EBRD: European Bank for Rip-off Deals?

Investment bankers and fund managers are happy to criticize the European Bank for Reconstruction & Development (EBRD) in private, but few will do so on the record. One of the few is Peter Rona, chairman and CEO of the First Hungary Fund, which has $130 million invested in Hungarian companies. Hungary is where the EBRD embarked on its mission, with its first loan to the private sector in 1991 and its first equity stake in early 1992. Now many believe the country has graduated. Its privatization programme is largely complete; and there is plenty of equity and medium-term finance available from the private sector.

Rona argues that the EBRD should step back from Hungarian privatization deals if there is an alternative private sector offer. In two cases he has made such offers but was told he must take a back seat, he says.

It’s unfair, he says, that the Hungarian privatization company APVRt and the EBRD should discuss the terms of a privatization deal, in which the EBRD later takes a stake, before the terms are made public.

A case in point, he says, is the forthcoming privatization of axle-maker Raba. Privatization minister Judith Csiha was in London last month and met EBRD officials. Within days of her return the cabinet decided the terms of the Raba tender, Rona indicates.

He also points to press reports that the EBRD has agreed with the finance ministry, before the involvement of other investors, to provide a subordinated loan, convertible into shares, for the upcoming privatization of Commercial & Credit Bank.

EBRD officials refute any suggestion that Csiha was in London to firm up the Raba deal. This was her first official visit to London, during which she met EBRD president Jacques de Larosière to discuss relations in general. Market sources point out that Rona has a special interest in Raba, which supplies North American Bus in which First Hungary Fund (FHF) has a 79% stake. (Hungary-based North American Bus has a subsidiary in Alabama which assembles buses for the American market.) However, the Hungarian cabinet has decided that private shareholdings in Raba should be limited to 10% of the equity.

As for the Commercial & Credit Bank, EBRD sources say the purpose is to “reinforce the bank’s capital and maintain maximum flexibility for a potential strategic investor”. The EBRD might or might not take a stake.

Other investment bankers and fund managers are more quietly critical of the EBRD’s sometimes aggressive role as a competitor in the Hungarian market. “There’s hardly anything not financeable by the market in Hungary now,” says the managing director of a western investment bank subsidiary in Budapest. “The EBRD has a harder and harder job finding those complementary roles.” Under its charter the EBRD must mix development lending with private sector equity and debt investment for commercial return. The criterion is that its involvement should encourage and complement that of private sector participants, rather than competing with them. In Hungary, as the financial sector matures, that is getting increasingly difficult. “The EBRD must recognize that it should move on, to Kazakhstan and elsewhere,” says a UK-based investment banker.

But, according to the EBRD’s Hungary team leader Gyuri Karady: “We are constantly re-inventing ourselves, and dropping products from our portfolio that the private sector can replicate”. He cites plain lending and transactions with Hungarian blue-chip companies as items that have fallen away.

Criticism of the EBRD’s role in Hungary centres on two deals: the privatization of Budapest Bank, and the sale of Egis Pharmaceuticals to a French buyer. In the case of Budapest Bank, critics say, the EBRD took a passive 32.4% stake to assist GE Capital Services, one of the richest companies in the world, to buy for practically nothing a bank whose bad bits were anyway puttable back to the Hungarian government.

An EBRD source rejects this interpretation. It was an extremely complex privatization and the second major bank to be privatized. In earlier, ultimately abortive, discussions with Credit Suisse, the EBRD understood it wasn’t needed and stepped back. But both GE and the Hungarian ministry of finance asked the EBRD to come back in to bolster the GE deal. “The aim was to have a neutral shareholder to add confidence to the transaction on both sides,” says an EBRD source. It was a “very nuanced agreement”. There were parts of Budapest Bank’s portfolio “which were difficult to understand” and which consequently were carved out or guaranteed by the government. The fact that Budapest Bank turned out to be a profitable investment could not have been guaranteed. In fact, in the depths of 1994 and its rejection by Credit Suisse, it looked more like “a jilted bride” than a jewel.

Criticism of the Egis deal concerns the exit rather than the entry. The EBRD bought a pre-privatization stake in Egis in 1993. The EBRD’s environmental due diligence gave comfort to other investors. The EBRD was also taking the risk that the privatization might never take place. However, there was a successful flotation of a minority of the equity in 1994. The government and the EBRD together held a majority of the Egis shares. The government stake was sold to NatWest Markets and then, together with the EBRD stake, was sold as a controlling majority to Servier of France.

That sale triggered a fierce reaction from some minority shareholders, including some influential foreign fund managers. They argued that the EBRD has a duty of best-

practice towards minority shareholders: that would have meant ensuring that an offer for control of the company included an offer to all shareholders at the same price. “The EBRD made a return with scant regard for the minorities,” says a UK-based investment banker. “One would have expected the EBRD to encourage good practice.”

EBRD sources respond that it is normally the buyer not the seller who is expected to make a full bid ­ although Hungarian stock exchange law at that time didn’t require it.

The World Bank’s private sector arm, the International Finance Corporation (IFC), which also has equity stakes in Hungary, is regarded as a less aggressive player in investment banking. “They’re more mature,” says a Budapest-based investment banker. “They only go into deals where they’re ultimately needed.”

Without wishing to lock horns with the EBRD, acting IFC resident representative Borbala Cako neverthless notes: “We like to exit through the stock exchange if possible. Although,” she adds, “we have to see what kind of strategic investor may come in.”

Insists Karady: “The stock exchange is our preferred exit too. But in this case it was felt by everyone that Egis needed a strategic partner to maximize its value.”

Other criticisms of the EBRD in Hungary are less strident, but have the same theme. Why, asks an investment banker, did the EBRD join Bayerische Landesbank to invest in the Hungarian Foreign Trade Bank? He can see no reason. Why, asks a fund manager, did the EBRD buy into Borsod Chem, a chemicals firm, at an early stage “when it was clear the market didn’t need them”?

The EBRD’s presence encouraged investors to believe Borsod Chem was environmentally sound, says a Hungarian investment banker. The EBRD also initially underwrote nearly the entire Borsod Chem issue.

A new test of the EBRD’s intentions will be the initial public offering of telecoms concern Matav expected some time this year, says the fund manager: “One should argue that there shouldn’t be a role [in Matav] for the IFC and the EBRD.” Except as sellers into the market, since each has a small stake.

The EBRD does know when to pull out of a deal and leave it to the private sector, says Karady. “We try to avoid crowding out private investors by screening deals at the concept clearance stage,” he says. “Sometimes we have to step back because the parameters of the transaction change and you have to change your approach.”

Perverse example

A perverse example of this was the Ferihegy airport terminal financing last December. The EBRD was involved in structuring a private-sector financing but, when the state decided to take over the deal and provide a guarantee, the EBRD stood back. “It would have been against the spirit of our charter, and no longer supporting transition [to a market economy],” says Karady. That decision was made despite having spent “more time on the airport terminal, in manpower terms, than any other financing”.

The EBRD also stepped back from a deal with Rona’s First Hungary Fund, an investment in Danube Knitwear, after Rona found an alternative lender, the Foreign Trade Bank. “It happened a few days before the signing,” says an EBRD source. “We said ‘fine’. We certainly didn’t crowd the new investor out.” Rona recalls them saying something different ­ that “if I didn’t accept their terms I would never do business with them again”. Rona cites examples where he believes his private sector alternative was forced out by an over-aggressive EBRD ­ Egis, where he offered “an important alternative”, he says, and most recently Raba, where he offered “a complete deal”. It appears that Rona ­ whose FHF includes such illustrious investors as Fidelity, College Retirement Equity Fund, Scudder Stevens & Clark, the UN Pension Fund, Mercury Asset Management, UBS, SBC, Norwich Union, Alliance Capital, and the IFC ­ has had quite a running battle of words with the EBRD. The EBRD has learned to work with or without him, as it does with many other fund managers and investment banks. Sometimes they work together. Sometimes it is impossible, given the EBRD’s private sector goals, to avoid an atmosphere of rivalry.

The privatization of agribusiness concern Babolna, on which the EBRD is working together with the IFC, is an example of the EBRD’s continued pioneering of new areas, says Karady. “It’s complex because it’s the agricultural sector, and because agriculture is expected to be one of the sectors most affected by Hungary’s planned accession to the EU.”

But the EBRD’s future ground-breaking work in Hungary is most likely to be with medium-size companies. Karady’s Hungary team is starting to concentrate on companies of $20 million to $30 million turnover, privatized two or three years ago, but without a strategic investor and without any obvious international profile. “We wouldn’t have wanted to touch any of these companies in 1993 or 1994,” says Karady. But the firms now have a two- or three-year track record and “you can credibly start financing on sound banking principles”, he says.

In January the EBRD also began the Hungarian Special Restructuring Programme (SRP). This is an Ecu30 million fund run by Sandtner Hamilton & Co of Frankfurt aimed at three- to five-year investments in Hungarian companies that require restructuring. The SRP aims to tread, as an industrial rather than a financial investor, in areas where the private sector is still wary. Its work will be helped out by an Ecu7 million grant from the EU’s Phare programme. That grant money will be spent on feasibility studies, due diligence, industry experts, accounts, lawyers and environmental audits. “Our people are industrial turnaround experts not financial investors,” says Spyros Papas, senior banker at the EBRD in London. “We can focus on companies that other investors can’t access. In my view there’s a lot of money to be made in this area,” he says.

It seems that, by moving down the company food-chain, the EBRD is ensuring it will have work in Hungary for many years to come.

“Ultimately, multilateral development banks may not be needed,” said EBRD president de Larosière in Washington last September. “The fact that they are no longer necessary will be a clear sign of their success.” However, he added, “that time has not yet come”. It seems the EBRD, even in its most developed market, is far from doing itself out of a job.