up sales of noncore assets -- from stakes in blue-chip French companies such as Total, Axa, and Belgian insurer Fortis Group to media holdings such as French TV stations M6 and Paris Première and cable units in France and Belgium.

The board also got a commitment from Mestrallet to jettison CFO Francois Jaclot, a distinguished French civil servant who had overseen the transformation of Suez from finance to industry. Mestrallet finally announced Jaclot's departure in mid-February, after the news leaked to the French press. "Jaclot has been a great financial person," says Mestrallet today. "But in 2003 and 2004, there aren't going to be any more big [deals], and we've got to manage our operations, tighten our belts, and cut investments." Mestrallet brought in Gérard Lamarche, a tough 41-year-old who had been CFO of Naperville (Ill.)-based Ondeo Nalco Co., Suez' water-treatment unit.

Mestrallet clearly has gotten the message. In January, the Suez chief announced a two-year program to cut debt by one-third, retreat from certain of the more risky emerging markets, and sell off assets.

The investment community will need more than just asset sales. A lot will depend on further moves to make Suez a tightly focused water and electricity group. That means simplifying a complex corporate structure and making accounts more transparent. Suez, unlike many other large companies, doesn't break down cash flow according to geographical units, making it hard to identify potential problem areas. "We'd like a breakdown of sales and profits so we can quickly understand what a crisis in, say, Argentina is going to cost," says Robert Miller-Bakewell, utility analyst at Merrill Lynch & Co.

If Mestrallet can start tackling these challenges, he could see market confidence in Suez return, and he could save his job. Insiders give him good odds of surviving, barring an unforeseen downturn. Suez still has a lot of cash -- $7.8 billion -- and is not facing any credit calls. Operating earnings are relatively strong. With the writedowns behind it, analysts estimate that Suez will be back in the black this year with net earnings of $1.45 billion. Even the group's harshest critics say there are unlikely to be any accounting skeletons. "Mestrallet is nice and very able, and he understands what has to be done," says one board member. "But as much as he is liked, he is in the bull's-eye here." These days, every CEO is a potential target.

By John Rossant in Paris

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