Equity 9 July 2019, 12:22pm

Hungary 4iG is buying T-Systems

Portfolio

Rumours proved to be truet, 4iG is buying one of the Hungarian IT market’s largest player, T-Systems that is a market leader in several segments. Magyar Telekom’s subsidiary is immense compared to 4iG. Its annual turnover is over 100 billion forints. In one fell swoop, 4iG is becoming a dominant player on the local IT market.

Small fish does eat big fish

It was announced in mid-June that Gellért Jászai, Chairman-CEO of 4iG has gained control of in the relatively small IT company, an interest of Lőrinc Mészáros, a gas fitter turned billionaire friend and key ally of Prime Minister Viktor Orbán. Jászai’s holding in 4iG was boosted in OTC deals to over 40% from 8% previously. He said the goal was to turn 4iG into a market leading large enterprise. The company has won contracts worth billions of forints, i.e. it has been growing organically, as well, but its explicit goal was also to grow in size rapidly via acquisitions.

In the last few weeks, a rumour was getting stronger that 4iG was eying the IT subsidiary of Magyar Telekom, owned by Germany’s Deutsche Telekom. T-Systems has annual revenues of over HUF 100 billion. The rumour had grounds, as it turned out today.

No purchase price yet

According to the Heads of Terms, at the closing of the transaction 4iG will purchase the shares of T-Systems Hungary. Prior to transaction closing, the small and medium size enterprise sales business of T-Systems Hungary will be carved out and will not be part of the transaction.

In the signed Heads of Terms, the parties agreed on the purchase price and the main conditions of the transaction, however, the full details of the transaction, including the Heads of Terms, will be binding upon the signing of the final sale and purchase agreement subject to the due diligence of T-Systems Hungary and the further negotiations between the parties.

According to the Heads of Terms, after the closing of the transaction the parties will enter into a long-term partnership agreement, under which T-Systems Hungary will continue to sell Magyar Telekom’s telecommunications services in the large enterprise and public segments.

Furthermore, the parties have agreed that 4iG shall have the right to use the T-Systems brand in Hungary during a three-year period following the closing.

The finalization and closing of the transaction depends on the due diligence process, the progress of discussions between the parties, the finalization of the contractual conditions, the signing of the legal documentation, and the receipt of requisite authority clearance(s). The closing of the transaction is expected in 2019.

Win-Win

Jászai said “the acceleration of digitalisation in the economy creates a unique business opportunity for 4iG. The goal of our company is to become one of the dominant large enterprises of the IT sector within two to three years both at home and in the region in this dynamically developing market environment."

"T-Systems Hungary is one of the most important milestones in the achievement of our growth targets," he added, noting that “after the successful closure of the transaction, Magyar Telekom, the leading service provider on the telecommunications market, can also become our strategic partner."

T-Systems, with 1,600 employees and several thousands of partners, is the leading infocommuncations service providerof the country, and the transformation partner of numerous corporations and institutions.

What did 4iG buy?

T-Systems Hungary is a subsidiary of Magyar Telekom. It offers a full range of ICT solutions to large enterprises, the public administration, and institutions. By 2018, the company has built up a massive market share, not only via state contracts, but also in sectors that generally offer contracts on a much lower scale, e.g. health care, transportation, utilities or the financial sector. It is a market leader with a 15% share on the most fragmented market of ICT services that make up nearly 40% of Hungary’s total IT market.

The company has grown into an immense integrator mostly via countless acquisitions. Its turnover reached HUF 114 billion last year, and its after-tax profit (partly owing to a one-off item) exceeded HUF 2 bn.

The company operates with particularly low margins, which is a consequence of its role as an integrator (it needs to pay the sub-contractors, as well), but it is also unclear how costs are accounted in relation to the parent company. In any case, a medium-high single-digit EBITDA margin and a 1-2% net profit margin speak volumes.

The value in T-Systems is that it is a key player on the ICT market, and as an integrated company it is present in virtually every segment; it is market leader in several areas; it is an integrator that - as a result of years of successful operation - has a host of references, and a stable creditworthiness (bank guarantees). It is embedded in countless long-term contracts with large enterprises and the state, multi-year deals from which it would be most difficult to remove it. It is rooted so strongly in this position that it is almost automatically invited to the relevant public procurement or corporate tenders. T-Systems has an intimate knowledge of supply procedures. Most of its 1,700 employees are highly qualified IT experts that represent a huge value on the IT labour market where supply is limited.

Doing well organically too

The statements published over the last few months clearly showed that 4iG is capable of growing also organically. 4iG has been winning contracts worth billions of forints either on its own or as part of a consortium. The announcements made in the first half of the year add up to around net HUF 17 bn worth of contracts, although these should not be simply added up, given that on some occasion 4iG won only as a member of a consortium, and the projects also span several years. In any case, the number gives us a good estimation of what we should be prepared for when it comes to 4iG.

4iG turnover was more than 1.5 times larger in the first quarter of 2019 than in the base period, and its Q1 EBITDA exceeded even the H118 figure.

How much is that much?

A due diligence process at T-Systems is yet to be carried out therefore the parties have not disclosed the purchase price.

It is difficult to put a price tag on T-Systems for two things. Firstly, because it is hard to say what the company can achieve (sales, margins, profits, growth, etc.) under the management of another company. Secondly, because the valuations of similar listed companies vary widely.

For the valuation of telecom companies they usually use the EV/EBITDA ratio. In order to assess the worth of T-Systems, we should take its EBITDA first. And right away we run into a problem, given that we do not know how the accounting of costs is done between the parent company and the subsidiary. Consequently, the changes to the EBITDA of T-Systems in the last few years can be used only a kind of indicative figure (e.g. to conclude that margins at the company are relatively low), but it is most difficult to say whether or not the company can achieve a greater EBITDA than last year. Lacking any better solution, we stick to the 2018 EBITDA of HUF 6.8 bn for our estimate.

The multiplier is not an easy question, either. It greatly depends on whether we use telecom or IT service providers as the basis, and the outcomes vary greatly depending on the scope of our focus, i.e. whether we look only at the region or the whole of Europe. Using the 2018 EBITDA of T-Systems and the EV/EBITDA ratio of telecom companies in the region, the estimated worth of T-Systems is nearly HUF 30 billion, while the multiplier obtained by examining European IT service providers gives us a value of over HUF 83 billion. That is quite a wide scale. Using Magyar Telekom’s outstandingly cheap 3.6x EV/EBITDA we get HUF 24 bn.

All in all, the price range is between HUF 30 bn and HUF 83 bn, and its middle is HUF 56 bn, i.e. realistically 4iG paid close to that sum for T-Systems.

Cover photo by Igor Golovniov/SOPA Images/LightRocket via Getty Images