KKR's Languid Bid Didn't Merit a Telecom Italia Submission
(Bloomberg Opinion) -- Telecom Italia SpA mishandled KKR & Co.’s 33 billion-euro ($36 billion) takeover approach from the start. Nevertheless, Italy’s national phone company has got one thing right in snubbing the private equity bidder now that it no longer seems serious about a deal.
To recap, KKR made a non-binding proposal in November pitched at a near-50% premium to Telecom Italia’s prevailing share price. The tentative offer came with a low acceptance threshold, meaning it would be viable even if media giant Vivendi SE, a 24% shareholder, didn’t take it. There was a cautious welcome from the Italian government. The board’s priority should have been deciding whether the price was in the ballpark and, if so, letting KKR conduct due diligence.
Instead, Telecom Italia turned on itself, replacing its chief executive and embarking on a new strategy to split in two that’s very similar to what KKR had in mind. Such moves might have forced the buyout firm to sweeten its indicative price had they not been overshadowed by a savage profit warning in early March.
Doubtless feeling it was in a better position to negotiate, three weeks ago the board instructed new boss Pietro Labriola to explore a deal with KKR. Unsurprisingly, the buyout firm has had second thoughts. This week it told Telecom Italia it couldn’t reconfirm its earlier non-binding proposal but might be able to if it was granted access to the company’s books. No company should grant due diligence to such a flaky overture and Telecom Italia has rightly declined. KKR was effectively walking away while giving the impression it wasn’t killing a deal entirely.
KKR’s reticence is, of course, largely the result of Telecom Italia’s mixed messaging and deteriorating financial performance. The average analyst price target for the stock has fallen 14% to 37 euro cents during the saga. Still, a bidder cannot expect access to its target’s internal data without first reaching an informal agreement on the broad terms of a takeover. Even shareholders desperate for an exit should recognize that would cede considerable negotiating power.
The poor management of the situation doesn’t undermine the logic of taking Telecom Italia private. The company needs radical restructuring which may be best achieved outside public markets. Net debt is 22 billion euros, huge relative to the 6.5 billion-euro market capitalization. Servicing both these borrowings and high capital expenditure is tough, given a weakening revenue stream from the core domestic fixed-line telecoms operation. Analysts expect zero cash flow to be left for shareholders in the next three years. Leverage is set to be the highest in the European telco industry, according to analysts at HSBC Holdings Plc.
KKR and Telecom Italia share the same vision of creating separate companies for the network infrastructure and customer-facing businesses. This should give the company an easier ride with regulators, but doesn’t immediately solve the debt problem. The network company could hold a disproportionately larger share of borrowings. But the rump services business would still have high debt relative to its cash flow, argues New Street Research. Analyst views of this new service company value vary widely — NSR gives it a 3 billion euros enterprise value, others get to three times that. This reinforces the benefit of undergoing transformation away from the stock market.
Less ambitious deal-making may help. A merger with Open Fiber SpA, the rival Italian broadband network, is being discussed. Analysts reckon that could generate synergies with a present value of 2 to 3 billion euros, a big chunk of Telecom Italia’s current market capitalization. Buyout firm CVC Capital Partners is considering taking a minority stake in part of the new services company. That could provide some funds for debt reduction. Still, neither are quick fixes.
Shareholders need to prepare for the long haul. They can but hope another takeover approach comes after the dust has settled — and that next time, the board doesn’t let it slip away.
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Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.
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