Credit Crunch Tests Romania’s Growth The Diplomat – June 2008Report
by Michael Bird Ana-Maria Nitoi
Additional reporting by Corina Ilie
While merger and acquisitions are hitting a peak of intensity, financing may prove a tougher call as banks become more cautious, argue lawyers
Early signs are that the international credit crunch is affecting the ability of businesses in Romania to attract funding from abroad, as well as discouraging more risk-taking foreign investors, as The Diplomat quizzes lawyers on the state of the business market.
Many lawyers believe the full effect will take up to nine months, which means the pinch will be felt in the second half of this year.
“This could ultimately mean more competition among lawyers for a shrinking volume of transactional work,” says Bryan Jardine, Wolf Theiss. “We have already seen situations where firms have been more willing to discount their standard fees to secure business in a more competitive legal market.”
It is also becoming harder for property developers to attract external financing for new projects. For this reason, Florian Nitu, Popovici Nitu and Associates has seen many projects put “on hold” in the real estate field.
Some lawyers believe that in 2008 attracting over 50 million Euro loans, say, to expand a Romanian-located retail business from an investment fund or bank may prove a much harder prospect than last year. Prudence and caution are making themselves known to Romania.
“The main effect of the crisis in the West will be the reduced appetite for risks and a certain reluctance by some investors to put a foothold in Romania,” says Gabriel Zbarcea, Tuca Zbarcea and Associates. “From this perspective, investments are likely to slightly slow down, but I do not expect a major crash or mortgage crisis. However crediting could get tighter and interest rates are likely to grow.”
From a regional perspective, Sebastian Gutiu, Schoenherr, believes larger markets in central and eastern Europe, such as Poland and Romania, will feel the effects of the slowdown more than smaller countries. “In the region as whole, this is not having an effect, because Serbia and Albania are booming,” he says.
For law firms, this will mean increased business in crisis management of companies. “The early signs are that some companies are restructuring and taking fewer risks,” adds Gutiu.
This will also effect the enthusiasm of new investors. “The international economic situation will not stop local companies further continuing their planned investments,” says Sorin David, David si Baias. “But firms that are not currently present in Romania will give more thought and will calculate more thoroughly their expansion plans in Romania and other emerging markets.”
Providing they have a flexible portfolio of specialists, law firms are ensured against crises in the markets. “It is too early to say what will be the impact of the recession, but law firms in Romania will not go bust,” says Catalin Baiculescu of Musat and Associates. “When times are good, law firms invest in their mergers and acquisitions department and, when times are bad, their specialisations turn to restructuring and insolvency.”
Bankruptcies in Romania have increased by over one third in 2007 compared to the previous year, according to a report by risk analysts Coface Romania. “Romania will face more cases in liquidation,” adds Baiculescu. “This is becoming a more important sector.”
Mergers: can intensity continue?
Giant numbers of mergers and acquisitions drawn up at the end of 2007 have been announced recently, such as French insurer Groupama’s 350 million purchase of insurer Asiban, Ford’s purchase of car factory Automobile Craiova and the buy-out by French dairy group Lactalis of LaDorna. “We see an increased interest in Romania after the accession to EU,” says Bruno Leroy, Gide Loyrette Nouel.
EU legislation affects every area of legal work from privatisations to public tender procedures and makes Romania more predictable for investors it also provides an umbrella of reassurance which is lacking in neighbours such as Ukraine, the Republic of Moldova and Serbia.
This is part of the reason why FDI in Romania in the first month of 2008 reached 663 million Euro, an increase of more than 65 per cent compared to January 2007.
But this investment enthusiasm may be reaching its peak. “I think M&A and private equity will slow a bit this year in comparison to 2007,” says Todd Shollenbarger, White & Case, “because financing is not as readily available as it has been historically. However, there’s still plenty of deal flow.”
From a foreign investment sector, energy, IT&C, steel and the automotive business seem to be the most popular, while in the domestic market pharmaceuticals, banking and insurance are showing great dynamism.
The largest potential deal could be Austrian steel producer Voestalpine, which is allegedly searching Romania for 1,000 hectares to invest around five billion Euro in manufacturing. Added to this will be Daimler, which is looking for a factory site and Mitsubishi, which is also rumoured to be interested in Romania.
Romania’s total foreign investment is expected to stabilise at around seven billion Euro for 2008, the same as for 2007. “We would expect an important share of FDI to come from significant greenfield projects,” says Zbarcea.
But in expected deals in Romania, Jardine anticipates few private M&A deals in 2008 with the magnitude of the recent 1.8 billion Euro transaction of Kazakh state oil and gas group Kaz Munai Gaz of Romanian oil and gas firm Rompetrol.
There is also great potential in large Romanian infrastructure projects, such as new highways, ports and an airport for south Bucharest, which could use secure funding from the EU backed up by multilateral institutions and the state budget. This will keep the legal business busy with big deals for the next five years, predicts Jardine.
Real estate: cracks
in market emerge
Real estate remains the most dynamic sector in Romanian business, but this unruly market is witnessing more risks and smaller returns.
There is still a massive demand for commercial, residential, office and logistic space, but with more supply coming onto the market, investors are becoming choosier about where to place their money.
“For two years Romania was a real estate paradise, even with the US sub-prime crisis and its knock-on effects in the UK, it was still a mini-paradise,” says Sebastian Gutiu. “It’s too early to say what the effect will be this year. There are still good chances, but it is getting increasing difficult.”
There seems to be more of a consolidation of existing plots than major transactions in the land market. In some ways this is due to a lack of plots for sale, while banks and developers have also become more selective in where to invest their cash. Mihai Mares, Mares and Associates, says that lately the selling of land plots have not increased, but construction companies are showing more interest to enter the market.
While there are still thousands of residential blocks from the former regime, these old buildings risk becoming obsolete in the next 20 years. Investment in a Communist flat may, in the future, leave a home-owner stalled in negative equity. The prices for old apartments will drop, says Mares, but he says the prices for buildings in the centre of Bucharest will continue to grow.
“There is still not enough supply on the market of homes,” says Gutiu. “In Bucharest maybe only 2,000 to 5,000 units will be delivered this year. And how much are these prices affordable for people who are living in old buildings?”
The real estate lawyer believes that this year will see a deceleration in the price of property.
Meanwhile Bryan Jardine says, in the real estate market, sellers’ expectations have rationalised in reaction to the credit crunch and tightening of liquidity on the international markets. “The real estate market will likely be the most directly affected by the credit crunch,” he says. “But the effects may not be as profound as in the West, given that there has been no sub-prime lending in Romania and banks have traditionally been much more cautious when offering credit secured by mortgages over real estate.”
It will be harder for new entrants on the real estate market to attract significant financing, while investing in real estate may no longer be considered the safest option. “Businesses are now carefully considering every acquisition,” says Catalin Baiculescu, Musat and Associates. “Most of our clients are not in the business of buying and reselling, but more in buying and developing. Also, banks are not as willing to refinance as in the last couple of years. A track record of successful developments helps a lot when asking for financing.”
The quality of previous projects by construction firms and developers will start becoming an important factor in whether investors are willing to put up the vast amount of cash needed for real estate development.
Meanwhile Dragos Radu, RTPR, believes big Romanian cities will start to transform in the next years. “Developers will start from the outskirts to the centre buying old apartment buildings to demolish them and build new apartment buildings,” he says.
Gabriel Zbarcea agrees. “Bucharest is no longer the main target for investors, as they have spotted real business opportunities in other growing economic regions, such as the west of the country,” he adds.
Privatisations: main target energy
Major privatisations are over, but there are still a handful of strong state companies for sale.
Gabriel Zbarcea, an ex-president of Privatisation Authority, pinpoints pharma producer Antibiotice and aerospace companies Romaero, Avioane Craiova and Ghimbav as attractive for sale.
There are also electrical distributors, Electrica Muntenia Nord, Transilvania Sud and Nord. At present these companies are included in Minister of Finance Varujan Vosganian’s plan for a massive state energy company, along with hydropower firm Hidroelectrica, thermopower firm Termoelectrica and the power plants at Rovinari and Turceni.
“The power complex announced by Vosganian will need investment from private industries,” Gutiu adds.
But Zbarcea believes it is “too late” to create such an energy champion on the structure of Austria’s OMV or the Czech Republic’s CEZ, which will have to operate as a ‘private company’ in all but name, with well-paid managers from the private sector, but a paymaster in the Government.
“It will be very hard to keep and manage this type of company,” says Zbarcea.
“It is not a liberal idea for 2009. It would be best not to make the national champion of energy.”
The lawyer also fears it may not be able to pass the test of the European Commission, which is becoming tighter in its policy on state aid.
If the plan does not happen, individually all of these companies will be targets for international energy groups. Gas producer Romgaz is also a major target for investors, but Zbarcea does not believe that will ever be fully privatised, because it remains a strategic asset.
Hydropower firm Hidroelectrica is the most attractive of these companies but, because its energy resource is water, this is not likely to be considered for sale in the short term.
Not included in the ‘energy champion’ plan is the power plant at Craiova, which will be a major target for investor, to be sold through the privatisation authority.
However even proposed privatisations in the last two years have stalled. Sales of Antibiotice, the energy companies and savings bank CEC have all been postponed. This is not likely to change in the next nine months.
“In an election year privatisations will slow down,” says Baiculescu. “They need political parties to support them and legislative changes are necessary. It is hard to gain a consensus in parliament at this stage, so Parliament and Government lose their focus on privatisations.”
He believes privatisations will start up again after the elections at the end of this year, as they tend to happen in the first two years of a new Government.
There are also still huge opportunities in gaining business from the Government in the outsourcing of services, argues Doru Bostina, Bostina and Associates. There is also business in dealing with the state companies which could be entering into liquidation or restructuring. “The Privatisation Authority still has around 8,000 companies that are in the post-privatisation process and require specialised legal services,” Bostina adds.
Many companies are looking to renewable energy, such as wind power, with energy giants Enel and Iberdrola buying projects in the east of Romania, around the Danube Delta region, where Gaz De France also has an interest.
But this will take some time to realise, as there are many legislative hiccups and environmental barriers to develop. “Wind energy will take a while until the market finally gets into shape,” says Gutiu. “At present 87 permits are needed to build a wind-power plant.”
Climate change has to be taken into account, which may change where the wind blows. The migration maps of avian life in the protected area of the Danube Delta are not yet defined. It is tough to state the environmental case for a windmill if its sails then proceed to chop up flocks of migrating birds.
Private-public partnership (PPP) is a buzzword thrown about by the current Government. Although Minister of Transport Ludovic Orban has spoken of private finance initiatives for infrastructure projects, few are happening.
Currently, PPPs are not functional in Romania because the legislation that regulates it cannot be properly applied. “To have an efficient PPP one needs political determination,” Doru Bostina says.
There are different forms of PPPs, such as a private company building, operating and running a road, before transferring this back to the state after 20 years, or mixing private finds with EU structural fund cash.
It is an inevitability that this will become important, but it is not happening in the short-term. “With many infrastructure projects required and significant EU funds available, we anticipate a significant grow in project finance and related legal assistance,” says Alexandru Reff, Reff and Associates.
Recently, a major private-public partnership in real estate, the Bucharest-based mixed use Esplanada project, has gained permission to construct. Hungarian group Trigranit will build the project, estimated to be worth around two billion Euro, which will be handed back to the state after 49 years.
Labour disputes: on the rise
One of the reasons Western investors such as Nokia and Renault have entered the Romanian market is due to the low wage workforce.
But with rising wages in the service sector, many unionised workers in manufacture are demanding salaries reflective of the rising cost of living.
Recent strikes include those at the Renault-Dacia factory in Mioveni, at steel manufacturer Arcelor-Mittal in Galati and at Belgian beer group InBev’s plant in Blaj, Alba county.
Sorin David believes the recent strikes will not scare foreign investors coming to Romania. “All these strikes rather take place in the privatised companies and not in the companies that were build up as greenfield investments and that is because when privatised the employees had higher expectations while their salaries were quite low,” he argues. “Many of such companies still have an excess of workforce compared to their productivity needs. In the future, these mega-structures will operate with fewer employees.”
Gabriel Zbarcea says that clients have become “increasingly aware” of the importance of labour issues. “Some of our clients do not participate in any negotiations with the labour unions without the presence of an attorney from our law firm,” he says.
Capital markets: stepping up
Although still an unsettled target for investment, local capital market operations are becoming more transparent and liquid, while foreign financial institutions from EU member states now have full access to the Romanian market.
“Erste Bank’s listing on the Bucharest Stock Exchange not only created a healthy precedent but also led to major legislative changes,” says Zbarcea.
Meanwhile Christopher Berlew, Salans, believes the capital market will see a growth in the near future.
“Overall the conditions seem right for more Romanian companies to be listing their shares both on the Bucharest Stock Exchange as well as on international stock markets like London or even Warsaw, Bratislava, Prague and Budapest,” Berlew says.
The local stock market will also be invigorated by the presence of the Ownership Fund (Fondul Proprietatea) in July 2009. The Romanian state will provide owners of property lost during Communism a total of four billion Euro of shares in state companies listed on the capital markets.
But this has been delayed by three years already, so this new date may also end up being a false hope.
Like many service industries expanding at a rapid pace in Romania, there is a massive worker shortfall of good graduates in Romania.
“There is a lack of supply and a growth of the market,” says Sebastian Gutiu, Schoenherr. “Another problem is that there are not enough existing lawyers who have the time to dedicate significant hours to training rookies.”
Training a probationary lawyer can take up to 18 months. “This could prove to be a bad investment,” says Dana Gruia Dufaut, “since the trainees can decide they do not want to become lawyers.”
Finding good local lawyers in a country such as Romania is considered to be the biggest impediment to an international law firm willing to enter a new market. “In Romania lawyers with the right skills are already hired,” says Salans’ co-managing partner Christopher Berlew. “An international law company, to establish locally, needs good Romanian lawyers with language skills and the ability to handle sophisticated transactions.”
Attracting Romanian lawyers back from the diaspora is an effective method of finding new workers. While a trained Romanian lawyer in New York may make a living doing deals on home foreclosures, in Bucharest he or she could get a job securing a half-billion Euro real estate deal.
“Many have chosen to re-establish themselves here,” says Cristina Daianu, Schindhelm. “It is much easier to start a firm and a career in Romania than in western Europe. In Germany lawyers would be in the top of their career in their 40s or 50s, here it’s in their 30s.”