Robert Smyth in Budapest -

Deutsche Telekom is finding that doing business in Hungary is getting harder all the time.

Already grappling with a costly corruption investigation, Magyar Telekom, majority owned by the German telecommunications firm, has now had a crisis windfall tax of 1.05% suddenly slapped on its revenues for a minimum of three years as Hungary's new Fidesz government attempts to balance the country's finances.

Passed by parliament on October 18, the windfall tax applied to a range industries, including the telecom sector, will mean that Magyar Telekom has to pay an estimated HUF27.5bn (€99.5m) for this year, or 42% of its profit, and €400m over five years. "The crisis tax means around a one-third reduction in Magyar Telekom's cash flow, which doesn't really make it profitable for it to invest," says Attila Gyurcsik, an analyst at Budapest-based Concorde Securities.

Gyurcsik says "temporary" taxes in Hungary have a history of not being temporary. For example, a temporary banking tax in place since 2005 was recently supplemented by a huge windfall tax, while an energy tax on profits has also just been extended with this new tax on revenue. Deutsche Telekom board member Guido Kerkhoff told state news agency MTI on November 17 that his company is considering legal action over the windfall tax, especially given it chiefly hurts foreign companies and is applied retroactively. "We understand and accept if countries facing a difficult situation have to launch painful measures, but the extra tax levied by the Hungarian government without prior notice was a cold shower for us," he said.

In September, Erste Bank downgraded Magyar Telekom from 'Accumulate' to 'Hold' since "instead of showing signs of recovery, Magyar Telekom showed acceleration in revenue losses, booked higher taxes and reduced its 2010 outlook." A substantial dividend cut now looks inevitable. Erste analyst Vera Sutedja believes that with the new crisis tax, it would not be possible for Magyar Telekom to keep its dividend level without raising its net gearing above 40%. Magyar Telekom is keen to keep its gearing to between 30 and 40%, which enables it to make acquisitions without going seriously into debt. This means considerably lower dividend yields from 2011 onwards; Erste has reduced its dividend estimates for 2010 from HUF74 to HUF60 and for 2011 from HUF70 to HUF40.

The new tax could have a silver lining, though. "The positive for Magyar Telekom is that all of its major competitors will be paying this tax, its competitors will also be forced to cut capital expenditure, while some may even have to leave the market," reasons Gyurcsik. "This could provide a window of opportunity to Magyar Telekom to purchase them."

Magyar Telekom has the wherewithal to make acquisitions, although the imposition of the tax is likely to make Deutsche Telekom ponder whether it is worth getting more deeply involved in an uncertain market. "The tax certainly sends out a negative message to investors about Hungary, and it might be prolonged for several years," says Gyurcsik. He doesn't believe that Magyar Telekom will attempt to pass on the cost of the tax to the consumer due to its strong relationships with the government, which remains a major customer of Magyar Telekom's services.

Otherwise engaged

Magyar Telekom has certainly been busy in the M&A market. The company beefed up its cable footprint, snapping up some 16 networks in the course of 2008 and 2009, adding Modultechnika, a cable TV and Internet service provider in Western Hungary in 2010. It is, in fact, aiming to become leader on Hungary pay TV market within 12 to 18 months. Furthermore, Magyar Telekom has long been expanding its portfolio to provide integrated telecom and IT solutions to customers, adding system integration and infrastructure support service provider KFKI Direkt and International System House (ISH), a market leader in the health IT services segment, both in 2009. Also in 2009, it acquired Telekom New Media and Telekom Content&Rights, integrated later as Telekom New Media, which Magyar Telekom says now holds the leading position in Hungary's interactive content services market. In July, Daten Kontor Group, an IT applications company group, was added to the portfolio.

"The figures show that good decisions were made in terms of revenues brought in from new businesses, but these still can't counteract the losses in fixed-line, and to some extent mobile," observes Akos Kuti, an analyst at Cashline Securities.

First-half revenues for 2010 were down by 7.1% to HUF297.8bn in the first six months of 2010 compared with the same period in 2009. This was mainly due to lower fixed and mobile voice revenues in all three countries it operates in - Hungary, Macedonia and Montenegro - together with a decline in Hungarian data revenues. Magyar Telekom has felt the financial crisis, but is well placed among its peers, seeing revenues fall by a relatively modest 5-6% overall, though its profits remain at the lower end of a regional comparison, observes Gyurcsik.

Revenues from international subsidiaries, primarily from integrated operators in Macedonia and Montenegro account for roughly one-fifth of group revenues. However, ownership of market leading Makedonski Telekom and Crnogorski Telekom has hardly been a smooth ride since Magyar Telekom is still paying the price of improper payments made in the Balkans, quite literally, with the cost of the ongoing investigations already adding up to around three times the amount of the original payments of around €20m.

Furthermore, at €8m Kuti feels that Magyar Telekom paid a little over the odds for Bulgarian alternative telecom Orbitel. It subsequently cut it losses after just four years in 2009 when it couldn't gain sufficient market share. "I believe Magyar Telekom will focus on acquisitions that are more fairly priced in future. However, I can't see any targets out there at the moment," Kuti says.

Outside of Hungary, Magyar Telekom's acquisition strategy is likely to continue on the Balkans and Southeast Europe. However, M&A openings lie few and far between, especially given that Deutsche Telekom holds stakes in various telecom firms across the Balkans that would prevent its subsidiary bidding. "Targets in other geographies, such as Greece's OTE, fall under the jurisdiction of Magyar Telekom's parent company Deutsche Telekom," says Kuti.