Investor outrage over recent deals has forced Italy’s legislators and top regulator to reexamine M&A rules favoring a powerful corporate clique. Don,t expect changes to happen overnight.
By David Lanchner
November 2001
Institutional Investor Magazine
Three of Italy’s leading companies , conglomerate Montedison, insurer La Fondiaria Assicurazioni and Telecom Italia , changed hands this summer. For certain of their shareholders, the transactions were cause to celebrate. Telecom Italia CEO Roberto Colaninno, for instance, pocketed an 80 percent premium on his TI shares. But for other, smaller shareholders, the sales offered no occasion for hoisting a glass of spumante. Not only did these investors not receive any premium, but many saw the value of their TI stocks tumble.
In Italy, said the late Enrico Cuccia, “shares are weighed rather than counted.” What the legendary chairman of merchant bank Mediobanca meant was that some shareholders are more equal than others. Acquirers seeking to take over a company aren,t required by law to bid for all of its shares, provided they go after a stake of less than 30 percent , which in Italy is usually more than enough to ensure control. Telecom Italia, for example, is now controlled by tire manufacturer Pirelli and the Benetton family, whose total holdings amount to just 29 percent.
One result of this cozy arrangement is that in takeovers Italian-style, select shareholders receive a premium while minority shareholders typically get the shaft. “Everyone knows that in Italy minority shareholders are less protected than almost anywhere else in the world,” says Guido Rossi, a Milanese corporate lawyer who headed Italy’s chief financial regulator, Commissione Nazionale per le Società e la Borsa, or Consob, in the early 1980s.
But now shareholder outrage over this entrenched class system has been ratcheted up by last summer,s highly visible deals. “These episodes are infuriating,” says Giordano Martinelli, a fund manager at Anima in Milan, who owns shares in La Fondiaria and Pirelli. “Everything being equal, I will usually buy a foreign company over an Italian company. There is less chance of my being penalized for being a small shareholder.”
Responding to shareholder wrath, regulators and politicians have pledged to reexamine Italy’s takeover law. The chairman of Parliament’s finance committee and president of Italy’s tiny but influential Partito Repubblicano Italiano, Giorgio La Malfa, was to hold hearings in November. “The recent controversies surrounding Telecom Italia, Montedison and La Fondiaria mean it is important that we take a close look at our takeover law,” he says.
Consob, meanwhile, surprised the markets by challenging La Fondiaria’s hastily conceived sale to fellow insurer Società Assicuratrice Industriale. Consob chief Luigi Spaventa says the decision sends a clear message that minority investors should be treated fairly. Maurizio Lualdi, who monitors the Italian market from London for Credit Suisse First Boston, says the Consob action “could fundamentally change the rules in Italy.”
Conceivably, Italy’s put-upon minority shareholders will enjoy actual reforms, such as a reduction in the 30 percent threshold at which an acquirer must bid for all of a company’s shares. But even backers of a more equitable system are skeptical, since the current one serves the needs of Italy’s business elite so well and may , some claim , even be beneficial for the economy, especially at a time of global financial stress. “I doubt any change will be enacted soon,” says Alberto Montanari, a Milan-based shareholder-rights lawyer.
All the same, the clamor for shareholder rights opens a revealing window into the workings of Italian capitalism that may in time spur sweeping changes under European Union prodding. As it is, the system allows the country’s wealthiest dynasties , the Agnellis, the Pirellis and, lately, the Benettons , to swap companies among themselves as though they were scopa cards, with scant regard for minority shareholders. Often this has occurred through the intermediation of Mediobanca, a wheeler and dealer in its own right via vast business holdings. Through cross-shareholding and furtive side agreements with other sizable shareholders, these powerful and secretive investors have been able to exert disproportionate sway over a wide swath of Italian industry, even though they sometimes own less than 10 percent of any given company’s shares.
Critics charge that the convoluted deal making involved is aimed more at preserving or expanding the power of these vested interests than it is at creating or sustaining healthy businesses. But many politicians and regulators contend that in sanctioning the existing regime, they are enabling entrepreneurs and midsize businesses with limited funds to buy or sell companies. Thus, they argue, the system facilitates the transfer of faltering companies into stronger hands and promotes combinations that achieve synergy , all at a reasonable price. Notes Consob’s Spaventa, “Very few entities have the means to bid for 100 percent of major blue-chip companies in Italy.”
This summer’s trio of high-profile takeovers illustrates the power of privileged interests and the impotency of minority shareholders, not to mention the ingenuity of deal makers. In the case of Telecom Italia, Pirelli and its CEO, Marco Tronchetti Provera, along with the Benetton clan, used a holding company called Olimpia to buy a 27 percent stake in Olivetti from another holding company, Bell, which was owned by Telecom Italia CEO Colaninno and his partners. Olimpia, in league with a variety of Italian banks, insurers and other companies, now controls Olivetti, the onetime typewriter company, whose only major asset is a 55 percent stake in TI.
Had the threshold for launching a full bid been, say, 20 percent instead of 30 percent, Pirelli,s Tronchetti Provera and his confreres would have been forced to buy all of the outstanding shares not only of Olivetti and Telecom Italia but also of TI’s listed subsidiaries, Telecom Italia Mobile and Internet service provider Seat Pagine Gialle. The combined market value of all these enterprises at the time of the bid was more than E100 billion ($89.3 billion). Yet Olimpia, the deal vehicle for Pirelli, the Benettons and Trochetti Provera, was able to circuitously take control of Telecom Italia by paying just E7 billion. TI’s Colaninno and a select few other shareholders did quite nicely for themselves. As for minority shareholders, they were out of luck.
The Montedison deal, on the other hand, did provide minority shareholders with a windfall. In May Electricité de France acquired a 20 percent stake in the Italian company and appeared ready to assume control, in partnership with French financier and steel magnate Roman Zaleski, who already held a 15 percent stake. But then the Italian government stepped in.
Uneasy that Montedison was about to be bought by a French government utility, Italy’s Parliament passed a controversial decree that limited EDF’s voting rights in Montedison to 2 percent. The politicians also made clear to EDF that an Italian partner with a larger stake in Montedison was necessary for the deal to be acceptable. So EDF teamed up with Fiat, easing politicians, qualms. Counting the automaker’s stake and the other partners, shareholdings, the EDF group controlled 52 percent of Montedison , well above the 30 percent threshold. Thus the holding company they formed to take over Montedison had to make a full takeover bid.
Minority shareholders reaped a 30 percent premium. Just the same, some were upset, says CSFB’s Lualdi, because they felt that “the premium might well have been higher if EDF had been forced to launch the full takeover bid earlier.” What’s more, the analyst says, “no one knows what the early sellers got,” though it was understood to be a lot.
In typical Italian fashion, the La Fondiaria and Montedison deals were intertwined, and Mediobanca was in the middle. Montedison, controlled by Mediobanca, sold a 29 percent stake in La Fondiaria, its insurance affiliate, to a rival insurer, Società Assicuratrice Industriale, in which Mediobanca also held a stake. This enabled the bank to maintain nominal control of all parties. The price paid , L2 trillion ($952 million) , represented a 50 percent premium to the shares, market price. But again, minority shareholders were left out in the cold.
Italy has attempted to crack down on shareholder rights abuses before. In 1992 the country adopted a law stipulating that any would-be acquirer of a company that sought to own more than 50 percent of its outstanding shares had to bid for all of the company,s shares. But in reality, few buyers needed that many shares of a company to gain control, so the rule was rarely triggered.
Parliament, meanwhile, had instructed Consob to establish the level of share ownership that would constitute control company-by-company, based on the size of the biggest shareholders, stakes. The idea was that if an acquirer bought more than the Consob-set threshold, which was updated yearly, in its bid to wield control, it would have to offer to buy a like amount from other shareholders. Thus if an acquirer bought 10 percent of a company’s shares to gain control, it was compelled to buy another 10 percent from other shareholders , though not necessarily at the same price.
The worthy, if muddled, objective was to provide partial compensation to at least some minority shareholders. But the result of this exercise in market manipulation was a bizarre three-tiered system: Large shareholders , the ones selling the prized shares needed to gain control , often walked away with large premiums, while a small percentage of investors in the never-never land between control and the legal threshold pocketed a more modest premium, and the vast majority of shareholders got nothing.
The government didn,t get around to introducing an updated takeover code , the Draghi Law , until 1998. Its namesake, Mario Draghi, who stepped down on October 1 after ten years as Italy’s Treasury chief, modeled the law on the U.K.'s merger code. In particular, he borrowed the 30 percent threshold for triggering an offering to all shareholders. “Before that there was no realistic threshold that triggered a full takeover bid,” says Draghi. “The new law was intended to make sure minority investors also profited from changes in control.”
But even Draghi concedes it hasn,t always worked that way. “A major part of the problem is Italy’s lack of an evolved shareholder culture,” the ex,Treasury head says. “Individual and institutional shareholders rarely attend shareholder meetings in Italy, and when they do, they almost never speak out. This means companies can usually be controlled with stakes of well under 30 percent. A 10 percent stake usually amounts to more than a third of the shares represented at any given shareholder meeting, which is enough for a blocking minority.”
Draghi underestimated the resourcefulness of Italy,s corporate barons, who,ve become adept at stopping just short of the 30 percent level that would compel them to extend a general offer to shareholders. Instead, they negotiate busily with one another over mutual shareholdings to protect their positions and maintain control. The resulting relationships can be as tangled as a plate of pasta.
Italian lawmakers, in drafting the Draghi Law, also failed to put into place British-style safeguards. For example, U.K. regulators have broad powers to thwart investors acting in concert to achieve control while each individually remains safely below the trigger point. “This is the real weakness of our law,” says Draghi. “Like the British, we need a rule that allows our regulators to ascertain concerted action from the behavior of the interested parties. That kind of broad regulatory power was part of my original ,98 draft law, but it was changed into a restrictive definition by Parliament.”
Will La Malfa’s hearings produce a tougher Italian takeover code? Don,t bet your shares on it. For a start, the legislator is hardly a disinterested observer. His center-right PRI party has close ties to Mediobanca. His father Ugo, the party’s co-founder, was a colleague of Cuccia’s at Banca Commerciale Italiana before World War II and became one of his close friends. La Malfa himself worked for Cuccia while studying law at the Università degli Studi di Pavia, and his first job was helping to set up Mediobanca,s equity research department. “Our family was always close to Enrico Cuccia,” acknowledges the legislator, 62.
“Traditionally, our party carries a larger weight than our [two Parliament members] indicate. We have very good connections within financial circles,” La Malfa told Institutional Investor during an interview in his Parliamentary suite in the 17th-century Palazzo Montecitorio. As a committee chairman and a member of conservative Prime Minister Silvio Berlusconi,s powerful Forza Italia coalition, La Malfa will have considerable control over the hearings.
But La Malfa’s political leanings and family connections make many observers suspicious. As one senior government official says: “I doubt that anything positive for shareholders will come out of these hearings. La Malfa’s sympathies are with the powers that be, not minority shareholders.”
Nonetheless, La Malfa insists that he will seriously consider a lower threshold amount. “Obviously, the most important question we are going to be looking at is the protection of minority shareholders and when a company should be compelled to offer a full takeover bid,” he says. “But the problem with lowering the 30 percent threshold is that you would go a long way toward freezing takeover activity and thus the rationalization of industry in Italy. This is a very delicate question.”
La Malfa’s committee is expected to issue its recommendations in late January, at which point he or another legislator or the Berlusconi administration may propose overhauling the Draghi Law. The ensuing debate could last for months. “It could take us a year to actually make any changes to the law,” admits La Malfa.
Before he makes any decision on the 30 percent trigger, La Malfa says he wants to hear from “the experts,” that is, mostly regulators and civil servants like Consob’s Spaventa and Draghi’s successor at the Treasury, Domenico Siniscalco. But when pressed, he makes it quite clear that he doesn,t think much needs to be done. “My initial view is that if you lower the threshold, then you make it very difficult for companies to change hands,” La Malfa asserts again. “I would not be in favor of lowering it too much.”
To be sure, even the most vociferous critics of Italian shareholder rights practices concede that legal changes alone wouldn,t be enough to bring about reforms , and may not even be necessary. They point out that Italy’s minority shareholders are partly at fault because they,ve tended to be lax about attending annual meetings. And when they do vote, they tend to allow banks , many of them aligned with the dominant corporate interests , to do it for them by proxy. “The real problem is not Italy’s laws,” says Elena Tedesco, an analyst at Brussels-based shareholder rights consulting firm, Déminor. “It is a result of the country’s weak shareholder culture and a small business elite that has traditionally dominated the equity market.”
The remedy may be time, suggests Draghi. “We are just starting to have big funds here, but the managers don,t yet have the same culture” as the U.S. or the U.K., he says. “Eventually, they will realize that they can improve their returns by taking a more active approach to their investments.”
Pirelli’s Tronchetti Provera conceded, in an August interview with Italy’s Corriere della Serra, that what had allowed him to win control of Telecom Italia so easily was his country’s lack of independent-minded fund managers. He noted that under similar circumstances in the U.K., institutional investors probably would have called a shareholder meeting and assembled sufficient votes to block a partial takeover. But Tronchetti Provera clearly believes that Italian investors, apathy is better than activists, demands for equal treatment. “I,d like to remind people,” he told the Italian daily, “that [the U.K.] has an excellent financial market, but it has lost its industries.”
Consob’s SAI inquiry could carry more weight than La Malfa’s hearings. The regulator’s argument revolves around the insurers, cross-shareholdings, according to one government source. La Fondiaria and SAI owned, respectively, 2 percent and 2.7 percent in one another even before Montedison sold out to SAI (to stay below Italy’s 30 percent bid threshold, SAI had to promise to sell its 2.7 percent stake in La Fondiaria as part of the deal). Under Italian law companies having such cross-shareholdings can only vote up to 2 percent of the other company’s shares, no matter what the size of their holdings. The idea is to thwart the formation of trusts. So to have sway over events at La Fondiaria, SAI must rely on the votes of Mediobanca, which owns 13.7 percent of the insurer, as well as a small stake in SAI.
“It seems fairly obvious that SAI purchased 29 percent of La Fondiaria and paid a huge premium, relying on the fact that, at least initially, La Fondiaria would continue to be controlled by Mediobanca on behalf of and in the interest of SAI,” says one government source. Of course, if some company other than SAI had bought La Fondiaria, Mediobanca would have seen its influence over the insurer diminish, something the bank wanted to avoid.
Consob essentially alleges that SAI, because of its restrictive cross-shareholding arrangement with La Fondiaria, must have had an implicit shareholder pact with La Fondiaria investor Mediobanca that gave the bank and SAI effective control of more than the critical 30 percent of La Fondiaria. “Usually, it is very difficult to prove that investors have an implicit shareholder pact,” says Consob’s Spaventa. “In this case, we had reasons to convince us that we could maintain that this was an agreement between shareholders.” (The regulator is not allowed to discuss details of a pending case.)
If Consob prevails and Mediobanca and SAI lose, the companies may be forced to make a L3.2 trillion bid for the 57.5 percent of La Fondiaria that they don,t already own, or dispose of the stake and pay Montedison a L499.6 billion breakup fee.
Consob’s ultimate ruling could mean that “in the future, if you want to go for a company, you may have to buy the whole thing,” speculates CSFB’s Lualdi. SAI is appealing the finding to the regulator, which was expected to either rescind or ratify its decision early this month.
Although Consob’s bold decision to challenge the SAI,La Fondiaria deal heartened many skeptics, they are likely to be troubled by Consob chief Spaventa,s position that the SAI ruling does not in fact signal an aggressive new enforcement stance. Bankers and executives rushing to craft the last-minute SAI,La Fondiaria marriage may simply have made a mistake in not unraveling the original cross-shareholding, giving Consob a rare opening to challenge a deal. “Consob is likely to stick to its guns, but SAI-Fondiaria was sloppily done,” says shareholder rights lawyer Montanari. Consob would not have a case, he contends, if La Fondiaria’s share in SAI had been disposed of earlier. “In the future, transactions like SAI-Fondiaria will simply be better designed,” suggests Montanari.
SAI and Mediobanca may prevail in any case. The insurer can challenge Consob’s decision in court, and given the absence in Italy’s takeover law of a definition of “shareholder agreement,” the regulator,s ruling could be overturned, according to analysts. If that happens, one very small consolation prize for minority shareholders could be a workable definition of a shareholder pact. Italy’s insurance regulator also has to approve the deal.
Legislator La Malfa has made little secret of his leanings. “When a pact is unwritten or tacit, it is disquieting to me that Consob has the discretionary power to decide that the threshold requiring a full bid has been breached,” he says. “In a country like Italy that does not have strong pension funds, groups of entrepreneurs can be an element of sound financial stability at companies.” His hearings will most likely question whether Consob had any right to challenge the SAI,La Fondiaria union.
The Berlusconi government supported the Pirelli bid for TI and Fiat’s inclusion in the Montedison group, and it isn,t likely to back any potentially disruptive takeover-law amendments while Italy’s economy is weakening and its markets falling. Why upset the country’s most prominent economic interests? After all, their votes aren,t just counted , they,re weighed.
