Would-be Eircom owners will want healthy return

The Republic has recorded a number of notable telecommunications firsts, not least the landing of the first transatlantic phone line at Valentia in Kerry. The consortium of private equity funds of the same name is set to record another first if their soon-to-be recommended €2.8 billion (£2.2 billion) bid for Eircom is successful.

If it goes through, the Republic will be the only EU member-state whose national telecommunications system is owned by US-leveraged buyout houses. The other 14 EU incumbents are either still owned fully, or in part, by their respective governments or listed on a stock market.

When the Government decided to sell its entire shareholding in Eircom just over two years ago, there was a certain amount of surprise as it was felt it would retain a stake for strategic reasons. Given the emphasis that the Government was putting on the Republic as a centre for e-business and high technology, it made sense to retain some control over the main platform where such advances would be delivered.

The decision not to retain a golden share or shareholding was taken in light of the huge - and subsequently unjustified - valuation put on Eircom by the stock market. The Government argued that the existence of a strong and independent Office of the Director of Telecommunications Regulation would ensure that the national interest was protected, even if the Government gave up its direct influence over Eircom.

The Government also appointed a new board just prior to the flotation. It was chaired by Mr Ray MacSharry, the former Fianna Fail finance minister and European commissioner. Mr Dick Spring, the former Labour Party leader, was also appointed as a nominee of the Employee Share Ownership Trust (ESOT). The combination of well-respected businessmen and politically connected figures that made up the board was seen as an important safeguard.

The Government also took comfort from the fact that Eircom was listed on three heavily regulated stock markets - Dublin, London and New York. The company was obliged to publish comprehensive financial information, and be open about its plans and problems. The splitting-up of Eircom into its mobile and non-mobile divisions, and their sale to Vodafone and Valentia, has removed the second two safeguards, although Vodafone is quoted on the London and New York exchanges.

Valentia is a private company and has started as it means to go on. The consortium has not disclosed the size of the stake that will be held by non-executive chairman Sir Anthony O'Reilly or the four investment funds that are behind the leveraged buyout. The group has also indicated that it does not believe that it has to disclose Sir Anthony's stake, despite his potential conflicts of interest due to his role as chairman and largest shareholder of Independent News & Media.

Sir Anthony's stake is reported in his own papers to be less than 5 per cent and will be dwarfed by the 70 per cent held by the three buyout funds and US bank Goldman Sachs. The remaining 25 per cent will be owned by the ESOT.

The three funds and Goldman Sachs are all expected to hold roughly the same size stakes but one in particular, Providence Equity Partners, seems to have been the prime mover in the takeover bids.

Rhode Island-based Providence describes itself in the following terms: "Our objective is to create value by building lasting partnerships with talented entrepreneurs and by providing them with the capital, industry expertise and broad network of relationships necessary to build companies that will shape the future of the communications and media industries."

The last part may not sound like the Eircom that most of its customers know but there is little doubt that Mr John Hahn, the joint managing director of Providence's London office, thinks Eircom is a good buy. Along with the 21 other investment professionals who work at Providence he will be putting up some of his own money to finance the deal.

The leveraged nature of the takeover means that the buyers only have to put up about around €800 million of the €2.8 million purchase price. The remainder will be borrowed from the banks, secured on the assets of Eircom and paid back out of profits.

The partners in Providence will not be putting up the full amount of their share of the €800 million. Most of it will come from a $2.8-billion (€3.3 billion) investment fund managed by Providence, called Providence Equity Partners IV. The source of the money in the fund is wealthy individuals and institutional investors who are happy to let Providence invest on their behalf, provided they generate above-average returns.

Mr Hahn, who is on the Valentia board, was previously the head of the London-based telecommunications investment group at US bank Morgan Stanley. He gained some prominence as one of the main advisers to German telecoms group Mannesman on its ultimately unsuccessful defence against Vodafone's takeover bid last year.

Providence's other investments include American Cellular, which operates mobile systems in the rural midwest and eastern United States. It also invested in Western Wireless, a leading provider of mobile communications in the western United States, which is the main shareholder in Meteor, the third Irish mobile operator.

Warburg Pincus, one of the other funds buying Eircom, is organised along similar lines. Based in New York, it has raised and managed nine private equity funds totalling $13.8 billion since 1971.

The company has a strategic link to Credit Suisse, the large Swiss bank group, but is owned by 50 or so partners who will all participate in the Eircom deal along with its managed investment funds.

Every three months, the partners meet in New York to review their global portfolio and Eircom will be on the agenda from now on. The man who will be briefing them is Mr Roberto Italia, the group's representative on the board of Valentia.

Mr Italia (34) joined the company in 1994 having previously worked in international business development with Telecom Italia. Warburg Pincus also describes itself as taking an active role in building businesses. It likes to be in charge, pointing out that it tends to originate most of the deals it gets involved in and is nearly always the largest shareholder.

Its portfolio of investments includes several US telecoms companies and Bharti Telecom in India.

The third fund involved in the buyout is Soros Private Equity Partners, which is represented on the Valentia board by Mr Ramez Sousou, who is the partner in charge of its London office. A former director of Goldman Sachs Private Equity, Mr Sousou, originally from Jordan, established the British office in 1999.

Soros Private Equity is an affiliate of Soros Fund Management, which runs the famous Quantum funds. The principle of Soros Fund Management is Mr George Soros, the Hungarian-born financier turned philanthropist. The private equity group invests on behalf of the Quantum funds and other backers.

It has already invested in Meteor along with Western Wireless. Other companies in its portfolio include Storm Telecommunications, a pan-European phone company. The final member of the quartet is US bank Goldman Sachs, whose European operation is headed by Mr Peter Sutherland, the former Irish attorney general and European commissioner. It will invest via its private equity fund, GS Capital Partners 2000, and will also be involved in raising the €2 billion debt package.

All four have much the same agenda. They need to get a return on their investment in Eircom that will justify their backers' faith in them. By their standards, an annual return of 20 per cent on the amount of capital invested is not unusual. This is not far off the earnings before interest, tax, depreciation and amortisation of the fixedline business, which was €537 million last year. It is significantly ahead of the operating profit of €181 million, indicating that the new owners will have to sweat the assets of Eircom hard.

If the buyout funds try to squeeze too much out of Eircom, they are bound to come into conflict with the ESOT, which despite its new-found enthusiasm for leveraged buyouts, is controlled by the company's unions.

Where the equity investors and the ESOT have found common ground is in the need to grow the business. The big pay day for Providence and its fellow travellers will come when they exit from their investment, either via a sale or another stock market flotation, which could be expected in three to five years.

Managing the business in a way that maximises its resale value while generating above average returns for investors is not a plan that automatically fits with the Government's aim of making the Republic a world leader in telecommunications based industries.