Telecom Italia: a sceptic in a convergent world?

Citation

Curwen, P. (2007), "Telecom Italia: a sceptic in a convergent world?", info, Vol. 9 No. 1. https://doi.org/10.1108/info.2007.27209aab.001

Telecom Italia: a sceptic in a convergent world?

Telecom Italia: a sceptic in a convergent world?

A regular column on the information industries

Peter Curwen is Visiting Professor of Telecommunications at the Strathclyde Business School, Glasgow, UK. E-mail: pjcurwen@hotmail.com

It is all agreed then – convergence is the only game in town during the first decade of the millennium. Well, not quite, because Telecom Italia just rode in and announced that it was splitting itself up into three parts. What follows seeks to explain why this happened and whether it is part of a soon-to-be wider phenomenon or just the result of special circumstances.

It is undeniable that Telecom Italia’s behaviour goes against the prevailing doctrine of the past several years: For example, Deutsche Telekom has repurchased the outstanding floated stake in T-Online, France Télécom that in Orange and Telefónica that in Móviles. But what appears to be rather odd under the circumstances is that Telecom Italia has also bought back the outstanding stake in TIM. TIM was a subsidiary of Telecom Italia which owned 56.1 per cent in December 2004. It raised its stake to 85.4 per cent during January 2005 and, at the end of June 2005, TIM was reabsorbed as a wholly-owned subsidiary. The two companies were formally merged as Telecom Italia in March 2006.

In fact, leaving aside the exception that proves the rule, namely BT’s continued separation from former mobile subsidiary O₂ (now owned by Telefónica), and the likes of Verizon Communications/Verizon Wireless which is complicated by (in this case) Vodafone’s large minority stake in the latter, the only significant example of a parent continuing to co-exist with a part-owned mobile subsidiary is NTT and NTT DoCoMo.

But it is not just an issue of the desirability of converged operations: there is also the issue of the cost of bringing back into the fold previously hived-off stakes in subsidiaries. In the case of Telecom Italia, this was compounded by two features not present in the other European cases mentioned above, namely the size of the floated stake and the complex structure of the parent company (Curwen, 1999, 2003). Table I indicates the position between the middle of 2004 when Telecom Italia and TIM were still separate (and to some extent competing) entities and the present day – the > entry is shorthand for “owns”. However, it is also important to bear in mind that prior to 2004 Telecom Italia had twice been taken over, and that in both cases – Olivetti and Pirelli – the acquirer was Italian. This reflected a continental European-style preference for domestic ownership of flagship industries (national champions) which was partly reflected in the tendency for governments to retain “golden shares” in companies such as Telecom Italia even after these had been ruled illegal by the European Commission.

Table I

Chinese boxes

One underlying rationale for constructing the system of “chinese boxes” was that different stages in the cascade of holding companies would be responsible for wholly different levels of group debt. Hence, at the end of 2004, Olimpia serviced its €3.2 billion debt via dividends from heavily-indebted Telecom Italia which in turn received significant amounts of cash from the debt-free TIM. By acquiring the rest of TIM, the flow of cash would be greatly enhanced and, importantly, would overcome the difficulty that if TIM was independently to take on more debt (to achieve a more efficient gearing structure) then this might have led to an expensive downgrading of Telecom Italia’s own debt. It should be noted that whereas Mr Provera, the Chairman, had rather abruptly switched tack in advocating the merger of Telecom Italia and TIM in the name of convergence benefits – he had previously argued that keeping them separate was essential to remaining competitive in the separate markets – analysts were understandably not persuaded that the claimed synergies were realisable.

To finance the €14.5 billion cash acquisition Telecom Italia borrowed €12 billion to which was added €2.5 billion cash-in-hand, in the process raising its net debt to €44.1 billion. In practice, the total outlay was €13.8 billion to buy TIM shares plus €2.3 billion in dividends but cash inflows meant that the net debt rose by “only” €11.2 billion.

In October 2005, Telecom Italia announced that it would be undergoing a revamp in order to foster fixed-mobile convergence (Cellular-news.com, 2005). A “One Company” organisational model would henceforth be deployed. However, the Financial Times was somewhat sceptical, arguing in February 2006[1] that Telecom Italia had been in such a mess that even recent cost-cutting, asset shedding and organisational restructuring had not sufficed either to boost the depressed share price or to result in an improved credit rating. In March, Olimpia felt obliged to write-down the value of its Telecom Italia stake by €1 billion even though this was based on a share price of €4.23 at a time when the market price was €2.38.

More bad news followed in June when the regulator announced that he was considering a forced split (in the style of BT) between the retail and network operations of Telecom Italia and also that its proposed new converged handset – branded as “Unico” – would be blocked until such time as a competitor appeared – a heavily restricted service was eventually launched in September 2006 branded as “Unica”. In addition, the European Commission stated that it intended to refer Italy’s golden share to the European Court of Justice. One month later, Vodafone confirmed that it intended to sue Telecom Italia for abusing its market dominance.

In August, rumours began to circulate that Telecom Italia was in discussions with News Corp., officially about a content agreement but who knew what else. Immediately, the Communications Minister stipulated that the fixed-wire network had to remain in Italian ownership but both companies denied that a share swap was under discussion. By early September it was further rumoured that Telecom Italia – still indebted to the tune of more than €40 billion, roughly the same as its market value – would sell all or part of its network and mobile telephony operations in order to concentrate upon broadband and media services, and its shares were suspended. On 11 September, Mr Provera unveiled plans to split the company into a utility business which would own the fixed-wire network, a retail unit that would own the fixed-wire subscriber base and the content division and a mobile operation, each with its own balance sheet and board. It was assumed that this would be a precursor to the sale of TIM and its Brazilian subsidiary, although the company claimed that such a move had not been authorised by the board nor had any offer been made. As for the agreement with News Corp., this was intended to enrich content offers over the internet.

The split was claimed to compensate for the loss of synergies between operations by leading to an easing of regulatory pressures and a sharper commercial focus. Analysts worried that the company had no coherent strategy and was simply responding to short-term financial pressures while Prime Minister Prodi was aghast at the idea of TIM falling into the hands of foreigners who already owned the other three mobile operators. Technically, he had no right to interfere but earlier in the month he had apparently forced Mr Provera to provide assurances that News Corp. would not be permitted to acquire control of Telecom Italia. Whether he needed to be concerned about TIM was a moot point. The price unofficially being touted for TIM was said to be €50 billion, but the financial markets were thinking more along the lines of €35-40 billion, or €45-50 billion after adding in TIM Brazil (which was almost certain to be sold off whatever else happened), and they struggled to identify a likely buyer at even that price although it was revealed that the chairman of MacDonald’s Italian subsidiary and some US private equity funds were thinking about a joint bid of some unspecified kind.

On the political front, some left-wing politicians predictably demanded that the government use the “defense of vital interests of the state” provision in the golden share to prevent the sale of TIM, whereupon the European Commission immediately stepped in to warn the government to do no such thing. Some politicians demanded that Mr Provera resign on the grounds that he had let the debt escalate and hence he could not be relied on to put any restructuring plan into effect. To general surprise, he did precisely that, being replaced by Guido Rossi. Others demanded that Mr Prodi resign for interfering in matters that were outside his competence. To general lack of surprise, he declined.

A number of conclusions can be drawn from this (as yet unfinished) story – Telecom Italia’s current position is that TIM will definitely be hived off but will not now be sold. In the first place, this is, taken in its entirety, a rather predictably Italian incident with operatic overtones. Second, it might, however, have played out in much the same way in one or two other European countries where national champions remain somewhat in vogue. Third, Mr Provera’s behaviour is open to debate. On the one hand, separating out the network assets is something that has already occurred at BT and is something that regulators elsewhere are likely to address soon, so Mr Provera could be seen as behaving proactively. Further, the view that content is king is hardly new, and Telecom Italia by no means alone in fancying that it will be more highly valued and better rated if it presents itself as a media company. Finally, something has got to be done to reduce Telecom Italia’s excessive net debt. On the other hand, Telecom Italia and TIM were only recently brought back together at huge cost, so why go through all that agony just to turn around and separate them again.

So is it clear-eyed strategising or emergency patching-up? For the moment this is unclear, but what is fairly certain is that no other European incumbent is going to follow suit and abandon convergence until the fat lady sings and it is all over in Italy.

Notes

1. See articles published at www.news.ft.com on 14 February 2006.