PARMALAT How the Milk Spilled

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Authors: Abdul Khader, Sanjib Datta,
Faculty Associate, Faculty Member
ICMR (IBS Center for Management Research).

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Snowballing Scandal

2003 was a tough year for Parmalat. The problems which hounded the company since the early-2000s came to a head at the end of 2003, and Parmalat all but collapsed under the strain.

For over a year before the scandal erupted, analysts had been expressing doubts about the inordinately high levels of debt the company raised from the market, despite showing high reserves of cash in its financial statements. Analysts were also concerned about the pattern the company adopted in investing its surplus funds, often choosing little known overseas funds in which to invest surplus resources. In late-2002, Joanna Speed (Speed), an analyst at well known investment firm Merrill Lynch, prepared an eighteen page report on Parmalat, in which she laid out in lucid terms why she felt investors should steer clear of the company's stocks." The key issue which continues to perplex us is why the group (Parmalat) continues to tap the market for relatively small, yet often quite complex debt issues, when its cash pile continues to rise,"¹ wrote Speed.

On the basis of this report, Merrill Lynch advised its investors to sell Parmalat stocks. "We consider that management's regular tinkering with the balance sheet to little obvious benefit of the group undermines investor confidence and overhangs the share price," said the report.²

As the effects of the report gained in momentum, several other analysts also became skeptical about Parmalat's financial systems. Rumors began circulating in financial circles about the company's opaque financial systems and its high levels of debt. Consob, the regulatory authority in Italy also initiated an inquiry into Parmalat's annual statements, and asked the company to submit the work done by its auditors in 2002, for verification. The company's credit rating was also slashed by Standard and Poor after the auditors, Deloitte and Touche expressed doubts about its investment of €500 million in an unlisted mutual fund called Epicurum, based in the Cayman Islands, a well known tax haven.

The controversy erupted with full force in early December 2003, when Parmalat found itself unable to muster the resources to honor a €150 million bond payment that had become due. Considering the cash reserves the company claimed to have €150 million was a meager amount and it surprised analysts that it was not in a position to raise the amount. However, company officials announced that it was only a temporary liquidity problem that would blow over. Parmalat also announced that it was unable to withdraw funds from Epicurum, and hence the problem. It requested its banks to help it resolve the liquidity crisis.

Very soon after this, however, Tanzi admitted that the accounts of the Parmalat group were not accurate and that the books had been cooked. On this admission, the company's banks immediately appointed Enrico Bondi, a well known turnaround expert in Italy as a consultant. Later Tanzi resigned and Bondi took over the company in an executive capacity.

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1] uk.biz.yahoo.com
2] uk.biz.yahoo.com