The deal would create the world's second-largest telecommunications company after Japan's NTT. It came after the German government assured Rome that it wouldn't interfere with the new firm's operations. It's not exactly a fine point: The German government owns 72% of Deutsche Telekom and will emerge as a 40% shareholder in the merged company.

Now comes the hard part -- selling the deal to shareholders, regulators and, perhaps most difficult of all, financial markets. The transaction is intended to create a European telecommunications powerhouse to counter the might of US phone giants aggressively expanding overseas. The German-Italian entity would have a market capitalisation of $178 billion, more than the $173 billion inmarket value of the proposed tie-up between SBC Communications Inc. and Ameritech Corp. Based on 1997 figures, its revenue of $62.3 billion would be second only to the $77 billion of Japan's Nippon Telegraph & Telephone Co.

Several hurdles loom. European regulators may impose debilitating conditions on the merger. And Telecom Italia shareholders can still opt for a hostile bid from Olivetti SpA, which is offering 11.50 euros ($12.20) in cash, bonds and shares for each Telecom Italia share. The German-Italian transaction values Telecom Italia in the 12-euro range, but the price fluctuates with changes in the share price of Deutsche Telekom. If Deutsche Telekom's share price falls significantly, the Olivetti option could look more attractive to shareholders.

Indeed, Wednesday, Deutsche Telekom fell 52 euro cents, or 1.4%, to 36.08 euros. Under terms of the proposed merger, three Telecom Italia shares would be exchanged for one Deutsche Telekom share. That would imply a value for Telecom Italia of 12.03euros per share. Bankers for the German-Italian team say their option is better because, under the Olivetti plan, minority shareholders don't get the benefit of a "control premium" -- which effectively reduces the value of the 11.50 euro per-share offer. Olivetti, however, is hoping that its partial cash offer proves more attractive than the merger's all-stock proposition.

The three-for-one stock swap would leave shareholders of the German company with 57% of the new group, while the Italians would have the rest. In addition, 5.61 Telecom Italia non-voting savings shares would be exchanged for each share in the new company.

Although Deutsche Telekom is larger than Telecom Italia, the transaction is being set up as a merger of equals, a crucial condition demanded by the Italians. They also sought, and won, last-minute assurances from the German government that the merger wasn't effectively a takeover of Italy's main telecom assets by the German government. To allay concerns, Germany's finance ministryassured the Italians that it would sell down its 72% stake as quickly as the market could bear.

The merged entity will be legally based in Germany, but will maintain dual headquarters in Bonn and Rome, people familiar with the situation said. The ten-person board will include five Germans and five Italians. The chairman will alternate each year between the Italian and German company. There will also be two co-chief executive officers -- Ron Sommer, who heads Deutsche Telekom, and Franco Bernabe, who leads Telecom Italia.

Telecom Italia is expected to call another board meeting next week to convene a special shareholders meeting to approve the merger. Because the group is subject to a takeover bid, Telecom Italia must secure backing from shareholders representing at least 30% of its capital in order to approve the deal. This could prove tough given that the company failed to even reach a quorum to hold a shareholders' meeting just ten days ago to put Bernabe's defensive strategy to a vote. Telecom Italiahas 1.5 million shareholders.

Not surprisingly, rivals to Deutsche Telekom and Telecom Italia attacked the proposed merger. "I don't think that the competitive players will get stronger competition as a result," said Klaus Esser, the incoming chief executive of Mannesmann AG, Deutsche Telekom's main competitor in Germany and Olivetti's partner in Italy. "But I think that politicians are making a mistake. After they opened the market and wanted more competition, more players now are moving back to structures that arose during the era of monopolies."

There's also uncertainty about the German-Italian merger. One senior banker involved said the agreement doesn't mean the deal is done. "We may still have to defend our deal," he said. "This could be complicated."