BT's IT Gear Leaseback Deal With IBM Said to Be Focus of Italian Probe

Daniele Lepido and Rebecca Penty (Bloomberg) -- Milanese prosecutors are investigating a suspected bogus leaseback deal between BT Group Plc and a unit of IBM as they try to piece together the accounting scandal at the British carrier’s Italian arm, according to people familiar with the matter.

The transaction, which was highlighted in KPMG’s independent review of BT’s business, may have been designed to inflate revenue through a one-time sale of equipment and then spread the expense of renting back the same equipment over several years, said the people, who asked not to be identified as the probe isn’t public. IBM isn’t under investigation, the people said.

The Italian scandal has eroded investor confidence in BT and its leadership after the carrier in January said it had unearthed “inappropriate” behavior and “improper” accounting going back several years in Italy. The company booked a 530 million pound ($660 million) writedown tied to the scandal and prosecutors in Milan opened a criminal investigation into allegations of false accounting and embezzlement.

Note by DCK: Major telcos on both sides of the Atlantic have been actively looking for ways to get costly IT assets off their books, and IBM has been one of the most active buyers of those assets. In the US, it's taken over cloud and managed hosting assets of AT&T and, more recently, Verizon. Read more:

The scrutinized deal involves a 2015 contract under which BT Italia sold electronic equipment that may not have existed to ITF Srl, a small company based in Tuscany, for 32.5 million euros ($35 million), according to the people. ITF sold the assets to IBM Italia Servizi Finanziari Srl and BT agreed to lease back the same assets from the IBM unit -- which specializes in financing IT assets -- for about 36 million euros over three years. BT halted payments after some months and can’t locate serial numbers for all of the gear, leading investigators to believe it may have been fictitious, the people said.

A representative for the ministry of justice, the arm of Italian government in charge of the Milanese prosecutor’s office, declined to comment, as did IBM. BT said it can’t comment on an ongoing investigation. Paolo Castellacci, the chairman and founder of  Sesa SpA, the company that controls ITF, confirmed the transaction and said in a phone interview he had no reason to suspect the equipment was fictitious. Sesa isn’t under investigation, the people said.

The leaseback deal is an example of the kind of transaction that BT, its accountants and Italian investigators have put under the microscope as they work to understand who was responsible for the fraud and what motivated the individuals. BT has fired senior managers in Italy since initially discovering the accounting deception last year.

In a typical sale-leaseback, the owner sells an asset to an investor who leases it back to the former owner for its use. Companies in many industries use the method to free up capital from assets such as real estate or equipment to focus on their main business.

Sophisticated Fraud

BT has said it was duped by a sophisticated fraud orchestrated by a few employees and missed by its long-time accountant PricewaterhouseCoopers, which the carrier is seeking to replace early.

BT executives have described a system of inappropriate loans in Italy, taken against accounts receivable, that were used to pay suppliers. BT now has to reimburse the financial-services companies that made the loans. Other improper transactions were associated with a shift of revenue and capital expenses to operating expenses as well as leasebacks, they have said.

“BT Italia asked us to find a player able to arrange a transaction from capex into opex and we found” the IBM unit, Castellacci said. The financial services company bought equipment from BT for about 32.5 million euros and sold it to IBM for 36 million euros, gaining 3.5 million euros on the deal, he said. The transaction involved about 80,000 pieces of gear, including computers and servers, he said.

ITF is controlled by Computer Gross Italia SpA, owned by Milan-listed Sesa. Last year, Sesa had revenue of 1.22 billion euros. Sesa shares have gained about 128 percent in the past four years, giving the company a market value of 360 million euros.

Investor Confidence

BT’s full-year earnings results scheduled for May 11 will be the next opportunity for Chief Executive Officer  Gavin Patterson to publicly highlight how the company plans to rebuild the confidence of investors and regulators even as it contends with a ballooning pension deficit and pressure to maintain its dividend growth plans.

The fate of its Italy business is part of a wider review by BT of its global services unit, which provides technology consulting, outsourcing and communications systems for customers outside the U.K. Executives said in January that if the money-losing Italy business can’t be made profitable, it could be sold.