In the first week of 1996, irate customers smashed windows at the Deutsche Telekom shop in Kassel, north of Frankfurt, and showered it with protest leaflets. Every television satirist in Germany tore into Deutsche Telekom in the following weeks, mocking the dense logic and baffling doublespeak that accompanied a new scale of charges introduced at the beginning of the year. Telekom made matters worse when it transpired it had inadvertently charged some New Year’s Day callers at peak rates, netting an embarrassing extra Dm13 million ($8.8 million) because of a computer error.
“This is happening regularly,” says one alarmed Frankfurt banker. “First there was the theft of telephone card units, then the sex services charging exorbitant rates to unwitting customers. And now this. People just don’t believe Telekom any more. They’re prepared to think the worst.”
Such disasters have recently turned Germany’s main telecommunications provider into public enemy number one. Can this be the same company which hopes to spark a German shareholder revolution, whip investors into a frenzy of enthusiasm and raise Dm15 billion towards the end of this year?
In panic, Telekom has thrown money at the image problem. It spent Dm40 million compensating customers for the Dm13 million gaffe and has run an apologetic advertising campaign that smacks of desperation. But the near-monopoly has no good news to tell to attract investors to its initial public offering. Despite the vital importance of the issue, Telekom’s story is still too nebulous to convince any sceptical private investor, let alone professionals, that Europe’s biggest-ever share offer will fly.
If it doesn’t, not only will Telekom fail to raise the amount it needs for investment, but the credibility of Frankfurt itself will suffer as a hub of equity capital-raising. The Bonn government has insisted that the work of the German syndicate members must be done out of Germany. It is said to have asked Deutsche Bank to manage the issue entirely out of Frankfurt rather than doing the deal from London, where it was about to move its investment bank. The newly-acquired Kleinwort Benson is also firmly excluded from Dresdner Bank’s Telekom team in Germany, although the Dresdner subsidiary is a member of the UK syndicate. Leading figures at Goldman are criticized by German banks for having to fly in from London for meetings.
Retail investors at home are the key to this issue and, if they don’t buy Telekom this year, they are hardly likely to go for the second tranche in 1998 – let alone the flotation of Deutsche Bahn, Deutsche Post or Postbank over the next five years. That would scupper Germany’s privatization programme.
The bad news is that the unwieldy 22-bank syndicate with its three global coordinators is riven with internal politics. The choice of Goldman Sachs as one of the three injured the pride of Deutsche and Dresdner. They’re obliged to treat Goldman as an equal despite the fact that two-thirds of the issue volume is expected to be raised in Germany. “It’s incredible to think they found it necessary to appoint a global coordinator with real clout in only one tranche,” says one of Telekom’s German bankers.
So there are three chiefs: at Dresdner, which has special charge of the German retail market, Euromarket veteran Hansgeorg Hofmann has just taken over from fellow board member Alfons Titzrath, who retired in December. Hofmann’s style is more boisterous than that of the understated Bernd von Maltzan of Deutsche, which is in charge of the German institutional market. Head of German equities at Deutsche, von Maltzan is something of a champion for German bankers who believe in the independence of Finanzplatz Frankfurt and are resisting the hegemony of Morgan Grenfell’s equities team in London. Goldman’s team, which will orchestrate a sales strategy for institutional investors outside Germany, is led by partners Scott Mead in London and Philip Murphy in Frankfurt.
Many banks in the syndicate complain that the lead-time has already been far too long. Banks started lobbying Telekom, the German finance ministry and even chancellor Helmut Kohl back in 1992. The three global coordinators and 19 co-lead managers were named in November 1994 and will have endured each others’ idiosyncrasies for two years by the time the issue comes to market in November.
“It’s normal for syndicate members to be appointed relatively close to the actual offering,” says one of the global coordinators. “Two years is the longest lead-time so far during which global coordinators have been named. So it has been very difficult to manage the expectations of the banks in the syndicate.”
Discipline is being enforced by Telekom itself, which refuses to tell the co-leads or even the global coordinators what underwriting quotas they can expect. “They want to keep the banks on tenterhooks as long as possible,” says one of Telekom’s bankers.
That has upset some German banks which are relatively unused to bookbuilding and prefer the old fixed-quota system whereby they knew in advance how large an issue would be, the size of their quota, and how much they would earn.
The higher-placed co-leads such as Commerzbank, WestLB and DG Bank are closely matched in placing power and each is fighting to win the largest quota, as much for prestige as for profits.
They are also watching their backs for new rivals: dozens of other institutions are seeking an underwriting role via the back-door, soli-citing Telekom, the finance and post minis-tries, trade unions, political parties and almost anyone in Bonn who will listen. Lloyds Bank subsidiary Schröder Münchmeyer Hengst is believed to be the only bank in Germany which has made a virtue of staying out of the syndicate, hoping that its aloofness will appeal to investors looking for impartial advice.
A few big German banks that wish to increase their visibility with international investors fear that the global coordinators will deny them a place in the foreign tranches. “The issue is at risk,” says one Frankfurt banker, “unless all the banks in the syndicate can use their full international placing power.”
Some banks boast that they have received private assurances on quotas from Telekom or the finance ministry, but the global coordinators dismiss such claims. As far as they are concerned, each bank’s share of the issue will remain open until the last minute.
“At the end of the day, the issuer and the global coordinators will look at each bank and at how much demand and what quality of demand they were able to generate – and allocate accordingly,” says a source at one global coordinator.
The size and the quality of demand are the big unknowns. Telekom must go to the market this year because the company needs the money for continued investment and restructuring – and also because it has made a public commitment to a listing in November. Although the company might have been wiser to give itself the option of a two-tranche issue extending into 1997, as some bankers suggested, retreating at this stage would look like an admission of failure.
The public bravado shown by Telekom’s bankers is in stark contrast to their private concerns about the size and the pricing of the issue.
Pricing misperceptions
Telekom originally said it wanted to raise Dm15 billion during 1996, 60% of it in the German market and 40% abroad (four international tranches are scheduled: America; the UK; the rest of Europe; Asia and the rest of the world). Now bankers estimate that the total placement could be nearer Dm12 billion, with only half of that placed in Germany.
In reality the syndicate will simply raise as much as possible – and hope that it reaches double figures. The issue’s total volume depends on the price, and predictions of what that will be are becoming more and more hesitant. Telekom itself has come to realize that it can only speculate about its earnings potential in two or three years’ time.
Telekom finance director Joachim Kröske made a serious gaffe in 1994 by suggesting that the issue price would be around Dm30. The problem is that that ballpark figure has constantly been repeated in the German press and sticks in the minds of retail investors. Convincing them of the validity of another figure may now be difficult.
On the same theme, when the syndicate was first formed, various banks tried to earn a cheer by setting their analysts to produce detailed reports on Telekom’s financial prospects. A Deutsche Bank Research report dated December 1994 confidently predicted pre-tax profits of Dm6.4 billion in 1995 and Dm12.7 billion in 2000. Vereinsbank Research made a highly detailed set of projections the following March (see table page 39).
Analysts who were bullish a year ago have gone to ground, insisting that serious comment is out of the question at this stage. After another year as Telekom-watchers they have learned to be cautious. Now most analysts are reluctant to say anything at all about Telekom until they see the 1995 results in May. In fact, they are actively trying to quash the impression created by their own forecasts.
Bill Coleman, telecoms analyst at James Capel in London, is one of the few analysts prepared to stick his neck out. On the assumption of pre-tax earnings of Dm5 billion in 1995, he says, Deutsche Telekom’s price-earnings ratio works out at 22, compared with an average of 12 for telecoms companies in Europe. “The balance sheet looks OK, but there’s a lot we don’t know about Telekom,” he cautions.
Peter Wirtz, telecoms analyst at Oppenheim Finanzanalyse in Cologne, points out that the company has already revised down its turnover forecast for 1995 from Dm69 billion to Dm67 billion. Therefore, Wirtz reasons, the price increases Telekom has just introduced will act as a greater damper on earnings. Moreover, the projected turnover of Dm80 billion for the year 2000 “looks like a very optimistic figure to me”, he says.
On the basis of his own projections for Telekom’s 1995 results, Wirtz estimates that the issue price will be Dm25 to Dm30 (five to six times nominal value). Although the price will in fact be based on earnings forecasts for 1997 and 1998, Wirtz’s figures are “pretty accurate”, says a Telekom banker who has seen the issuer’s financial projections for those two years.
Forecasts so far have assumed a substantial improvement in productivity and the reduction of the workforce by a further 40,000 by the year 2000. But the banks know well that any earnings estimate has to be highly provisional because Telekom’s financial situation is about to change dramatically.
Enormous reserves have to be built up rapidly to meet pension obligations (previously paid by the state) and, from 1996 onwards, the company will not only have to charge value-added tax but will also be liable to pay income tax for the first time. Some changes will be for the better: Telekom no longer has to transfer earnings to the state to cover the losses made by the postal service. “Deutsche Telekom has more unresolved issues on the pure reporting side than any other German company,” says one of the global coordinators.
In the meantime, a battalion of competitors will have emerged to face Telekom in the terrestrial and mobile telecoms market. Telekom will lose its monopoly of land-based telephone services on the first day of 1998. A number of competitors are planning to launch rival services as soon as they get their licences in the spring of 1997.
Wirtz of Oppenheim Finanzanalyse expects the main challengers – RWE, Mannesmann, Thyssen, Veba and Viag – to achieve an annual turnover in telecoms of up to Dm10 billion each within five years. They may grow even stronger as a result of a recent spate of alliances. Vebacom and Mannesmann Eurokom have agreed to marry Veba’s terrestrial network with Mannesmann’s D2 mobile web, while RWE Telliance will merge with VEW Energie and VEAG Vereinigte Energiewerke to create a new national terrestrial network. Internationally, German firms have forged alliances with Cable & Wireless, British Telecom and AT&T.
New telecommunications legislation, establishing what these companies will be allowed to do, and how they will be regulated, exists in draft form. But it may be heavily amended before being passed by parliament in late June or early July. Until the shape of the market is clear, no one can accurately price Telekom stock. The delay in the legislation was the reason for postponing the issue from spring to November.
Chief executive Ron Sommer complains that it took five months to agree new tariffs with government agencies – while in the meantime emerging competitors were free to plan their own prices. That interference will not go away. Moreover, even after the Telekom stock is placed, the government will still be a majority shareholder.
In the face of this adversity and uncertainty the syndicate members can hardly go out and market the issue to institutional investors. They plan to hold their fire until early September when they begin a 12-week campaign of marketing to institutions.
“It would be a huge mistake to approach investors beforehand,” says one of the global coordinators. “Banks would be doing a very dangerous thing to spread information months before the offering without being controlled by Deutsche Telekom and the global managers. That would dilute the story and endanger the whole offering. Anyone who talks about Telekom now is misinforming the investment community. The danger is that we would have to go back and correct that point of view.”
Yet some of the leading banks in the syndicate have already made some bold assumptions. The first non-German house to secure a top position in a German privatization, Goldman Sachs, won its global coordinator’s mandate by convincing the government and Telekom that the US institutional market – particularly long-term investors who can be reached only via a full listing on the New York Stock Exchange (NYSE) and via a top-flight US investment house – was vital to the success of the placement. At the time of its appointment, Goldman said it expected a full 20% of the issue to be raised in the US.
Some investment bankers question that assumption. Goldman’s adversaries in the syndicate point out that the recent initial public offering (IPO) of German chemicals group E Merck raised Dm2.4 billion altogether, but just 5% of that in the US market – although without a NYSE listing. “It wasn’t even worth making the trip over there,” says one German banker.
Pros and cons of a US listing
Daimler-Benz is the only German company so far to have achieved a NYSE listing, before its capital increase in 1994. Although Daimler reached new investors, US ownership of the company increased to just 8% and has since returned to the original 6%. A number of German corporations argue that a lower level of American depositary receipt (ADR) programme has taken them the same distance – and avoided the headache of negotiating a disclosure deal with the US Securities and Exchange Commission (SEC).
Like Daimler-Benz, Deutsche Telekom will have to produce a reconciliation of some balance-sheet items to US GAAP accounts – the SEC argues that German-style accounts don’t offer the necessary transparency to international investors. Although Telekom is free of some of the accounting difficulties encountered by Daimler – pension reserves and the valuation of semi-manufactured goods were both thorny problems, for instance – Telekom will still be obliged to publish two sets of results.
If the US figure is substantially adrift of the German figure, that will trigger distrust among investors. Daimler’s two-year track record of double accounting shows that the discrepancy between the two net earnings figures can fluctuate wildly from the huge (over Dm2 billion in 1993) to the acceptable (around Dm200 million in 1994). The problem is predicting the degree.
One sure result of producing US GAAP figures, according to Wirtz of Oppenheim Finanzanalyse, is that sophisticated investors will take a less generous view of the company’s balance sheet. “There won’t be the usual valuation adjustments on the stock because of the assumption of conservative [German] accounting,” he says.
But tempering their fears of investor apathy, bankers are heartened by the generally robust demand for telecoms stock. Robert Millington, an analyst at BZW in London, recalls that the three main telecoms privatizations of last year – Dutch KPN, Spain’s Telefonica and Portugal Telecom – generated $16 billion worth of demand in pursuit of $5.7 billion worth of stock.
But this year there will be plenty of alternative telecoms issues. STET of Italy is scheduled to raise $6.5 billion in the first half, while Telefonica is aiming for the second half with its $1.5 billion issue. There are three smaller issues too, OTE of Greece, Bezeq of Israel and Orange of the UK, looking for a total of around $2 billion. Adding Deutsche Telekom’s $10 billion, that makes $20 billion of new stock from a single sector this year.
There is a hope that the stock’s weighting in the Dax index, the index of 30 leading German shares, will be sufficient to pull in demand. Institutional investors who track the index, so the theory goes, will be obliged to invest in Telekom because it will be a dominant component of the Dax.
If the Dax committee at the Frankfurt Stock Exchange had decided to include Telekom’s entire market capitalization in the Dax, Telekom would certainly have become the heaviest-weighted stock in the index, triggering huge demand. But only the listed part of Telekom’s equity capital will feature, comprising only about 3% of the Dax.
Telekom and its advisers are assuming “normal” conditions when the issue comes to market. According to one Telekom banker, that means a dollar rate of around Dm1.50, a continued trend toward lower Deutschmark interest rates and no fall in the Dax from now to November. In nine months’ time, those objectives may not seem so modest.
Some international investors are increasing the German weighting in their portfolios. Morgan Stanley recently decided to raise its weighting in Germany from 7% to 16% of its European model portfolio. Its strategists expect short- and long-term German interest rates to fall further, providing economic stimulus and encouraging domestic investors to switch to equities.
Eberhard Weiershauser, treasury partner at Schröder Münchmeyer Hengst in Frankfurt, hopes that other international investors will follow suit. “London has been pro-French for three years now. You need a microscope to see the positions in German securities.”
But, as with all large issues now, the level of international institutional demand depends mainly on the enthusiasm of retail investors. “A successful retail placement is the precondition for everything,” says one of the global coordinators. “No institution abroad will invest in Telekom if it’s shunned by the German market.”
Millington of BZW points out encouragingly that retail demand has absorbed around 50% of the equity in the last three continental telecoms issues. “The importance of domestic demand is clear,” he says. “If we take the average of around 50% retail participation in the last three privatizations and add on around 10% of stock placed with domestic institutions, the mountain of around $20 billion of new telephone company issuance falls to around an $8 billion drain on international investors.”
But the equity culture is evolving slowly in Germany. Just 6% of German households have direct investments in equities; most of the nation’s Dm3 trillion in private wealth is held in low-risk instruments such as savings accounts, three-month term money, or government bonds.
Telekom acknowledges that it will have to reach “new groups of investors”. And everyone agrees that a huge marketing exercise will be needed to change public attitudes towards share ownership as a worthwhile long-term investment. But no one wants to foot the bill.
The finance ministry is thought to be reconsidering the possibility of tax breaks on share ownership – although that option was ruled out last year – but a look at the government’s books suggests that a U-turn now would be unlikely. Germany is in danger of failing to meet the Maastricht convergence criteria this year because its budget deficit is too high, so the government would be reluctant to forego tax revenue.
Rüdiger von Rosen, head of the German Equities Institute (DAI) and figurehead for the equities lobby in Germany, says privately that he has given up hope of persuading the government to make tax concessions on equities ownership – or at least to remove incentives on alternative investment vehicles – in time for this year’s sale of Telekom stock.
Last autumn Kröske ordered the banks to reduce custody charges for first-time investors. (Minimum annual charges often gobble up all the gains on a modest share portfolio of, say, Dm15,000.) But the banks flatly refused. None of the main German institutions has any intention of reducing its bank charges. “If we have to start trying to convince people that the Telekom share is attractive, we’ve had it,” says one Frankfurt banker. “The share’s attractions have to be self-evident.”
Education, but no concessions, seems to be the strategy. Commerzbank has run advertisements about saving for retirement by investing in equities. Dresdner Bank is enclosing information on Telekom shares when it sends statements to its four million retail customers – but it will be making no concessions on the usual fees. “We won’t be sacrificing large sums,” added the Frankfurt banker. “A charge of Dm20 [his bank’s annual custody fee for securities accounts] won’t put investors off.”
Setting a precedent
Bank charges and additional incentives will make no difference, say the banks, and the hugely-discounted Volksaktie (people’s share) for the mass market is a thing of the past in Germany. “Looking at privatization issues over time,” says one of the global coordinators, “we’ve seen that the number of participants is going down and the average allocation is going up.”
Yet Bonn has told German banks that those which reduce custody charges on equity portfolios will be looked on favourably when the issuing syndicates for future mandates are selected. Telekom is just the first in a series of privatization issues which will come up in Germany over the next five years.
According to a recent valuation, Deutsche Postbank is worth between Dm4 billion and Dm5 billion and should be ready for flotation between 1998 and 2000. Other candidates for privatization mega-issues are Deutsche Bahn (the railways) and Deutsche Post (the postal service). A second Dm15 billion tranche of Telekom stock is planned for 1998, followed by the sale of the government’s majority share in the company. When the syndicate is appointed, Germany’s top banks are no longer guaranteed leading positions.
During the first wave of privatizations, when stock in Volkswagen, Viag, Veba, Depfa Bank and other state-owned corporations was floated, Dresdner and Deutsche played as a team. Germany’s two largest banks took turns to hold the top position in each syndicate, to the exclusion of other institutions. It wasn’t until the Lufthansa privatization in 1994 that Bonn held its first-ever beauty contest for investment banks. In the event Dresdner won, but the point had been made.
German banks have grasped that mandates no longer pass down from generation to generation and they are responding by building up their placing power and custody services abroad. Dresdner recently purchased US asset manager RCM to increase its market base in North America. Commerzbank bought Jupiter Tyndall of the UK, Martingale Asset Management in Boston and has established an asset management operation in Singapore. Bayerische Vereinsbank is still looking for an asset manager in the US after its thwarted attempt to acquire part of the Oppenheimer Group of New York.
Dresdner and Deutsche acknowledge that the good old days are over. When Schroders, the London merchant bank, was selected last autumn to carry out a valuation of the German Postbank, German financiers viewed this as a disturbing precedent. “Just as they chose Schroders to make an expert valuation, so they could choose Commerzbank or WestLB to lead a privatization,” one German banker notes. Although neither of those institutions has the international placing power of Deutsche, Dresdner or Goldman, they are now considered by rivals to be experienced enough to coordinate a major privatization issue. So are a number of non-German banks.
Bonn’s more eclectic approach is not the result of a new generation of young Turks in the government and the finance ministry. Chancellor Helmut Kohl, who is personally credited with many key decisions (including the choice of Goldman Sachs as a global co-ordinator for Telekom) has been in office for 14 years and senior personnel at the finance ministry are equally long-term.
“The federal government is more aware of the impact of European integration and the idea of reciprocity between nations,” says one Telekom banker. Bonn has to be seen to be giving foreign institutions a fair chance.
It is a sign that the Bonn government realizes how much is at stake with the Telekom issue, since failure will be impossible to conceal. In the past, issuing banks in Germany have often taken unsold stock onto their books and fed it into the market gradually. Now, recent financial legislation requires the disclosure of a shareholding of more than Dm100 million in a public company – less than 1% of the new Telekom stock would be worth that sum.
Moreover, the German banks’ fund management arms are less willing than in the past to accept unsold stock into their investment vehicles. If banks were seen to be left with paper on their hands that would severely dampen prospects for the second Telekom tranche in 1998 and for the whole German privatization programme.
