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France Inc. Follies


There is something just so French about the spectacular rise and the messy fall from grace of France T?l?com (FTE) chairman Michel Bon and Vivendi Universal (V) CEO Jean-Marie Messier. Their ascendance demonstrated what could result when audacity was backed by the collective firepower of the French state and French finance. And their humbling is a reminder of the increasing limitations of France Inc.

Under French law, the government must maintain majority control of France T?l?com's capital. That means Bon has had to pay cash rather than shares for acquisitions--building up one of the largest piles of corporate debt in the world. Messier, meanwhile, deftly used the clubby relationships at the heart of France Inc. to build his media empire. Now, the club has begun to turn against him, with close ally Bernard Arnault, boss of LVMH Mo?t Hennessy Louis Vuitton (LVMHY), quitting the board on June 25.

Both men are blaming "speculators," "hedge funds," and "arbs" for plunging share prices. Yet market rules are the ones that count. Had Messier been more straightforward with his board, and had Paris loosened its grip on France T?l?com, the two CEOs would be on a more solid footing. The question is whether France Inc. is learning the lesson.

Save for a nasty cold, Michel Bon doesn't look like a man under stress. Dressed nattily in a gray suit, the chairman of France T?l?com gamely showed up for a mid-morning press show-and-tell on June 25 at the company's research center just south of Paris. But the crush of reporters and TV camera crews that greeted Bon wasn't interested in seeing him demonstrate a new wall-size videoconferencing system. All they wanted to know was how France T?l?com's boss is going to solve a spiraling crisis at the company.

While U.S. investors panic over the American telecom sector, France T?l?com has its own $60 billion dollar question to answer. That's how much debt the telco is carrying--the legacy of a spending spree that turned the French company into the most debt-ridden carrier on earth. Until recently, investors warily accepted that the phone giant could afford to spend $4 billion a year on interest out of its $12 billion in operating income. Then, in mid-June, came news of yet another liability: France T?l?com may have to shell out an additional $4 billion to protect its investment in German telco MobilCom.

Shareholders pressed the sell button. Their fears turned to panic following the June 24 decision by Moody's Investors Service to downgrade France T?l?com's debt to one notch above junk level, citing concerns it may not be able to find buyers willing to refinance nearly $15 billion in bonds that come due in the first half of next year. Standard & Poor's followed suit on June 25. France T?l?com says the moves will add $100 million to its annual debt-servicing costs.

Market reaction has been brutal. Since June 19, France T?l?com's shares have tumbled 40%, and are now trading at only one-third the price at which they were first offered to the public five years ago in France's largest privatization. For the first time, analysts are suggesting that a massive government bailout or sales of core assets may be required to salvage this Gallic icon. France T?l?com's market capitalization has sunk to just $10 billion--$7.5 billion less than the 84% stake it owns in European wireless operator Orange. Thus, the markets ascribe negative value to the company's $42 billion in annual revenues, 90 million customers, and $31 billion in physical assets. "You've got to ask: `Is this reality?'," Bon implored the press. "No, it's not."

It may all seem unreal to Bon, but France T?l?com's travails could escalate to the level of a national--if not Continental--crisis. As France's most widely owned stock, it already is dragging down the entire Paris bourse. And while there is no danger the company will shut down, its weakness could hold back development of everything from broadband access to 3G wireless systems not just in France, but across Europe

Fixing France T?l?com is shaping up to be the first major test for the incoming center-right government of President Jacques Chirac and Prime Minister Jean-Pierre Raffarin. Although the state still owns more than 55% of the company, the new administration insists it has no plans to bail it out. But pressure from shareholders, creditors, and the company's 147,000 French employees could well force the government's hand. The rest of the Continent will be watching how Chirac & Co., who want to steer France onto a more free-market course, deal with the mess. "How are you going to convince people of the need for liberalization and privatization when you have France T?l?com turning out this way?" asks Elie Cohen, a former board member and research director at France's prestigious National Center for Scientific Research.

The scope for government action is limited, however. The newly installed leadership can't offer France T?l?com debt relief or low-interest loans without running afoul of European Union rules against state aid to companies. Besides, Paris is under pressure from the rest of the EU to rein in its budget deficit, and so would find it hard to justify--much less pay for--such a massive bailout. Even government-guaranteed bonds would be hard to get past Brussels. "They'd flagrantly contravene the European Commission, and France would rather come up with something more subtle than that," says Rick Deutsch, head of European credit research for BNP Paribas in London.

That leaves only a handful of other solutions. France T?l?com was already planning to sell off about $5 billion in assets this year, including minority stakes in other carriers and tech companies. But to really slash debt, analysts say the carrier may now have to unload bigger assets, such as all or part of Orange. Yet Orange would probably fetch far less than the $40 billion France T?l?com paid for it two years ago. Besides, the wireless carrier was the source of 92% of its parent's revenue growth and nearly 28% of operating profits last year.

The most plausible scenario is recapitalization. The government could sell some of its France T?l?com shares outright and pump the proceeds back into the telco, but it would need legislative approval to reduce its stake below 50%. Analysts think that's a long shot, in part because the state would rather sell at a higher price. Instead, France T?l?com will likely undertake a rights issue, offering existing shareholders a chance to buy additional shares at a discount. Bon and the government have repeatedly rejected such an option, even though it was used successfully by carriers like BT Group and Royal KPN to get back on their feet. The nagging question is whether the government would agree to a rights issue now. Doing so would require coming up with cash to avoid dilution; declining to participate would water down its stake and require authorizing legislation.

And what of Bon's fate? Analysts say sacking him wouldn't solve the company's current crisis. And because Bon's boss is the state, his tenure is political. He's friends with Chirac's advisor, former Prime Minister Alain Jupp?, and was recruited to T?l?com by the new Labor Minister, Fran?ois Fillon, who authored the original legislation to privatize the company. "For the current government to get rid of him would be extremely difficult," says Cohen. However, some speculate Bon may be sent packing after the harsh medicine has been administered. Then Raffarin's team can put its own exec in place to take credit for the recovery.

Pretty tough stuff, but these are tough times. With all the simple fixes for France T?l?com already exhausted, the government needs to be thinking way, way outside the box. By Andy Reinhardt, with Stephen Baker and Carol Matlack, in Paris


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