Hungary’s pangs

As the government takes companies back into state ownership and introduces a series of ’crisis taxes’, a lack of foreign investment is hitting law firms

After its two-thirds majority vote in the April 2010 election, Hungary’s governing party started this year with a controversial new constitution that saw thousands of protesters take to the streets of Budapest. Critics fear the new laws – which remove democratic checks and balances in areas including media and central banking – threaten Hungary’s democracy.

If the government fails to make the laws comply with EU legislation, Hungary could lose funding from the EU and the International Monetary Fund (IMF), which could cripple the economy. At the time of writing, though, the government had tried to unblock credit talks with the IMF and European Central Bank by introducing changes to its central banking law that the EU criticised for threatening the bank’s independence.

“While the EU has threatened to freeze Hungary’s funds, a threat that would be detrimental to the economy and particularly small- to mid-sized businesses, the general conviction is that hopefully it won’t happen,” says Tamas Tercsak, managing partner of Salans’ Budapest office. “Assuming the funding will continue, the Hungarian economy is not expected to suffer any damage and the mood in the legal market will remain calm.”

While the new constitution looks unlikely to rumble the market, some have seen the alarm bells ringing for foreign investors.
“The controversial measures of the government have increased the ­perception of political risk, and some foreign investors stepped back last year,” observes David Dederick, managing partner of Weil Gotshal & Manges’ Budapest office. “Whether because of controversial new laws, dramatic drops in lending activity or the European debt crisis, some foreign investors are saying it’s just not the environment it once was.

“International law firms that were overly dependent on foreign investment-­related work are finding the current market more challenging.”

The investment heyday goes back to the early 1990s, when foreign investors scrambled for a patch in the former post-Soviet bloc.

“For many years, Hungary was a gateway to the region – the country that foreign investors and multinationals came to first,” says Dederick on why Hungary is packed with foreign investors. “Successive socialist-led governments were prolific privatisers and Hungary did attract a lot of foreign investment. Now the government is keen for the state to take a greater role in businesses and the economy, taking ’strategic’ companies back into state ownership, as with vehicle manufacturer Raba.”

Back to basics

Raba, a majority state-owned Hungarian transport maker which was bought back by the government in late 2011, is not the only example.

Last year saw the Hungarian state become the largest stakeholder in oil and gas group MOL, which controls refineries in Croatia, Italy and Slovakia, after a repurchase of shares (see box, page 28), while around $14.6bn (£9.2bn) of privately managed pension funds have effectively been brought under state control. More recently, the government has laid out plans to set up a telecommunications provider from state-owned power wholesaler MVM.

“The current government clearly prefers maintaining a certain degree of state ownership in some key sectors,” says Orsolya Banki, a partner at Taylor Wessing’s Budapest office. “The focus on state ownership, however, is not expected to change thedominance of private companies in most commercial sectors.”

The automotive industry is a case in point. “Daimler, Audi and Opel have all made significant investment plans in recent years,” says Dederick, pointing to Daimler’s €800m (£677m) investment into the construction of a new Mercedes-Benz factory in the town of Kecskemét, Audi’s €900m-€1bn investment into the expansion of its production facilities in Györ, and Opel’s €500m plan to build a plant in Szentgotthárd that will be the company’s biggest engine production facility worldwide.

“These major investments provide significant work for a number of law firms, especially those with close links to the industry in Germany. They also lead to additional investments by clusters of automotive industry suppliers and ancillary businesses, which in turn provide firms with even more work,” says Dederick.

Nevertheless, law firms should not put their eggs in one basket.

“Given the general decrease of M&A transactions, law firms who cover several legal fields do better in the present economic environment,” says Taylor Wessing partner Orsolya Banki, pointing to the government’s introduction of a ’crisis’ tax for certain sectors. “The so-called ’crisis taxes’ imposed on the energy, retail and telecoms sectors have, of course, hurt the financial performance of these sectors, and due to the losses of the bank sector it has become difficult to find external financing for Hungarian investment projects. In the coming months, the direct crisis taxes will be replaced by some indirect taxes lev-ied on consumer services provided by banks and telecoms companies.”

Despite new taxes putting a three-year dampener on the profitable ­energy, retail and telecoms sectors, full-service law firms believe their glasses remain full.

“Firms which focus mainly on transactions have suffered due to the dry-out of M&A and property, but there’s been an increase in structuring and litigation work,” says Gabriella Ormai, managing partner of CMS Budapest. “And as always, tax and employment lawyers, banking, regulatory and competition experts are busy. Firms that built a mixed practice as their primary strategy have tended to be more crisis-proof.”

While these firms feel the pinch a little less, those with limited geographical reach are feeling it a little more.

“There are only a few ’pure Hungarian’ transactions and the sizeable ones involve either more countries in Europe or more countries globally,” Ormai says. “In these wide-coverage transactions it’s important to be able to offer a high-quality service all over the place. Having said that, Hungary stands a good chance of restoring its financial stability in 2012, which may put it back on the investors’ map in the near future.”

That future is already starting to look a little brighter, with Ormai pointing to more activity at the start of this year. “The beginning of 2012 was more active on the M&A side and we have seen transactions both in the TMT and the manufacturing sector,” she adds, noting that activity bounced back down again in the second quarter of the year. “Investments were made mainly in the renewable energy industry and automotive ­sector.”

A case in point is Hungarian energy giant MOL Group, which has dominated the country’s M&A rankings in the past five years. Grading by value, three of the top five transactions since 2007 have involved the company, but a new group of Hungarian targets is expected in the next half-decade.

“A new wave of company acquisitions is expected for the coming years as owners of companies privatised in the early 1990s are approaching ­retirement age,” concludes Banki. “These owners are more likely to sell their business to foreign investors given the scarce funding possibilities for Hungarian companies.

“It’s a prospect that gives the M&A sector hope that the time when law firms were engaged in transactions that expanded businesses will soon return.”

In brief

A new political environment is causing a few worries for Hungary’s lawyers, while M&A has been dominated by one company in the past year. However, firms predict that things will begin to brighten in coming months, despite minimal foreign investment.

Key figures

GDP (current US$, 2010)
$128.6bn

Annual inflation (April 2012)
5.7%

Population (February 2012)
9.96m

Life expectancy at birth
74

Unemployment rate(Q1, 2012)
11.7%

Source: World Bank, Hungarian Central Statistical Office

Budapest: top tips

There are a number of high quality restaurants in Budapest. For example, the Onyx Restaurant in district V received a Michelin star last year and is known for its innovative food and stylish atmosphere. It also has an excellent wine selection with more than 200 different varieties.

For something more relaxed, the Art Deco-style Callas Café, next to the State Opera, offers impeccable food with live salon music, making it perfect for both business and pleasure.

As for hotels, check into the Corinthia or the Four Seasons. Both are located in the heart of Budapest and have the best views in town.

And don’t forget to visit the Szechenyi Bath and Spa and the Gellert Baths and Spa – they are great for relaxation after
a long day at work.

Tamas Tercsak, managing partner, Salans Budapest