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What does the return of the brash media magnate mean for Western Europe’s lovely, sick traviata?

by Carlo Svaluto Moreolo

International bewilderment accompanied the verdict of the Italian general election, held 13-14 April, which confirmed Silvio Berlusconi would head the country’s executive for the third time in 14 years.

Berlusconi’s first term from 1994-95 lasted less than a year due to his shaky centre-right coalition. On his return he kept his backers happy from 2001-06.

Now Italians, bored after two years of a centre-left government lacking unity and credibility, have awarded the 71-year old media magnate, and the country’s richest man, a much stronger majority. This despite his repeated court appearances on corruption charges, which make many see him as unsuitable for leading the country’s much-needed reforms.

For the first time in the republic’s history, only six parties are represented in parliament. The strong majority of the three that form the right-wing coalition should enable laws to pass more quickly than in previous Italian governments.

What does this controversial comeback mean for the country’s investment panorama? Little, if the behaviour of the Milan Stock Exchange is to be trusted. Italian indices hardly moved when the election result was confirmed on Monday 14 April.

Limited powers

With its muted reaction, the market recognised Berlusconi has limited power to change the economy, which has stagnated for the past decade or so, by reducing taxes and engaging with unions and trade associations. A looming European recession led even this proponent of spectacular but unlikely promises, to note that high tax rates will hardly fall, albeit they won’t rise.

However, the Milan stock market, 13th in the world by market capitalisation, reserves some positive surprises as we head to a general recovery of global equities. First, the tie-up of Borsa Italiana with the London Stock Exchange last October, will make the Milan market more efficient in terms of costs, says Marco Opipari, head of Dresdner Kleinwort’s Italian mid-small caps research team, based in Milan.

Strength of finance

But most importantly, Opipari believes the Italian financial sector is in better shape compared with other countries in Europe. Italian indices have underperformed European peers but this is because of the indices’ weighting on financials, but the sell-off of banking and insurance stocks is overdone, Opipari says, as Italian banks’ balance sheets are more secure.

‘The Italian banking sector doesn’t have the same problems as other European banks,’ Opipari says, as the banks haven’t had to re-evaluate their balance sheets after the collapse of large portfolios of dodgy assets. Italians have been encouraged to borrow more in recent years as UK citizens have, but this hasn’t changed a conservative attitude to lending by Italian banks.

Also, Italy’s banking sector has recently undergone a wave of consolidation that has created important synergies, Opipari points out. Starting with the merger of large caps Banca Intesa and Sanpaolo 18 months ago, other smaller banks have merged to find the benefits of cost savings and synergies. Opipari says: ‘The benefits of these synergies have yet to be reflected by earnings in many cases’, which means there is scope for a rerating of many banking shares.

Another attraction is that Milan has one of the highest average dividend yields in Europe – more than 5% after last year’s share price falls. In a few cases, such as Telecom Italia, dividends were cut after a commitment to too high a payout, but this is an isolated example, says Opipari.

Telecom Italia’s history embodies another stigma attached particularly to family-related business in Italy: complex ownership structures that via layers of holding companies allow families control without putting too much capital at stake.

This can scare away investors who are not keen to buy smaller stakes that are ‘second-tier’ compared with those of holding companies. In the case of Telecom Italia, dividends were used to finance a holding company’s difficult debt position.

Again, such family ownership is not the norm, says Opipari. As well as financial services, where consolidation should continue and its benefits feed through, his team of analysts is positive on Italy’s largely publicly owned utility companies.

On a macro-economic level, whatever Berlusconi does, the country faces a similar destiny to its European peers, with a strong Euro making exports difficult. However, the stock market is braced for a fast recovery, should global equities rebound in the coming months.