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The privatization of France Telecom is looming. A bill allowing the state to sell down its stake to a minority holding is expected to become law in February. And the cash-strapped government badly needs privatization receipts. The company's shareholders face being swamped with a deluge of new stock this year or, worse, a more complicated strategy.
The French government has several incentives for privatizing France Telecom. France is running a huge budget deficit. And even if privatization receipts don't count towards cutting deficits under EU accounting rules, they provide much-needed income.
Moreover, France Telecom looks to be finance minister Francis Mer's most dependable source of income. Selling 10% of the company would raise €5 billion at current market prices. Other government stakes are far less promising. Air France is small beer, for instance, and utility group EDF (Electricité de France) might not be ready for sale until 2005.
Privatizing France Telecom would also demonstrate that last year's bail-out of the group was a success. In April the state invested e9 billion in the company's rescue rights issue. Now it is sitting on a mark-to-market profit of €4.3 billion on the investment.
Capital gain
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Realizing this gain would make the French treasury look canny. And this would help France in its duel over state-aid rules with EU competition commissioner Mario Monti, who is investigating bail-outs of other French companies such as Alstom. Mer can point to France Telecom as evidence that the state is operating just as a rational private investor would.
But if the incentives for privatization of France Telecom are clear, the timing is less certain. If the government is simply planning to sell down part of its 54% stake, it would be wise to do so as soon as it could. A natural window for share sales opens up in the next couple of months. Fund managers have only recently received a slug of dividends and are inclined to invest them. But this window could close in the spring.
It is not clear, though, that France Telecom will be privatized via a share sale. Some French bankers think the government's holding will be diluted via an acquisition first, for political reasons.
The French treasury has long been looking for a Trojan Horse deal to help it privatize France Telecom. If it supported a stock-financed acquisition that diluted its holding to below 50%, and then sold stock on the back of this or soon after, the operation could be presented to the public as support for the company's strategic development. And that would help the Treasury deflect any criticism that it was flogging off a national asset.
This strategy is not without pitfalls. France Telecom would have to persuade investors that the deal stood up on its own merit – and wasn't a mere fig leaf for privatization. That might not be easy. There is no obvious deal for France Telecom to do.
The group is still tying up the loose ends of one strategic deal – to buy out the minorities of its mobile unit Orange. Other minority buyouts would be unwise. Wanadoo, the internet unit, is ridiculously expensive, trading on three times France Telecom's multiple of enterprise value to ebitda. And buying in the listed data services unit Equant would dilute France Telecom's cashflow.
Moreover, given France Telecom's imperial past, investors might be suspicious of any moves to expand the business. True, privatization would allow the group to finance deals in shares. That would mark a break from the past when – because the state was barred from selling down to a minority – France Telecom could only buy other companies for cash. This was what led to the company overstretching itself and nearly collapsing under the weight of its debts.
But this strategic flexibility will be cold comfort to shareholders if a silly deal is cooked up. Shareholders can only hope the state's need to preserve the value of its investment in France Telecom will override its political concerns.
Whether or not a Trojan Horse is wheeled out first, the government is still likely to replenish its coffers with a big share sale. How big? The answer will depend, in part, on market conditions. But the French will have noted previous botched block trades of shares in Dutch telecom KPN and Italian utility Enel.
These deals weren't big enough to stop investors worrying about government shareholders offloading more shares in the future. That has kept the share prices depressed, making future sales more difficult. So the French might be tempted to go for a jumbo transaction, perhaps €5 billion or more.
Deal structure options
There are two ways of achieving this. One would be to do an accelerated book build of shares combined with a convertible bond. The technical difficulty here would be managing shorting of shares by investors hedging their exposure to the convertible. A large offering would, after all, suck in every arbitrageur in western Europe.
The alternative is a secondary offering of shares marketed to retail investors as well as institutions. That would be easier to organize but would take longer to execute, exposing the deal to any wobbles on the stock market.
The price of France Telecom shares might already reflect the risk of a big share placement. They trade at a discount to other European telecoms on multiples of cashflow.
A well-managed offering could lift a cloud hanging over the share price. But if the company is bounced into a silly deal first, the discount might persist.
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