Courage Under Fire

Over the next few years, capital markets in Europe will be undergoing dramatic changes, changes that you could broadly describe as “liberalization.” This liberalization is going to be both legal, as the advent of the euro allows pension funds and the like to invest wherever they want in Europe (as opposed to being limited in their investments outside their home countries), and cultural, as the dogma of shareholder value spreads. One consequence will be more hostile takeover attempts of the kind that Olivetti launched this weekend against Telecom Italia.

In one sense, this will be a good thing, because it should shake up entrenched managers who have been running companies as private fiefdoms and result in the breakup of conglomerates whose various pieces don’t belong together. After all, a plausible case can be made that the takeover wave of the 1980s injected a necessary note of urgency into corporate America, and made American businesses far more efficient and profitable than they had previously imagined.

Paradoxically, though, it’s not clear that the takeover wave made the businesses that actually got taken over more efficient and profitable. As nearly everyone recognizes by now, most acquisitions are mistakes for the acquiring company, which tends to overpay in expectations of gains–either from synergy or from superior management–that never arrive. Certainly it’s hard to think of a superior American company that’s been created by a large- scale acquisition, with the notable recent exception of MCI/WorldCom (DaimlerChrysler may also count; the jury is still out on Citigroup). In other words, the beneficial effects of the takeover wave may have really been on those companies that made changes in order not to be taken over.

One reason for this seems to be that takeover attempts so often seem motivated by considerations that, strictly speaking, don’t have anything to do with the economics of the deal. Take Olivetti’s offer, which involves a relatively small company trying to take over a very large company.

In order to take over Telecom Italia, Olivetti is going to sell its stake in its own cellular business to the German powerhouse Mannesmann A.G. for $10 billion, then raise another $50 billion by borrowing and selling off other assets. If it succeeds–which at this point actually seems somewhat unlikely–it will own Telecom’s cellular service (instead of its own) and its massive land-line business, which is clearly the prize jewel. It will also have more than $40 billion in debt on its balance sheet. And since Telecom is going to fight the takeover, that means the price of the deal will likely rise. Telecom Italia’s shares may well be undervalued, because it generates a huge amount of cash and its stock is still suffering the effects of 18 months of management turmoil. But investing in Telecom because you think it’s a bargain is one thing. Eviscerating your own company and getting in hock up to your ears to buy the whole company is another. Especially when you’re doing so for non-business reasons.

Olivetti’s chairman, Roberto Colannino, has done a good job of reinventing his company as a telecom company, selling off floundering PC and information-technology divisions, building a land-line infrastructure, and making a very profitable move into cellular service in partnership with Mannesmann. But Olivetti is now about a fifth of the size it once was, and Colannino apparently wanted something bigger.

In addition, Colannino, in trying to sell the deal to government officials, has emphasized that if Olivetti doesn’t take over Telecom Italia, someone else will, and that someone else will likely be a non-Italian company. Obviously, this isn’t really a good reason for Olivetti to make the deal–looking out for the national interest is hardly a recipe for business success–but Colannino seems to think it’s important. Then there’s just the chutzpah aspect of it. This weekend, the Italian prime minister told the Wall Street Journal, “At this point, you have to appreciate [Olivetti’s] courage.”

Here’s a good rule of thumb: When companies are praised for being courageous in making a deal, it’s a bad deal.