Investors Mol-ified by success in INA takeover

By bne IntelliNews October 13, 2008

Nicholas Watson in Prague -

Its share price apart, all in all it's been a pretty good year for Mol Hungarian Oil and Gas. Fresh from seeing off - at least for now - an unsolicited takeover bid from Austrian rival OMV, Mol is now finally the largest shareholder of the Croatian energy firm INA.

On October 10, the final result from Mol's public tender for the 31% of INA shares not owned by Croatian government showed that the Hungarian firm had managed to secured 22.15% of that, raising its total stake to 47.15% from the 25% stake it bought from the state in a 2003 privatisation and making it the biggest shareholder.

Ironically, the global financial crisis worked in Mol's favour. Its tender offer of HRK2800, or €400, per share was deemed too low by institutional investors when it was launched at the beginning of September and few offered up their shares initially. However, after stock markets around the world tanked as the credit crunch deepened, the price began to look much more attractive and investors, including the Croatian war veterans fund, rushed to sell their INA shares before Mol's offer closed. By the close of October 9, INA shares had dropped to HRK2,100 (€290), well below Mol's offer. Mol's shares, meanwhile, plummeted over 14% on October 10 to HUF10,720, but had recovered to HUF12,770 by midday on October 13.

The next move is for the Croatian government to sell Mol a 19% stake from its current 44% holding as part of its efforts to join the EU, which frowns on such large state holdings, thereby giving the Hungarian company a controlling stake. According to analysts, the government is expected to soon resume talks with Mol over a new shareholders' agreement and the sale of this 19% stake, which could involve a share swap as opposed to purely a cash offer.

Ambitious goals

So what has Mol got for its money? INA, which Mol's offer values at about €3.9bn, is a central plank of the Hungarian firm's strategy to diverse its business both geographically and by segment. INA is primarily an upstream company with this segment generating 124% of the group's cash flow in 2007. "To put it bluntly, while most operations lose money, upstream is very profitable," says Gergely Varkonyi of Deutsche Bank.

INA has proven and probable reserves of 375m barrels of oil equivalent (boe), which is just 14% less than Mol's, a much larger company. Most of the primarily gas reserves are located in Croatia with the remainder in Syria, Egypt and Angola. The average reserve life is 16 years based on P2 reserves, slightly higher than Mol's 13 years, while its reserve replacement ratio stood at an impressive 128%. The reason for this is what while its onshore assets, like Mol's, are mature, unlike Mol it has growing offshore domestic gas production in the Adriatic Sea through a joint venture with Eni, where production began in 1999 and accounted for 39% of total gas production by 2007. The total recoverable reserves of Adriatic gas are estimated at 20bn cubic meters, and production is expected to continue for over 20 years.

This will go some way to enabling Mol to fulfill its goal of raising current production of around 85,000 boe per day (boe/d) to as much as 120,000 boe/d by 2013. This is an ambitious aim and not one that many analysts believe can be fully met. Much of the production growth will have to come from enhanced oil recovery (EOR) at its domestic fields, which account for 72% of production, and exploration and development of newly acquired assets in Russia. Deutsche Bank expects Mol's production to pick up by 2.5% in 2010 and by 7% in 2011, driven predominantly by Russian growth and stable Hungarian output. "However, our peak 96,200 b/d estimate in 2012 is a good 30% below the company's target," notes Varkonyi, though adding that Mol "can only outperform our expectations."

Indeed, in the second quarter Mol reported that its crude oil production actually declined by 9% on year mainly due to the sharply lower volumes from the ZMB oilfield in Russia. Inadequate infrastructure, both below and above ground, is cited as the main problem at its Russian fields, which now include the BaiTex and Matyushinskaya fields. BaiTex already has 2P reserves of 64.4m barrels, 30% higher than ZMB, yet its production was only 2,000 b/d, or 8% of ZMB's, during the quarter.

Despite this, Mol more than quadrupled its net income in the second quarter to €458m mainly due to a favourable revaluation of its debt as the local currency soared against other major currencies, the stronger oil price and an outstandingly profitable downstream business (a Wood Mackenzie survey found that Mol's refineries in Hungary and Slovakia are the most efficient refineries in thr whole of Europe). The oil price has since significantly come off its highs, but on September 19 the firm's chief executive, Gyorgy Mosonyi, told reporters this wouldn't have a significant impact on the company's profitability because, "MOL is a downstream-oriented company, where the crack spreads for diesel and gasoline remained stable or even improved."

"Diesel crack spreads practically exploded in the second quarter, achieving all-time high levels, which worked especially in Mol's favour as its product slate is geared towards diesel, ensuring a competitive edge for Mol," says Akos Herczenik, an analyst with Raiffeisen Group.

It's this kind of performance that so attracted Mol's regional rival, OMV. The Austrian firm, however, abandoned its bid to take over Mol in August after an acrimonious year-long battle, saying that EU conditions for allowing the merger to proceed were too onerous to make the move worthwhile. This was a victory for Mol, which had fought tooth and nail to prevent what it regarded as a hostile takeover by a foreign government (OMV is 32% state owned). As well as pushing the Hungarian government to pass a law to prevent "strategic assets" from falling into foreign hands, dubbed "Lex Mol", the oil and gas firm started loading up on its own shares to prevent OMV from getting its hands on them. At one point, Mol controlled over 40% of its own stock through share lending agreements and treasury stock, meaning that OMV had little chance of raising further its 21.3% stake that it had built up over the past year.

The big question is what OMV plans to do with that stake now it's supposedly given up on its aim to take over with Mol.

OMV has publicly stated it intends to hold on to its stake in Mol, notwithstanding the announcement on September 25 that it had struck a repurchase agreement, or repo, with Bayerische Hypo-und Vereinsbank for 10m Mol shares, which will cut OMV's stake in the Hungarian firm to 11.7% until January 2009, when it will buy the shares back. The market has been abuzz with the reason behind this repo deal. Does it presage a renewal of hostilities, asked some? MOL's statutes limit the exercising of voting rights at 10%, so by transferring a 10% stake to Bayerische, OMV might be able to increase its influence at shareholder meetings if the bank and other shareholders back it. Others believe OMV simply wants to put those shares to work and needs financing for the short term. Mol's next shareholder meeting is not scheduled until April when OMV will once again probably hold its full holding.

Whatever OMV has in store for its shareholding, one thing for certain is that, ironically, the Austrian firm is now ensuring Mol will remain out of the hands of any other acquisitive regional rival for the time being. "There's no way past OMV for any company that wants to take over Mol," says Philipp Chladek, another analyst with Raiffeisen. "As long as OMV doesn't sell its shares in Mol to anybody else, Mol can remain independent - that's definitely the case."

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