Robert Dean in Budapest -

Fierce competition in the fixed-line and mobile markets is the unhappy lot of most of the world's former telecommunication incumbents, forcing them to grow beyond their domestic markets and traditional activities. However, as a scandal at an overseas unit shows, Magyar Telekom has found doing business beyond Hungary’s borders trying, to say the least.

Moody's announced Thursday it was sticking with its 'Baa1' rating of Magyar Telekom following a review that it began at the end of August because of the company's delay in publishing its financials for 2005.

That failure to report its 2005 earnings on time was due to irregularities found at its Montenegrin subsidiary, which cost the company not only around €12m, but also long-serving CEO Elek Straub his job in December.

The alarm was initially raised by accountants PriceWaterhouseCoopers, who during the course of the audit of Magyar Telekom's accounts found two contracts that overseas subsidiaries had entered into which appeared to involve violations of the company's internal control systems, as well as certain laws.

An independent investigation carried out on behalf of the company's Audit Committee then found a total of four contracts that investigators were unable to find sufficient evidence of a proper business purpose. The total amount of the four contracts was about €7.9m.

Magyar Telekom’s reputation took a hit from the scandal, though the worst of the incident now appears behind the company, leaving investors to focus on matters more related to financial performance criteria.

"While the investigation is ongoing, the auditor has signed the books and I don't envisage further problems, and no delay to the publishing of the next annual report even if the investigation takes more time," says Attila Gyurscik, an analyst at Concorde Securities. "Investors are more worried about dividends and more in terms of dividends is likely to be offered."

New markets, new services

Those returns will, of course, depend largely on the success of Magyar Telekom's acquisition strategy, which the purchase of Telekom Montenegro in 2005 was part of.

Magyar Telekom began its buying spree with Macedonia’s former monopoly in 2001. It has since embarked on a smallish green-field project that saw the company offering alternative telecom services in Romania and paid €8m for the Bulgarian alternative telecom and ISP Orbitel.

"These investments are not big amounts and Magyar Telekom also has the know-how now to compete with incumbents [having been one itself]," says Gyurcsik.

Magyar Telekom has been acquiring companies at home too, as it continues its transition into what it hopes will be an all-encompassing telecom and IT company. Magyar Telekom’s plan is to achieve one-third of its overall revenue within three years from IT services, one-third from broadband, and one-third from access – i.e. fixed and mobile voice.

Gyurcsik commented that the move into the IT business side of things was the right move, as the company can now provide complex services based on fixed, mobile, internet and systems integration, which is unique for the Hungarian market. The acquisition of KFKI should fit nicely alongside its own IT arm T-Systems.

And Krzysztof Kaczmarczyk, an analyst at Deutsche Bank, says the revenues from the data centre Dataplex and local IT holding company KFKI were key drivers behind Magyar Telekom overshooting expectations for its third-quarter results.

However, Dataplex is illustrative of a potential pitfall for Magyar Telekom's aggressive acquisition strategy, which is to pay significantly over the odds.

While the role of data centres is growing in importance, paying around €20m for Dataplex shortly after it had been sold for around half that amount is hard to justify.

Magyar Telekom maintains it paid a fair price for Dataplex, arguing that the value of Dataplex had multiplied after investment group Wallis bought it from the investment wing of the pharmaceutical firm Beres. While Wallis might have brought in some big customers, including the likes of postal giant Magyar Posta, €10m remains quite some mark-up.

On the operational side, Magyar Telekom's profits are unlikely to grow significantly, but the share price and dividends could benefit from the increasingly positive macroeconomic climate in Hungary.

Though its fixed-line business is declining, Magyar Telekom owns the market-leading mobile operator so is, to some extent, protected from this trend.

Magyar Telekom will have to face up to the further thrust of domestic competition from the number-three fixed-line provider HTCC, which is acquiring the number-two operator Invitel, but neither as yet have a mobile wing.

Competition will further intensify, according to Vera Sutedga, an analyst at Erste Bank in Vienna, but she notes that HTCC and Invitel’s combined revenue from fixed-line activities significantly lags that of Magyar Telekom’s fixed-line revenue (€348m compared with €1.3bn in the 12 months ending September 30, 2006).

“HTCC can’t get more competitive in the short term, as it has to integrate and needs more time,” says Gyurcsik.

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