PARMALAT

How the Milk Spilled

 

Parmalat was a highly successful food company - that was until it entered bankruptcy
protection in 2003. Investigations revealed that, for years the company had been using
false accounting and complicated financial systems to create a picture of financial
health, misleading investors and analysts alike.

In late-2003, when news broke out that Parmalat, one of the biggest and most
successful companies of Italy had used fraudulent accounting for well over a decade and
a half to hide its real financial position, people were only mildly surprised. After all,
accounting scandals had almost become a trend of the times.

It all started with Enron, the American energy giant which broke down in 2001 following
revelations that the company's huge success in a very short time had its roots in posting
inflated profits and using complicated financial transactions to hide debts. The Enron
fiasco led to lifting the veil on another American company, WorldCom, which eventually
acquired the dubious distinction of being the biggest bankruptcy ever witnessed in
business. While America was still reeling with the shock of the bankruptcy of two of its
bigger companies, Europe did not lag behind. So while the US got Enron, WorldCom and
several other big names, Europe responded with Ahold and Vivendi. Parmalat, though a
big blow to Italy, was just another company added to the already long list of fraudulent
companies and did not stir people too much.

Some analysts commented that accounting scandals were to the 2000s as

environmentalism and sexual discrimination were to the 1990s. In other words, they
were the most discussed and analyzed of all corporate activities. So common had they
become that some business schools even introduced ethics courses for their
accountancy students.

Parmalat, set up by Calisto Tanzi (Tanzi) in the 1960s, was a food company with a
global presence. From milk to yoghurt, to juices and biscuits, it seemed impossible to
eat or drink something without Parmalat having a presence in that category. The
splashing milk drop logo of the company was one of the best recognized corporate
symbols and the company seemed to stand for all that was good and healthy. That was,
until the events of 2003 proved that behind the façade of goodness and health was an
unhealthy penchant for complicated financial structures that milked the publicly held
Parmalat Group to keep the Tanzi family companies running.

Tanzi was well known in Italy as a devout and sober person. He and his family were
never ostentatious in the display of their wealth and were regular contributors' to
charity. It seems ironical that the same Tanzi was languishing in prison for committing a
fraud involving billions of euros.

THE ORIGINS

Tanzi was a young man of 22, when he inherited the family business that was started by
his grandfather. "Tanzi Calisto e Figli - Salumi e Conserve" (Tanzi Calisto & Sons - Cold
Cuts and Preserves), produced processed foods like seasoned ham, cured meat and
tinned tomatoes. Tanzi, who had a strong entrepreneurial streak, was not satisfied with
simply running the family business and decided that he wanted to explore new products
and markets to help the business grow. On a trip to Switzerland, he noticed a carton of
milk on a super market shelf and decided that the route to success was through milk. He
set up a pasteurization plant near Parma to produce milk and sell in the areas
surrounding the town.

In 1963, the name 'Parmalat' was given to the company and the milk was also marketed
under the same name. (Parmalat meant 'milk from Parma', latte being the Italian for
milk. Parma was well known as a center for culinary excellence in Italy, and Tanzi
capitalized on this reputation). Parmalat was the first branded milk to be produced in
Italy and became hugely successful. Over the years, the company expanded operations
to other areas of Italy, and Parmalat soon became a national brand.

Tanzi's commitment to innovation and marketing contributed to the company's success.

Parmalat was the first milk processing company to package its milk in a tetrahedron
shaped carton called 'Tetra Pak' and use the Ultra High Treatment technique in the
production of milk. Tanzi's innovativeness considerably increased the shelf life of milk
and Parmalat became well known for its long life milk. The company was also one of the
earliest to use sports persons to endorse its milk, earning it global recognition as the
'milk of champions'.

Over the years, Parmalat diversified into a variety of other products like yoghurt,
vegetable sauces, fruit juices, baking products, soups and mineral water. In the 1980s,
the company expanded rapidly and entered several other countries around the world. In
1990, to raise the money to support its rapid expansion, the Tanzi family gave up 49
percent of their stake in the company and Parmalat was floated on the Milan Stock
Exchange. By the early 2000s, the small company from Parma had become a global food
empire spanning 30 countries and employing over 35,000 people.

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.

For all Bondi's skill turning around hopeless cases, Parmalat is likely to prove a
monumental challenge. His biggest challenge would be to unravel the Byzantine
financial systems, involving several overseas subsidiaries and accounts in banks around
the world. This itself, was likely to take a number of months, considering the
complications that arose as investigations proceeded. Then he would have to devise a
suitable plan to help put the company back on its feet.
As the investigation deepened, it became clearer that the complicated systems of
accounting were created quite deliberately by company officials and that they been
operational for well over 15 years, since the late-1980s. The company used a
complicated system of bond and derivative deals to transfer amounts between its
different subsidiaries around the world to create a picture of financial health for the
entire group. It had a regular system for creating false accounts and exercised it four
times a year, when the quarterly results were announced. In fact, a subsidiary called
Bonlat was created in the Cayman Islands, specifically to act as a routing agency for all
overseas transactions of the company.

Most of the money went from Parmalat to other overseas subsidiaries that were
operating poorly or to Tanzi family businesses and Bonlat acted as an intermediary in
the transactions. It was said that Tanzi issued directions to officials at Parmalat that
money be sent through bank transfers to companies owned by him or his family, or to
other subsidiaries of Parmalat. The amount so transferred would be accounted for as a
credit owed to Parmalat from the other companies. Most of the amounts however, were
book entries and created huge assets for Parmalat, even when no money actually
existed. The balance sheets of the subsidiaries were then adjusted to make sense of the
group's overall financial position, and then reported as audited numbers. The company
used complex derivative transactions (many of which defied the comprehension of
specialist investigators after the scandal broke), to aid these transfers and cover huge
group debts. The amounts thus transferred came to millions of euros over the years and
were so cannily done that the company's auditors also failed to discover anything wrong
with the system.