Europe's biggest takeover battle is heating up. Olivetti's $58 billion bid to buy bigger rival Telecom Italia (TI continues to galvanize the Milan market and has generated a backlash in Rome as the Italian government worries that foreign telcos are massing at the border.

In Milan, trading in the takeover-related stocks set a record, and the blue-chip Mibtel index rose 2.5%. Olivetti shares dropped 6.7% to 3 euros on heavy volume of 163 million shares. Telecom Italia, meanwhile, rose 9% to 9.86 euros on 149 million shares traded, closing just short of Olivetti's 10-euro-a-share bid.

Massimo D'Alema, the Italian prime minister, said Rome is of the view that "the government should be absolutely neutral" about the information-technology and telecommunications group's bid for the former state telecom concern. But D'Alema warned that Telecom Italia "is not going to be sold in pieces and it is not going to be purchased by foreign interests."

On Monday, the prime minister added: "We are still the main shareholder in Telecom. We have to decide if, how and at what conditions to sell our stake." The government, which privatized Telecom Italia in 1998, still holds a 3% supervoting stake that makes it the telecom's most important stakeholder.

Traders have speculated a foreign telecommunications player may participate in the takeover. Rumors on the exchange floor in Milan have had Bell Atlantic ( BEL and British Telecom ( BTY as potential allies of Olivetti in taking over Telecom Italia. Officials at Bell Atlantic and British Telecom declined to comment on Olivetti-Telecom Italia rumors.

Bell Atlantic had an option on Olivetti's stake in its Infostrada long-distance and Omnitel cellular ventures. This weekend Olivetti agreed to sell those assets to Germany's Mannesmann, the engineering and telecommunications provider, because Olivetti needs the money to fund the proposed Telecom Italia takeover.

The focus is now on the next stage of the game. Most observers think that Olivetti's chief executive, Roberto Colaninno, a 64-year-old accountant from Mantua, will be obliged to raise his bid. "The price, 10 euros, is too low," said Luciano Pichler, president of the Italian Association of Financial Analysts. "The offer is surely a weak one, and it's easy to forecast an increase."

The majority of traders and brokers also consider the structure of the offer somewhat weak. Telecom shareholders will get 60% in cash and 40% in shares and securities issued by Olivetti unit Tecnost. Based on the offer of 10 euros, the bid is divided in this way: 6 euros in cash, 2.6 euros in securities issued by Tecnost and 1.4 euros in Tecnost stock. Tecnost makes lotto and lottery machines, leaving many analysts confused as to why a Telecom shareholder should trade stock in one of the best telecommunications companies in Europe to get something with the Tecnost brand name.

Too, the company will be burden by a huge amount of debt. Tecnost and Olivetti will borrow from a pool of financial institutions including Donaldson Lufkin & Jenrette, Chase Manhattan Bank, Lehman Brothers and Merrill Lynch. In Italy, Colaninno and the group of Italian industrialists who support his ambitious plan are assisted by Mediobanca, a leading merchant bank.

Luca Ciarrocca is the deputy editor of Milano Finanza and Mercati Finanziari in Milan. Ciarrocca was a financial news reporter for Il Giornale in New York for nine years, and previously worked in Milan for two weekly financial magazines: Il Mondo and Mondo Economico. At time of publication, Ciarrocca held no positions in any of the stocks discussed in his column, although holdings can change at any time. He welcomes your feedback at