04.11.2010
By invitation: The Hungarian Experience
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| CEO of Euro-Phoenix |
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By using a case study from HungaryLes Nemethy, CEO of Euro-Phoenix Financial Advisors Ltd., writes on how taxation influences the company's value.
In a nutshell, the Hungarian government has levied Special Taxes on banks and on major companies in the energy and telecommunications sectors, as well as on supermarkets, depriving all of these organizations of a substantial portion of their profits over the next three years. In the meantime, the Government intends to reduce the tax rate on individuals to a flat rate of 16% (perhaps even lower). The corporate tax rate will also be reduced to 16%.
All of those companies facing a tax decrease to the new flat tax would of course see an increase in their valuation. This usually happens according to some kind of multiplier effect—that is to say, a one euro increase in cash flow may create an increase in company value of approximately five or six euros.
Conversely, prima facie, those banks, supermarkets, energy and telecommunication companies facing the “Special Tax” would see fairly dramatic declines in value, with a similar multiplier effect.
However, the situation is not that simple: the increase in consumer purchasing power (thanks to reduced individual tax rates) should help promote additional spending on telecommunications services, gasoline, and groceries, which may fully or partially offset the effect of the Special Tax. Much depends on whether consumers decide to save or spend the tax windfall. Presumably banks may also need to write off fewer bad loans if consumers have additional disposable income. So the long-term effect on valuation is highly uncertain.
Markets abhor uncertainty. For anyone who now wishes to sell or raise financing today for a company affected by the Special Tax, there are major uncertainties ahead, which may make any transaction or financing extremely difficult:
· Investors and financiers will also find it very difficult to forecast whether consumers will save or spend the tax windfall, hence it will be difficult to forecast revenues of the companies affected by the Special Tax.
· It will also be impossible to forecast how much of the tax companies will be able to pass on to their customers. (If the entire tax could be passed on, there would arguably be no impact on valuation).
· Investors and financiers may fear that the Special Tax will be extended beyond the three year period currently intended by Government.
· It is still too early to predict what effects this taxation program will have on investor confidence.
· It is still too early to predict whether the Special Tax will be sufficient to plug the fiscal gap. After all, multinationals have an amazing aptitude for tax planning, in order to find legal ways to avoid taxes. Furthermore, it remains to be seen whether the Government announces structural reforms. If the fiscal gap is not plugged, the Government may be forced to resort to additional measures.
It is probable only a minority of owners of telecom companies, energy companies, and supermarket chains may be contemplating a transaction over the next few years. For most owners of these companies, the possibility of reduced cash flow will be more significant than a diminished valuation. There may however be a few such owners contemplating exit, who may be tempted to postpone transactions until after the uncertainties have been resolved, as investors will tend to value such companies based on conservative (one might say pessimistic) scenarios.
Overall, however, for the vast majority of companies not affected by the Special Tax, valuations and the environment for transactions is likely to improve.
Les Nemethy is CEO of Euro-Phoenix Financial Advisors Ltd. (www.europhoenix.com), a Central European corporate finance company focused on Mergers & Acquisitions. He is the author of “Unlocking your Company’s Value”, available at www.lesnemethy.com