Olivetti: The sack of Telecom Italia

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Every chief executive in Europe should heed the lessons of Telecom Italia's defeat. No company is beyond attack and the art of how to fight a hostile raider must be learned, or relearned, urgently. Olivetti's was a daring stroke, inspired by Roberto Colaninno's ambition and by a group of advisers each believing their improbable target was attainable. But its assault was as blunt and simple as a battering ram.

Above all, this was a battle lost by Franco Bernabè, the conscientious industrialist. His bankers wanted all-out war against Olivetti. Bernabè tells Euromoney exclusively why he held them back. He hoped a cogent industrial plan for tomorrow would carry more weight than windfall profits today for investors and banks. He tried to run the giant telecom firm as usual, recoiling from any measure he wouldn't have taken in the ordinary course of events. He didn't understand that takeover battles are extraordinary episodes - bare-knuckle fights where victory is the imperative.

In reconstructing the most important takeover contest of the decade, Euromoney reveals details for the first time of how the scheme was hatched. It appeared an impossibly audacious bid, but many separate groups independently had hit on the idea last year. Colaninno dreamed of leaping beyond Olivetti's limits; Lehman proposed a subtle grasping of control; Mediobanca a full-scale assault; DLJ was working on an LBO and then, crucially, Chase said it was financeable.

It is a story of tense moments previously untold: of how the crucial financing came to the brink of collapse; how Mediobanca, true to form, was more deeply involved than the other banks knew; of the fearsome defences proposed by CSFB and JP Morgan to which Bernabè said no. He explains how he had developed "antibodies to leverage". And he reveals the history of his dealings with Ron Sommer of Deutsche Telekom. Even some of the principals in the story failed to understand that this was never a deal about the telecoms business. It was the biggest straight fight in European corporate history. Greed, politics and, most importantly, the will to fight carried the day. Marcus Walker reports

Lehman Brothers, Milan, Friday May 21: Roberto Colaninno, chief executive of Olivetti, has a weight on his mind. It is the last day of Olivetti's tender offer to shareholders of Telecom Italia, and the market is leaving its answer until the final hours. Colaninno is unsure of winning an outright majority of Telecom Italia's shares. A victory shy of 50% could unravel the financing of his takeover, thanks to a secret clause in the loan agreement Olivetti has struck.

A worldwide club of banks has lent up to $25 billion to Olivetti's bidding vehicle, a minor subsidiary called Tecnost. They want to be sure that Tecnost can get two hands firmly on Telecom Italia's cashflow so it can repay the debt. With a large minority share, Tecnost might get only one hand on the cashflow, and the loan syndicate has reserved the right to pull out. "The banks are a pain in the ass," says one of Olivetti's advisers from Lehman Brothers.

Colaninno confers with his long-time investment banker Ruggero Magnoni, Lehman's head of European corporate finance. Tendered shares might yet reach 50% before the Milan stock exchange closes for the weekend, but Olivetti had better be prepared for less. The two men gather top colleagues for a conference call to Colaninno's other advisers at Chase Manhattan, Donaldson Lufkin & Jenrette, and Mediobanca. What if? asks Colaninno.

The four advisory banks have come too far on this adventure to see it falter over details like €6 billion in cash. If the loan syndicate starts making excuses, they promise Colaninno, we'll step in ourselves with all the money you need.

A reassured Colaninno heads over to Mediobanca at 4pm accompanied by Magnoni. Acceptances of Olivetti's offer are being monitored inside the three-floor, peach-coloured palazzo of the legendary bank on Via Filodrammatici, tucked behind the Teatro alla Scala opera house. Mediobanca staff are on the phones, double-checking the numbers. The offer closes at five o'clock; the counting goes on.

Gradually, a cast of characters from the five-month drama assembles on Mediobanca's first floor. They have come to take the final curtain. They are just in time for the last twist in an already bizarre plot.

Colaninno is joined by his two sons, Matteo and Michele, and by colleagues from Olivetti. They include chief telecoms strategist Marco de Benedetti, son of Carlo, Olivetti's former monarch whose reign went from glory to infamy. Olivetti's finance head Luciano La Noce arrives late on the scene after going for a coffee, as is his way.

Ruggero Magnoni is joined by Lehman Brothers' number two on the Telecom Italia deal, top M&A brain Vittorio Pignatti, and by others from the army of Italians who staff Lehman's European outposts.

Chase Manhattan calls by. Its contingent includes Milan chief Alessandro Mitrovich and the young Englishman Richard Blakesley from the London M&A team. Three of Italy's top corporate lawyers arrive. Sergio Erede, Umberto Nicodano and Carlo D'Urso have guided Olivetti throughout this baptism of fire for Italy's new takeover law.

The host bank's contingent is led by three of its bright young hopes. Matteo Arpe, 34 and already head of capital markets, corporate finance and treasury, has handled most of Mediobanca's work on Telecom Italia. Alberto Nagel and Massimo di Carlo are the two other figureheads of the new generation.

Mediobanca is traditionally shrouded in mystique and mired in intrigue. Since the 1980s it has fought a rearguard action to preserve its network of influence, resisting the growing pluralism of Italian business and finance. But in helping a provincial upstart, Colaninno, to fight an open-market contest against a blue chip packed with directors from the Italian establishment, Arpe's investment-banking division has shown that Mediobanca can work with the grain of modernity, as well as against it.

The atmosphere in the rooms and corridors of Via Filodrammatici reminds some present of a tense football match. Some onlookers make bets on the result.

Then the dénouement: a Reuters screen declares that the core shareholders who dominate Telecom Italia's board of directors have sold their stakes to Olivetti. It is a final humiliation for 50-year-old Franco Bernabè, who became chief executive of Telecom Italia only six months earlier with much expected of his reforming talent. It is also a shock to Credit Suisse, a core shareholder that has taken a lonely public stand against selling to Olivetti.

At Mediobanca, some have already deduced from the numbers that the Telecom board has abandoned Bernabè. The core shareholders help take Olivetti beyond 50%. By 7:30pm, the master spreadsheet confirms it. Champagne bottles open, and the search begins for an improbable restaurant; one in central Milan to seat 40 at nine o'clock on a Friday.

Somehow, Santini's can squeeze them in. A crowd of victors leaves Via Filodrammatici, juniors mixed with seniors as hierarchy goes out of the window along with a champagne cork. But exhaustion leaves little space for revelry. Some head straight for their homes in Milan and London, back to families they've hardly seen since last year.

Telecoms, or just money?

The hostile takeover of Telecom Italia will go down as the symbolic first deal of a period of upheaval in European capitalism. Unlike the fall of RJR Nabisco to Kohlberg Kravis & Roberts in 1988, to which it has been compared, the tale of Olivetti and Telecom Italia is a beginning, not a culmination. Its chutzpah may never be matched, but the meekness with which Telecom eventually succumbed to Olivetti will accelerate the upsurge of mergers and acquisitions across the eurozone. If chief executives heed this tale, their first step may be to leverage up.

Where the Telecom story is like KKR's most famous buy-out is in its central ambiguity. Does the deal have anything to do with running a business better? Since Franco Bernabè was finding his feet when Olivetti struck, the question of Colaninno's superior management credentials will stay unanswerable.

"Olivetti's planned takeover of Telecom Italia has compelling commercial logic" - at least, that is what a Lehman Brothers brochure from May 7 says. But some telecoms experts at the investment banks on both sides of the contest are not so sure.

On the victory night of May 21, David Wheeler, a telecoms specialist at CSFB who advised Telecom Italia on its defence, speaks to a former colleague at his old firm, Lehman Brothers. "I don't get it. Where is the industrial logic in this transaction?" asks a dismayed Wheeler. "Don't spend too much of your time looking for it, because there is none," replies his friend. "I shudder to think how much you are going to make out of this," says Wheeler, imagining the prolonged spin-off deals that Olivetti will throw the way of its bankers. "Shudder again," comes the answer.

In one interpretation, the takeover of Telecom is an exercise in pure financial mechanics. Take a company with a $9 billion annual cashflow, debts of about $9 billion, and equity floating like plankton all over the world. Buy up its shares using someone else's money - tonnes of it. Then sit back and watch as the cashflow pays off the mortgage in a few years. Hey presto: you are left holding a massively valuable asset.

You don't have to care whether the target supplies telephones, paperclips, or potatoes. Low gearing and a stagnant revenue projection are all you need to see. One of Olivetti's M&A advisers says of Telecom Italia: "This thing oozes cash even in its dilapidated state, so the debt is paid down phenomenally fast."

In reality, Olivetti's motives for seizing Telecom Italia exceed this minimalist picture of a leveraged buy-out. Colaninno, 55, is a man looking for a way to crown his career. He is also conscious of the need to keep pleasing his shareholders, who have recently got used to Olivetti's stock price rising. During 1998, Olivetti ran out of options to grow by less melodramatic means. And having turned itself around since a near-death experience in 1996, Olivetti is convinced it can make a qualitative improvement to the running of Telecom Italia, not just a capital gain through the use of leverage.

Colaninno can make a good case for himself as a man to revive Telecom. Perhaps, as his bankers insist loyally, his case is stronger than Bernabè's because Colaninno has more experience at the cutting edge of the telecoms business. But that is not why he won.

The compelling financial logic of a leveraged buy-out underlay Olivetti's victory. It allowed Olivetti to hand out wads of money to institutional investors and commercial banks, and to do it now. Bernabè could only promise to increase investors' wealth over time by improving the company. To banks he promised years of famine.

The Italian solution

A further ambiguity surrounds the fall of Bernabè. Was this a revolutionary exercise in transparency, or a piece of unfinished politics? There are points in the battle at which ministers deferred to markets. But equally, there are points at which both Italian and international investors took their cue from Leviathan.

Italy has a national talent for embracing the outward forms of progress in a show of fervour, while preserving a traditional reality. Deeper adaptation follows slowly. The model is in Giuseppe di Lampedusa's novel, The Leopard. As Garibaldi's army invades Sicily, a young Sicilian aristocrat quips: "If we want things to stay as they are, things have got to change." At least that way the next king can be from Piedmont. That's better than a republic built on French revolutionary ideas.

Anglo-Saxon fund managers don't bear comparison with Garibaldi's redshirts. But the Italian government appears aware of its own paradox: it has to please these newcomers in order the better to defend its national champions against control by foreign industries. Prime minister Massimo D'Alema, no economic libertarian by ideology, could easily have derailed this aggressive, American-style takeover. Instead he gave it green lights and verbal encouragement, in order to secure a latter-day Piedmontese solution.

Legal harbingers

The story of Telecom Italia's takeover is introduced by a pair of heralds, one cautious, the other bullish. They are both pieces of legislation. The first is the general privatization law 474 from 1994. It paves the way, among other sell-offs, for the fragmented state telephone monopoly to become the quoted company Telecom Italia. But the law hedges against free markets' awkward habit of developing their own will.

Law 474 gives the Italian government a set of veto powers, together dubbed the golden share, over privatized companies of national interest. These powers include a ban on wielding more than 3% of a company's voting capital, unless the treasury ministry gives special permission.

When Telecom Italia is privatized in October 1997, the 3% restriction is copied into article 22 of the company's by-laws. This allows the government of Romano Prodi to assemble a control syndicate of Italian and foreign shareholders to guarantee an Italian management, even though the core shareholders collectively buy only 6.97% of the equity.

The second herald is the law on takeovers, named after treasury director-general Mario Draghi. It comes into force on July 1 1998 and attempts to kick-start the restructuring of Italian industry. Article 212 says that the 3% voting ceiling under the privatization law evaporates if you make a formal offer for 100% of ordinary shares. If this troubled national economy is to embrace efficiency, the Draghi law is arguing, it has to accept that all companies should be in play.

The first real test of the new order is destined to come from a mid-sized telecoms group from Piedmont. By July 1998, Olivetti is grasping for a way forward. Chief executive Colaninno wants to be a hands-on industrialist. At present, he's more like an investor.

His main asset is a minority stake in mobile-phone venture Omnitel, which Olivetti controls through an alliance with Germany's Mannesmann. The partnership works fine, and the venture is increasingly successful. But for Mannesmann and the two other big investors, Bell Atlantic and AirTouch, Omnitel will only ever be their Italian sideshow. None of them wants to take it to a higher level.

Roberto Colaninno and his telecoms strategist, Marco de Benedetti, begin analyzing their main competitor, Telecom Italia, from mid-1998. They study it as many firms do their rivals. It clearly has big scope for improvement. Olivetti's fibre-optic fixed-line venture Infostrada - a total novice - has been stealing customers almost effortlessly.

Telecom Italia is trading at low multiples compared with other big European telecoms players. It is clearly a cheap opportunity. But how can little Olivetti possibly take it over?

Colaninno discusses Olivetti's future with his investment bankers. They include Lehman's Ruggero Magnoni, and Chase's M&A team. He can continue with the status quo for several years, watching Omnitel's growth level off. He can use the cashflow from Omnitel to start a small venture abroad. Neither route appeals.

In September, Lehman Brothers makes what it thinks is a provocative suggestion: enter Telecom Italia. The treasury ministry is looking to sell its 3.95% stake in the company, partly a hangover from its failure to convince AT&T to stay a strategic investor. Colaninno could add himself to the circle of Telecom Italia's core shareholders, and offer himself to the government as the prayed-for Italian solution to its shambolic management.

In October, a confidential, highly trusted, personal adviser to Colaninno makes a bolder proposal. Use the Draghi law, and bid for 100% of Telecom Italia. Its chairman has resigned, and the share price is down to about L10,000 (now equivalent to €5). The government will welcome a saviour. No accommodation with the present board is necessary. This appeals to Colaninno far more than a pact with the existing core shareholders. The adviser could hardly be better qualified. It is Mediobanca.

In November, Silvio Scaglia, the chief executive of Omnitel, phones Colaninno. Scaglia has received an intriguing call from the US. Donaldson Lufkin & Jenrette has some sketchy ideas about a private-equity leveraged buy-out of Telecom Italia. They want to hear Scaglia's opinion - and whether he'd like to front it. Scaglia consults his largest shareholder, Colaninno, and says let's do it together. You should talk to Lehman, Colaninno says. Scaglia says he'd like DLJ included in the discussions.

In late November, the situation changes. Telecom Italia chooses the highly reputed Franco Bernabè as new chief executive. The appointment lifts the share price up past L14,000. A 100% takeover will be exorbitant now, and definitely hostile.

But Colaninno has set his sights on Telecom. He calls Chase in New York to ask whether the money for this adventure exists. Chase has been close to Olivetti since the Carlo de Benedetti era. More crucially, it has a special vantage point on the world. It sees so much of the goings-on in global lending that it is uniquely able to answer Colaninno's question.

On Christmas Eve, Don McCree gets a call from head office. Chase's head of European syndicated finance learns that Olivetti wants a big answer fast. McCree, his number two Ruth Traugott and their loan-market team draw up an assessment of the achievable contribution from every significant bank in the world. They have to keep the plan secret. They base their analysis on lenders' recent words and deeds, and the psychology of each bank's decision-makers.

McCree and Traugott conclude that $25 billion in fresh cash is available for a single deal. That would be the biggest bank financing of all time, beating KKR's $14 billion loan to buy RJR Nabisco. (In retrospect, McCree thinks they were too conservative. The international loan market seems an almost bottomless pit.)

The investment bankers team up

In mid-December, Colaninno puts together his advisers from Lehman, Chase and DLJ. In the new year, they meet mainly in Lehman's offices in London and Milan. For extra privacy, they use Chase's office in Geneva.

Ruggero Magnoni and Vittorio Pignatti head the Lehman team, Richard Blakesley and European M&A chief Jim Downing lead the Chase team, and telecoms specialists Jim Cantwell and John Curran represent DLJ. The agenda: how to structure the biggest hostile takeover in history.

Lehman, a self-professed conservative firm, feels there isn't the money for a swashbuckling assault. They present various options for building large minority stakes, such as 30%, on the market. Various diplomatic options exist for coping with the 3% voting ceiling.

Chase is more aggressive. An offer for 100% of ordinary shares is financeable. Acceptances of such offers never reach 100% anyway. And an overwhelming stake would allow Olivetti to merge with Telecom Italia, getting directly at the cashflow to pay back the debts. In addition, an offer for all shares is important for international credibility. The international investors owning 37% of Telecom Italia will revolt if they suspect a stitch-up. DLJ backs up Chase with a let's-do-it attitude.

Lehman agrees, and the banks decide to advise Colaninno to bid for 100% and to finance it as if they are going to receive 100%. If they can cope with the worst case, a lower-level victory should prove comfortable.

The banks advise an offer price of e10 a share. It's a premium above Telecom Italia's market price, it can be raised at a tactically opportune moment, and it's a nice round number. Most important, it is less than the company is worth, and everybody knows it. You can only do the deal if the market's price is below the asset's value. It puts the total price of Telecom Italia at $58 billion - over seven times the size of Olivetti - which means the planned syndicated loan can cover about half.

The rest of the bid structure is tricky. Lehman's Pignatti knuckles down to finding the solution. Olivetti can't offer its own equity, because it has many other shareholders besides Colaninno and his allies. The share price will dive if Olivetti announces a huge rights issue, only to cancel it if the long-shot takeover fails. The first idea for paper payments is a bond with an embedded call option on shares in Telecom Italia Mobile (TIM), the target's majority-owned cellular-phone venture.

But the bond can't be Olivetti's either. Olivetti is an unwieldy company for acquiring Telecom Italia directly, because Colaninno's circle controls only 14% of its equity. Every major step taken before and after the takeover would need board approval. The Olivetti board reflects a diffused ownership.

Luckily there is Tecnost. In late January, Pignatti remembers this Olivetti subsidiary that Lehman tried and failed to take private in the autumn. Tecnost has only a few operations, including gambling machines. The Olivetti management appoints its board and can pass any desired measure the same day. And Tecnost is still quoted on the Milan Borsa, which entitles it to offer listed securities for an acquisition. Tecnost becomes the flexible weapon with which Olivetti will assail Telecom Italia.

In the last week of January, an intriguing new participant joins the advisers' conference. A common assumption at Chase, Lehman and DLJ is that Colaninno has appointed the small but well-connected outfit Mediobanca (staff: 300) as an afterthought. The bid needs backing from an insider to the Italian system lest it appear an American-sponsored raid, and Mediobanca is the consummate insider.

In reality, Mediobanca has been working separately and silently with Colaninno on taking over Telecom Italia since Olivetti started thinking about it. It was Matteo Arpe, the precocious head of investment banking, who advised Colaninno to go for 100%, cutting through the complexity of the 3% ceiling. Attentiveness and privacy are part of the firm's perfectionist code. Mediobanca has merely applied its tight-lipped PR policy to its co-advisers.

Sessions with Colaninno at Mediobanca give the London-based advisers a rare glimpse inside 10, Via Filodrammatici. As they sit in a raftered room on high-backed wooden chairs, doors open periodically, figures float in, pronounce cryptically, and float out. Chase's Blakesley is reminded of a power-wielding 18th-century monastery.

Typically, Arpe and his chief executive, Vincenzo Maranghi, say little and observe their brash London colleagues arguing. At one meeting, Colaninno loses patience with an endless debate between the Lehman and Chase bankers about how Italian institutions will react to the bid, and tells them all to shut up. "Why don't you listen to what Mediobanca have to say?" he says with exasperation. "They are the only one of you who know anything about Italian corporate finance."

Colaninno is a strict ruler over his investment bankers. If you stray from what he wants, says a source at Chase, "he bites your head off". But all the advisers, errant and obedient, have total respect for their stubble-faced leader.

Lehman and Mediobanca dominate the strategy formation, and Chase the financing. Poor old DLJ is struggling to find a role of its own. The young Paolo Fundaro is planted at Lehman as a pair of ears, and works on financial modelling. But Jim Cantwell and John Curran are rarely seen at meetings.

Cantwell and Curran are both enthusiastic strategic thinkers about the global telecoms sector. But this battle has little to do with telecoms. It is a financial game, based on convincing the bank world and the equity market they can make a fast profit by just saying yes.

Secondly, the deal is about overcoming Italy's political and legal complexity. The best Italian connection DLJ has is Jim Cantwell's new villa in Tuscany.

Legal headaches

While the bankers prepare the bid strategy, a small band of Milan lawyers faces an inhuman workload. Olivetti's law firm is Studio Erede. Two partners deeply involved are Umberto Nicodano and Roberto Cera. The firm's head partner is Sergio Erede. Colaninno trusts his counsel absolutely.

Carlo D'Urso, lawyer to Lehman Brothers and Mediobanca, is also pivotal. Alessandro Foti of Lehman is a lawyer by training, and forms a bridge between the legal work and the investment bankers.

Each point in the proposed bid has to be run past the lawyers. Every detail takes a marathon discussion, instead of the nigh-instant answers the London M&A advisers are used to. An Anglo-Saxon banker jokes: "Italians love to talk. That's why their mobile-phone business is so great." In fact, the lawyers are struggling with the inadequacies of Italian law.

In mid-February, the legal team is joined by the ancient Ariberto Mignoli, professor at Milan's Bocconi university, chairman of Mediobanca's shareholder syndicate pact, and one of the most expert navigators in the jungle of Italian corporate law.

The lawyers have to overcome untested ambiguities in the Draghi law. Once you plan a tender offer, you have to announce your intention. But when is the intention formed? The lawyers reckon it's when Olivetti's board has met and approved a plan. They tell Colaninno to keep his company out of the preparations.

Article 2358 of Italy's Civil Code says you can't lend money to your parent company so it can buy your assets: that's financial assistance. This means Olivetti can't overtly buy Telecom Italia with its own balance sheet. It can't say that it will merge bidding vehicle Tecnost into Telecom, which is the logical solution to repaying Tecnost's huge leverage. The lawyers tell Olivetti to adopt a position of studied ambiguity on merging Tecnost and Telecom.

Article 104 of the Draghi law says vaguely that a takeover target needs shareholder approval for any frustrating measures. Olivetti has to make sure that when it announces its intention to bid, it somehow triggers article 104. Olivetti is destined to fluff it.

But the hardest issue for the lawyers is overcoming the golden share. Erede is convinced that under the Draghi law any 100% tender offer automatically scraps the 3% voting ceiling in the privatization law and Telecom Italia's by-laws. But Telecom has arguable scope to fight this - as it later does, claiming that a 100% offer is bogus unless you secure a majority of shares.

Erede is convinced Olivetti will win if the issue ever comes to court. But the problem is convincing the market of this beforehand.

In early February, Olivetti seeks a pre-emptive answer from Milan stock market regulator the Commissione Nazionale per le Società e la Borsa (Consob). Erede approaches Consob chairman Luigi Spaventa. But Spaventa replies that the 3% ceiling is an issue for the courts, not a stock-market regulator. Erede knows the answer is correct, but it's of no help.

Next, Olivetti seeks an indication from the government in Rome that it will waive the golden share following a 100% bid. The state legal office replies that there is no way to pre-empt the issue. Olivetti must buy the shares and ask Telecom Italia's chairman, Berardino Libonati, to register them. Then only Libonati - the adversary - can apply to the ministries of finance and industry to cancel the 3% ceiling. Olivetti's headache continues.

The investment bankers and lawyers spend January and most of February planning a cascade of events of almost nightmarish complexity. Olivetti needs to pump Tecnost full of capital to leverage. For that, Tecnost needs a €10 billion rights issue and Olivetti a €2 billion rights issue, for which Olivetti needs an extraordinary shareholders' meeting. Without that, banks in the loan market won't sign on, and Olivetti needs to know they'll sign before sending Consob a letter saying it intends to bid. Consob's approval of the letter is needed to block Telecom Italia from taking frustrating action. And before any of that can happen, Olivetti needs to do a deal with Mannesmann.

Antitrust law requires Olivetti to sell its existing telecoms business before buying Telecom Italia. Omnitel is the strongest competitor to Telecom Italia Mobile. But Colaninno doesn't want to give up Omnitel before he knows he's going to win Telecom Italia.

In mid-January, Colaninno goes to see Klaus Esser, heir-apparent at Olivetti's telecoms partner Mannesmann. Colaninno is in a weak bargaining position. He needs Esser to write him a put option on Olivetti's stakes in their joint ventures Omnitel and Infostrada. Happily Esser doesn't mess him about. Both men know what a fair price is, and they agree on €7.9 billion.

Ironically, once Colaninno is in charge of Telecom Italia, his own former companies will eat away at his market share and pose the main danger to the cashflow underpinning the leveraged buy-out.

By the week of Monday February 15, too many people know about the plan. Someone - a banker, lawyer, regulator, ministry official or politician - is talking to the press. A speculative report about an Olivetti move on Telecom Italia surfaced and sank in January, but now the Italian dailies are carrying loud rumours.

Consob demands that Olivetti let the market know of its intention by the end of the week. Colaninno replies that he will convene a board meeting on Saturday, and will inform the stock exchange afterwards. Colaninno then sends a rocket of anger around the groups working on the takeover plan.

The game is afoot, and Olivetti is not quite ready yet

A marked man

Franco Bernabè, the tall, multilingual chief executive of Telecom Italia, who grew up in the former Austrian province of South Tyrol, is a loner. He has strong views on how a company should be run.

He joins the telecom giant on November 19 1998 because he wants to work in an industry of the future. Since 1992 he has overseen the restructuring and privatization of oil, gas and chemicals group Ente Nazionale Idrocarburi (ENI). His transformation of the debt-ridden, wasteful and scandal-hit ENI is held up as a model at Harvard Business School. But the oil man wants to be part of the cutting-edge business on everybody's lips: telecoms, with its prospect of explosive growth through wireless telephony and the internet.

Telecom Italia is far from that cutting edge. Managerial instability since privatization in October 1997 has brought constant reorganization without direction. The only thriving part of the sprawling group is its cellphone subsidiary. Telecom Italia Mobile (TIM) has a distinct culture, a market-conscious management, and more customers than any other mobile operator in Europe.

Bernabè encounters a crisis of motivation at Telecom Italia. The workforce feels it has been left alone to rot, and the company feels as if it's on the edge of a nervous breakdown. The best people are leaving. Bernabè gives himself two months to learn the company and figure out the structure it needs, then some weeks to get to grips with international telecoms strategy, and 12 months to show a visible transformation of the group.

He likes to figure things out for himself. At ENI he wrote the conglomerate's entire industrial plan alone on his laptop. He has no true confidants and has brought nobody with him from his old company.

Bernabè spends December and January holding hundreds of meetings with managers, looking for diagnoses and for talent. He draws up a new management team, using the best people available inside the company. Bernabè forms a six-point reform plan.

First, Telecom has to concentrate on its core business, supplying fixed and mobile telephony. Bernabè plans to divest everything else, from the TV business Stream to the manufacturing companies Sirti and Italtel.

Second, Telecom needs a far simpler organization. Attempts to penetrate every nook and cranny of Italy have created an articulated geographical bureaucracy, with regional and local layers duplicating the central directorate in Rome.

Third, Telecom must become client-driven. It lacks departments dedicated to specific segments of the customer base. The same people are trying to manage everything from households to small businesses to the internet. Henceforth specific groups will be empowered and accountable for different chunks of the market.

Fourth, Telecom Italia needs to benefit somehow from the migration to mobile phones in Italy. Mobile lines will soon match the number of fixed lines. TIM is the biggest beneficiary but Telecom only owns 60%. Bernabè plans to merge the two companies. TIM personnel can take over operations they perform much better than the parent company, such as marketing. It is to be a partial-reverse merger.

Next, Telecom's international business needs urgent reassessment. The company has invested in mobile, fixed-line, start-ups, incumbents; anything going. Bernabè decides that foreign operations will henceforth be limited to start-ups and mobile ventures. The focus will be on Europe, including eastern Europe, and Latin America.

Finally, there is the question of international alliances. By early February, Bernabè views a German link-up as the best option.

At the Davos World Economic Forum in late January, Bernabè seeks out almost every significant international telecoms boss for a chat. One chief executive he doesn't get round to meeting is Ron Sommer of Deutsche Telekom, so immediately after Davos he pays Sommer a visit.

The two men discuss how former state monopolies can cope when national markets open up. Bernabè believes Italy will follow the German model, in which full liberalization leads to a speedy loss of margins and market share. The answer for Telecom Italia is to create economies of scale on a European level, in order to boost its competitiveness in Italy. Bernabè keeps an open mind about whether to merge the companies, or to form an alliance that targets specific business areas.

Sommer wants a merger. Like Bernabè, Sommer believes that a continental marriage is needed to shore up his domestic competitive position. Their companies are complementary: the Italians have an excellent mobile business, the Germans are one of the world's biggest internet providers. A merger of equals with internal meritocracy can give each side the other's strength. There is little scope for cost-cutting to show the financial markets, but fusing can create synergies through cross-selling and aggressive, targeted expansion.

A merger has another interesting effect for Sommer. The Italians' low debt would dilute Deutsche Telekom's balance sheet. With the cash both sides have available plus stock offers, the combined company could leverage an acquisition of over $100 billion with little effort. Sommer is eager to go global, breaking into the US major league within a few years. Deutsche Telecom Italia (a name the two bosses consider) could buy anything it wanted.

Sommer already has an alliance and joint venture with Michel Bon of France Télécom. But the French government insists on maintaining 51% ownership of its national champion, so France Télécom is not available for the merger Sommer wants. He asks Bernabè to keep their discussions top secret. Only the two chief executives and Sommer's intimate adviser Goldman Sachs know about the liaison.

Déjà vu all over again

In mid-February, Bernabè's internal planning and conversations with Sommer are disturbed by loud rumours that Olivetti is going to bid for Telecom Italia. It makes no sense, thinks Bernabè: Olivetti has only just escaped from a decade of troubles. Bernabè knows that Italian and international investors hold him in high esteem. He is confident he can see off a foolhardy raid by going about his normal business.

Nevertheless, Bernabè's chief financial officer, Fulvio Conti, thinks they had better hire some defence advisers. Conti arranges a selection pageant. Morgan Stanley and Credit Suisse First Boston arrive at Telecom Italia's Rome headquarters on Wednesday 17 February.

CSFB has been aware of Telecom Italia's vulnerability to a raid since December. When Olivetti reveals its hand, global co-head of M&A, Scott Lindsay, recognizes that the LBO phenomenon that shook America in the 1980s has just hit Europe. Lindsay says to a colleague: "To quote Yogi Berra, it's déjà vu all over again."

A team from JP Morgan show up in Rome, having made an appointment for a courtesy call some weeks earlier. Conti takes them by surprise: "Just so I can clarify this, we're talking to three banks and we're going to choose one as our defence adviser."

The three banks present their cases. JP Morgan is blunt. You can double your money just by stripping down and refloating Telecom Italia a year after an LBO. Managing director of M&A Chris Bataillard argues: "A takeover bid needs absolutely no vision of telecoms whatsoever. It needs no synergies. It just needs money."

Conti decides to hire CSFB, and also Banca IMI, the investment-banking arm of the San Paolo IMI group. Both Credit Suisse and San Paolo IMI are core shareholders of Telecom, so Conti figures they will be the most committed defenders.

A board meeting of Telecom Italia is set for Sunday, which must approve the appointments. But on Friday the management learns that the Olivetti board will meet the next evening, and shifts its own board to Saturday morning: it might be useful to pass some pre-emptive defence resolutions.

Olivetti learns almost instantly of Telecom's plan to convene on Saturday - both sides' boardrooms are riddled with connections. So Colaninno brings forward his own board's session to Friday at night-time. Olivetti ruthlessly assembles its directors. Marco de Benedetti drags the fever-ridden billionaire Luca Crespi out of bed, much to his chagrin.

The board meets at midnight in Olivetti's big, ugly complex of towers on the outskirts of Milan. Vittorio Pignatti of Lehman and Matteo Arpe of Mediobanca present the plan for a leveraged 100% offer for Telecom Italia. The board members are astonished. Once over the shock, they are delighted - on condition that their beloved Omnitel is only dumped if the takeover succeeds.

The next day, Saturday February 20, Olivetti sends Consob, Telecom Italia, and the stock exchange a letter announcing its intention to bid. All ordinary shareholders will get an offer of €10 per share, consisting of €6 in cash, €1.4 in Tecnost stock and €2.6 in Tecnost bonds. The total e53 billion bid will be funded by a €22.5 billion syndicated loan, €12 billion rights issues, and a €18.5 billion floating-rate note. Olivetti will sell its existing telecoms interests to Mannesmann: it is finalizing the contract.

On Monday, Consob replies that the letter is invalid. It wants cast-iron guarantees on the Mannesmann deal. Olivetti takes another four days to complete the €7.9 billion conditional sale. On Thursday, Olivetti writes a second letter to Consob, this time tight enough to trigger article 104, banning frustrating action without a shareholder vote.

Telecom Italia is trapped.

Deal frenzy

Some of Olivetti's M&A advisers are baffled why Telecom Italia does not use its four days of freedom to adopt vigorous defences. If this was British Telecom under siege, there would surely be a robust pre-emptive strike. Little do the Olivetti camp know of the argument that is raging in Rome.

Olivetti races to build its war chest. Nearly 50 banks express an interest in contributing to the syndicated loan. Others have declined because of conflicts of interest or because, like Citibank, they dislike the hostile nature of the buy-out.

Chase and its co-advisers deliberately create a deal frenzy by putting a mountain of money on the table. Lenders will get a first-phase margin of 2.25% over Libor and a 1.75% fee. There's so much interest that the Olivetti camp decides to set an entry level of e1 billion. Many banks have never lent that much to one company before.

Colaninno and finance chief La Noce are shocked at the money their advisers say they must hand out. We are a single-A credit, La Noce protests. The bankers explain that Olivetti has to brazenly seduce the market. Lenders view it sniffily as a mischievous rebel. Telecom Italia is a part of Europe's corporate establishment and a relationship client (though in truth not a very rewarding one). The necessary tactic is to hold fatter profits under banks' noses than they have made from Telecom Italia in years.

"In the end, greed won," says an Olivetti adviser, with an apologetic shrug for the brutal simplicity of his own profession.

In late February and early March, Colaninno holds summit meetings with chairmen and chief executives of 30 banks from Europe, north America and Japan, who are considering authorizing the €1 billion contribution. Colaninno explains the motives and mechanics of the takeover.

Colaninno completes his tour of banks with 26 acceptances and over €30 billion offered. There won't be room for all of them. Only Société Générale, Paribas and ABN Amro have turned him down.

Banco Bilbao Vizcaya says yes at first, but two days later rings back and pulls out. Olivetti's advisers are convinced that BBV has consulted Telefónica, Spain's privatized telecoms player in which BBV is a strategic shareholder, and decided to keep its powder dry. (BBV did not reply to Euromoney's enquiries.)

Telefónica boss, Juan Villalonga, will claim in late March that his company "has had no role" in the Telecom Italia takeover. True, but Villalonga certainly toys with the idea. The former investment banker is intrigued by all the deal-making. Villalonga meets Colaninno twice and phones Bernabè, fishing for information. Perhaps he can buy some assets after Colaninno wins? Or perhaps he can be Bernabè's white knight? Thanks for your interest, Bernabè replies.

On March 15, Colaninno unveils his industrial plan for Telecom Italia to investors in Milan. He will cut staff in fixed and mobile telephony by 19,000 and sell non-core businesses such as manufacturing and real estate. International operations will stick to Europe: no more Latin American ambitions. He will form international alliances for the mobile business. He expects flat fixed-line revenues and sharply falling tariffs. The biggest single difference to Bernabè's strategy is keeping TIM separate from Telecom. The Olivetti camp attack Bernabè's plan to dissolve the entrepreneurial culture of TIM in its bureaucratic parent company.

Colaninno and his advisers debate when to raise the offer price from €10, a level roundly criticized in the markets as too low. But the sweetened offer of €11.50 on March 29 will be the only adjustment in Olivetti's offer. Otherwise, Olivetti's offensive is as clear and simple as a battering ram.

Telecom, in contrast, seems to be changing its defence all the time.

On Saturday February 20, as Olivetti posts its first notice of a bid, Telecom Italia's board convenes. Eight of the 10 non-executive directors, not all of whom attend today, represent the insurance groups Generali, Alleanza and INA; the banks BCI, Unicredito Italiano and San Paolo IMI; the Agnelli family holding company Ifil; and the treasury and telecommunications ministries. The other two directors represent the 87% of Telecom Italia owned on the open market.

Franco Bernabè and his finance chief, Fulvio Conti, present the choice of defence advisers: CSFB and IMI. Some board members want them to add an adviser independent of the core shareholders. JP Morgan gets the nod over Morgan Stanley.

The investment bankers team up on Sunday. The sixth floor of Telecom Italia headquarters on Rome's Via Flaminia becomes the advisers' home for the next three months - longer than they will care to remember.

CSFB and JP Morgan have sent the largest teams. The head CSFB adviser is Andrea Morante, who knows Bernabè from his ENI days. Others in the contingent include telecoms expert David Wheeler; and Bernardo Italico, recruited as part of BZW, the former UK merchant bank that arranged the flotation of Telecom Italia together with Mediobanca. The JP Morgan contingent is led by Enrico Bombieri, head of Italian M&A, with the day-to-day work done by Will Gardner and Francesco Silva. Banca IMI's leader is Ugo Formenton, another who worked with Bernabè at ENI.

Then Gerardo Braggiotti shows up. Lazard's star player on European M&A has won the family of corporate finance boutiques a slice of the action. Braggiotti was once the rising star of Mediobanca. He was booted out in late 1997 after a running argument with old-guard chief executive Maranghi about the bank's direction. Braggiotti's last big deal for Mediobanca was the privatization of Telecom Italia, when his understudy was Matteo Arpe. Now that Arpe is one of Colaninno's most effective advisers, Braggiotti would seem to be the perfect counterweight.

However, Lazard's day-to-day leader on the Telecom Italia defence is Arnaldo Borghesi, head of the firm's Milan subsidiary. Braggiotti is distracted by simultaneously working on an attempted revolution in Italian banking: the merger of Unicredito Italiano with BCI. Braggiotti is destined to be thwarted once more by his enemy, Mediobanca's Maranghi.

The four advisory banks work separately to formulate their ideas. They all come to the same conclusion. This defence needs leverage. JP Morgan and CSFB in particular, veteran powerhouses of hostile takeovers, work on schemes for a blistering leveraged counter-attack.

That same Sunday, Bernabè listens to what his 40 or so investment bankers have to say. They present a fearsome arsenal for crushing the raider. The main weapons are:

*The me-too defence. An ambitious leveraged recapitalization, entitled me-too or self-help. You set up and float a front company, possibly find a strategic partner (somebody like Telefónica) to buy a large minority stake, and you pump it with €30 billion through bond and bank debt. Then you launch a friendly takeover of Telecom Italia. Olivetti is promising to fill shareholders' wallets with money. Anything Olivetti can do, Telecom can do better.

*A white knight. Several other European telecoms companies might be interested in riding to the rescue in one form or another. A full merger through a cash and stock offer is one option; so is a role through investing in a me-too vehicle. Even a strategic alliance, like AT&T and BT, could be an impressive part of an industrial plan to show the markets.

*A legal Kosovo. A phrase used by one investment banker, another calls it a legal Vietnam; you bomb Olivetti with lawsuits, target every possible point of its bid, and draw it into a quagmire of court cases.

*A Pacman defence. You acquire Olivetti, or perhaps buy a 30% stake, and kill off its predatory ambitions.

*Disposals and payouts. Telecom has plenty of valuable assets it can sell. It can pay the receipts straight to shareholders. The purpose is to cancel out the money that Olivetti is dangling in front of the market.

*A TIM buy-out. You can raise the total value of Telecom by paying cash or stock for the 40% of TIM's equity that Telecom doesn't already own.

*Dry up the loan market. The advisers assume - as Chase did in December - that there's a ceiling in the syndicated loan market. In that case, Olivetti's biggest problem will be finding enough liquidity. So go to banks immediately and soak up $20 billion. Later you can find something useful to do with it, like buying TIM.

*Convert savings shares. Telecom has 2.2 billion non-voting shares. Give them voting rights, and Olivetti confronts more than the 5.3 billion shares it bargained for.

*A special dividend. Unfortunately, there is a legal limit to the cash reserves Telecom can distribute. Because of that, Telecom has to choose between a worthwhile special dividend, or:

*A share buy-back. The maximum allowed is 10% of ordinary shares.

The investment bankers are unprepared for Bernabè's response. He says: "I am not going to do anything I would not have considered in the normal course of business. I want to make a distinction between this highly leveraged, speculative bid, and a solid commercial strategy. Our defence will be our industrial plan."

Bernabè rejects all the options that smack of financial engineering. He hates the nature of Olivetti's bid: it is a leveraged buy-out, reminiscent of the US in the 1980s. And he remembers how LBOs sank companies in America, forcing them to strip to the bone to pay off the cost of having bribed the stock market.

Colaninno might choose to play such a game of financial vandalism. Bernabè has made up his mind not to join him.

Besides, he is confident he has no need to fight fire with fire. Short-termist American investors might succumb to the lure of a leveraged offer, Bernabè tells his advisers, but Italian shareholders see the long-term value in his reforming approach. His commercial strategy will come first. Financial measures will be tailored second.

Bernabè's rejection of the entire financial defence menu provokes an argument that goes around in circles for days. The investment bankers try to convince Bernabè he is wrong. Many feel he is old-fashioned in his ideas about debt. Good financial engineering can also be good commerce.

The defence advisers say many shareholders are telling them Telecom Italia could do with more debt. The healthy pressure would force the management to refocus on its core and most productive business, domestic telephony.

Bernabè believes he does not need pressure from creditors to help him restructure the group. And he is convinced a substantial debt burden could trip up Telecom Italia. The telecommunications business is changing so fast that only the nimble can thrive. Freedom from debts gives you flexibility. Today's fat operating margins won't last, and Telecom Italia will have more strategic options with a clean balance sheet.

Many of the investment bankers camped at Via Flaminia find it hard to gain access to Bernabè after the first meetings. Only Morante of CSFB and Lazard's Braggiotti master the knack of getting impromptu encounters through Mario, the security guard who doubles as cappuccino-fetcher.

A compromise

Over the next three months, Bernabè and especially his chairman, the lawyer Berardino Libonati, will use legal quibbles in public to disrupt Olivetti. They encourage savings shareholders to believe they can sue Olivetti for threatening their dividends. Libonati claims he can't register Olivetti as a Telecom shareholder unless it wins over 50%. Telecom Italia appeals regularly to Consob about technicalities. But Bernabè is clear in his own mind about lawsuits. If he can't beat Olivetti outside a courtroom, he will stop fighting.

Early on, Bernabè asks his investment bankers for their views about the various potential white knights. They go over British Telecom, France Télécom, Deutsche Telekom and Telefónica. But Bernabè doesn't pursue the theme any further.

Nor does he tell the advisers he is already talking to Ron Sommer. The relationship is at a formative stage, and he does not want to be rushed into a marriage by the Olivetti battle. Bernabè wants to see off Colaninno alone if possible, and let commercial rationale dictate the nature and timing of the German alliance.

The defence advisers manage to persuade Bernabè to use only the three weakest pieces of financial engineering they have concocted:

*A stock offer for TIM shares fits Bernabè's industrial plan, as well as raising the capitalization of Telecom. A stock offer rather than cash avoids unnecessary leverage.

*Buying back 10% of shares using reserves is obviously nice for shareholders.

*Converting savings shares to voting capital is clearly a financial gimmick, but at least it doesn't involve leverage.

Thus the discussions between Telecom Italia's management and the advisers end in an awkward compromise. Bernabè's corporate morality and aversion to debt have struck off the spicy dishes on the defence menu. The outcome is a defence plan A, consisting of an industrial reform plan, plus three gambits with Telecom's stock.

On Tuesday morning, three days into the defence teams' conference, Telecom Italia's chief financial officer Fulvio Conti calls in sick. Once it dawns that he has resigned, rumours fly in the advisory camp that Conti has leaked the defence ideas to Mediobanca. "Bullshit," says Conti when asked about this by Euromoney.

In reality, Bernabè has lost trust in Conti. Conti tells Euromoney later he thinks this is because he was never a confidant of Bernabè. "There was no incident or accident." Neither Bernabè nor Conti will say exactly what underlay the resignation.

Gianni Stella from ENI replaces Conti. Stella is a friendly character who sounds as if he's swallowed a megaphone. His English is below the standard of Conti's, and the non-Italian advisers feel their access to the management slip away. Their work goes uncoordinated. "We were four banks with no quarterback," says an American adviser.

Richard Blakesley of Chase observes the frustration getting to Telecom's defenders. He runs into CSFB's David Wheeler at Heathrow airport. Blakesley merrily greets his old friend from Lehman days, but Wheeler pretends to be busy on his mobile phone. Suddenly, Wheeler escapes through a narrow gap in the waiting lounge. There are a lot of bright guys on that defence team, thinks Blakesley. But they haven't been allowed to shine.

A U-turn, and a scandal

From late February to early March, the markets and the media try to assess bidder and target. They are sceptical about Olivetti's chance of winning. Colaninno seems to have an admirably red-blooded plan for Telecom Italia. But the David-versus-Goliath fight just seems overambitious. And the offer price is far too low. By rights, Telecom Italia should be the favourite. It ought to counter-attack vigorously - as its frustrated advisers know it can.

Then there is a U-turn on leverage.

Bernabè presents his industrial plan and his modest three-point financial defence in Europe and north America during mid-March. Telecom Italia shareholders tell Bernabè the share buy-back is fine, and the savings-share conversion - using warrants to create a market conversion rate - is palatable. But the TIM buy-out stinks.

Investors don't want their undervalued stock depressed further by offering it for TIM shares. It would be better to buy the equity with cash. A defence adviser mutters: "We told you so." Bernabè caves in and adopts plan B: the same as before, except cash for TIM shares.

Telecom Italia needs a loan to fund the €23 billion cash offer. The advisers want to take the full amount to the syndicated loan market, where they can create conflict and steal available funds from Olivetti. CSFB and JP Morgan let the bank world know that Telecom is coming with a big loan. They fight to convince banks to hold on to their liquidity.

But Gianni Stella balks at the margin and up-front fees it will take to compete with Olivetti's heavy artillery. Telecom's existing credit lines are much cheaper. The fresh money sought is cut and cut again, until Bernabè plans to solicit a mere €5 billion.

The revised offer for TIM shares puts cash in the hands of investors. The problem is, many of them are the wrong investors. Bernabè needs to match what Olivetti is touting to Telecom Italia shareholders. But the overlap between TIM ownership and Telecom equity is erratic.

Nevertheless, the Telecom camp hopes that defence plan B will finally shift the company's share price up toward the €10 bid level. Bernabè wins board approval for the leveraged purchase of minority TIM shares on Saturday 27 March, and publicly trumpets the offer.

As trading resumes on Monday, the Telecom share price duly rises from an opening level of €9.70. But in the afternoon, the stock falls sharply. A mystery seller is offloading heavily through broker Euromobiliare. Trading in Telecom Italia reaches 55 million shares, 10 times the usual daily volume. The stock finishes two cents below Friday's close. Telecom's investment bankers monitoring the trading are furious.

Behind Euromobiliare there is Lehman Brothers. Behind Lehman, there is Olivetti. On Tuesday, the company's lawyers tell Olivetti to admit it has sold 24.4 million shares in Telecom Italia. Olivetti has made the trade thinking it wouldn't have to disclose the sale. After all, it didn't have to disclose the purchase either, and both trades were below the 2% reporting threshold.

Colaninno is not informed about the sale of shares. Finance head Luciano La Noce orders the sale of a 0.5% stake in Telecom Italia built up in February. La Noce has no compelling reason for selling the shares. It is a convenient way to raise $200 million towards the imminent bill for Olivetti's syndicated loan. For reasons of propriety, Olivetti explains to the angry regulators at Consob, it sold the shares before and not after raising its offer price that Monday evening.

There is uproar among investors at the news that Olivetti's trading has depressed Telecom's stock price. US institutions, with painful memories of Olivetti's past unreliability, call Telecom Italia's investment bankers and complain that Colaninno is an untrustworthy buccaneer.

Colaninno understands the damage that has occurred. He uses his talent for disarming frankness in addressing a meeting of over 100 angry investors in Milan. He offers no ingenious excuses. "It was a great mistake," he simply says. "I beg your forgiveness." But Colaninno can't mollify the entire financial markets in person. For the first time since the takeover contest became public, the momentum swings the way of Franco Bernabè. Olivetti has shot itself in the foot.

Twelve days later, Telecom shoots itself in both feet.

The Turin fiasco

Italy has many beautiful cities. Turin is not one of them. The members of the Olivetti camp find various ways of avoiding the tedious industrial conurbation where Telecom Italia's shareholders are to vote on its defence plan on Saturday April 10.

The DLJ team picks by far the best remote vantage point. They retire to Jim Cantwell's Tuscan villa and try out the wine cellar. They figure if Telecom loses its shareholder vote, they are drinking to celebrate; if Telecom wins, they are drinking to commiserate. In the event, Saturday becomes somewhat hazy. Cantwell and Curran only learn the result when they buy a newspaper in the town square the next morning.

Alessandro Foti of Lehman is left as the token Olivetti banker to observe the farce unfolding in Turin. The lawyer Sergio Erede drags him along. At 9:45am, before the Telecom EGM is due to start, Foti runs into Massimo Perona of JP Morgan, a former colleague at Mediobanca. Perona wears a dark expression. "There's going to be no meeting today," he says.

The previous night, Telecom Italia thought holders of 38% of its equity were planning to attend the meeting. That would be enough to secure the 30% approval of Telecom's defence plan required by the Draghi law. Any less than 35% attendance, however, would be pushing it. A proportion of investors plan to abstain or vote against. Below 33%, the meeting would not even be quorate.

On Saturday at 10am, the investors who have registered at the Lingotto exhibition centre, a former Fiat factory, number only 22%. The investors and Telecom Italia suspect each other of playing games. Investors are hanging about in corridors, waiting to see which way the wind blows, think the Telecom camp. Telecom is bouncing us around between registration desks, think investors: perhaps it's scared of holding the vote.

Many foreign institutions that said they would come to Turin have failed to begin the bureaucratic application process early enough. Some have suffered glitches at their proxy custodian. Other international fund managers did not realize they could vote by proxy. Telecom's advisers have not done enough to whip the shareholders to Turin: even the advisers have differing understandings of the rules.

Many Italian institutions are puzzled by the stance of the Bank of Italy, which owns 2.3%. It reverses its decision to attend, in order not to be seen backing either bidder or defender. But Italian investors take this as a political sign to pull out themselves.

At a quarter to eleven, 45 minutes after the meeting was due, Bernabè gives up. Chairman Libonati declares to the sparsely populated hall that there is no quorum.

The real problem is that Bernabè's defence plan B, including the cash offer for TIM, is merely OK. To convince shareholders to kill Olivetti's bid, Bernabè needed a slamdunk. Or else Bernabè could have threatened to resign unless his plan was approved, topping Colaninno's threat to walk away if the Turin meeting approves the defence. But as things stand, investors decide they like the company in play. Maybe Colaninno can be made to improve his offer; or maybe Bernabè can be forced to show them a plan C.

When shareholders realize what plan C is, they call Bernabè's advisory banks and ask whether they can vote again on plan B.

Deutsche Telecom Italia

Bernabè makes an exception to his rule of doing nothing he wouldn't do under normal conditions: he allows himself to accelerate the Deutsche Telekom link-up. Within days of the Turin disaster, Bernabè draws up a merger with the Germans in a series of one-on-one meetings with Ron Sommer in hotels around Europe.

Telecom's four sets of advisory bankers continue pushing their preferred me-too defence. And they tell Bernabè he can put plan B to shareholders a second time, if he swallows the humiliation of Turin. But on Thursday 15 April, Bernabè tells his bankers: "I've got an idea I've been working on." Most of them are seriously sceptical. Has Goldman Sachs cooked this up, they wonder? Bernabè doesn't ask for their opinion. He tells them to help him finish the project.

The next morning the Financial Times has a scoop: Deutsche Telekom is Telecom Italia's white knight. The source's spin is slightly in favour of Telecom Italia, feel Bernabè's advisers: some think it came from the top. Bernabè denies being the source, or trying to bounce the government into accepting the deal. Others suspect Goldman Sachs. (A senior source at Goldman is adamant that they didn't plant the story.) Telecom Italia's advisers lack a motive, since they are trying to take Bernabè down a different path. The leak proves embarrassing for Bernabè, because he has not yet consulted the government.

On April 22, Sommer and Bernabè take their merger on tour to London. Back in Rome, they work with CSFB, JP Morgan and Goldman Sachs to pinpoint more synergies. Bernabè's bankers are convinced that Sommer cares about size and future leverage. He has offered stock but no cash for Telecom Italia because he wants to keep his powder dry to buy big in the US.

Telecom's defence advisers are surprised at how the usually aloof, rational Bernabè changes character in the company of the charismatic Sommer. After a public presentation the two bosses meet backstage. "Hey, great job, Franco," says Sommer. "Great job, Ron," says Bernabè, and they slap hands in a high-five. CSFB and JP Morgan feel protective towards their man. Sommer has totally seduced Bernabè, they think. And Goldman has played Cupid.

At the treasury in Rome, minister Carlo Azeglio Ciampi sees some merit in the strategic concept of two complementary telecoms firms creating continental synergy. The treasury asks its advisers, NM Rothschild and Morgan Stanley, to assess the merger scheme. Officials are worried about the DaimlerChrysler syndrome: a merger of equals in which the German partner is more equal than the other.

Rothschild and Morgan Stanley have advised the treasury since February, when the intended sale of its Telecom Italia stake suddenly became sensitive. Ciampi's powerful team of reformist technocrats are anxious to handle the takeover contest correctly. They commission reports from the two investment banks on how to behave, and what to make of the actions of Olivetti and Telecom.

Some of these reports also wing their way to Palazzo Chigi, the office of prime minister Massimo D'Alema. He is a more political animal than Ciampi, and is concerned about the problem of Telecom Italia in all its wider aspects. Since its privatization, Telecom Italia's fragmented ownership has contributed to its lack of firm direction, and made it a potential target for a foreigner.

The Italian government can use its golden share to block acquirers. But it would be highly embarrassing to have to veto a company from another European country. And the golden share is under pressure from the European Commission. The Olivetti solution makes sense for D'Alema. His public praise in February for the "courage" of Colaninno's bid still rings in the ears of Italian shareholders.

D'Alema and the more studiously neutral Ciampi can agree on one thing: Deutsche Telekom is a problematic white knight. The German state owns a 72% stake, and would control 40% of the merged company. A top treasury official in Rome is heard to say: "I think we may have the right ingredients but the wrong chef."

The government of chancellor Gerhard Schröder lets the management run Deutsche Telekom. Still, the symbolic foreign renationalization of Italy's biggest listed company is too much for the Italian government to stomach. Probably it would be too much for any government. And probably every European government (except the UK) wants its foremost national assets controlled by domestic companies, over which it has some moral suasion.

D'Alema and Schröder fail to reach agreement on Deutsche Telecom Italia. D'Alema demands that Schröder adopt a deadline for selling the German state's share. Schröder responds that the disposal must depend on the financial markets. D'Alema proposes that both governments create a single, joint golden share in the new company. Schröder cannot accept the renunciation of Germany's ordinary voting rights.

The financial markets are unimpressed with Deutsche Telecom Italia. Two elephants mating, laughs The Wall Street Journal, and everyone joins in. The dilutive nature of Deutsche Telekom's stock offer sinks the value of the bid down to just over €12 per Telecom Italia share. Investors must choose between a politically unlikely €12 deal in late 1999, or an imminent opportunity to sell to Olivetti at €11.50. The market is not wildly exited about either offer.

But the Italian solution is the only one firmly on the table.

The 50% hurdle

The period for accepting Olivetti's offer begins on April 30. Colaninno, his colleagues and bankers wonder how many acceptances they will get. The domestic retail investors who own 34% typically won't tender: it's too complex for them. Italian and foreign institutional investors will act only in the final days. The only guaranteed tenders are from the risk arbitrageurs at investment banks and hedge funds.

The arbs are finding it hard to move into the market. Most of the big investors - those owning over $100 million of Telecom - have held and waited since February. The arbs have tried to pick up shares from small institutions and the retail market. But they are finding it hard to bet on black or red. Italian politics and law are just too complex. DLJ gets questions it can't answer from pleading hedge funds. Will Bernabè take legal action, will the government lift its golden share?

When Olivetti negotiated its giant loan back in March, it agreed to an unpublicized clause. The banks would only guarantee the funds if Olivetti won 67% of Telecom Italia. At that level, Olivetti can force a merger between Telecom and bidding vehicle Tecnost. By early May, Olivetti has lost its confidence that it can win 67%. Suspicion among international investors is bigger than expected. Olivetti's dumping of Telecom shares and the role of the government give many foreign funds the impression of business as usual in Italy.

Colaninno wants to go back to the lending banks and renegotiate the 67% condition. He discusses with his advisers how low they may have to put the hurdle. Chase's Ruth Traugott argues strongly that they can't ask international banks to guarantee funds for a minority takeover. If Olivetti pushes for that, the syndicate will unravel. Olivetti renegotiates the loan: it needs to win 50% plus one share. Acceptances trickle in during the last days of the offer. On Tuesday evening, Olivetti reaches 4.85%. On Wednesday, it has 9.03%. By Thursday, only 19.89%.

On Thursday evening, Credit Suisse lets the world know it is sticking by Bernabè. "Credit Suisse Group believes that there is greater long-term value to be realized from its investment in Telecom Italia than that represented by the Olivetti offer," its statement says. The decision comes from the top: David Mulford, former US treasury secretary and chairman of CSFB International, wants a moral stand, and Credit Suisse chairman Rainer Gut approves it.

On Friday afternoon all the Italian core shareholders, who dominate the board, help pull the rug from under Bernabè. The sale announcements from Unicredito Italiano, the Agnelli family, Generali, and even Bernabè's defence adviser IMI bring many Italian institutional tenders in their wake. Friday's tenders bring the final figure to 51.9%. Colaninno has won, and the financing is watertight.

In the losing camp, the recriminations begin. Market rumours claim that Credit Suisse has already sold out using derivatives. "That's absolute bullshit," says a banker at CSFB. The group sells its holdings in Telecom Italia during the first week after the battle. The CSFB defence advisers are outraged at the core shareholders' sale, although nothing that occurs in Italy surprises Andrea Morante.

Some involved in the takeover battle believe the Italian government has put pressure on the board members to sell to Olivetti. The government, the theory goes, wants a clean outcome, and the board members' 6% stake helps take Olivetti narrowly past the 50% mark.

The flaw in the theory is that at the time they sell, the core shareholders do not know their stakes will be so decisive. They only know that Olivetti has surpassed its 35% minimum, not whether the outcome is heading for 40%, 50%, or 60%. Even at Mediobanca, the score filters through with a long time-lag.

In fact, the Italian core shareholders tender their stakes for a simple reason. None of them originally wanted to be a strategic investor in a telecoms group. They agreed to form a control syndicate in 1997 because the government of Romano Prodi persistently courted them, in the name of the national interest.

Now that D'Alema has replaced Prodi, and has publicly and privately encouraged Colaninno, the core shareholders feel their political reason for sitting on Telecom's board has been undermined. They decide to follow all that's left: their financial interests. Exiting Telecom gives them all a large capital gain.

For one board member there is a further factor. Insurer Generali has an influential 8.5% owner called Mediobanca. "I would not underestimate the fact that Generali could also have some different interests," says a source at another core shareholder.

In the US, board members are expected to assess a bid, recommend a course of action to all shareholders, and stick by their recommendation. Telecom Italia's core shareholders take a more detached approach. They watch where politics and the market are heading, and then assess their interests.

If D'Alema has asked Telecom Italia's control syndicate to tender their stakes, he is pushing at an open door. In fact, a core shareholder speaking under the strictest confidentiality claims that D'Alema has asked the group - the establishment - to remain in the company, to help give pedigree and credibility to Colaninno's rule. "But we're not a telephone company," says the source. "We're not going to stay in to do...what exactly? We wouldn't determine the strategy."

Bernabè reflects

The Telecom Italia board convenes on May 25 at company headquarters in Rome. Franco Bernabè, chairman Berardino Libonati, and the non-executive directors resign with effect from June 28.

Roberto Colaninno turns to shoring up the shareholding of Olivetti against potential raiders, and prepares for the hard work of running Telecom Italia.

"This was our battle to lose," says one of Telecom's advisers. That belief is a motto among the investment bankers who toiled in vain to convince Bernabè to launch an aggressive financial counter-attack. But they also realize why Bernabè's beliefs did not allow him to answer Olivetti's fire with fire.

Some participants in the epic battle think Bernabè should have stuck stubbornly by his principles. Instead, he accepted the weaker of his advisers' financial strategems. Telecom Italia's defence ended up neither fish nor fowl.

Realistically, however, Bernabè would have had to match Olivetti's firepower. A pure industrial defence would have been blown out of the water. Banks and equity investors would have weighed two similar restructuring visions - and gone with the instant profit.

On one of his last days at Via Flaminia, Bernabè ponders his defeat. He recalls his expressed wish to follow only normal commercial behaviour. "Perhaps I should have done something more aggressive. But it's what I would do again."

He smiles when he thinks of his investment bankers, pushing their me-too defence. "My background is in industries that nearly died of debt in the 1980s and 1990s," he says. "I developed antibodies against debt. I didn't want to get involved in that kind of exercise. That's part of the reason why we lost." His instincts grow out of the old industrial Europe, which managers like him have helped to reform.

Bernabè knows that debt can create value for shareholders, especially with today's low interest rates. On the other hand, he argues, Telecom needed to stay flexible amid growing competition. It should have retained a clean balance sheet, to embrace leverage at a commercially driven moment - such as the US acquisition he and Ron Sommer might have made in a few years.

If he had used a leveraged buy-out to stop Colaninno, he feels he would have put a straitjacket on Telecom Italia, leaving it struggling to cope with the coming change in the telecoms business.

"I'm happy not to have done it," says Bernabè. "To bear the responsibility of having seriously damaged the growth potential of the company would have been a too-heavy burden. I moved out of ENI because I wanted to get into a sector that had growth potential. To get back into a situation created by myself..."

"I think Colaninno did a good deal, because he got the company at a good price." With those words for the victor hanging in the air, he says goodbye. Bernabè walks down the main staircase of Telecom Italia's sleek, modernist head office. Outside, the rain begins to fall on Rome.