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Commentary: Deutsche Telekom Needs More Than an Ax


By Jack Ewing

By all accounts, Ron Sommer's days as Deutsche Telekom's (DT) boss are numbered. With the company's shares trading below their 1996 initial public offering price, Chancellor Gerhard Schr?der--in a difficult fight to get reelected--can no longer afford the steep political price of supporting the embattled telco exec. Auf Wiedersehen, Herr Sommer.

Sommer's departure, though, will do nothing to solve the giant telco's key problem--its huge debt load of $66 billion. The debt won't get any smaller just because Sommer cleans out his desk. The obvious solutions have all been tried or contain big downsides. Deutsche Telekom's new boss--may the Lord have mercy on his soul--must go further. And so must the German government, which still owns 43% of the company.

Here's a proposed action plan: First thing, hold a rights issue. Yes, we know that selling new shares at a discount to existing shareholders would dilute equity, and theoretically pummel them even more than they've already been pummeled. But with debt constituting the biggest drag on DT shares, history shows that shareholders will ultimately benefit. BT Group PLC (BTY) and Dutch telco KPN both saw their shares rise after they used rights issues to help get debt under control. Investors welcomed the fresh capital and were willing to forgive the share dilution.

The new boss should also insist that the government accept some responsibility for Deutsche Telekom's woes. A big chunk of the company's debt stems from the cost of rewiring East Germany, an investment made for political reasons in the early 1990s, when DT was still wholly owned by the state. Germany's government has also benefited massively from the sale of third-generation mobile-phone licenses to providers, including Deutsche Telekom.

So how can Berlin make amends? Direct government aid would be unfair to other players, and the European Union wouldn't allow it. But it's clear that the government has prevented Sommer from cutting costs. The politicians should stop playing football with Sommer's head and instead allow the company to reduce the staff of 255,000 more quickly. The simplest way to pay down debt is to boost cash flow. That means cutting costs.

There's another favor the government can do for Telekom: Overrule regulators who have blocked the sale of Deutsche Telekom's cable-TV systems. John C. Malone's Liberty Media Corp. (L) was ready to pay $5.4 billion earlier this year, but the Federal Cartel Office blocked the deal after the Colorado-based media mogul refused demands that he spend billions upgrading the systems for use as voice telephone networks. In retrospect, it's clear the regulators were wrong. Germany is stuck with an antiquated cable system run by a quasimonopoly, and Deutsche Telekom has been denied crucial capital. The government can overrule the Cartel Office. Sommer's successor shouldn't take the job until the government promises to do so.

The good news about Deutsche Telekom is that, though its debt is way too high, the company is better off than competitors such as France T?l?com (FTE). Klaus E. Kaldemorgen, head of equities at Deutsche Bank's DWS fund-management arm, estimates Deutsche Telekom still has about two years to get debt under control. "Cash flow is high enough to finance the debt," he says.

However, Deutsche Telekom, whose bonds are currently rated three notches above junk, has no margin for error. If something unexpected hits cash flow, it will have to consider more drastic solutions, such as a workout that would force bondholders (primarily international institutional investors) to accept less than face value. No one expects such a step now. But then, no one predicted the current crisis. Unlike Sommer, the new CEO can reverse past decisions without having to admit he was wrong. That's an opportunity for some fresh thinking. In the interests of Deutsche Telekom's 3 million German shareholders, it's an opportunity he can't afford to squander. Ewing covers German business and politics from Frankfurt.


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