New Hungarian Legislation to Screen Foreign Investment
Les Nemethy and András Hanák look into a new law that aims to protect “strategic” Hungarian companies from being acquired by non-Hungarian parties, and its potential effect on foreign investment.
Photo by Florence-Joseph McGinn/Shutterstock
On May 25, the Hungarian government promulgated a decree requiring its de facto approval 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, for example where (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 mln) and where a mere 10% or more of the equity of a company is sold.
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 (for example, in 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 is approved) will be extended, adding further uncertainty (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 it was supposedly designed to protect.
An investor, when analyzing whether to put in an offer on a company, always weighs 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 these players to find investors (typically transactions of up to a few million euros) because a small investment rarely “moves the needle” but transaction costs are pretty similar to larger transactions.
Effects on Valuation
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.
Ambiguity and Vagueness
The way strategic sectors are defined by the decree is, in the view of most observers, too broad, or at the minimum too 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 an 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 or approve 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 this hypothetical case: if Multinational A were to acquire Multinational B, any Hungarian leg of the transaction could be blocked by the minister.
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.
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 by other observers may be addressed in the meantime.
Les Nemethy is CEO of Euro-Phoenix (www.europhoenix.com), a Central European corporate finance firm, author of Business Exit Planning (www.businessexitplanningbook.com) and a former president of the American Chamber of Commerce in Hungary.
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