Christopher Condon in Budapest -
No one could argue that OTP Bank, Hungary's dominant financial group, has not made a radical transformation in the last 12 years. Once the country's monopoly holder of retail deposits and a lumbering state-owned institution, OTP has proved fast on its feet since being privatised in the 1990's on Hungary's stock market. It has leveraged that early advantage into a big market share across a full array of modern financial services. In cards, mortgages, insurance, private banking and many other niches, OTP has played smartly and aggressively.
The group is coming off another impressive year. On Wednesday, it reported 14.5% growth in pre-tax profits and a return on equity of 28% in 2006. The figures were largely in line with analysts' expectations.
Chairman and CEO Sandor Csanyi has led an aggressive push abroad, as well. OTP has swallowed 10 banks in 8 countries since 2002, becoming a serious regional player. Its biggest success has come in Bulgaria, where DSK is number 2 in the market and growing fast.
But moving onward and upward may be about to get much more difficult for OTP. The bank's home market, OTP's cash cow, is beginning to mature. Hungary's economy is also slowing markedly because of a government austerity package needed to harness a runaway budget deficit. To keep its high growth story on track, OTP will now rely very heavily on its new acquisitions in Ukraine and Russia. And there, Csanyi and his Hungarian colleagues may be out of their element.
"The risk lies in whether OTP can pass on its know-how in Russia and Ukraine," says Attila Vago, senior analyst with Concorde Securities in Budapest.
A closer look at OTP's expansion outside Hungary shows a very mixed record. Small acquisitions in Slovakia and Croatia have not sparkled. RoBank, a Romanian bank bought in 2004, has performed worst of all and is expected to lose another 8m in 2007, its third year in the OTP group. OTP has simply failed to grow the bank in line with a very quickly expanding market.
Bulgaria's DSK, by contrast, had a banner year in 2006, contributing 86% of all profits from foreign subsidiaries and a healthy 12.6% of the entire group's profits.
But sceptics point out that OTP's success with DSK owes much to the two banks' similarities. DSK was the big state-owned retail bank, badly in need of direction and modernisation, but stuffed with deposits in a fledgling banking market. Roughly speaking, DSK and Bulgaria were a rerun of OTP and Hungary 15 years previous. All OTP had to do was repeat the process, with the added advantage of having learned from mistakes.
When OTP sets its sights on Ukraine and Russia last year, it couldn't find another DSK. Instead, Csanyi last summer spent 650m on JSBC, Raiffeisen's corporate banking arm in Ukraine, paying 4.7 times book value. A few weeks later he followed that by buying Russia's Investsberbank for 377m, at 3.8 times book value. The prices raised some eyebrows, but OTP's boss vowed that those prices will look cheap in a few years given the growth potential of those markets.
Most analysts, including Tamas Simonyi, a banking specialist for KPMG, say OTP's strategy is the right one. With its margins shrinking at home, it needs to move into high-growth markets abroad. But execution is another matter.
Laszlo Urban, OTP's new deputy CEO, makes it sound rather easy. He acknowledged the problems the bank has encountered abroad, particularly in Romania, but insisted the spectacular growth rates in Ukraine and Russia presented something of a can't-miss opportunity.
"All we need to do is establish good branch networks, and with the same product line simply ride the wave," he said in an interview.
Russia's banking market is expected to grow by 40% in 2007, much faster than the 8% expected globally and the 12% seen likely in Central and Eastern Europe, according to McKinsey & Company, which is also advising OTP on integrating its acquisitions. But it may not be as simple as Urban makes it sound.
Gernot Jany, an analyst for the securities arm of Erste Bank in Vienna, is bullish on OTP. But, he says, the bank must be very careful to find the right local talent to fill top management positions in Ukraine and Russia.
"They have good knowledge in the banking business, but they have to rely on people there. They cannot do it from Budapest," he says.
Urban and Csanyi said much the same thing on Wednesday, but they have already lost some key people at Investsberbank because they refused to meet their demands for higher salaries.
Urban, meanwhile, spoke optimistically about the drooping Hungarian market, where overall economic growth is expected to slump to 2-2.5% this year after several years at around 4%, and consumption is expected to shrink in real terms. He said OTP had plans for combating its margin compression and the general economic slowdown.
The bank's biggest borrowing clients, he said, provide the lowest margin businesses, at 1-2% and falling, bringing average margins down to 4.75% in 2006. OTP will be getting more aggressive, he said, to attract smaller, but higher-margin clients, like SMEs and mortgage borrowers.
"Even with relatively aggressive pricing we can make a higher profit," Urban said.
OTP has also launched a major re-branding effort that will include all its businesses in Hungary, as well as some foreign subsidiaries. The move will connect the group's wide ranging products and services under one corporate image and, the bank hopes, do away with the last vestiges of its old reputation as a plodding state bank.
If things go worse than expected either at home or abroad, it could speed the day when OTP becomes an acquisition target, itself. In recent months, Megdet Rahimkulov, who lives in Hungary and owns the former Gazprom Bank subsidiary AEB, has caused a stir by accumulating nearly 6% of OTP shares.
But Rahimkulov is mostly seen as a pure financial investor. It could require 10bn for a successful takeover bid, and even then could be easily blocked. Under pressure from the EU, the Hungarian government is about to give up its "golden share" that would allow it to veto a takeover, but there are other big hurdles written into OTP's rules of association.
These limit voting rights to 10% for any single shareholder, 33% for any group of shareholders acting in accord, and 50% for all foreign shareholders. Wood & Company, an investment bank based in Prague has called a takeover all but impossible under these rules.
Others say a takeover is possible if it has management's blessing, which should leave Csanyi around long enough to see if his bets on Russia and Ukraine pay off.
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