Tough times ahead

Unfortunately, Hungary faces tough times ahead as it tries to cut the European Union's widest budget deficit. Prime Minister Ferenc Gyurcsány has cut public jobs, raised taxes and slashed subsidies to trim the shortfall.

Last week we also saw important macroeconomic data come for Hungary, which indicate the rate of growth of its economy and the inflation.

Hungary's preliminary third quarter growth in GDP (Gross Domestic Product) data of 1% came significantly below the market consensus of 1.55%, says Reuters. Adjusting with the calendar effects, the figure showed a 1.1% rise year on year.

In our view, the weak GDP data might sustain rate cut expectations. However, the latest comments from the Hungarian National Bank (MNB) suggests that it is still concerned about higher inflation figures (due to the rise in food prices, and 2008 wage agreements.)

The CPI (consumer price index, a measure of inflation) data for October was 6.7%, higher than market expectations of 6.3% (again, as reported by Reuters), and up from the previous figure of 6.4%, year on year, in September.

The MNB will, therefore, have difficulty lowering interest rates, currently the highest in the EU at 7.50%, as inflation is still too high.

Richter merger?

The Hungarian pharmaceutical company, Gedeon Richter, has announced plans to combine with Poland's Polpharma to create the largest pharmaceuticals firm in the central and eastern European region.

The Richter-Polpharma group would be the second largest generic producer for the Russian market, and the largest producer in central Europe.

It is estimated that the merger will have a combined market capitalization of Ft923bn ($5.3bn).

The combination is subject to approval by Richter's shareholders at the group's annual meeting on Dec 18.

Erik Bogsch, Richter's chief executive, said the acquisition targets outstanding growth potential in Poland, Russia and ex-Soviet countries.

The press quoted him as saying, "Consumption per capita is low in Poland, and that's where we feel the biggest potential growth in the region will come from.

"Consumption per capita stands at $240 a year in Hungary and Czech Republic, and at about $140 in Poland."

On the Budapest Stock Exchange (BSE) on Wednesday (Nov 15) closing, before the news came out in the public, the closing price for the Hungarian pharma was Ft36,360 ($209), with a volume of 30,000 shares traded.

A day later when, the news broke, the volume increased 10-fold, and the closing price of last Thursday was almost 7% higher.

Most of the local brokerage houses have raised their target prices for Richter's shares, as they realized the potential of such a merger.

Richter announced the intended merger the same day as its third quarter (3Q) earnings report, which pretty much came in line with market expectations; although there were some disappointing domestic figures, there were also more uplifting ones in terms of exports (especially from Russia.)

The lack of positive numbers from local sales is not surprising, given the government's current health care reforms, which have forced the pharmaceutical company to decrease prices and forced the drug producers to subsidize some of the costs for health care in Hungary.

The analysts of Cashline Securities expect the export sales to continuously improve, and the domestic market to stay flattish.

This is one of the reasons why we have a buying recommendation on the shares.

In addition, the new merger will provide a good reason to buy Richter even while there is a such low economic growth in the country, and uncertain financial turmoil in the US and European markets.

The 3Q earnings of OTP Bank, Hungary's largest lender, were also published late last week.

The results were better than the market consensus, due mostly to a net profit of Ft55.68bn ($320.5m), up 4% yoy, above the expected Ft54.1bn ($311.4m), as reported by Portfolio.hu.

Improving figures from the underlying business, and rising profit at the Russian unit (which struggled in the previous quarter), was expected to make OTP rally at least in the short-term.

However, because of the negative banking sentiment currently prevailing in the US and Europe, OTP has followed the negative international trend, and its price has been eroding for the past weeks.

Mol, the region's largest oil and gas producer, reported third quarter earnings more or less in line with the already low market expectations.

Upstream

The upstream (exploration and production) had some disappointing figures, with lower production in Hungary and a weaker dollar.

In fact, the upstream profit delivered a 43.9% fall yoy (to Ft19.6bn ($112.8m), much below the market consensus of Ft25bn ($143.9m).

The petrochemical division recorded outstanding performance. Unfortunately, the segment is not significant enough to counterbalance the negative impacts at other sections of the business.

The Cashline Securities analysts don't feel that MOL is cheap to buy. They have published a report with a recommendation to "hold" the shares after the EU Internal Market Commissioner, Charlie McCreevy, officially started legal action against Hungary over Lex MOL, or MOL law.

The new law protects Hungarian companies from any hostile takeover attempts from a state-owned foreign counterpart.

Lex-MOL was drafted after an attempt by Vienna-based oil company OMV for MOL, in a deal which could value MOL at $20bn.

Credit Rating Raised

Hungary's credit rating outlook was raised to stable from negative by Fitch Ratings after the government's efforts to cut the European Union's widest budget deficit.
Prime Minister Ferenc Gyurcsány has cut public jobs, raised taxes and slashed subsidies to trim the shortfall after the EU threatened to cut aid.
The measures will help Hungary reach its deficit targets for the first time since 2001, according to the Fitch report.
The upgrade was due to the narrowing budget deficit and the anticipation that budget deficit targets for 2007 and 2008 will also be met. However, 2009 is less certain due to the 2010 elections.
The government wants to cut the budget deficit to 6.4% of gross domestic product (GDP) this year and 4.1% next, from last year's unwanted record high of 9.2%. This year's shortfall may actually be 6.3%, which will help reach the 2008 target, according to the Fitch report.
The austerity measures slowed economic growth to 1.2% in the second quarter, the second slowest in the European Union after Denmark. Fitch predicts Hungary's GDP will rise 2% this year and 2.5% next year, lagging behind neighbors such as Slovakia and Romania.
Investors are now awaiting third quarter earnings for Hungarian companies. The analysts at Cashline Securities have published a buy recommendation on OTP Bank as they believe that the third quarter earnings report (published on Nov 14) might not bring any negative surprises, and, in the current bullish market, no bad news means good news. In addition, the Russian and Ukranian subsidiaries of OTP might bring better numbers.
Sluggish
After two sluggish quarters, the net interest margin might increase, which would be quite positive for the bank. On the back of that, according to local press sources, OTP is pursuing negotiations with AXA (a world leader in financial protection and wealth management) to sell some stake of OTP's domestic insurance unit (Garancia). Furthermore, market rumors say that AXA could purchase up to a 10% stake in OTP as well. These plans seem rational, since the performance of OTP's insurance unit became less attractive lately, and OTP needs additional capital to make acquisitions in Russia.
In the meantime, AXA has 2% market share only in Hungary. AXA's 10% stake in OTP would strengthen the partnership and help protect the bank against a hostile takeover, although such an attempt is not thought likely.
In the view of Cashline, the news will stir up the trading waters around OTP. Considering that the analysts are expecting a relatively strong flash report, they are looking for a positive reaction, unless there is a downturn in the global markets. As the share price of OTP has been depressed for the past few months, they see it as a good entry point to buy at the current levels (Ft9,300-9,400) before the third quarter earnings can bring an upswing.
Mol, the largest oil and gas company, will also report on Nov 14. Our analysts estimate lower numbers in this quarter, and don't see a shiny earnings report. Mol will not be favored by increased oil prices due to a high tax proportion in Russia and declining production in Hungary.
The weak US currency has not helped either, as MOL is a US dollar earner. The relatively mild weather thus far has also decreased the demand for fuel.
Even though the report will not bring any kind of positive surprises Mol's trading is determined mainly by the take-over speculation from Austrian rival OMV.
The first company to publish earnings will be Magyar Telekom today (Thursday, Nov 8), a subsidiary of the German giant Deutsche Telekom.
The analysts at Cashline Securities have issued a buy recommendation on the telecommunications company as it has growing sales, costs under control and a favorable shift in working capital, enough to keep cash generation outstanding.
It also has solid earnings, despite an unfavorably strong Hungarian forint, which is detrimental for the company's bottom line .

Interest rates held

The National Bank of Hungary (MNB) kept the benchmark interest rate unchanged at 7.5% on Monday (Oct 29). The MNB said that the recent rise in food prices carry some risk from the point of view of mid-term inflation goals (inflation expectations might elevate.) The central bank said in a statement that the mid-term inflation trend is still favorable (and the 3% inflation goal is achievable for 2009), partially due to Hungary's lower economic growth.

The decision to keep rates on hold reflected a cautious attitude of the central bank, and came as little surprise.Analysts believe that rates will fall faster if global markets are more ready to take risk, and this strengthens the forint.The rate will fall more slowly than projected if food or service prices rise more than expected, or if wage increases pick up.The analysts at Cashline Securities do not see dazzling prospects for the future of the Budapest Stock Exchange, as they expect Hungarian stocks to continue to underperform compared with regional peers, at least until the Hungarian companies publish their quarterly results (in first half of November.)

Part of the reason why this week has seen very low participation from investors in the Hungarian market is that they are taking no positions in the local market given the uncertainty caused by the BSE being closed today and tomorrow (Thursday and Friday, Nov 1-2)

MOL, meanwhile, has received the E2.1bn syndicated loan which the company applied for at the beginning of October, press sources reported.MOL, Hungary's largest company, and the leading oil and gas refiner in the region, said earlier that the loan was for financing operations and acquisitions.However, apart from raising its stake in Croatia's INA, there are no further public acquisition targets.Cashline's analysts think that the money could also be used for treasury share purchases, but as the Lex-MOL law has come into force already (which prevents hostile takeovers of strategic Hungarian companies), an attempted takeover from Austrian oil company OMV will be very unlikely.

The Slovakian government plans to build an oil pipeline between Slovnaft's Bratislava refinery (Slovnaft is an affiliate of MOL, with the Hungarian company owning 98%) and OMV's Schwechat refinery in order to decrease the dependency on Russia's "Friendship"(Druzba) pipeline, press sources have reported.The Slovakian government had wanted to start the building process in 2005, but at that time they found it too expensive (it would have cost around SKK30m, about $1.3m).

Gasoline hike
Economic news portal Portfolio.hu claimed that Mol had announced a Ft4 per liter hike on the gross retail price of gasoline effective as of tomorrow, while diesel prices will rise by Ft6 per liter.These price hikes come in line with the all-time high oil prices currently experienced, as an oil crude barrel cost has increased to $93, which is the record highest level yet seen.The hikes will boost the price of the most popular type of gasoline to an average Ft282.50 ($1.62) per liter, level with this year's highest price, set in August.Diesel will cost Ft176 ($1) per liter on average, higher than at any time since September 2006.

The Budapest Stock Exchange index, BUX, moved marginally up last week on average volume. The BUX closed on Monday 15 of October at 28,307 points. Meanwhile the Dow Jones Industrial average in the US closed last week at a historical high of 14,164. Mol, the largest Hungarian oil and gas company, traded for the past week above HUF 27,000 and slightly above HUF 28,000. OTP had uneventful trading between the levels of HUF 9,400 and HUF 9,500.

The Financial Times reported that Mol hired Goldman Sachs to advise on its defense against a bid from Austrian rival OMV.
Goldman will join giants UBS and Morgan Stanley in advising Mol, the newspaper said. The European Commission has threatened to take action against Hungary for approving the Lex Mol law, which gives the government power to veto a bid for Mol. JPMorgan Chase & Co. and Deutsche Bank AG are advising OMV, the newspaper said. The final outcome between the battle of Austrian OMV and Hungarian MOL is uncertain, and could last many more months, as well as whether the European Union will actively pursue a change in the new “Lex-Mol.” The outcome is very much unclear so I predict MOL shares will trade around the current levels.

For this week there was news for Richter, the largest pharmaceutical.
Richter announced on Monday Oct 15 that it acquired a 95.78% stake in Pharmafarm, the Romanian retail and wholesale group for EUR13m. The group operates 14 pharmacy units in 3 Romanian counties representing 2.5 percent market share at retail and 7 percent at wholesales business in Romania. Completion of the transaction remains subject to the approval of the Romanian Competition Authority.
Forest Lab and Richter said high doses of its experimental antipsychotic drug did not show statistically significant improvement in a mid-stage trial for the treatment of schizophrenia. However, low doses reached a significant effect. The companies are to continue developing the drug. This is negative news for the shares, however, it is hard to quantify the effect. I expect there will be some negative impact in the trading, especially if there will be a sell-off in the global markets.

Lex MOL bill passed

The Parliament approved "lex MOL" on Monday October 8. The law will come into force sometime next week. This law prevents foreign state-owned companies from taking over strategic Hungarian firms. The Lex MOL law is one of the strictest regulations in Europe, which could generously decrease the interest for Hungarian equities from international strategic investors. State-owned Austrian energy firm OMV's attempt to launch a hostile takeover of its Hungarian peer sparked the drive for the new legislation.
I believe that the Budapest Stock Exchange will under perform other regional markets as MOL, the largest oil and gas company will stay under selling pressure. This new law could also affect somewhat stocks like Richter (pharmateutical) and Magyar Telekom (subsidiary of Deutsche Telekom) as investors realize that those companies will not be subject to any hostile take-over attempt, reducing in that way its attractiveness as shareholders will not be compensated when selling their stake to a potential buyer. Analysts predict that in the case of the largest retail bank, OTP, it will not affect as much as already a hostile takeover for the bank was nearly impossible since its management has a strong control over the company already.
Furthermore, the Hungarian market has been underperforming in the past period, which could be related to preparing to "lex MOL.”
If the European Commission takes steps against the law, it could take years until any official decision is made by the European Court.
Last week, Internal Market Commissioner Charlie McCreevy wrote to Hungarian Economy Minister Janos Koka warning that he would push through a case against Hungary in the European Court of Justice if “Lex-MOL” was passed.
Koka, however, insisted the new law did not break European Union rules.
``It's not about protection against foreign investors,'' he told the Financial Times. ``It's about protection against illegal hostile demands.''
Vienna based OMV has for months pushed MOL to sit down at the negotiating table and last week offered 32,000 Hungarian forints per share, thus valuing the company at around 20 billion dollars. OMV asked MOL to unwind the shareholding structures that have given the management control of about 40 per cent of equity and to lift the 10 per cent voting limit on shareholdings. MOL’s management rejected the bid and conditions from OMV. Changing the rules would require 75 per cent of votes at an extraordinary general meeting, but the MOL board is now thought to have gained a voting influence of over 40 per cent by lending shares to banks with close links to the energy firm's management.
Several of MOL's independent shareholders (London based Centaurus Capital hedge fund and Templeton Asset Management) have come out in favor of talks with OMV, but so far MOL’s board has refused to change their ideas with respect to any possible synergy with its Austrian rival.

OMV bids for MOL

Vienna based oil company OMV AG finally made a hostile bid for MOL NyRt last Tuesday (Sep 25) offering Ft32,000 per share (a deal worth Ft2.8 trillion or $15.7bn) while the stock was trading around the Ft27,000 level. OMV asked MOL to unwind the shareholding structures that have given the management control of about 40% of equity, and to lift the 10% voting limit on shareholdings. MOL's management rejected the bid and conditions from OMV.
Centaurus Capital, a London-based hedge fund which holds 1% stake in MOL, strongly criticized the company's tactics in attempting to defend against the bid from its Austrian competitor.
Other significant prominent investors of Mol, the region's largest refiner, such as Templeton Asset Management, have also criticized it for its attitude towards the hostile bid.
Martin Bartenstein, Austria's economic minister, suggested that Hungary should consider taking a blocking minority stake of just over 25% in Mol.
"That way, the Hungarian government could ensure OMV was not taking over MOL, but rather that this was a deal between equals," he said.
However, Hungary's purchase of a minority stake to fight a hostile takeover would be the "wrong solution," economy minister János Kóka said.
Hungary is not interested in creating a regional oil and gas monopoly, and wants to keep Mol in private ownership, which makes it a more effective and faster-growing company than state-controlled OMV, Kóka claimed.
As stated by Bloomberg news, analysts predict that the Hungarian company and the government will impede any kind of a hostile takeover.
"This takeover is unlikely to go through without Mol management's approval," Goldman Sachs' analysts wrote this week.
"We view it as likely to open up a long period of negotiations between OMV, Mol and the Hungarian government, including legal battles."
OMV's management will speak with investors in several European cities this week to detail their takeover plans.
"The Hungarian Parliament will probably accept the so called "Lex-Mol" law that would prevent any kind of hostile bid or takeover of any national strategic company.
If this law is finally passed next week, the Budapest Stock Exchange might experience some selling pressure, as the attractiveness of its main stocks like OTP (the largest bank) and Richter Gedeon NyRt (pharmaceuticals) will decrease, since a foreign company will be less likely to take it over.
The chances of Mol shareholders abolishing the voting limit and canceling the company's own shares are slim, so there is a very low probability of OMV's public bid succeeding.
In my opinion, "Lex-MOL" does not make too much of a difference in the battle between MOL and OMV.
OMV expects the European Union to investigate whether the new law, allowing Hungary to veto the merger, complies with Union competition rules.
The EU is "monitoring the situation very closely," Oliver Drewes, a European Commission spokesman confirmed yesterday (Monday, Oct 1).