Hungary: Toughing it out
1 July 2013 | By Christian Metcalfe
7 July 2014
9 January 2014
New legislation presents challenges to investors as the Hungarian government advances its ‘unorthodox’ political agenda
6 January 2014
25 November 2013
21 October 2013
Many foreign investors are keeping faith with Hungary despite EU concern over recent regulatory reforms
Since the 2010 election Hungary’s coalition government of the right-wing Fidesz and the Christian Democrats has served up a legislative feast. In three years the government has forced through about 600 laws to reform and take control of the media, healthcare, education, pensions, agriculture and the judiciary, while pressurising the foreign investors that dominate the economy.
This outpouring of legislation, along with a controversial new -constitution, antagonised foreign allies and provoked alarm in the US and at the European Commission, the Council of Europe and the European Parliament – bodies Viktor -Orban had wooed hard to gain admission to Nato and the EU while prime minister in 1998-2002. He is also the country’s present prime minister.
In late May, the EU let go its greatest point of leverage when it approved Hungary’s exit from the -Excessive Deficit Procedure, a dog-house for spendthrifts. But patience in Brussels may be running out.
Last month the Venice Commission, the panel that advises the Council of Europe, said the latest changes to the constitution were threats to democracy and the rule of law, and contradicted “principles of the Fundamental Law and European standards”.
That view has given strength to calls for closer monitoring of the country’s respect for EU standards that, if approved, would make Hungary the first EU state subject to such monitoring.
Hungary was in a real mess in 2010, with the economy close to bankruptcy and a rudderless political system, and the present government justifies many of its actions on the grounds that its overriding goal is to pull round the economy. While the economy shrank in 2012 it returned to growth in the first quarter of this year.
“There is some dust-settling going on,” says David Dederick, managing partner of Weil Gotshal & Manges’ Budapest office. “There’s been a lot of controversy, but investors who are happy to remain are adjusting to the new environment and getting back to business.”
Evidence of this can be seen in the success of the US$-denominated Hungarian government bond issue at the beginning of 2013.
“This showed that sentiment towards Hungary had changed,” observes Csilla Andrékó, Kinstellar’s Budapest managing partner. “While there are still a lot of political concerns raised by the EU, the business community seems to have increased its confidence.”
“If you look at recent figures for foreign direct investment,” adds Dederick, “they don’t look bad. The question is of transaction volumes – if Daimler reaches into its treasury and finances the construction of a factory in Kecskemét it may not generate that much legal work for international law firms. It’s one deal and they’re financing it themselves. The general trend is a diminished level of investment and transaction volumes in the area where international firms have historically been most active – cross-border work.”
Although not all big deals lead to such an outcome, Lego is investing €300m (£260m) in a state-of-the-art factory in Nyiregyháza in north-eastern Hungary – for which Gide Loyrette Nouel advised on not only the acquisition of the greenfield site but also on all construction, utility, infrastructure, energy supply, and tax-related issues.
Coming ninth in Ernst & Young’s Globalisation Index, above the UK and close trading partner Germany, Hungary is globally integrated and international companies have a big stake in what is going on.
How they are affected depends on what sector they are in – those in utilities or banking are tied to their customers in Hungary and “either have to sell out or stick it out” says Richard Lock, founding partner of Lakatos Koves & Partners. “Contrast that with those invested in manufacturing plants, call centres and so on – they are relatively untouched as the government realises if life is made unpleasant they could say ‘forget Hungary’ and move.”
While the government has previously imposed so-called ‘crisis taxes’ on the banking, energy, retail and telecoms sectors, pressure on the banking sector – which is around 85 per cent foreign-owned – was
increased last month when the government revealed plans to impose a 7 per cent tax this year on $2.8bn of municipalities’ debt held by banks.
With an election due next spring Dederick observes: “Foreign investors don’t vote – certain measures may have an impact that wouldn’t be felt by an ordinary Hungarian.”
One measure that was felt by the Hungarian people was forcing energy service providers to cut fees by 10 per cent – a move that has provoked some multinationals such as E.on, GDF Suez, EDF and RWE to announce an intention to sell shares to the state.
“Energy price cuts are great vote-winners,” adds Lock. “The way [Orban] is doing things goes down well with the populace. He has a high chance of winning the election.”
A pleasant surprise
While lack of foreign investment has hit law firms in recent years, 2013 has been a pleasant surprise for some, particularly in the M&A area.
“Last year was mainly state-related, but this year has seen private cross-border M&A come back,” says Andrékó. “We have just finished advising on the purchase of Hochtief’s stake in Budapest airport by a Canadian pension fund and we’re working on an acquisition in the media sector with a deal value of around €100m.”
Lock adds: “A new generation of investors is coming in. We’ve seen Gulf investors, Norwegian investors and Asian investors, but also local buyers, which is a phenomenon that fits in with the government’s view of the world – that foreign investors got too much and now local investors should have an opportunity to buy at a discount.”
Venture capital investments via the European Investment Bank’s Joint European Resources for Small and Medium-sized Enterprises (Jeremie) programme (see box, below) has also been a source of instructions according to Pál Jalsovszky, managing partner of Jalsovszky Law Firm.
“Although the legal fees are quite low it will give us the opportunity to be around the table when the funds exit,” says Jalsovszky.
Race to the bottom
While 2013 was tough in the M&A sector for local firm Oppenheim, M&A and corporate head Mihály Barcza puts this down to “incredible fee offers” from competitors, in particular the international firms.
Fee competition is a common complaint among firms.
“There is an obvious tendency on the client side to optimise legal fees,” says Eszter Kamocsay-Berta, co-head of Gide Loyrette Nouel’s Budapest office. “It’s some of the major international firms that are driving the so-called ‘race to the bottom’. It doesn’t do any good for the profession or the level of service, but it’s difficult to combat and compete against.”
But Jalsovszky believes these firms have little choice.
“This is a period of survival for them – if they want to keep work they must go lower in terms of fees,” he adds.
Litigation and disputes has been another strong source of work with firms looking to expand this capability. Kinstellar is aiming to acquire a senior and experienced team in the next six months. Meanwhile, aggressive moves by the Hungarian tax authorities mean tax boutique Jalsovszky has seen particular strength in litigation.
The collapse of Hungarian national airline Malev in 2012 saw a surge in aircraft financing, with other airlines, in particular the budget ones, picking up capacity.
While insolvency and restructuring continues to be strong, project finance is not picking up and real estate remains weak.
“Real estate development and property are silent now,” says Péter Berethalmi, managing partner at Nagy és Trócsányi. “Construction is close to zero and apart from huge investments in the automotive industry it’s very quiet.”
So is there a prognosis for growth?
“If a firm wants to grow,” says Dederick, “the only way to do it is by taking business from competitors and that is a much harder proposition than growing when the market is growing and all boats rise. I wouldn’t predict robust growth
given the economic outlook.”
A silver lining to the M&A cloud
Jeremie (Joint European Resources for Small and Medium-sized Enterprises) is an initiative of the European Commission together with the European Investment Fund. The aim is to improve access to finance for small and medium-sized enterprises.
Under the programme various financial instruments (equity, loans, guarantees etc) are offered.
The programme, and particularly its venture capital sub-part, has been active in Hungary since 2009. In the past three years about 90 venture capital investments have been financed through Jeremie funds and the invested amount exceeds €100m (£85m). With the sharp decline of acquisitions and private capital investments seen in recent years, these investments represent something of a silver lining to the M&A cloud. Furthermore, they have activated the start-ups sector, especially in the IT, telecoms and biotech industries.
Investments from Jeremie need to comply with certain criteria. Only companies that have been operating for not more than five years with an annual turnover not exceeding €5m are eligible. The maximum amount of investment may not exceed €1.5m in one year and €4.5m in total.
In Hungary, the Jeremie programme is run by eight fund managers selected and mandated by the Hungarian programme co-ordinator.
The second round of the programme is about to start (with 10 new fund managers) and the tender for the third has been launched.
While it is clear that from next year new ventures will be able to choose from a variety of financial resources, the question remains – are there enough promising start-ups to soak up the available funds?
Pál Jalsovszky, managing partner of Jalsovszky Law Firm
Annual inflation (May 2013): 1.8%
Population (Jan 2013): 9.9m
Life expectancy at birth: 74
Unemployment (Mar 2013): 11.8%
Source: World Bank, Hungarian Central Statistical Office