On May 25th, the Hungarian Government issued a decree requiring de facto approval of the Hungarian Government with respect to ambiguously defined “strategic” transactions whereby interests in Hungarian companies are acquired by foreign entities
, which fulfill (in our opinion excessively broad) criteria—e.g. where in arguably broadly defined sectors (i) a majority interest in a Hungarian company is acquired or (ii) the amount of the transaction surpasses HUF 350 million (a little more than EUR 1 million!) and where a mere 10% or more of the equity of a company is sold.
This article discusses the above decree by examining the following subjects: (a) likely deterrent effect on foreign investors; (b) effects on valuation of Hungarian companies; (c) ambiguity and vagueness of the rules; and (d) possible conflict with EU laws.
a, Deterrent Effect on Foreign Investors
Negotiating a purchase and sale agreement requires considerable effort (company staff, lawyers, possibly financial advisors, due diligence investigations, etc.) as well as related costs. This decree will add cost (e.g. preparing the Government submission), while greatly adding to the uncertainty facing the investor.
Furthermore, the time between signing a purchase and sale agreement and closing (assuming the transaction will be approved) will be extended, adding further uncertainty (e.g. it becomes trickier to deal with risks like currency fluctuations, loss of one or more clients, etc.). Investors always abhor uncertainty—given they are usually in a stronger position, through astute negotiation, they typically pass on most risks to sellers, which ironically, would make the Hungarian parties bear the cost of the decree, precisely the parties whom the decree was supposedly designed to protect.
An investor, when analyzing whether to put an offer on a company, always weights the costs and benefits of doing so, and this legislation skews the equation toward avoiding Hungarian targets. While this may satisfy some nationalist desire to keep Hungarian companies for Hungarians, it will serve to diminish capital available to Hungarian corporations and their owners.
This deterrent effect may be particularly significant for investors in smaller companies. It is already extremely difficult for smaller companies to find investors (e.g. transactions up to a few million euros) because a small investment rarely “moves the needle” but transaction costs are pretty similar to larger transactions.
b, Effects on Valuation of Hungarian Companies
Whenever the number of potential willing investors is curtailed, valuation suffers. In our opinion, generally the most favorable way to sell an interest in a company is a competitive process. Should one or more potential bidders decline to participate due to the decree, valuation will suffer. The decree may, in certain cases, negate the case for a competitive process. It is difficult to estimate the percentage by which valuation might be impaired: for some companies, it might make the difference between being saleable versus non-saleable. For others it might suppress valuation by a percentage well into the double digits.
c, Ambiguity and Vagueness of the Rules
The way strategic sectors are defined by the decree is, in most observers’ view too broad or at the minimum ambiguous, which leaves room for discretionary application by the Hungarian Ministry that has authority to block transactions. The decree supposedly tracks recent EU legislation permitting screening of non-EU investment on grounds of genuine national security concerns and public order considerations. In an effort to overzealously protect Hungarian companies from unwanted raiders the decree covers sectors where no such concerns may arise. As illustration, the sale or investment in an agricultural milk producer, an IT startup, a limousine car service, a hotel or even a restaurant may be subject to a reporting obligation (which requires disclosure of a host of sensitive and proprietary information) and leaves 45 days for the Minister to deny approval of the deal.
Further as both direct and indirect acquisitions of control or minimal (10%) interest are subject to the reporting obligation, it is entirely possible that transactions of parent companies outside Hungary may trigger a filing obligation in Hungary by a Hungarian company and its indirect parent. Some observers note the hypothetical: if Multinational A were to acquire Multinational B, any Hungarian leg of the transaction could be blocked by the Minister.
d, Possible Conflict with EU Laws.
One cannot escape the first impression that the decree runs afoul of EU laws when it is also applicable to investments by EU companies whose ultimate beneficial owners are also EU entities.
This regulation is contrary to specific EU legislation permitting the screening of foreign (i.e. non-EU) investments in narrowly defined sectors for specific national security/public order concerns and is a violation of one of the fundamental freedoms of the European Union: freedom of movement of capital.
Conclusion
It may be fair to say that the main cost of the decree may be most heavily borne by the very enterprises that the decree is designed to protect (e.g. small and mid-sized enterprises). We do not understand the strategic intent of the legislation. To the extent that there are legitimate strategic interests that need to be protected, legislation could be better targeted to apply to a narrowly defined strategic interest.
The Hungarian Government announced that the operative provisions of the decree will be incorporated into an Act of Parliament in the coming weeks. We hope that some of the concerns raised by this blog and other observers may be addressed.
This article discusses the above decree by examining the following subjects: (a) likely deterrent effect on foreign investors; (b) effects on valuation of Hungarian companies; (c) ambiguity and vagueness of the rules; and (d) possible conflict with EU laws.
a, Deterrent Effect on Foreign Investors
Negotiating a purchase and sale agreement requires considerable effort (company staff, lawyers, possibly financial advisors, due diligence investigations, etc.) as well as related costs. This decree will add cost (e.g. preparing the Government submission), while greatly adding to the uncertainty facing the investor.
Furthermore, the time between signing a purchase and sale agreement and closing (assuming the transaction will be approved) will be extended, adding further uncertainty (e.g. it becomes trickier to deal with risks like currency fluctuations, loss of one or more clients, etc.). Investors always abhor uncertainty—given they are usually in a stronger position, through astute negotiation, they typically pass on most risks to sellers, which ironically, would make the Hungarian parties bear the cost of the decree, precisely the parties whom the decree was supposedly designed to protect.
An investor, when analyzing whether to put an offer on a company, always weights the costs and benefits of doing so, and this legislation skews the equation toward avoiding Hungarian targets. While this may satisfy some nationalist desire to keep Hungarian companies for Hungarians, it will serve to diminish capital available to Hungarian corporations and their owners.
This deterrent effect may be particularly significant for investors in smaller companies. It is already extremely difficult for smaller companies to find investors (e.g. transactions up to a few million euros) because a small investment rarely “moves the needle” but transaction costs are pretty similar to larger transactions.
b, Effects on Valuation of Hungarian Companies
Whenever the number of potential willing investors is curtailed, valuation suffers. In our opinion, generally the most favorable way to sell an interest in a company is a competitive process. Should one or more potential bidders decline to participate due to the decree, valuation will suffer. The decree may, in certain cases, negate the case for a competitive process. It is difficult to estimate the percentage by which valuation might be impaired: for some companies, it might make the difference between being saleable versus non-saleable. For others it might suppress valuation by a percentage well into the double digits.
c, Ambiguity and Vagueness of the Rules
The way strategic sectors are defined by the decree is, in most observers’ view too broad or at the minimum ambiguous, which leaves room for discretionary application by the Hungarian Ministry that has authority to block transactions. The decree supposedly tracks recent EU legislation permitting screening of non-EU investment on grounds of genuine national security concerns and public order considerations. In an effort to overzealously protect Hungarian companies from unwanted raiders the decree covers sectors where no such concerns may arise. As illustration, the sale or investment in an agricultural milk producer, an IT startup, a limousine car service, a hotel or even a restaurant may be subject to a reporting obligation (which requires disclosure of a host of sensitive and proprietary information) and leaves 45 days for the Minister to deny approval of the deal.
Further as both direct and indirect acquisitions of control or minimal (10%) interest are subject to the reporting obligation, it is entirely possible that transactions of parent companies outside Hungary may trigger a filing obligation in Hungary by a Hungarian company and its indirect parent. Some observers note the hypothetical: if Multinational A were to acquire Multinational B, any Hungarian leg of the transaction could be blocked by the Minister.
d, Possible Conflict with EU Laws.
One cannot escape the first impression that the decree runs afoul of EU laws when it is also applicable to investments by EU companies whose ultimate beneficial owners are also EU entities.
This regulation is contrary to specific EU legislation permitting the screening of foreign (i.e. non-EU) investments in narrowly defined sectors for specific national security/public order concerns and is a violation of one of the fundamental freedoms of the European Union: freedom of movement of capital.
Conclusion
It may be fair to say that the main cost of the decree may be most heavily borne by the very enterprises that the decree is designed to protect (e.g. small and mid-sized enterprises). We do not understand the strategic intent of the legislation. To the extent that there are legitimate strategic interests that need to be protected, legislation could be better targeted to apply to a narrowly defined strategic interest.
The Hungarian Government announced that the operative provisions of the decree will be incorporated into an Act of Parliament in the coming weeks. We hope that some of the concerns raised by this blog and other observers may be addressed.