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CFS Discussion Paper Series

Selling State Comnpanies toStrategic InvestorsTrade Sale Privatizations in Poland., Hungary,the Czech Republic, and the Slovak Republic

VOLUME TWO

Case Studies

Susan L. RutledgeMartin C. Stewart-SmithChristina KappazMaziar Minovi

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CopvrightO 1995The World Bank1818 H Strcet. NWWashington, D.C. 20433. U.S.A.

All rights reservedManufactured and printed in the United States of AmericaFirst printing. January 1995

Thc findings, interpretations, and conclusions expressed herein are entirely those of the authors and should not Fattributed in any manner to CFS. the Legal Department. the World Bank, or to members of the Board of Executive Directo-or the countries they represent. Thc World Bank does not ,uarantee the accuracv of the data included in this publicatio-and accepts no responsibility whatsoever for any consequence of their use. The paper and any part thereof mav not be citcor quoted without the author's expressed written consent.

CFS Discussion Paper Series, No, 106

Selling State Compames toStrategic InvestorsTrade Sale Privatizations in Poland, Hungarythe Czech Republic, and the Slovak Republic

VOLUIME TWO

Case Studies

Susan L. RutledgeMartin C. Stewart-SmithChristina KappazMaziar Minovi

TABLE OF CON-TENS

Acknowledgments ivForeword vNote on Methodology viThe Companies in the Case Studies viiThe Trade Sale Process ix

Case StudiesPoland 1

Fampa - Beloit 3Norblin - Universal 9Polkolor - Thomson 13Polam Pila - Philips 19Kwidzyn - Intemational Paper 25Porcelana Walbrzych - S &C K Holding 31

Hungary 35Oroshiza Factory - Guardian Industries (Hunguard) 37Gard6nia - Gitco 41Lehel - Electrolux 45Zalakeramia - Hungarian Investment Company 49Csemege -Julius Meinl 53Szolnoki Factory - Brigl & Bergmeister 57Duna Hotel - Marriott 63

Czech Republic 67Cokoladovny - Nestle & BSN 69Kyje Plant - Coca-Cola Anatil 73SSZ - EntrepriseJean Lefebvre 77Severok6men - WimpeyAsphalt 81Centropen - Novotny/Management 87Elektrosignal - Management 91

Slovak Republic 95Tatramat - Whirlpool, Quasar 95Jacobs Suchard Figaro 99

Czech Republic & Slovak Republic 103Prior Stores -Kmart 103

Tables and MapsTable 1. Foreign Currency Exdhange Rates viiiMap 1. Poland 2Map 2. Hungary 36Map 3. Czech and Slovak Republics 68

ACKNOWLEDGMENTS

There were many contnbutors to this paper. Our thanks go to the govemment officals who made this project possible:Jerzy Strzelecki, then Undersecretary of the Ministry of Privatization of Poland, and Michal Mrozek, Minister's Plenipo-tentiary for Foreign Relations, Lajos Csepi, Chief Executive Officerof the Hungarian State Holding Company, and ErzsebetLuAcs, Director of the Company, Roman Ceska, First Deputy Minister of the Ministry of Privatization and Administrationof NationaJ Property of the Czech Republic, and Jan Porvank, Director of Economics of the Ministry of Privatization ofthe Slovak Republic. Our thanks are also due to Michael Gold of the advisory group funded by the United States Agenyfor International Development (USAID), who provided conmments on the privatization process in the Czech Republic.Our deep thanks go also to the many company managers, investors, and legal and financial advisers who found time tomeet with the research teams and search their memories and their files for the details of the stories in the case studies. Ourthanks go also to the labor union leaders who provided their perpective on trade sales. We are also grateful for the supportof Marko Simoneti of the Central and Eastem European Privatization Network.

The concept for the paper was developed by Kevin )bung, Chief of the Private Sector Development and PrivatizationGroup of Cofinancing and Financial Advisory Services (CFS), who supervised the development of the paper until itspublication. Susan L. Rutledge of CFS wrote the analysis of issues found in trade sales, supervised the team that preparedthe case studies, and acted as project manager for the paper. The case studies were prepared by a Bank research team ofChristina Kappaz and Maziar Minovi of CFS and Martin C. Stewart-Smith of the Legal Department's Private SectorDevelopment Unit. They designed the format of the case studies, visited the companies in the survey, wrote copious notesand commented on the many drafts that followed. Douglas Webb, Peter Kyle, and Zoe Kolovou of the Legal Departmentalso contributed to the conceptual design of the paper. LesAndrew Nemethy of CFS (and formerly of the Hungarian StateProperty Agency) and Hafeez Shaikh, also of CFS, provided helpful comments and suggestions. Thanks also to liham

Zurayk and Anil Sood of the World Bank who supported the project from its earliest conception, and to the Bank staffwhoprovided useful comments on the drafts. Valuable background researh on the companies was prepared by AndrewAlexandrowicz of ITCA in Warsaw, by Ladislav Venys of the Anglo-American Business Institute of Prague, and by JoanStein of Central Europe Trust in Budapest. All supervised teams of researchers who diligently worked with the companiesin the survey to provide a first draft of the case studies, and later to find the answers to our folow-up questions. Andrew G.Berg, then of the Harvard nstitute for International Development, assisted in reviewing the trade sale process. RogerLeeds of KPMG Peat Marwick provided valuable advice at all stages of the paper. Invaluable assistance also came from oureditors, Bruce Ross-Larson of American Witing Corporation, and especially Emily Evershed, who patiently worked throughthe complex details of the case studies. Christian Perez typed the many changes to the text, Gerry Quinn designed the6/yout of the paper and John Swepston completed the desktop preparation for printing

Substantial funding for the paper was provided by the Government of Japan.

is SPzC Sun COMPMs TO STwacc Ivsroas VaLnA 1\o

FoimwoRD

This paper looks at the experience of four countries in Central Europe - Pbland, Hungary the Czech Republic, and theSlovak Republic - and reviews their experience in trade sales. Selling state companies to strategic investors (or "tradesales") is an inportant form of privatization and one that could generate substantial benefits for the national economy. Yettrade sales were used only for a limited number of companies. The paper reviews the experience of 1990-92 and looks atthe problems encountered by goverrments in Central Europe - and the solutions they found. As background to thepaper, 22 case studies were prepared on companies that had been privatized. The paper takes the solutions that worked,and presents them as a list of recommendations for trade sales.

However, the paper does not attemnpt to address other important issues in privatization. It does not assess the relativemerits of different methods of privatization. Nor does it discuss the governments' institutional structures or their fundingneeds. The recommendations in the paper are intended to make trade sales more efficient and the process more effective.But the recommendations must be tailored to fit the circumstances of each country

Many readers will browse only the Executive Summary and selected chapters of Volume One (Analysis of Issues).However, for those readers interested in the dpamics of selling (or buying) state companies- in the ups and downs of theprocess - Volume Two (Case Studies) will also provide interesting insights.

This paper was prepared as part of the CFS Disussion Paper Series on privatization in developing and transitioneconomies. Other papers in the same series have covered privatization programs in Argentina, the legal and regudatoryframeworks in the countries of the former Soviet Union, and, most recendy, privatization of the rctail sector (or "small-scale privatization) in Hungar, Poland, and the Czech Republic. The purpose of the Discussion Paper Series is to dis-seminate current practices and the "lessons" learned in privatizaton. As a Department that covers all the 'World Bank'sborrowing counties, Cofinancing and Financial Advisory Services (CFS) endeavors to share with outside readers some ofits cross-country experience in privatization. We are pleased to present this review of trade sale privatizations in Poland,Hungary the Czech Republic, and the Slovac Republic.

Inder Sud Kevin YoungDirector ManagerCofinancing and Financial Private Sector DevelopmentAdvisory Services (CFS) and Privatization Group (CFSPS)

ChSTUDS v

NoTE ON METHODOLOGY

In designing this Discussion Paper, the preparation of case studies on trade sales was intended to be of value to outsidereadersm In many cases, pocymakers are obliged to rake recommendations without hard data, and widtout facts at theirfingrtips. The 22 case studies prepared for the Discussion Paper provide some insit into the practical difficulties ofcompleting trade sales. In total, 6 cases were from Poland, 7 from Hungau, 6 firom the Czech Republic, and 2 from theSlovak Republic, while one case study spanned both the Czech and Slovak Republics (Table 1).

The 22 companies were selected from a small universe. In Poland, the Privatization Ministry recommended 9 compa-nies, of which the Bank selected 6 for in-depth review. In Hungary and in the Czech and Slovak Republics, the Bank teamprepared a list of trade sales taken from the international press. On the basis of this list, and recommendations fromgovernment officials and the local consultants, the Bank selected a number of companies and requested that thiy partici-pate in the survey. A few companies declined, but most were willing to be part of the study

The criteria for selecting companies were simple -- that the company had at least 100 employees at the time ofprivatizaon, that the sale was concluded and the transfer of ownership completed, that the company was not in a regu-!lted industry (such as a telecommrunications utility). The survey was imited to completed transacions because, in caseswhere the sale was not concluded, it is difficult to separate fundamental differences from negotating posins. Regulatedindusties were ecluded because of the overriding importnce of regulatory policies in prmtation of suh copanies.

In 19 case studies the investors were industrial companies. Of these, 16 we foreign mulnationals and 3 were localcompanies. In another 2 cases (both in Hungary) the investors were financial institutions. However, both had substantilinvestnments in the same sector and took an active role in supervising management of the companies.

The initial focus or dhe survey was on the full divesdture of state enterprses. However, after hours of discussion, itbecame dear that in 6 of the 22 cases the investors had purchased selected assets, which the government contributed tojoint ventures, and some assets remained with the former state enterpise. Such was the contnuing nature of the reuc-unng process in Central Europe.

The prepaation of the case studies required several steps. The Bank team prepared a six-page list of questions abouteah company and the steps of privatzation. The local consulting firms in each country spent hours with company manage-ment discussi the questions and drafing a summary of the answers. Between March andJune 1993, a Bank team of fourofficials spent six weeks in Central Europe vising the companies and discussing the privatiation process further Wherepossible, the team meat with the government officials responsible for the trnsacto at the time. In addition, the teamspoke with the legal and financial advisers involved in the privatization of the companies.

In the months that followed, the Bank team sorted and assimilated the mountain of information gained duing themeetings. The final drafs were forwarded to the companies, which often provided additiond insight into the privatizationprocess and gave an update of the companies' experience after privatization. All the financial tables were prepared bycompany mranagenent and were not based on idependent sources. Although many companies suggested revision ofwording to improve accuracy, none requested that significant data be taken out of the case studies. In addition, the caseswere forwarded to the privatization miniies and agenacies for heir review.

Although efforts have been made to provide as accurate a report as possible, some of the case studies may inludeinaccuracies or omissions. The information in the case studies should not be used as a basis for irnestment decisions.

v SELLN SuAE COMPANIs To SnGc INEsrom, VoE Two

THE COMPANIES IN THE CASE STUDIES

Approximate EmploymentDate of Annual (at time Of

Privattzaton Sector Revenues prbvatlzalon)

PolandFarnpa February 1991 Papermaidng $10 million 840

machineryNorblin April 1991 Copper and brass billets, $9 million 858

bars, rods, and wirePolkolor May 1991 Color television tubes $44 million 4,500Polam Pila May 1991 Lamps and lighting $59 million 3,290

componentsKwidzyn August 1992 Pulp and paper $150 milion 3,620Porcelana August 1992 Porcelain ware $8 million 841

HungaryOroshaza November 1988 Float glass S42 million 600(Hunguard)

Garddnia February 1991 Textiles $16 million 6W0

Lehol April 1991 Durable household $134 rnilbon 4.800appliances

Zalakerimia May 1991 Coramic files and $15 million 840building materials

Csemege July 1991 Food and beverage $198 rrillion 3,873retailing

Szolnold December 1991 Paper $4 million 690

Duna March 1993 Hotel $11 million 400

Czch RepublicCokoladovny February 1992 Confectionery products $287 rmillion 7,696Kyje April 1992 Soft drinks not available 100SSZ July 1992 Engineering bridges. $197 milon 3,977

and construction of roads.bridges, railways, and airports

Severokhmen August 1992 Cnushed stone for $10 million 1.100construction

Centropen October 1992 Writing insiruments $9 million 600Elektro6ignal December 1992 Airfield lighting S5.5 milon 350

devices, traffic signals,and audio equipment

Slovak RepublicTatramat May & July 1992 Washing machines. $23 million 1,300

water heaters.vending machines, and smallelectical appliances

Figaro August 1992 Chocolates and S27 million 619confectionery products

Czech & Slovak RepublicsPrior Stores May-August 1992 Department stores not available 6.00

CAME SUDIESr

Table 1. Forein Curnecy Exchange Rates

1984 1985 1986 1987 1958 989 1 19 991 192 1993

Austrbia (S) 22.05 17.28 13.71 11.25 12.565 11.815 10.677 10.689 11.354 12.143France (F) 9.592 7.561 6.455 5.34 6.059 5.788 5.129 5.18 5.5065 5.8955Gemany (DM) 3.148 2.4613 1.9408 1.5815 1.7803 1.6978 1.494 1.516 1.614 1.7263Netherlands (G) 3.5495 2.772 2.192 1.7775 1.9995 1.9155 1.69 1.7104 1.8141 1.9409United Kingdom (£) 0.8646 0.6922 0.6781 0.5343 0.5526 0.6228 0.5186 0.5345 0.6613 0.6751

CZechoslovaida (KCs) 17.13 16.00 14.38 13.00 14.31 1429 28.00 27.84 28.90 -Czech Republc(Kc) - - - - - - - 29.96Slovak Republlc (Sk) - - - - - - - - - 32.20

Hungary (Ft) 51.199 47.347 45.927 46.387 52.537 62.543 61.449 75.62 83.97 100.70Poland (ZCM 126.2 147.9 197.6 315.5 502.6 6,500 9,500 10.957 15,767 21,344

Rates per USS1. Note: Fgues are for yearerd.Surce: IMF Econnic Inon. an System.

TiM SElLNG SWE COMPNES TO Smnm=c _NSts, VOUJLN Two

THE TRADE SALE PROCESS

Each of the countries in the survey had a different preparation, negotiation and approval process for tradc sales. In addi-tion, the procedures changed over time, as governments gained more experience in trade sales. However there were somecommon elements that applied to all 22 case studies.

In all the case studies, eniterprise management played an important role, particularly in the early preparatory phases.Enterprise management was responsible for dafing an initial prrvatization plan, which would indude a review of possibleclaim against property title, a summary of debt outstanding, and a review of contingent liabilities, such as obligations todean up environmental damage. Management would also commission the valuation of enterprise assets. As requiret bylaw, this would include the market valuation of the enterprise' s land and buildings. In some of the case studies, enterprisemanagement conducted a formal-or informal-process to identify a preferred strategic investor and would includc thename of the investor in the privatization plan submitted to the government.

T'e plan was reviewed by several parties. Tlle line ministry (or other 'founding orgWa") would review the proposal andgive comments. In the Czech and Slovak Rcpublics, the law clearly stated that the founding organs had the right to givecomments on the proposed plan, but they could not block the plan. Similarly in Hungary and Poland, line ministries had anoppomunity to submit comments but not veto the plan. Labor unions were also consulted, and in Hungary, local govern-ments (who sometimes received shares in the privatized companies) also reviewed the documents. In addition, formalapprval of theworkers' council (in Poland) and, until recently, of the enterprise council tin Hungary) was required beforeprivatization could begin.

In Poland, the next step was formal transformation of the stite enterprise into a commercial company, and ownership,of the state company was transferred to the privatization ministry for sale. Elsewhere, legal transformation was oftenregistered with the courts onlywhen most of the details of the trade sale had been determined.

9Uth the pivatzation proposal of enterpnse management in hand, the privatization ministry or agency would reviewthe plan. In some case studies, privatization officals requested that a tender be conducted to obtain proposak fromadditional investors. In others, they noted that enterprise management had conducted a competitive process - or thatthere existed few possible trade investors for the cornpany - and accepted the recorunendation of enterprise manage-ment

'The final terms and conditions of sale for the state company were set (or in some case studies, finalized) by theprivatization ministry or agency. Often this was a two-stage process. The questions of price and investment commimentswere often determined through a tender. But the important details of representations and warranties by the government,and by the investor, were often worked out through negotiations, and reflected the specific conditions of the state companybeing privatied

Final govenment approval for the sale was made by either a council of ministers for the government, or by theexeative board of the privatization agency After government approval, the sale documents were submitted to the courtsfor regstration.

cAsmzs ix

I. POLANDFampa - BeloitNorblin - UniversalPolkolor - ThomsonPolam Pila - PhilipsKwidzyn - International PaperPorcelana Walbrzych - S & K Holding

Map 1. Poland

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POLAND

FAMPA- BELOIT

Enterprise Status before Privatization variable payments based on sales of products that used BeloitFampa was the sole Polish manufacturer of equipment for technology. Fampa paid royalties of 5 percent of turnover tothe papermaking industry. Fampa's operations induded the Beloit for transactions with COMECON countries and 8production of papermaking machinery, as well as engineer- percent of turnover for all other transactions. Fampa also hading and consulting services. These core operations were a license from Flakt A.B. (Sweden) for ventilation and heatsupplemented by the production of vacuum pumps, specialty recovery equipment, although thcsc products represented amachines, and spare parts. relatively small part of the enterprise's business.

Fampa was founded in 1854 under the name of Although Fampa had developed significntmarkets out-Fullnerwerk, and was a Geman family business. Following side of Central and Eastem Europe (Turkey, Egypt, Iraq,World War H, Fampa was nationalized and began operating Cuba, and China), its monopolistic position in all of Centralas a Polish state-owned entcrprise under the auspices of the and Eastem Europe had, according to the Fampa Manage-Ministry of Industrq ment, bred complacency and rendered the enterprise increas-

From the mnid-1960s, Fampa had relied heavily on the ingly vulnerable to the Wcstem competitors that began touse of technology from the U.S. firm Beloit Corporation. enter its home territory in 1990.Fampa had the right to use Beloit technology through a li- Most of the machinery produced by Fampa tpiclly tookcense agreement with Walnsley Limited (U.K), a subsidiary one to two years to complete. Purchased components (pri-of Beloit. The Walmsley license allowed Fampa to sell Beloit marly drying cylinders and air conditioning sysems for heatedmachinery to Council of Mutual Economic Assistance air) conprisedabout40percentofthevalueoftheenterprise's(COMECON) countries only, although special arranments sales (ie., Fampa's value added was only about 60 percent ofwere made for sales to other countries, such as Cuba and sales). Nearly 70 percent of purchased components wereEgypt In addition, Fampa was entitled to segl to a large num- Westerber of other den .;oping countries at a different royalty rate.Royalty payments for the use of the license were made yearly Preparation for Saleby Fampa to Walmsley and were (1) a fixed amount, adjusted PoROTO SEPMER 1990 Fampa's management and work-yearly for inflation and payable regardless of sales, and (2) ers were instrumental in initiating the enterprise's

Summary of Fampa-1Belolt Agreenmet Shareholder structurepercentage of ownship

Type of Company:Manufacturer of papermaking machineryLocaton:The company has one plant, in Jelenia G6ra. 40 km from theGerman borderDate of Sab:-February 16. 1991Sale (1993):ZI 212 billion (US$9.9 million)Employmen at Daft of SaMb840Emoyent (May 1993): Shareholder Date of sae 12131192 12(31193

N2 s icInvor: a Fampa Employees 0.0 1.0 12Beloit Corporation (U.S.) * Polish State Treasury 20.0 3.0 0.0US$7mPidyion ktooc Inves Dtor. Beloit Corporetdon 80.0 96. 98.8US$7 millionInvearmt CommitmentUS$15 million over 7 years

3

pnvatizaton. Recognizing that a strategic investor able to case, optimistic, and pesimistic. The valuation used discountinject capital and know-how into the enterprise was essential rates of 17.5 percent and 22.5 percent over 5-year and 15-for survival in a market economy, the management began year cash flow periods. This exercise resulted in a range ofapproaching several leading international manufacturers of from Zl 67 billion (US$7.1 million) to ZI 248 billion (US$26paper machinery in March 1990 to gauge their interest in million). Arthur Andersen dismissed the discounted cash flowforming a joint venture (the only permissible form of foreign valuation, arguing that it required excessive guesswork andinvestment at the time) with Fampa. that therefore the final results were unreliable. Two addi-

Fampa's workers' council approved the idea of tional valuations were conducted, based on net asset valuesprivatization by a margin of 87 to 13 in a secret ballot vote. and price/earnings ratios. The net asset valuation was ZIThey believed that wages would increase as a result of 47.773 billion (US$5.03 milion), while the priceearningsprivatization and recognzed that, as a state-owned enterprise, ratio resulted in a valuadon ranging from US$5.77 milion toFampa had limited ability to improve its competitive posi- US$9.11 million. AswascommonPolish Govenmment policy,tion. The management communicated the advantages of the results of these valuations were not disclosed to the po-privatization and informed workers about every step of the tential investors.privatization process. The Ministry of Privatization initially saw Fampa as a

Prior to enactment of the Privatization Law in July 1990, candidate for inclusion in the first tranche of eight compa-the only pivatization option available to Fampa was the for- nies slated for an initial public offering ([PO) of shares onmation of a joint venture. Before the establishment of the the Wrsaw Stock Exchange. This decision was based on theMinistry of Privatization (July 1990), responsibility for Ministr's standard criteria for selectingIPO candidates: hardprivatization had been assigned to a Plenipotentiary for currency sales and a well-respected name. However, folow-Privatization under the Ministry of Finance. The eady ing N. M. Rothschild's preliminary analysis, it became evi-privatization efforts of the Polish Govemment received sig- dent that Fampa was not suitable for a public offering. Thenificant finam l and logisticd support from the Britih Know- need for new technology demanded a substantial capital in-How Fund, which encouraged the Plenipotentiary for vestment program which the enterprise could not financePrivatization to select state-owned enterprises as test cases owing to the coUapse of many of its traditional COMECONfor initial privatization. Although Fampa had not finalized a markets. In addition, the lack of modern managem t tech-joint venture agreement by the time the Privatization Law niques was apparent. N. M. Rothschild strongly believedwas enacted, the enterprise was widely considered by the that Fampa needed a strategic investor with the necessaryPblish Govemment to be a leading privatization candidate capital and management and production expertise to permitand was thus selected for the pilot privatization program. the enterprise to become a world class competitor. The Min-

The British Know-How Fund agreed to finance most of istry of Privatization agreed, and decided that the best meansthe pre-privatization procedures. N. K Rothschild & Sons of attaining a foreign strategic investor was through a publicof London was recnrited in July 1990 by the Ministiy of tender rather than through a public offering, since the latterPrvatization to coordinate and supervse the privatization could result in diversified ownership rather than acquisitionprocess. Previously, in April 1990, Access Limited (a Polish by a strategic investor. In contrast to its policy with Polkolorconsulting firm) had conducted an appraisal, also financed (another case study in this volume), the Ministry ofby the British Know-How Fund, that had included an assess- Privatization decided on privatization through a trade salement of the enterprise's operations and markets and the for- rather than through a joint venture, on the basis of an infor-mulation of a business plan. This appraisal was completed in mal Ministy policy to the effect that any privatization in-June 1990. volving a foreign investor controlling a stake of at least 20

Afinancial auditwas preparedbyArthurAndersenwith percent would be so conducted. Fampa was the first enter-assistance from Access limted, and this included restruc- prise in Poland selected for a trade sale and the first to betuningFampa's accounts in aWestern format. Access worked privatized through a public tender.together with Arthur Andersen in accordance with the Polish The Ministry's initial intent was to sel only a minorityGoverment's program of twinning local consultants with stake in Fampa for fear that the sale of majority control to aforegn consultants in order to build up local expertise. This foreign investor would be politically unpalatable. However,twinning program was supported by the British Know-How the potential investors were interested only in a majority stake,Fund. with the result that the Ministry decided to sdl an 80 percent

ArthurAndersen also conducted a valuation, employing stake to a strategic investor. In accordance with thethree methods. ArthurAndersenfirst conducted a discounted Pr.vatization Law, the remaining 20 percent would be madecash flow valuation using several potential scenarios - base available for purchase by Fampa's employees.

4 SEUu STm Coimrns ro SDUmc INwrsrows, Voum Two

FROM SEvrEMBER 1990 To prepare itself for the eventual trade Timetable of Key Stepssale, on September 25, 1990 Famnpa submitted an applica-tion to the Ministry of Privatization to transform the enter- 1689

prise into a joint stodcompany.Thenewjointstockcom Fampa management decided to initiate privatfzatbonprise into a joint stock comnpany. The new jont stock corn- March 1990pany, fuMly owned by the Polish State Treasury, was registered Fampa management made initial contacts with potential in-at the local district court on October 3, 1990 (with a share vestors.capital of Zl 47.773 billion (US$5.03 million). As would be- April-Junh 1990

An appraisal was conducted by Access Limited.come standard procedure in Poland, the Ministry of July1990Privatization then assumed responsibility for Fampa. The The Privatization Law was passed and the Ministry ofcompany's Artides of Association were drafted by Access Privatization was established.Limited. The consulting firn drafted theArticlesofAssocia- July 1990

t n s hr , t The Ministry of Privatization appointed N. M. Rothschild astion since this was the first trade sale. In later deals, the financial adviser.Ministry of Privatization used standard articles to create the September 18,1990first draft which was then given to the companies for review. A retquest for bids was published in The Financial Times.

At the company level, relatively little other preparatory September 25,1990Famrpa management submitted an application for transfor-

work was done. The company introduced a new organiza- mation into a joint stock company to the Ministry oftional structure in January 1990, but could not implement Privatization.any significant physical restructuring owing to its lack of both Octberr3,1990financing and access to modem technology Pampa man- Fampa was registered as a joint stock company.

MId-eeember 1990aged, however, toreduce the number of employees from 921 Rnal bids were submitted by Beloit, Voith. and Valnet.in December 1990 to 840 at the time of privatization (Febru- January 1991ary 1991). Furthermore, priar to privatiZation, Fampa man- Beloit was selected as winner of the public tender. Negotia-aged to spin off a small portion of its social assets, primarily a tions began based on a draft share purchase agreement.February 16, 1991school which was given free of charge to the local govern- The share purchase agreement was signed.ment (to ensure this govefrnment's support, since Fampa wasthe first major privatization in the region).

N. M. Rothschid actively approached potential strate-gic investors On September 18, 1990, an announcement to review and comment on the offers before interal discus-requesting bids for an 80 percent stake in Fampa was pub- sions began at the Ministry of Privatization.lished in The Financial Times, speciying that bids should be The bidders were narrowed down to Beloit and Voith,submitted within six weeks and should include the price to since Valmet's technical expertise did not cover the full pod-be paid for the shares, the investment commitment for the uct range supplied by Fampa. Voith had some experience innext five years, a proposed share structure for the company, Central and Eastern Europe - in the mid-1980s the com-and a general description of the technology that the investor pany had formed a joint venture in Russia with the Paperwould transfer to Fampa. The dosing date was subsequendy Machinery Works enterprise in PetrozavodskAdecisive fac-extended to mid-December 1991. tor in the final evaluation of Beloit and Voith was the license

Five firms expressed interest in purchasing Fampa Beloit agreement, mentioned earlier, with Wlmsley Limited (UK),(United States); J. M. Voith AG (Germany); Valmet (Fin- that gave Fampa the right to use Beloit technolog7 Thle li-land); Simon (United Kingdom); and Kleinewefers (Ger- cense agreement was due to expire in four years in Decem-many). An information memorandum, prepared by N. M. ber 1994. Nevertheless, if Fampa were to be sold to an in-Rothschild, was distributed to these firms after each signed a vestor other than Beloit, the company could no longer con-confidentiality agreement. However, only three bidders - tioue using the Beloit license and would have to pay a pen-Beloit, Valmet, and Voith -submitted final bids. According alty of US$4 milion for early termination of the license agse-to enterprise management, Simon and Kleinewefers were ment. Voith's proposal stipulated that the Ministry ofdropped because of the limited nature of the proposed joint Privatization should be responsible for paying the liquidatedactivities and this was unacceptable to the company. Vlmet damages. Therefore, the price offered byVoith was necessar-suffered from financial difficulties, having accumulated losses ily US$4 million less than any price offered by Beit.of US$250 million in 1990. For this reason, Fampa manage- The issue of the license agreement, coupled with thement did not consider it a suitable partner. The offers were strong tecnical capabilities and international standing ofsubmitted to N. M. Rothschild and distributed to the Minis- Beloit, resulted in the Mlinistry's selection of Beloit inJanu-try of Pmivatization, Fampa, and Access, which had ten days ary 1991.

CASE SiUDY I POLA.: FAMA - BEhr

Terms and Conditions of Sale Environmental liabilitieswere discussed extensively dur-Beloit offered US$7 million for 80 percent of the shares with ing Fampa's negotiations but were not included in the salesa comniitment to purchase the refmaiing 20 percent of the contracLshares on the basis of the greater value of US$3 million or50 As Fampa was the first state-owned enterprise in Polandpercent of Fampa's after-tax profit for each of the five years sold through a trade sale, it was a leaming process for thebeginning January 1, 1991. This clause was included in case Ministuy of Privatization, which had not yet developed poi-Fampa's employees did not purchase aU of the shares to whih cies regarding trade sale negotiations and was not familiarthey were entided. In addition, Beloit pmmised to invest with warranties or investment commitments. Therefore, theUS$7 million over a five-year period, to intrduce new prod- Ministry was particularly reliant on its financial adviser, N.uct lines, and to buy back shares from employees at 100 per- M. Rothschild, for advice on these issues. The final round ofcent of the price paid by BeloiL This would entitle employ- negotiations was expedited by the direct participation of theees to a profit of 100 percent from the shares that theybought Vice Minister of Privatization, who was able to make irnme-at a discount and sold to Beloit. Several of these provisions diate decisions as issues arose.were modified during the negotiations process. Beloit paid US$7 million in cash for an 80 percent stake

The draft share purchase agreement was presented for in Fampa.negotiation on January 9, 1991 and signed on February 16, Beloit agreed to an investment commitment of US$151991. Priorto signature, Beloit'slawyers,AltheimerandGray million over seven years No specifications were made re-(United States), reviewed the status of contracts and licenses garding the type of investment or where money should becritical to the functioning of the business. Speed was of pri- allocated. This commitment was a change from the originalmary importance during negotiations, since the Ministry of offer, which prescribed US$7 million over a five-year period.Privatization wanted to complete a sale soon after passage of Fampa and Beloit agreed to tenninate the license agree-the Privatization Law. ment between the two companies. A new arrangement was

One of the major issues in the negotiations was the pricec made under which Fampa-Beloit would pay a royalty of upAlthough Beloit was not made privy to the valuation pre- to 6 percent of turnover for conducting research for Beloitpared for the Ministry, its price proposal of US$8.6 milion Corporation. Furthermore, the government assured Beloitas the value of Fampa was within the valuation range esti- that an existng license agreement with Polimex Cekop, amated by Arthur Andersen. Nevertheless, the Ministry put state-owned foreign trade organization, would be terminated.pressure on Beloit to increase its price. Beloit would not Beloit was granted a three-year corporate tax holiday and achange its price but rather increased its investment commit- five-year holiday for duties on capital imports. The Ministryment. of Privatization granted the tax exemptions on behalf of the

Another major issue during the negotiations was the re- Ministry of Finance (in most subsequent transactions, inves-vision of the Articles of Association. The revised Articles tors have had to negotiate similar exemptions direcdy withwere registered at the Court of Registration immediately af- the Ministry of Fmance). Significandy, in contrast to mostter closure of the deaL Unofficial discussions had bcen held subsequent trade sales, no employment commitment waswith the court officials to ensure that the document would negotiated.not be delayed by the procedural problems normally associ- The Anti-Monopoly Office provided a letter of no ob-ated with registration. Since a majority stake was to be sold jection for the privatization of Fampa. The govenmuent as-to a foreign investor, the exstng Polish law required specia sured Beloit in the share purchase agreement that Fampaapproval from the Ministry of Finance for Fampa's could set sale prices for its productswithout interference andprivatization. This approval was granted two weeks before also gave its assurances that the land title was free and clearthe signing of the contract. (Such approval on sales of enter- and provided a guarantee against expropriation. This provi-prise to foreign investors is no longer necessary.) sion was incorporated only in the first few share purchase

During the privatization process, the state enterprise's aemens, as investment treaties that the Polish Govern-management right in the land (but not in the buildings ment subsequently signed with major Western govemmentsthereon) wa converted into a perpetual u%Oms, which is a made this clause redundant.form of lease for a term of 99 years. Under this arrange-ment, ownersip of the land remains with the state. Since Post-Privatizationthis was one of the first privatizations, the Land Law had not FINAN&L Sm oION Gross profits were negative inboth 1991yet been clarified with respect to the detailed format of the and 1992 owing to the folowing (1) a decrease in orderspepetual =&c, and the Ministry of InternalAffairs there- caused by the recession in the pulp and paper industry (2)fore delayed granting its consent until after the privatization the completion of old contracts at price levels that are cur-was completed. rently unprofitable; (3) the cancelation of contracts; (4) the

6 SUZNG SiM CoMAiNso SrMcss bCoS7, VoaM Two

liquidation of inventory-, and (5) the adjustment of deprecia- Ftion to U.S. accounting principles. (in mUllons of zlotys)

1991 1992 1993SHAIE STRUCIURE In accordance with the Privatization Law, 1990 (15 mos.) (10 mox.) (12 mo.)the Ministry of Privatization made 20 percent of the shares Incorne Statementavailable for Fampa's employees at half price. These shares Net Sales 64,309 208.830 129,264 212.094

wereoffered in two tranches. The first tranche of 15 percent Gross Profit 17,378 (9,341) (115,730) 68,977Taxes 13.457 3.153 0 0

of the shares was made available from March 13 to March T Profit 3,921 (12,494) (11S,730) 68.977

20,1991. During this tranche, Beloit made arrangements withlocal banks to provide low interest loans to assist employees Balance Sheet

CurrentAssets 61,124 02,460 126,615 189,901in purchasing the shares. In addition, if the employees paid Long-Term Assets 41,308 91,735 80,013 120,975

for the shares with Treasury bonds instead of cash, theyben- Total Assets 102.432 174,195 206,628 310,876

efited from a 20 percent discount on top of their 50 percent Foreign Debt 16 50.554 118.646 199.220discount. As a result of this financal assistance, Fampa's Domestic Debt 35,670 9,494 21,017 36.199

employees purchased 12 percent of the shares during the first Other Liabilities 28.442 29.807 (4,952) 60,114tranche. The rema.iing shares were made avaiable in the Equity Capital 38,304 84,340 71.917 15,343

second tranche from March 20, 1991 to March 13, 1992, butno credit arrangements were offered. Accordingly, only anadditional 5 percent of shares was purchased. Since losing the bid for Fampa, J. KL Voith AG has en-

Beloit increased its shareholdings by purchasing addi- tered into negotations to form a joint venture in the Czechtional shares from workers and, as of May 1993, held 96 per- Republic, but as of mid-1994 no final agreements had beencent. The 1 percent of shares purchased by workers and not reached. Voith's joint venture in Russia does not pose a di-sold to Beloit was almost entirely in the hands of managers. rect threat to Fampa's market posidon, since it is not able toIn June 1993 Fampa purchased the remaiiing 3 percent of compete with Fampa in volume and product quality.employee shares that had not been purchased. In May 1994Fampa purchased additional shares from workers, thus in- PHSCAL REShUCrURIG Prior to privatization, Fampa hadcreasing its stake to 99.27 percent. Employees still retained taken on commitments to install a new sewage treatment sys-0.73 percent of the company shares. tem but lacked the funding to complete the project. One of

The price at which Bcloit purchases the shares from the first investments made by Beloit was the installation ofemployees is based on a formula related to profit and the this system at a cost of approimately US$1 million. (Byexchange rate between the zloty and the U.S. dolar. As of mid-1994 Fampa had completed about US$270,000 of theApril 1992, employees were being paid approxmately five investment plan, and had begun another US$300,000 of thetimes the value they paid for their shares. Certain restric- plan.) Beloithasexceeded its commitments andhas upgradedtions are included in this arrangement: Beloit is obliged to Famnpa's facilities toreduce pollution furtherthanis requiredbuy shares from employees who wish to sell them, and upon by Polish law.retirement employees are obliged to sell theirshares to Beloit. Beloit's plan for upgrading Fampa's facilities was de-Fampa's management, in fact, observed that employee share signed in line with its corporate policy of maintaining posi-programs were of dubious benefit, in view of the time and tive employee relations. The new management's first step waseffort required to set them up and the fact that many em- the modernization of the production area, which includedployees sel their shares shortly after receipt. improvement of the working envirornent. New executive

offices are to be constructed lasLMARcr PosMoN Fampa no longer had a monopoly on thedomestic markets but still had a dominant position. In mid- ORGANIzATONALRSrRCruNG Afterprivatization,thework1993, Fampa held about an 85 percent share of the Polish force was reduced from 751 in November 1991 to 527 inmarket for papermaking nachinery and equipment and an November 1993. Despite these reductions, a healthy rela-approximately 30 percent share for services provided to the tionship was established between the Beloit management anddomestic market. Although total sales for 1992 fel in rela- the work force.tion to 1991, Fampa successfully overcame the collapse of Beloit inherited social assetswithabookvalueofZi 15.3many of its key COMECON markets. Exports accounted bilion (US$1A4 mlion). These included two holiday resorts,for about 70 percent of 1992 sales versus less 35 percent of and apartments (30 percent of which were occupied by em-sales in 1991. Significantly, 68 percent of 1992 total export ployees) and canteen facilities. Since privatization, Beloit hassales was hard currency denominated. been disposing of the social assets acquired from Fampa. A

C.tw SumD I PoLAND: FAmPA - BErw 7

holiday resort was leased to the Solidarity trade union and teen facilities have been leased. The company's long-term706 apartments were sold to a cooperative on a 25-year in- plan is to liquidate all of the remaining social assets.terest-fiee line of credit. The cooperative sls the apartments In March 1993 the company name was changed fromto cmployees on preferential tenns. A social club and can- Bdloit Fampa SA to Beloit Poland SA

8 S.ELG SET CoMuz To S<racc INvEsOus, VoLumE Two

POLAND

NoRBLIN - UNIVERSALEnterprise Status before Privatization a result, Norbln's financial situation deteriorated significantlyNorblin manufactured bilets, bars, rods, and wire made from and the enterprise incurred a tremendous debt. Almost over-copper,copper alloys,brass,andsilver. Priortoprivatization, night, Norblin went from being an ideal privatization candi-exports constituted approximately 70 percent of the date (a profitable, well-respected enterprise with significantenterprise's sales. Norblin's largest export market Wlas Ger- hard currency revenues) to a debt-laden cnterprise on themnanny Export sales to all countries except the Unitd States verge of bankruptcy.were channeled through Impexmetal or Universal, two Pol-ish foreign trade organizations. Sales to the United States Preparation for Salewere made through BCIS Metals Agencies, Inc., which was PRIOR TO OCTOBER 1990 In early 1990, before the Ministryowned jointly by npmpexnetal and Universal. (It was not un- of Privatization began operations, Norblin was considered acommon for Polish foreign trade organizations and manu- leading candidate for privatization by the Plenipotentiary offacturing companies to set up joint distribution companies Privatization. The enterprise's management also advocatedin foreign countries; however, this format was typicaly fol- rapid privatization, but the workers' council was much morelowed only when some input of the producing company, such skeptical and was initially unwilling to support management'sas after-sales servicing, was required). On the Polish market, privatization effort. Upon its formation in August 1990, theNorblin sold directly to industrial customers. Prior to 1990, Ministry of Privatization intervened so that Norblin could beNorblin had a virtual monopoly on the Polish brass wire induded in the first wave of privatizations. The Ministrymarket and held a 10 to 25 percent share of the domestic rod obtained the support of the workers' council by agreeing tomarket. replace Norblin's managing director.

In 1990 Norblin experienced a sharp decline in sales Most of the preparatory work was financed by the Brit-caused by (1) the onset of recession in Germany; (2) the col- ish Know-How Fund, which organized tenders for rmost oflapse of the COMECON bloc; and (3) a sharp decrease in the advisers and consultants working on the case. Any costsdomestic construction activity. The crashing of the not covered by the British Know-How Fund were coveredenterprise's three main markets caused 1991 sales to drop by by the Ministry of Privatization.more than 60 percent in real terms compared with 1990. As One of the first studies undertaken for Norblin was an

Summary of Norblln-Univeral Agreement Shareholder structurepercentage of ownership

Type of CompsnryManufacturer of copper and brass billets, bars, rods. and 100%wireLocaton:__The company has one plant, in WarsawDaOt of Sale:April 27, 1991Ernployment (Mas1993):370Sabs (1993):2 191 billion (US$8.9 million)Employmen at Dafe of Sale: Shar-hdder Date Of sale 12J311928S8 Sharehdder Dsb of sale _______Nene of SltatgIc Invesor Workers 0.5 0.5Universal S.A. (Poland) Polish State Treasury 19.5 19.5Price Paid by SlealgIc Investora1 32 billion (US$2.9 million) * Universal 900 80.0Investent Commitmnnt:None

CASESTUDY2 PoLAND NORmUa -U SAL 9

appraisal conducted by Proexim, a Polish consulting firm, In accordance with standard procedures, the Ministry ofwhich examined such factors as the enterprise's products and Privatization assumed responsibility for the company fromthe amount of export sales. Proexim felt that Norblin had a the Ministry of Intdustry.strong profit potential and was a good candidate for Poland's The company also tried to make itself more attractive tofirst group of initial public offerings (IPOs) to be listed on potential investors by transferring some social assets free ofthe Warsaw Stock Exchange. charge to local cooperatives. These cooperatives were con-

InAugust 1990 the Ministry recruited Barclays de Zoete sidered self-financing and received no guarantees fromWedd Limited (BZW) (United Kingdom) to act as principal Norblin. Norblin also reduced its work force from 950 infinancial adviser for Norblin's privatization. In addition, 1990 to 858 in 1991.Central EuropeTist (United Kingdom), a management con- BZW managed the public tender, with Baker &suiting company, was recruited to develop a marketing strat- McKenzie (United Kingdom) acting as legal advisers to theegy for the company. Ministry of Privatization. The costs of the tender process

Proexim's positive evaluation was later reassessed in the were shared by the British Know-How Fund and the win-light of a financial audit conducted by Coopers & Lybrand ning bidder. The Know-How Fund paid BZW about two-with assistance from a local consulting firm, Polish Invest- thirds of BZW7s fees, while the winning bidder paid the re-ment Company. (In the early days of Poland's privatization maining one-third.program, the Ministry of Privatization often assigned local On the basis of the audited financial information, BZWconsulting firms to work with international firms, with the prepared a discounted cash flow valuation which estimatedintention of developing the expertise of the local firms). The the company's value at Zl 60 billion (US$6.3 nillion). Thefinancial audit was conducted to satisfy the regulatory re- book value was established, on the basis of Coopers &quirements of the new Polish Securities Exchange Cornris- Lybrand's audit, at ZI 141.2 billion (US$14.9 million). BZWsion, which required tbat the prospectus accompanying each then circulated a short summary of Norblin and generated ainitial public share offering contain audited financial state- list of about 35 potential investors. In December 1990, BZWments. When the financial audit revealed Norblin's real fi- completed an information memorandum and began ap-nancial situation, the Ministry was stil planing to privatize proaching investors. Ten companies expressed interest in re-the enterprise through a public share offering. The new au- ceivmg the memorandum. The formal invitation to submitdit indicated a real threat of insolvency since Norben's sales bids was published in eady Februay in The Fiwncid ]Imawere plummeting at such a rate that the company risked be- and the Polish newspaper Rzerpospoia. The deadline foring unable to service its debL Coopers & Lybrand and BZW preliminary offers was set for February 28, 1991. The timetherefore advised the Ministry of Privatization against selling period allocated for submission of bids, although short, wasNorblin through a public share offering. Thy pointed out considered sufficient because BZW had already given sub-Norblin's need for a strategic investor that would take a sig- stantial information on Norblin to the potential buyers.nificant management stake in the enterprise and would help BZW strongly favored sale to a foreign investor able tostabilize its financial condition as weil as develop distribu. provide the investment and working capital required to pultion channels for its products. Norblin out of its financial distress. However, only one in-

The Ministry of Privatization considered the following ternational investor, Ravensale, a privately held U.K coin-options for a financial restructuring of Norblin prior to pany, was interested in Norblin. Two Polish investors, Uni-privatization: (1) negotiating a debt - equity swap with versal and Impexnetal, both foreign trade companies withNorblin's banks; (2) injectig new capital; (3) having the previous relationships with Norblin, approached BZW ex-government assume the debt; (4) changing the debt from pressing interest. In the end, three firms submitted bids:zlotys to hard currency; and (5) filing for bankruptcy. None Ravensale, Universal, and Impexmetal.of these approaches was implemented. Universal is a Polish foreign trade organization that was

On the basis of the consultants' advice, the Ministry one of the largest companies to be privatized in 1989 beforedecided that the best solution for Norblin's finandal diffi- the Privatization Law was enacted. Universl is widely rec-culties would be to find a strategic investor and sell Norblin ognized as one of the more prominent cases of nome'klatwathrough a public tender, rather than through an IPO on the privatizations, led by enterprise managers without supevi-Stock Exchange. sion by the government. After repeated efforts, the com-

pany eventually managed to be listed on the Warsaw StockFROM OCToBER 1990 For the trade sale, Norblin was trans- Exchange in 1992. Universalhadalong historyof exportingformed into a joint stock company on October27, 1990. This Norblin's prodtuctsandwas thus famiiar with the enterprise.new company was fuly owned by the Polish State Treasury. Exact critera for the evaluation of bids were not de-

10 SEItiNG SDUE CoMAss To STL&Gc INYwroRs, Voun Two

fined, but the bidders were asked to structure their offers on Tlmetbb of Key Slepsthe basis of assuming all existing debt. Ravensale eventuallywithdrew its offer because it wanted the Ministry of Summe 1990

Privtizaionto asumcat easta prtio of he ebL ni- Norblin was selected to participate in the first tranche of Ini-Privatization to assume at least a portion of the debt. Uni- tial Public Offenng privatizations.versal was selected over Impexmetal primarily because the August 1990former offered a higher price for an 80 percent stake. In The Ministry of Privatization hired BZW as financial adviser.addition, Universal was favored because it had already been Fall 199

BZW advised the Ministry against sale through a share offer-privatized, whereas Impexmetal was still state owned. ing and recomrmended a trade sale.OctobuMNovember 1990

Terms and Conditions of Sale The Ministry decided that Norblin was inappropriate for aThemajorissueinthenegotiationswasprice,givenNorblin's public share offering and decided to seek a strategic inves-deteriorating financial condition. According to BZW's valu- tor.October 27,1990ation (which estimated the value at 21 60 billion, or about Norblin was transformed into a joint stock company.US$6.3 million), an 80 percent stake would have been worth December 1990Zl 48 billion (US$ 5.04 million). However, Universal suc- BZW completed an information memorandum and ap-cessfully negotiated a lower sales price, claiming that Norbln's proached potential investors.

escaatin deb mad thevalutionobsoete.Early Februar 199escalating debt made the valuation obsolete. An announcement of invitation to bid was published.

Universal agreed to purchase 80 percent of Norblir's February 28,1991shares for ZI 32 billion (US$2.9 mllion). The Ministry of This was the deadline for the submission of bids.Privatization agreed to allow Universal to pay the amount in April 27, 1991Pivaation agredolloUnvesaltopayheaShare purchase agreement was signed between Norblin andtwo equal installments: the first was paid on the date of sale Universal; Universal paid the first installment of the purchaseand the second one year later on April 27, 1992. Univsal price.provided the Ministry with a promissory note (co-signed by April 27,1992the Export Development Bank) to guarantee the second in- The second installment was due but Universal was unable to

pay.stallment. April 27,1993

In accordance with the Privatization Law, Norblin's A revised deadline was provided for Universal to paythe sec-employees were offered 20 percent of the shares at 50 per- ond installment.cent of the share price paid by the strategic investor. Oneyear after privatization, when the workers' entidelment to theshares expired, only 0.5 percent of the employee shares had This case has received wide press coverage, and bothbeen purchased. According to Norblin management, the the Ministry of Privatization and the new owners have beenemployees were skeptical about tLe company's prospects. criticized. The selection of Universal as the new owner is a

A portion of Norblin's facilities are located on property heavily contested issue. The investigating agency for thesubject to restitution claiims. The Ministry of Prvatization Polish Parliament, NIY, prepared an analysis of the case inagreed to indemnify Universal with regard to any valid resti- which it concluded that Tmpexmetal should have been cho-tution claims. sen over UniversaL The Solidarity trade union organized a

press conference during which it criticized the Ministry forPost-Privtization selecting Universal over linpexmetal and also criticized Uni-PAYMENT By UNwVEsAL Universal was unable to meet the versal for not taling a more active role in Norblin.second installment of the purchase price because of financial The Ministry justified its selection by arguing thatdifficulties, and the Ministry of Privatization postponed the Imexneal had offered a lower price. In addition, Univer-payment date until April 1993. The payment has stfll not sal offered access to foreign markets, and at the time of se-been made, as Universal claims that it was promised dear lection its financial position was perceived to be stable. Intitle to all of Norblin's property and that the costs associated 1992, Uniesal suffered an operating loss of almost 2l 6 bil-with this process are roughly equivalent to the value of the lion (US$380,000) but managed to earn a net profit of ZI 4.8second payment. Universal and the Ministry are trying to billion (US$304,000) on the basis of ZI 10.8 billionnegotiate a settlement. The share purchase agreement con- (US$685,000) of extraordinary income resulting from thetained dauses to force payment by recovery of shares, but exchange rate devaluations (since most of Universal's tum-the Ministry of Prvatization preferred to extend the dead- over is in hard currency).line rather than exercise this option because it did not wantNorblin returned to state hands. MA= POSMON The company's sales continued to decline

CAsE STuDm2 PoLANo- Nomn -UNIVEAL 11

sharply in 1992, falling by over 60 percent in real terms com- Rnanclul Intomutlonparedwith 1991. Since 1990, sales have plunged by 85 per- (in mUons of zlotys)cent in real terms.

As of miid-1993, the U.S. market made up the majority 1990 991 1992 1993of exports (90 percent), up from approximately 10 percent Income Statementin 1990. The growth was relative. In real tems, U.S. sales NetSales 573,012 363,183 168.344 190.686Gross Profit 36,201 (90.320) (100.171) (73.113)remained stable, but Norblin was unable to recoup lost sales Taxes 7.562 0 0 0to Germany and formner COMECON countries. On the Net Profit 28,639 (90,320) (100,171) (73,113)Polish market, as of mid-1993, Norblin was unable to recap- Baarce Sheetture its market share in the non-brass wire market, where CurentAssets 138.669 81,908 67,711 57,929competition was intense, with 32 nonferrous metal mills op- Plant & Equip. 251,841 196,818 173,889 192,332

emting in the country. OtherAssets 23,281 13,734 21,470 15.085erating m ute country. Total Assets 413,791 292,460 263,070 265,346

FINANCiAL SrIUATION Universal was unable to stabilize Current Bank Debt 96.450 96,000 81,325 0Norblin's financial position. The company's liabilities (ap- Cualents 16,748 30,981 43,143 168,342

proximately ZI 150 billion in 1991, or US$13.7 million) had Long-Term Bankincreased to over 2i 230 billion (US$14.6 million) by 1992. Debt 19,269 34,440 69,306 0

Other Long-TermnNorblin continued to suffer huge losses (ZI 90 billion, or Liabillties 0 10,300 36,500 130,358

US$8.2 million, in 1991 and ZI 100 billion, or US$6.3 mil- Debt to Govt 17 370 1.930 2.499lion, in 1992) which threatened to wipe out the book value Total Uabililies 132,484 172,091 232.204 302,199

of the company. Equity Capit 281,307 120,369 30,866 (36,853)

Universal and Norblin's management have together beenattempting to negotiate a debt for equity swap with major Note: The increase in debt was the restut of devaluation of the zloty,

since some bank debt was denominated in U.S. dolas No newcreditors. By mid-1993 some renegotiation of loan terms had bank credits had been extended.taken place. The company's largest creditor, WielkopolskiBank Kredytowy, towhich Norblin owed ZI80biDion (US$3.7

Ailion), agreed to convert its obligation from a short-termnto a long-term credit at a favorable LIBOR interest rate. matic reduction i' sales. By 1992, employment was reducedUnder the new terms, Norblin only was obliged to pay inter- by over 60 percent compared with 1991 levels. The reduc-est every month, until the end of 1993, and the principal tions were implemented in phases. In each case, the workerspayments were spread between 1994 and 1996. Negotia- were given severance payments of one to three months intions with creditors were complicated by the fact that the accordance with seniority: These massive layoffs did not re-company was technically bankrupt (extensive losses over the suit in significant public unrest, sine low unemployment inpast two years had wiped out over Zl 200 billion (US$9A the Warsaw area enabled most workers to find new jobs.million) of equity so that the ccmpany had a negative bookvalue). In short, there was not enough equity as of mid-1993 CURRENT STus More than three years after privatization,to satisfy the creditors in the proposed debt-equity swap. although Norblin had become a private company, the Polsh

Government had been paid only 50 percen; of the sales priceORGANIZATIONAL RESTRUCTURING In response to the and the companywas technically bankrupt (ie., its liabilitiescompany's deteriorating financial position, Norblin's man- exceeded the book value of its assets). Negotiations withagement had, by mid-1993, been changed three times since creditors have been complicated by the fact that the newLawprivatization at the initiative of Universal. on the Fmancial Restuctring of Banks and State Enterprises

The new management reduced costs by liquidating some does not cover private companies and the fact that creditorsindirect departments and laying off most of the work force, steadfastly have refused to write off significant amounts ofbut tihese measures were insufficient to counteract the dra- debt.

12 SEmNC ST= ComrANI ir STL4x=c INvMs, VoLumE Two

POLAND

POLKOLOR - THOMSON

Enterprise Status before Privatization ization of the economy, beginning in 1989, the domesticPolkolor was the sole Polish producer of color picture tubes market became increasingy competitive as large multinationalfor television and was established in 1977 as a licensee of companies such as Sony, Toshiba, and Philips, and subse-RCA to manufacture color television picture tubes. This li- quendy (to a lesser extent) new Polish manufacturers (Curtiscensing agreement provided for the transfer of technology International), began selling in Poland. Polkolor's sales plum-and management expertise in exchange for royalties paid to meted and the enterprise accumulated over US$12 millionRCA In the early 1980s Polkolor became autonomous in of unsold inventory. InJanuary 1991, after a period of mini-the manufacturing process and RCA's management role was mal activity, Polkolor was forced to stop production-declining.

Poikolor's ebtimated plant capacity was about 800,000 Preparationtubes per year, although actual production was only 400,000 In late 1989, as the enterprise's position in the market weak-to 500,000 tubes. Fifty percent of Polkolor's total sales came ened, Polkolor's management, with support from the work-from exports. The enterprise's main export market consisted ers' council, approached severl leading manufacturers ofof the forrner COMECON countries (with the Soviet mar- color tube displays as potential joint venture partners.ket alone representing 10 percent of the enterprise's annual Polkolor's management contacted several Korean and Japa-revenues). Polkolor's main non-COMECON market was nese companies, induding Toshiba, as well as Philips (Neth-Turkey, where its technology was stll competitive. Polkolor erlands) and Thomson Consumer Electronics (France) inwas one of the few Polish manufacturers that did not rely on Europe. Since the technology used by Polkolor differed fromforeign trade organizations for its export sales but used its their own, the Korean (Samsung) and Japanese companiesown trade offices and other intermediaries. did not appear interested. Both European companies, how-

On the domestic market, Polkolor's main customers ever, expressed interest, but, Philips did not pursue this in-were Elemis (Warsaw) and Unimor (Gdansk), which were terest, citing concerns over Polkolor's financial difficultiesstate-owned television manufacturers. Following the liberal- and the threat of a strie at its planL Thomson, the only

Summary of Polkolor-Thomson Agreement Shareholder structurepercentage of ownership

Type of Company:Manufacturer of color television tubesLocation:The company has one plant, in Piaseczno, 15 kms from War-sawDate of Sale:May 22. 1991Sales (1993):ZI 684 billion (US$43.4 million)Ernployment at Date of Sale:4.500Employment (May 1993): Shareholder Date of joint venture 12131/92Thomson-Polkolor (joint venture): 3,200Adextra S.A. (former state enterprise): 600 C3 Adextra SA 49.0 49.0Nane of Strategic Investor: Thomsn Consumer Elctrnks 51.0 51.0Thomson Consumer Electronics (France)Price Paid by Strategic Investr:US$35 million cash contribution to joint ventureInvestment Commitment:None committed

CASE STuDY 3 PoUND: PoIoDLo X THOYSON 13

prospective investor interested in further negotiations, was at relatively low cost. Thomson was also interested infiamliarwith the technology used byPolkolorbecause in 1987 Polkolor's strong distribution capability in the formerThomson acquired RCA. Earlier, in 1984, General Electric COMECON countries, where Thomson expected 50 per-(GE) had bought RCA, but when Thomson purchased the cent of Polkolor's production to be sold in the future.company, GE retained licensing activities in a separate sub- Thomson and Polkoior agreed to have Ernst & Youngsidiary, GE/RCA Licensing Corporation. prepare a 'valuation" on the basis of discounted cash flow

Thomson wanted a presence in Central Europe and and replacement value. The estimated value of Polkolor wassurveyed alternative production sites. Former Czechoslova- roughly between US$60 million and US$90 million. How-kia was ruled out because it was a smaUl market and it used ever, the valuation was simply a compilation of two separateJapanese technology. An enterprise in East Berlin was passed appraisals of estimated replacement values of individual ma-over because it was only an assembly operation and, in addi- jor components of production plants (reduced by accumu-tion, already had many interested bidders. Polkolor was se- lated depreciation). One appraisal had been prepared bylected by Thomson as the best investmnent candidate for the Polkolor, and the other by Thomson. The resulting valuationfollowing reasons: (1) Polkolor used familiar technology; (2) was completed in late 1990. The cost of the valuation wasall of Thomson's worldwide production of television tubes paid jointly by Polkolor and Thomson. A financial audit waswas based on RCA technology-, (3) Polkolor had the capacity also carried out by an independent Polish Lonsulting com-to fulfill not only domestic demand but also export orders; pany, Towarzystwo Konsultant6w i Doradc6w, which was af-and (4) the enterprise was a good fit with Thomson's global filiated with Emst & )bung. Polkolor paid the fee for thestrategy, since it produced smaEler (13-20 inch) sets, which financial audit.were not being produced at otherThomson factories. On April 12, 1991, Polkolor was transfomied into a joint

Negotiations with Thomson were initially led by stock company, Polkolor SA - one of the first state enter-Polkolor's management, which had been involved from the prises to be transformed. The Ministry of Privatization de-beginning in the srmrch for joint venture partners. In early cided on a joint stock company rather than a limited liability1990 the workers' council pressured the Ministryof Industry company, since the former would make it easier for a com-to fire management for, among other issues, failing to reach pany of its size to raise capitaL Following the transformation,agreement on the joint venture. By September 1990, nego- the MinistLy of Privatization took over the role of Polkolor'stiations had not progressed and it became evident to the founding organ from the Ministry of Industry.Polkolor management and workers as well as to the govern- When Thomson's proposal was submitted, Polkolor hadment that the enterprise was approaching insolvency and accumulated over US$20 million in debt. The policy of theimminent bankruptcy. Polkolor had reduced its work force Polish Govermment was to have investors assume all existingin 1990 from 6,000 to 4,500 as a cost-cutting measure, but liabilities. This condition, however, was not feasible inthis action could not keep the enterprise from halting pro- Polkolor's case, as Thomson's joint venture offer was contin-duction inJanuary 1991. gent on the assets of Polkolor being debt free. Thomson had

In February 1991, Thomson submitted a fonnal offer further stipulated that it was interested solely in Polkolor'sto the Ministry of Privatization proposing a joint venture with assets related to production of color television tubes. ThusPollolor, in which Thomson would hold the majority stake. Polkolor was split into two parts. Tlle core production assetsThe Ninistry accepted Thomson's proposal despite an infor- (representing 80 percent of total assets on a book value ba-mal policy to the effect that privatizations involving the trans- sis) were contributed to the joint venture, whereas the re-fer of a stake of at least 20 percent to a foreign investor would maining assets and all of the liabilities remained in Polkolorbe conducted through a trade sale rather than a joint ven- SA (laterrenamedAdextra SA). It was assumed at the timeture.The Ministry made this exception primarly on the basis of formation that most of the liabilities in Adextra SA, in-ofPolkolor's dire financial condition. Production at Polkolor cluding Z: 350 bilion (US$31.9 million) in bank loans, wouldhad come to a halt when Thomson made its proposal. be restrucured via debt for equity swaps. At the time, Adextra

The Ministry of Privatization and Thomson could see had extensive social assets and other non-core businesses.mutual benefits in the joint venture. Polkolor would gain ac- They included resorts and 'worker hotels," a day-care centercess to new capital and technology that would enable it to for enterprise employees, a bus service and a fire departmentpenetrate new market oudets in the West, without which its for the enterprise, as well as a tooling plant and machine fab-survival was in question. The joint venture would also rication plant.stengthen the Pblish electronics industry At the same time, The Ministry of Privatization accepted Thomson's of-Thomson would have access to Polkolor's extensive produc- fer, since it had no alternative solution for Polkolor at thetion capacity to manufacture traditional color picture tubes time. A preiminary agreement was signed, but a delay fol-

14 SmULZN STAE COMS ro STx1EGc INSOitS, Vouwm Two

lowed, as some of the details of the joint venture agreement Timetble of Key Stepshad not yet been finaized. Through senior officials of theunions at the plant, Polkolor workers put pressure on the La 19

Polish Government to cometofiPolkolor management initiated contacts with potential Inves-Polish Government to come to final agreement with tors.Thomson, and the Ministry appointed a special plenipoten- Eaqry 190tiary to negotiate with Thomson. Polkolor's workers' council fired the managing director for,

The joint venture agreement, drafted byThomson's law- among other issues, failing to reach agreement with a strate-yers, was signed on May 22, 1991 (and was notarized August gic investor.September 19906, 1991). Complications remained, however. The joint ven- Polkolor was approaching insolvency and Imminent bank-ture was to be a limited liability company and Thomson ruptcy.wished to make its contribution in the form of a promissory Early February 1991

note,,ur dNationale de P . (Liited The Polkolor factory closed.note, guaranteed by Banque zanonale ae rans. (I=nstea Late February 1991liability companies were not pennitted to make contributions Thomson Consumer Electronics submitted a formal offer tothough promissory notes, since the commercial code requires the Ministry of Privatfzation for a joint venture with the pro-that the application for registration of a new limited liability ductive assets of Polkolor. A preliminary agreement wascompany include a declaration by all members of the man- signed by the Ministry of Privatization and Thomson.April 12, 1991agement board that all cash subscriptions have been paid.) Polkolor was transformed into a joint stock company.The issue was finally resolved by the main Warsaw registra- May 22,1991tion court. Finally, on September 20, 1991, the joint venture A joint venture agreement was signed with Thomson for thecompany was registered as a limited liability company. productive assets of Polkolor, leaving the liabilities and non-core assets with lne state enterprise.

August 1, 1991Terms and Conditions of the Joint Venture Poikolor workers held a strike to put pressure on the PolishUnder the arrangement, the assets related to the production Governrment to finalize the agreement with Thomson.of color television tubes were transferred to the joint venture August 6,1991

company, .omsnPol r wThe joint venture agreement (deed of association) was nota-company, Thornson-Polkolor, while the remaining assets re- rized.lating to non-core activities, such as transportation facilities September 20,1991and repair and maintenance shops, as well as the liabilities, Thomson-Polkolor was registered as a limited liability corn-remained with Polkolor SA pany.

The assets contributed by Polkolor SA to the jointven-ture weze valued at US$33.6 million. This represented a sig-nificant discount to the previous valuation range (US$60-90mfilion) estmated by Ernst & Young Thomson had argued venture and for three years from customs duties for spea-successfully that at least 40 percent of Polkolor's equipment fied components used in manufactur (phosphoms, glasswas obsolete, especially its glass and metal parts plants. and component parts for electron guns.) It was estimated

In exchange for the assets, Polkolor SA received 49 that in 1992 the exemptions represented ZI 194 billionpercent of the share capital of the joint venture. For its 51 (US$9.1 million) of savings. In addition, Thomson negoti-percent stake in the joint venture, Thomson contributed ated a 'put option" whereby under specified conditions itUS$35 million in cash (in the form of a bank-guaranteed could withdraw from its investment in Poland and sell :^spromissory note.) Thus the shareholder structure of the joint shareholding back to the original owner. In addition,venture was as follows: Thomson negotiated a clause that would allow it to repatri-

ate its share of the company's earngs as wel as the pro-Polkolor S.A. 33.6 million 49% ceeds from its put option (if exercised).Thomson 32.0 milion 5j% Under the terms of the contract, Thomson was requiredThomson-Polkolor 68.6 million 100% to invest US$35 million in capital investment within three

year. The agreement did not call for Thomson to maintain aThomson negotiated an agreemnent that the Polish Gov- given level of employment, but for workers not hired by

eminent would assume liability for environmental cleanup, Thomson-Polkolor, Thomson agreed to continue payment foralthough no environmental audit had been prepared prior to 12 months August 1991 (the date of notarization of the sale.)the privatization. However, Thomson was also obliged to produce a minimum

Thomson also negotiated exemptions from corporate of 1.5 million color picture tubes per year.income tax for the first six years of operations for the joint Polkolor's earlier license fee agreement with RCA was

CA=z Snrm 3 PoLAm PoLOwa -THOMSON 15

renegotiated as part of the formation of the joint venture. 12-month period to pay wages to workers remaining withThe licensing issues were not a crucial part of the overall ne- Adextra, and to others later dismissed. Thomson also irnple-goiations, since the existing agreement was terrninated and mented extensive employee training, including over 2,000another was negotiated with GE/RCA Licensing Corpora- person-days of training abroad. ITaining was primarily intion. However in late July and early August, Polkolor was management, in use of current technology, and (for both sup-delinquent in its payments of license fees to RCA and it was pliers and customers) in quality assurance. Between 1992 andnecessary forThomson to pay the outstanding amounts owed 1994, with increasing production, the company's work forceby Polkolor in order for the licensing agreement to be trans- expanded - from 3,200 in 1992 to 4,300 in 1994.ferred to Thomson Consumer Electronics. In addition, In addition after privatization, Adextra still had 81 sepa-Thomson was able to negotiate a lower licensing fec than rate businesses that were not part of its core activities andPolkolor had paid. Thomson argued that it did not have a needed to be divested. The resort hotels were sold, and thepreferential position because of its relationship with RCA. fire department transferred free-of charge to the South War-According to Thomson, the new licensing agreement was saw local government. In other cases, the businesses wereprepared on an "arm's length" basis and any other strong spun off to Polkolor employees and the services contractedinvestor in the consumer electronics industry could have ne- out to the former employees.gotiated a similar agreement.

FINANciAL RESTRUCURING Creditors were offered Adextra'sPost-Privatization interest in the Thomson-Polkolor joint venture in exchangeMARKr PosMoN With the formation of the joint venture, for their outstanding loans to Polkolor S.A. When it was aPolkolor was able to increase sales and improve production state enterprise, Polkolor had borrowed ZI 350 billionquatity significantly. The company's product defect rate was (US$36.8 million) from four banks. Of this amount, ZI 138reduced from nearly 20 percent of production to less than 1 billion (US$14.5 million) represented a loan by the Paris of-percent (between 0.4 percent and 0.8 percent) by mid-1993, fice of a state-owned Polish bank, PKO BP PKO's loan hada level comparable with the standards of Thomson facilities been in 1988 guaranteed by BRE, the Export Developmentworldwide. Thomson Polkolor expects to produce 2.3 mil- Bank (then state-owned), which was in turn guaranteed byiion color picture tubes in 1994- more than the company's one of Polkolor's suppliers, KGHM Polska Mied z, the state-prior cumulative production over 12 years from 1977 to 1991. owned copper iniing concem.Also, sales increased from ZI 684 billion (US$ 43.3 million) The creditor banks had participated in discussions on ain 1992 to ZI 2,171 billion (US$ 101.7 million) in 1993. debt-equity swap but had not finalized an agreement on the

Polkolor also benefited from access to Thomson's dis- swap before the creation of the new joint venture. KGHMtribution network. (Thomson had, in mid-1993, a 31 per- was not made aware of the proposed debt-equity swap untilcent share of the European market, a 33 percent share of the about December 1991, when PKO called upon the guaran-U.S. market, and a 36 percent share of the Asian market.) As tee of BRE, which in turn seized KGHM's cash on accountmid-1993 Thomson Polkolor was selling 25 percent of its with BRE in the amount of the guarantee. (BRE was under-production on the Polish market, and another 70 percent going privatization at the time and was unable to meet thewas sold outside the former COMECON countries through guarantee.) KGHM, which had not been a party to the priorThomson's international distnbution network. Sales to West- negotiations and was not interested in participating in theem Europe grew from virtually nil to almost 60 percent of debt-equity swap, began legal action against the parties con-total revenues in 1992. cemed. One of the concems raised by KGHM was that the

equity held by Adextra was not sufficient to pay back thePHYSICAL RESTRUCrURING Thomson invested over US$25 debt and interest owed to KGHM, let alone that owed to themillion within the first 12 months on improved production other three creditors. Completion of the debt-equity swapfacilities (induding a glass furnace, a new press for produc- was also complicated by the unwilingness of BRE and PKOtion of glass panels and a "matrix" facility for color enhance- (a privatization candidate) to take a significant loss. The debt-ment) as well as on basic infrastructure (such as windows, equity swap was to have been cornpleted within 90 days (thatpipes, cables and roofs). Thomson expects total investment is, by December 1991) or Adextra SA was to have beento reach US$114 million by the end of 1994. liquidated. As of mid-1993, neither had occurred. Further-

more, none of the banks had taken action and the copperORGANI oNAL RESTRUCT1URNG During the first year of enterprise had suspended its lawsuit against both Adextraoperations, Thomson Polkolor maintained the size ofthework and Thomson, since all were hoping that the governmentforce assigned to the joint venture. Also in accordance with would assume some of the liability or that some other solu-the joint venture agreement, the company continued for a tion would be found.

16 SEUUiG STA= CoNmsPAN SmtiO c INvERL mRs, VoLums Two

In addition, at the time of Polkolor's initial transforma- taiffs that followed Pobland's associate membership in thetion into Pblkolor SA, shares were set aside for employees European Community. Thomson had to pay 15 percent dutyon preferenti&l terms. In the year following privatization, on components while the competition was importing finishedhowever, only three employees had purchased shares. color picture tubes duty free. Thomson contested the issue

Also in mid-1992, on the recommendation of NIK, the with the Ministry of Privatization, which resolved the matterState Security Control Bureau, the Privatization Ministry re- in Thomson's favor, subsequently upholding the duties cx-cruited an outside consultant to estimrate its potential envi- emptions.ronnental liability. The consultant found lio major environ- In addition, Thomson has arranged for new loans tomental damage. A subsequent environmental audit by Polkolor. In late 1992, Thomson arranged for a US$20 mil-Polkolor similarly found no major damage. lion syndicated loan with the Polish Developmert Bank as

Despite the tax and duties exemption granted in the the lead bank. In addition, Thomson Consumer Electronicsjoint venture agreement, Thomson-Pblkolor was charged has provided a US$150 million credit line to Polkolor forcustoms duties as of March 1992, after the reshuffling of working capital requirements.

CaSE Srw 3 POLAn: PoLowi - TWNs 17

POLAND

POIAM PILA - PHILIPS

Enterprise Status before Privatization States, and Canada. Polam Pila's standard of quality hadPolam Pila was the dominant enterprise in the Polish lighting given the enterprise its competitive edge over other smallindustry prior to the liberalization of the economy. A pro- light source manufacturers in Europe. However, obsoleteducer of incandescent, compact, and fluorescent lamps, equipment and lack of access to modern technology, as wellPolam Pila sold its products in the domestic market (40 to as poor quality control, were eroding the company's ability45 percent of sales) and in Western markets. to maintain such standards.

Polam Pila was created as an independent state enter-prise in 1981, when the national monopoly producer, Polam, Preparation for Salewas broken down into many smaller independent companies. NEGOTATONS CONDUCrED BY 1HE COMPANY By the end ofIn 1990 Polam Pila employed 3,290 people and operated 1989, Polam Pla's management had decided that the enter-under the supervision of the Ministry of Industry. prise could survive only by bringing in a foreign partner able

The period following trade liberalization left Polam Pila, to provide the capital and technology essential to competi-along with the entire Polish lighting industry, in financial dis- tiveness. The enterprise management concurrently ap-tress, primarily because the lifting of trade barriers allowed proached GTE Sylvania (United States), Philips (the Neth-the import of higher quality and lower priced products. The edands), Osram (Germany), and Luma (Sweden), a GIEcompetitive position of Polish producers was further weak- affiliate. General Electricwas not approached because it hadened by a shift in market demand toward energy saving and recently acquired the Hungarian company Tungsram, a ma-specialized products with higher profit margins, but which jor competitor of Polam Pila's in the international market.local manufacturers could not readily produce. Luma was itself restructuring and was thus not inter-

Quality control concerns perpetuated the need for re- ested. GTE Sylvania was nrled out because it was appar-structuring in Polam Pila. In the past Polam Pila had met ently interested in using Pblanm Pila as a manufactuning basesafety standards in Gennany, the United Kingdom, the United for lower-quality items rathcr than as a means of developing

Summary of Polam Pile-Philips Agreement Shareholder structurepercentage of Ownership

Type of Company:Manufacturer of lamps and lighting components 100%Locatlon:The company has one plant, in Pila, 100 km north of PoznanDae of Sale:May 23, 1991Sales (1993):ZI 1,251 billion (US$58.6 million)Employment at Date of Sale:3.290Employment (1992):3,090 Shareholder Date of Sale 12/31/92Name of Strategic Investor:Philips Lighting Holding B.V. (The Netherlands) E Polish State Treasury 13.3 13.3Price Paid by StrategIc invetor: * Workers 20.0 0.2ZI 153 billion (US$14 million)Investment Commitnmnt * Philips Ughting Holding 66.7 86.571 million guilders over five years (US$41.5 million)

CA Sn 4 PauD: PoLAM PHA PHms 19

the Polish market. Osram was too deeply involved in discus- vestment needed to nmitipte the environmental damage andsions to acquire Narva, an East German producer, to have a to bring the company in compEiance with prevailing envimn-serious interest. mental standards was estimated to be between ZI 40 billion

Philips, on the other hand, was interested in both mar- (US$42 million) and ZI 100 billion (US$10.5 million). Theketing Polam Pia's products in Poland and developing an results of this audit were used in the negotiation of the con-export business for the enterprise. Philips' decision may also tract.have been a competitive response to General Electric's ac- Inadditiontoconductingpreparatorystudies,Polam Pilaquisition of Tungsram. On the basis of Philips' favorable attempted to seUl off non-operating assets. The enterpriseplan for the enterprise's development, Polam Pila's manage- transferred a school to the local school board free of charge,ment determined that Philips would be the most suitable joint but could find no takers for its other social assets (employeeventure partner. aparttnents and a holiday resort). Apartments built to at-

Pblam Pila's management initiated preparatory studies tract university grduates to Pila could not be sold since theirwith Phlips in early 1990 when they began negotiations for a rents did not cover operating costs, and rent control regula-joint venture. Most of these studies were financed jointly by tions prevented any rent increases.Philips and Polamr Pila. An appraisal was conducted thatincluded a survey of the Polish market, a business plan, and NEGonTAToNs CoNDuaED BY TIE MINIS OF PRIVATIZAIiON

a detailed study of Polam Pila's manufacturing capabilities. Tle Privatization Law, passed in July 1990, had an impact onIn early 1990, Polam Pila recruited Meritum, a local consult- enterprises such as Polam Pila that were undergoinging firn, to undertake a valuation of the enterprise. Meritum privatization. For Polam Pila the impact was threefold: (1) itestablished Polam Pila's value in the range of Zl 600 billion discouraged the creation of a joint venture where more than(US$632 million) to ZI 800 billion (US$ 84.2 mfllion) on 20 percent of the enterprise's assets was privatized; (2) it setthe basis of replacement value and an undefined "economic" out a dear process for the trandormation and sale of statevalue. Philips disputed this valuation, indicating that it could enterprises; and (3) it stipulated the need for competitiveaccept only an independent valuation by an intemational ac- bidding in trade sales.counting firm. Following the process established by the Privatization

Philips and Polam Pila agreed to have the Netherlands Law, the Polam Pila mmngement began iscussions with theoffice of KPMG/Peat Marwick (KPMG) carry out a finan- workers' council to obtain approvai for the transiormation.cial audit and valuation. Using audited financial statements Philips gave members of the council a tour of a Phiips fac-as of September 1990, KPMG estimated the asset valuation tory in Western Europe to persuade them that their factoryof Polam Pila in a range between Zi 130 bilion (US$13.7 would have tremendous growth potential under the Philipsmidlion) and Zl 280 bilion (US$29.5 million). KPMG then umbrela. The council approved transformation, having ac-tested the asset valuation against business valuations. They cepted the argument that a strategic investor would improveprepared a discounted cash flow based on profit projections Polam Pila's financid position and would thereby pave thedeveloped jointly by Polam Pila management and Philips. A way for increased wages. The labor union also gave its sup-discount factor of 20 percent (which was thought to be fa- port to the transiormation.vorable to the government) generated a valuation of Zl 290 After receiving the approval of the workers' council, thebilion (US$30.5 million). XPMG tested the result against management submitted an application to the Ministry ofprice-earningsratios for international lighting companies and Privatization to initiate the transformation process. At thefound it to be comparable. However, the valuation of ZI 290 Ministry's request, a detailed business plan was prepared bybillion was furither reduced by the enterprise's debt of ZI 84 Phlips and Polam. Pfla and submitted to the Ministry in Oc-billion (US$8.8 million). The final valuation prepared by tober 1990.KPMG was Zl 204 billion (US$21.5 milLion). Polam Pila Philips requested transformation into a limited liabflityand Philips shared the comsts of KPMGs work. company, which would require less detailed disclosure pro-

As Polam Pila's operations could have involved a signifi- cedures, but the Minstry decided on transformation into acant negative impact on the environment, Philips recruited joint stock company, as this would allow for greater flexibilitylocal ground and water pollution appraisal specialists to con- in future sales of shares, particularly for the workers. Induct a series of enviromnental studies and to estimate the November 1990 the Vice Minister of Privatization signed theentaerprise's liability under Polish environenta laws. The authorization for Polam Pila to be transformed into a jointstudies showed some soil contamination from chemicals and stock company (based on a share capital of Zl 200 bilion, oralso provided information regarding removal and preventive about US$21 million. On December31, 1990 the newcom-procedures in addition to estimated cleanup costs. The in- pany was registered with the courts.

20 SmEII SDrU CAms To SmuGIc INVEsroNs, VowL Two

The Articles of Association (company statutes) were TImiable of Key Slepsdrafted by the Ministry of Privatization with the assistance ofa Polish lawyer and were based on a standard format. Dur- L 193Bing later negotiations with Philips, the Articles. wr . Polam Plia initiated a search for a joint venture partner.

Early 1910and included in the sales contract. Polam Pila initiated preparatory studies and began to finalize

Although the Privatization Law required publication of negotiations with Philips.an offer for sale in order to establish a compettive process, Sepbnr1M

KPMG completed a valuaton of Polam Pila.the Ministry made an exception in Polam Pila's case and re- Oe obir tquested a waiver from the Council of Ministers. The Minis- Polam Pila submitted a transformation plan to the Ministry oftry justified a direct sale to Philips for several reasons. Fr Privatization.Polam Pila, after reviewing other manufar!-!ers, had estab- Novembw 1990

hshed a clear preference for Phnwps, and there wem few al The Vice Minister of Privatization signed the authorization forhPolam Pila to be transforrnqd into a loint stock company.

temnative serious bidders. Second, Polam Pila and Philips End 1990had already expended considerable management and finan- Samuel Montagu was hireu as financial adviser to the Minis-cial resources in developing a future strategy for Polam Pils try of Privatization.

December 31, 1900Third, negotiations had begun before the Privatization Law Polam Pila was registered as a joint stock company.was passed. Februy 25,1991

The Ministry of Privatization presented a formal requcst The Council of Ministers agreed to sell a 51 percent stake into the Council of Ministers for permission to implement a Polam Pila to Philips.

March 1991direct sale without a competitive process. The request fu- Final negotiations were begun between Philips and the Min-eled debate in the Council over the impact that this would istry of Prvatizabon.have on the lighting industry, particularly on weaker compa- April 1991nies. The Council therefore requested that the Ministry take KPMG reviewed Polam Pilas accounts again to ensure hat

a comprehensive look at'-he entire sector and the intma- the value had not changed by more than 5 percent from thea comprehensive look at the entire sector and the interna- tire of valuation.tional market affecting Polam Pila before proceeding wih May 23,1991this politically sensitive request The Ministry then hired a The sale of Polam Pila was finalized; Philips' stake was in-British investment bank, Samuel Montagu, to conduct the creased to 66.7 percent.fist sector study in Poland. (Sector studies subsequently be-came a commonly usea procedure in the Polish privatizationprogram for large enterprises.) Following completion of thesector study, the Council of Ministrs granted the waiver inFebruary 1991 and agreed to sell a 51 percent stake in Polam of reasons. Philips would benefit fiom tax incentives thatPila to Philips. the government offered for joint ventures but had not yet

At the end of 1990 Saii.Lel Montagu had been reauited established for trade sales, and under a joint venture Philips'(via a competitive tender) to also assist in negotiating the cash payments for the equity sales wud flouw to the privatizedshare purchase agreemenL Polam Pila was one example in company rather than to the State Teasury. In the final con-which enterprise management initiated serious discussions tract, Philips did receive certain tax exemptions.with the ultimate investor, thus, the role of the Ministry's When final negotiationsbegan in earlyMarch 1991, overadviser (Samuel Montagu) was primarily to close the trans- a year had elapsed since the first discussions on privaiizationaction. Since this was one of the first privatization transac- had been hekl Pressure to conclude the negoiiations as rap-tions and the Ministry had limited resources, it used grant idly as mossible was generated by Polam Pila's deterioratingfunds provided by the European Community and requested finanaal position (a very large increase i financig costs cre-Samuel Montagu to accept success fee payments from the ated a net loss in 1991) and by the frustration of workerssales proceeds. This method of payment was not used in awaiting increased wages. According to the Polam Pia man-later privatizations, since the Budget Law requires that al agement, completion of the deal was acceerated bvthework-privatization revenues should be directed to the central bud- ers' thrcat to strike if negotiations were not conduded rap-get and should not be used to finance the privatization pro- idl (When negotaions between Philips and the govem-cess. ment fell apart, the local Solidarity trade union representa-

As has been noted, initial discussions between Philips tive asked its president to raise the issue with the Minister ofand Polam Pila had focused on fonning a joint venture. Privatization.) This is thus a case in wlic pressure fromPhflips preferred this method over a trade sale for a variety workers played a criical role in speeding up prhvazaton.

CAsi STr 4 POLW: POLAM PMA - PHnS 21

The share purchase agreement was signed on May 23, sate Philips for all undisclosed liabilities that excecded 51991. Itwaswritten in English, although in laterprivatizations percent of the company's total value.the Ministry required all contracts to be in Polish. Philips was also granted a corporate income tax holiday

of three years- the same concession that it would have beenTerms and Conditions of Sale given had a joint venture been chosen. In addition, PhilipsPrior to agreement on the final price, KPMG again reviewed was granted an exemption from inport duties on approxi-Polam Pila's accounts as of April 30, 1991 to establish that mately 37 million guilders (US$21.6 million) of equipmentno adverse change had occurred and that the value had not that it had to import as part of its planned capital investmentchanged by more than 5 percent since September 1990. program (1991-93). The Ministry of Privatization negoti-Philips agreed to pay ZI 153 billion (US$14 million) for a 51 ated this exemption with the Ministry of Finance. The sharepercent stake in Polam Pila. The price implied a value of Zt purchase agreement included a clause requiring the govern-300 billion (US$27.4 million) for the company (at the high ment to indemnify Philips in the event that such taxes wereend of KPMG's valuation). Philips also made a commit- imposed.ment to invest a total of 71 million guilders (US$ 415 ml-lion) over five years. Eight million guilders (US$4.7 million) Post-Privatizationwould be used to improve manufauring skills and 63 mil- MARK=E PosmoN By mid-1993, severe consolidation amonglion (US$36.8 million) would be used to produce energy ef- Polish lighting eq,ipment manufacturers had taken place.ficient lighting products and reduce pollution. The commit- Many of Polam Pila's former competitors had become insol-ment also induded training programs aimed at improving vent; of the 44 state-owned producers existing in 1989, onlyquality control. No employment commnitments were made. 7 survived. The strongest of these was Polam Pabianice.

By the time the transaction was completed (May 23, In mnid-1993, Polam Pila controlled over 53 percent of199 1), Philips had increased its stake in the company to 66.7 the Polish market for incandescent lamps and nearly 58 per-percent of the equity as compensation for assuming atl of cent of the market for fluorescent lamps. The company hadPolam Pila's environmental liabilities. The Polam Pila case is regained its strong domestic position and a majority share inthe only Polish example in these case studies of an investor the market after a significant decline in sales recorded in latereceiving additional shares in exchange for acquiring aul en- 1990 and in 1991. The coinpany had become the most effi-vironmental liabilities. Philips promised both to clean up cient domestic producer in the low quality segment becausepast environmental damage and to invest in methods that of its relatively modern production facilities.would help Polam Pila meet basic environmental standards. The domestic market was being penetrated by foreignThe Ministry of Privatization agreed to transfer an additional competition (former Eastern European manufacturers and15.7 percent of the total shares to Philips for these environ- large multinational companies such as General Electric andmental expenses. The environmental audit was used in de- Osram). In mid-1993, Polam Pila's management contendedtermining this percentage. that Tungsrarn and producers from the CIS were the

At the close of the transaction, the Polish State Treasury company's most inportant foreign competitors in the do-maintained a 13.3 percent equity stake, whereas 20 percent mestic market This dramatic increase in competition hasof the shares were set aside for the employees. In compli- significantly reduced the company's net margins as comparedance with the Privatization Law, workers were offered 20 with 1990.percent of the total shares at a 50 percent discount. Since Polam Pila strengthened its intemational position byPhilips was not interested in minority shareholders, which coming under the Philips umbrella. Although as of mid- 1993could lead to a competitor's obtaining infonnation as a share- Polam Pila sold almost 89 percent of its exports under theholder, Philips agreed to assist the workers in the purchase Pila brand name, most of its export sales were channeledof their shares. In exchange, the workers agreed to sell these through the Philips distribution network Through Polamshares back to Philips immediately at full price. Philips Pila, Philips successfully increased its entry into many lowerthereby acquired all but 0.2 percent of the workers' shares end price-sensitive market segments. In fact, the flexibilitywhile the workers received cash. to sel independently greatly benefited Polam Pila, as major

Under the terms of the agreement, the government was buyers were becoming increaigly reluctant to become de-obliged not to allow the remaining minority shares to be pendent on supplies from such Tmonopolistic pmducers" asbought by Philips' competitors. The agreement also allowed Philips.the comnpany to relocate its equipment and property to theNethelands in the event of nationalization. An indemnity PHYSICAL REsTRuCnrRING By the end of 1992, Philips hadclause was also included to protect Philips against any undis- spent 27.6 million guilders (US$152 million) on investnentsdosed liabilities. The government was required to compen- and 3.6 million guiflders (US$2 million) on environmental

22 Smi ST COMP r vo STmC Lwsss, VoLUME Two

protection. According to Polam Pila's management, thesc Flnamiai Informaffonsums exceed Philips' commitments for the period. (in bilions of zlotys)

OpmrinoNAL RESTRUCFURING Philips' restructuring actions 1990 1991 1992 1993induded the introduction of training programs aimed at im- Income Statementproving quality control; the revamping of Polam Pila's orga- cNsts 347 5152 747 1251nizational structure; and the implementation of cost reduc- Gross Profit 102 47 111 319tion measures (such as lowering the defect ratio, reducing Financing Cost 6 68 37 103material consumption, improving logistics, reorganizingmain- Extradinary Items 96 (21) 74 216tenance, and improving purchasing practices). Exbaordinary Credit

In addition, management from Polam Pila and Philips (Charge) (5) (6) (35) 2

jointly prepared a three-year plan (1992-94) aimed at stabi- Profit beforeTax 91 (27) 39 218*ing and restructuring the company so that it could regain Net Profit 59 (27) 39 218

its dominant position on the domestic market and improveeBalance Sheeits competitive position on foreign markets. Current Assets 174 222 228 491Plant& Equiprent 403 386 514 841

LABOR RELATnoNs Although only minimal reductions in the Other Fixed Assets 6 16 21 14work force were made (from 3,290 to 3,090 employees) af- Tota Assets 583 624 763 1346ter privatization, workers who had initially supported Short-Term Loans 129 96 8 17privatization turned against the process because the new Long-Term Loans 2 3 178 324

Other Uabili0ies 1 102 114 210owner not only failed to implement the promised wage in- Total Uabilities 132 201 300 551creases but also froze all wages. The unions initiated a dis-pute with management that received national media atten- Equity Capital 451 423 463 795tion and created negative public perceptions of the Note: Exbaordinary items indude payments of interest on overdueprivatization process, particularlywhere fcoreign investors were liabilties. Reclassifiation of flabilffles (among short-tenm, lng-term.involved. 'Me dispute was resolved in.1993.and.Ph.ps wa-.- and other liabilities) resulted from the long-term credits from IFC andnvolved. The dispute was resolved in 1993 and PhlipSwas ~ ING as wea as from a commnercial loan from Philips. The incease inforced to increase wages. te cost of goods sold in 1991 was the result of a sharp decrease in

sales of high margin prducts to the USSR.

FINANcIAL RESMRUChIUNG Immediately after the sales trans-action, Philips took significant steps to improve Polam Pila'sfinancial condition. For example, Philips guaranteed a loan Impact on Privatization Policiesmade by Bank Handlowy prior to the privatization and also As one of the first trade sales conducted by the Polish Gov-guaranteed a loan extended by the Dutch bank ING (for- emmnent, the acquisition of Polam Pila by Philips involved amerly NMB) to improve Polam Pila's liquidity and to pre- number of significant policymaking issues. For example, thevent the company from paying penalty interestL Philips also transaction confirmed the trend by the Ministry ofextended a commuercial loan (120 days) for components from Privatization to consider non-price issues (such as investmentPhilips in the Netherlands and initiated negotiations with the conmmitrnents, the business plan for the enterprise being pur-International Finance Corporation (IFC) to provide Polam chased) in determining the ultimate buyer of a state enter-Pila with a long-term credit. (The IFC provided a US$15 prisc In addition, the Polam Pila case is the only one of themillion long-term loan in February 1992.) These actons al- cases studied in which the Polish Government gave an inves-lowed Polamn Pila to repay all loans to the Polish banks (ex- tor additional equity for assuming all responsibility for envi-cluding working capital credits). ronmental deanup.

In addition, the case established a precedent for the Sec-TAXES As of May 1993, Philips had requested indemnifica- tor Privatization Program, which calls for a comprehensivetion from the Ministry of Privatization for a new border tax study of a given sector before the sale of a major enterprisethat Philips was required to pay. operating in that sector.

CAS STuDy 4 PoAw: Poi.m PILA - PHMS 23

POLAND

KWiDzYN - INTERNATIONAL PAPER

Enterprise Status before Privatization however, Kwidzyn competed with two other important pro-Celuloza Kwidzyn (Kwidzyn) was the largest and most mod- ducers- Myszk6w and Skoivin (the largest Polish producer).em paper mill in Poland with a total reported capacity of Prior to 1989, paper distribution in Poland was controlled270,000 tons per annum of wood-free paper and board. It by a central planning authority. With the liberalization of thewas also the only integrated bleached pulp and paper mill in economy, the demand for paper fell and Kwidzyn's capacityPoland capable of producing fine grades of white paper. utilization rate -which had never been above 70 percent -

Established in 1981 as a state enterprise with the Mlinis- fell to roughly 50 percent. Products of lower cost and quality,try of Industry as its founding organ, Kwidzyn used exten- primarily from the CIS, were being imported in large quanti-sive Western machinery supplied primarily by Beloit Corpo- ties. In addition, imports from Finland provided serious com-ration. Additional papermaking capacity was added in 1985 petition.and 1989. With the increaseL competition and lower capacity utili-

Kwidzyn's products were sold on the intemational and zation, Kwidzyn's financial position had begun to deterio-domestic markets. Kwidzyn was the only notable Polish ex- rate by 1990 and the enterprise suffered a net loss in 1991,porter of paper products to the West. (Its principal markets although Kwidzyn did not as yet have significant debt out-included Gernany, Austria, and Italy.) On the domestic standing. Given the enterprise's huge undepreciated assetmarket, Kwidzyn supplied about 80 percent of writing pa- base, these financial difficulties were exacerbated by theper, 55 percent of printing paper, 40 percent of pulp, and 20 diidenda (an asset tax levied regardless of profitability) andpercent of newsprint. Kwidzyn maintained its own distrlbu- the popiwek (excess wage tax). In addition, despite thetion neivork, with sales of fine paper, for example, to print- company's modem equipment, the quality of paper produceding companies and paper goods manufacturers. Kwidzyn at Kwidzyn was wel below intemational standards, whichfaced no real domestic competition in the printing paper made further penetration of Western markets difficult. Atmarket, as the output of the only other significant producer the same time, Kwidzyn suffered from a lack of capital to(Kostrzyn) was of lower quality. On the newsprint market, enable it to install new technology and thus improve the effi-

Summary of Kwidzyn-lntematonall Paper Agreement Shareholder structurepercentage of ownership

Type of Compan- Producer of pulp and paperLocation:The company has one plant, 100 km southeast of GdanskDate of Sale:August 10, 1992Sales (1992):ZI 2.4 billion (US$150 million)Employment at Dat of Sale:3.620Employment (May 1993):3,450 Shareholder Date of Sale 12131/92Name of Strteic investor:Intemational Paper, Inc. (U.S.) 2 Polish State Treasury 20.0 20.0Price Paid by Stric investor:US$120 millionInvesment ComminlmntUS$175 million over four years

CAsE Snnn 5 POLAD KwmzyN - ItmRAiwNAL PAm 25

ciencyof its operations and the quality of its products.Acapi- established a precedent for sector studies. Ptior to furthertal-intensive industry competing on a worldwide level, with consideration of the Kwidzyn case, the Ministry ofinsufficient capital reinvested, will typically lose its competi- Privatization recruited Hambros Bank of London in Maytive edge. 1991 to conduct a sector assessnent of the Polsh pulp and

paper industry. Hambros submitted a comprehensive sectorPreparation for Sale report identifying some 10 enterprises in the pulp and paperIn early 1990, the elimination of central plunning and the sectorthatcouldbeattractivetoforeigninvestors. Hamnbrosliberalization of the economy led to an overall reduction in felt that the remaining approximately 30 enterprises were toothe size of the market for pulp and paper. This collapse of small, had obsolete papermaling equipment, or were poorlythe domestic market, togetherwith Kwidzyn's loss of market structured, and would have to be liquidated or merged.share, forced the enterprise to halt production for several Kwidzyn was one of the priority mills identified for immedi-weeks. While the enterprise was investigating the possibility ate trade sale because of its size and its relatively new equip-of increasing Western exports, the substandard quality of ment.Kwidzyn's paper was recognized by both management and OnthebasisoftheinformationinHambros'sectorstudy,the workers' council. It became apparent that a strategic in- the Miistry of Privatization decided that Kwidzyn shouldvestor was needed to provide access to both new markets be sold to a strategic investor through a public tender. Theand additional capital for modernization. decision to privatize through a trade sale was influenced by

In the early stags of privatization, the Kwidzyn man- an informal policy of the Ministry's that any privatization inagument had considered a joint venture and in late 1989 they which a foreign investor controled a stake of at least 20 per-had approached the United Nations Industrial Development cent would be conducted through a trade sale rather than aOrganization (UNIDO) for assistance in identifyingthe major joint venture.companies in the pulp and paper industry. This action re- During the pre-privatization phase, restrictions weresulted in some informal contacts, but no formal discussions placed on Kwkdzyn's management by the Ministry in orderwith potential inestors took place until 1991, when the Min- to protect the value of the company. Management could notistry of Privatization took an active interest in the case. sell assets or assume new credit without approval from the

In the earlyfail of 1990 the management had approached Ministry (via the company's Suprvisory Board). Also dur-the newly established Ministry of Pnivatization to initiate the ing the pre-privatization stage, preparatory studies were con-process of transformation and pivatization. At the request ducted. At the sugestion of Hambros, ArthurAndersen wasof the Minist" the Kwidzyn management submitted a for- hired to conduct a financial audit and valuation. Arthurmal application for traiformation, which induded financial Andersen prepared an audited balance sheet and an unau-data and a business plan for the development of the enter- dited profit and loss statement for the first quarter of 1992,prise. In December of that year the restatement of Kwidzyn's as wel as an unaudited balance sheet as of May 31, 1992.financil statements was completed. The statements were prepared under Polish accountng laws

In January 1991 Kwidzyn was ansdormed into a joint and were tranlated -but not restated - into the format ofstock company, fully owned by the Polish State Treasury. In international accounting standards. (It should be noted thataccordance with standard procedures, the Ministry of the translation of accounts into international accounting stan-Privatization assumed jurisdiction over the company from dards would incorporate the format, but not necessarily thethe Ministry of Industry since the Privatizaion Law autho- principles, of international accounting standards.) In Julyrized the former to act on behalf of the State Treasury as 1991 ArthurAndersen completed a valuation and an appraisalowner of the transformed company. The company's share which, among other things, found an accrued interest pen-capital was set at ZI 900 billion (US$82.1 million) and its alty on unpaid debts. Kwidryn received a copy ot the ap-fixed assets were revalued in accordance with the Januay praisal, but not the valuation. The valuation was not dislosed1991 Law on the Revaluation of Assets of State Enterprises. to potential investors. ArthurAnderse's fee was paid by theOne-third of the total capital (Z1 300 billion, or US$27.4 Ministmillion) was placed in reserves and the remainderwas placed In September 1991 the Ministrys intention to privatizein equity. Kwidzyn was announced in the press, and in November

The workers' councd and the labor unions supported Hambros began contacting potential investors and distri-the measures taken to prepare the enterprise for privatization, uted an Information Merorandum to 13 pre-qualified in-and agreenents were reached with management on levels of vestors.employment and wages. Ihe first preliminary offer was submitted in early 1991

By the spring of 1991 the Polan Pila privatization had by the Austrian company Lenzing AG. Intenaional Paper

26 SEUNG S=E CowrAm To STZAUGc usTwom Vowuz Two

began its own negotiations with the Ministry ayearlater and, Timeable of Key Stepsin May 1992, Intema,eonal Paper made an alternative pro-posal. In order to strengthen its bidding position, Lenzing Late 1989formed a joint venture with another Austrian *irm, Kwidzyn management contacted UNIDO to idenfify potentialformned a joit venture with another Austrian firm, strategic investors.Frantschach AG, to create Kilo Holdings. Fall I1M

International Paper had also considered a greenfield in- Kwidzyn management submitted an application for transfor-vestment but decided instead to bid for Kwidzyn. Among mation.other reasons, International Paper felt that (1) it could not The restatement of Kwidzy19s financial statements was com-obtain access to attractive greenfield sites; (2) construction pleted.of a new plant involved greater risk and cost than acquiring January 2,1991an existing plant; and (3) it had a comparative advantage in Kwidzyn was transformed into a joint stock company.

manaingassts n a orl dgss eve. Inemaionl Pper May 1991managing assets on a world class leve. International Paper Hambros Bank of London was hired to complete a sectoralso saw Kwidzyn as an attractive investment because it op- study and to act as financial adviser to the Ministry oferated at a lower cost than Westem European mills but at Privatization.the same time had modem Western equipment with waste- July 1991

Arthur Andersen completed its appraisal and valuation oftreatment processes that could potentially meet Western en- Kwdzyn.vironmental standards. In addition, Kwidzyn fitted well into November 1991International Paper's existing distribution network. During An Information Memorandum was distributed by Hambros tothe 1980s International Paper had expanded its operations potential investors.

in Wste Euopewit th acuistio ofAuseda-Ra of Dec. 1991 -July 1992in Western Europe with the acquisition of Aussedat-Ray of Negotiations were conducted with International Paper andFrance and Zanders Feinpapiere in Germany. Intemational Kilo Holdings.Paper also felt that, as an international pulp and paper com- July 31,1992pany, it could offer needed capital for on-going operations Final bids were submitted to the Ministry of Privatization.

and apial nvetmet, nowedgeof ow estto se ur- August 10, 1992and capital investmnent, knowledge of bow best to use cur- The Ministry of Privatization announced that Intemationalrent technology, and the marketing and financial siDs needed Paper was the winner of the tender.to compete in competitive intenational markets. IntemationalPaper also considered that, with the rapidly changingmacreconomy, any investment in Poland would carry a sig-nificant level of risk.

During the negotiations the investors maintained dose local community development; and (6) the probable impactcontact with Kwidzyn and made presentations in Pblish to of the sale on privatization within the paper sector. So thatthe company's employees. Communication beteen the Min- non-price characteristics could be compared, both biddersistry of Privatization and the Kwidzyn management was fa- completed a detailed questionnaire on their specific planscilitated by the appointment of an official from the Ministry for the company and the community This was the firstto sit on the Supervisory Board of Kwidzyn. However, the privatization case in Poland in which al bidders included, asprnmary negotiations with investors were conducted by the part of their proposals, significant social commitments to theMinistry of Privatization officials and their advisers, and local community.Kwidzyn's management board. OnAugust 10, ten days after the submission of final bids,

Before presenting its final offer, lGlo requested an envi- the Ministry announced that it had selected Intemnationalronmental audit. Dames & Moore, a consulting firm, was Paper. Although inbormation on the weighting of each of thehired. Similarly, International Paper commissioned its own criteria in the decision-making process is missing, it is knownenvironmental audit. According to Kwidzyn management, that the price and investment conmmitments offered by Inter-the environmental damage from the mill is not substantial national Paper were a significant factor in the Ministy's de-since the plant uses a biological sewage process (based on cision.the use of oxygen). The plant is one of the few plants in Eu-rope, and the only plant in Poland, to use the process. Terms and Conditions of Sale

After several months of negotiations, the Ministry of International Paper paid US$120 million for 80 percent (7.2Privatization set a ten-day deadline for the submission of fi- million shares) of the total shares of Kwidzyn. The sale pricenal bids on July 31, 1992. The bids were assessed on the assumed a value of US$150 million for the entire company,basis of: (1) price; (2) investment commitment; (3) pro- as compared with a book value of roughly US$90 million.posed inputs (technology, marketing); (4) business plans; (5) International Paper made a commitment to invest a mini-

CAS SWY 5 PabUND KwImN - INnNAnroeA PAM 27

mum of US$175 million in Kwidzyn's operations. Additional Financhil Informationcornmitments ranged between US$50 million and US$500 (in thousands of zotys)million, but would be dependent on market conditions.

The sales contract included provisions for enforcement 1990 1991 1992

of the minimum investment commitment. By 1992 invest- Inwme Statementment comnmiitments had begun to play a dominant role in NetSales 1,138.826 1,646.539 2.366,380negotiationswith potential investors. On the basis of the ex- Gross Pr86 272,09) (301.676) (26299,073perience with earlier transactions (particularly with the cases Taxes (250,393) (53,617) (78,588)of Krosno and Tonsil, both privatized in 1990 via initial pub- Net Profit 21,703 (83.842) (11,281)lic offerings) in which privatization did not bring needed in- Balance Sheetvestment capital to the companies, the Polish Government CurrentAssets 405,568 651,957 861,804

developed different approaches to encourage the necessary Other Fixed Assets 60.376 693542 62.155investment commnitments for subsequent trade sales. In Total Assets 3.808,772 3.826,014 3,826.105Kwidzyn, the capital investment program was strengthened Current Bank Debt 67.221 40.540 60.000by the establishment of a 'stepped" system of penalties. The Trade Payables 1,003 350,330 245°017

total investment of each bidder was divided into a number of Long-Term Bank Debt 46,920 63,487 45.543declining "steps" or tiers. The amount due under the pen- Debt to Govermmenet 33,664 (14,332) 5.221alty clause would be based on the amount of promised capi- Total Uabilfflies 339,808 440,025 355,781

tal investment that had not yet been made. The intent was Equity Capital 3.468.964 3.385,989 3.470.324to set penalties so high that it would be in the investor's in-terest to pay the portion of committed investment rather than Note: The negative Debt to Govemrnent positon for 1991 resultedthe penalties. from prepav'ment of taxes in excess of the final amount due at the

In addition, International Paper made a commitmnent to end of the year.retain the existing labor force for a period of 18 months, tointroduce training programs, and to increase wages and thewage differentials for skilled jobs. On environmental liabil- Kwidzyn proved that all investments made for the construc-ity, the company required that the Ministry warrant that al tion of these buildings were financed by a bank loan, andneeded deanup known to the Ministry be disclosed, and that therefore had been paid for by the enterprise. All Teasurythe Ministry provide an indemnity for damage caused by subsidies were spent on social assets rather than on build-Kwidzyn to third parties prior to the sale. ings. Therefore, Kwidzyn was not required by law to make

In accordance with the Privatization Law, Kwidzyn's payments to the local authorities for the buildings.workers were entitled to purchase up to 20 percent of the The Kwidzyn case is unusual in terms of property rightsshares at half the nominal price. International Paper offered in that Kwidzyn managed to obtain clear property rights onto make loans on favorable terms to Kwidzyn employees to the facilities. This is in contrast with other cases in which thebuy shares in exchange for the right to repurchase the shares Polish state enterprise did not obtain clear title and the in-immediately, thereby increasing its total share holdings. How- vestor requested the Ministry to provide a warranty in theever, in a referendum the employees decded not to purchase share purchase agreement to the effect that the title to thethe shares in anticipation of new legislation, which was ex- real property held by the company was free and dear.pected to give employees 10 percent of shares free of chargeand allow them the right to purchase an additional 10 per- Post-Privatizationcent at 50 percent of the regular share price. (The hoped-for MAR PosmoN Following prmvatization, Kwidzyn has ex-legislation was to reflect a nationwide agreement among la- panded sales both domestically and on foreign markets. In-bor unions, enterprise management, and government. The ternational Paper placed significant emphasis on improving"Enterprse Pact," as it was known, was later derailed.) Kwidzyn's domestic distribution network. The company also

As was common practice in Poland, the management managed to develop significant new export markets through-right of the state enterprise was converted into a perpetual out Western Europe.umuqra, which is a form of lease for a term of 99 years, with Although, as of mid-1993, Kwidzyn's dominant positionthe ownership of the land remaining with the state. on the Polish market appeared safe, the company was facing

For the title to the buildings, Kwidzyn first needed to increased competition from severl other recendy privatizedobtain consent fom the local government to confirm title to state-owned enterprises in the sector, notably Kostzyn, whichthe buIldings which were built on State Treasury land. was acquired by a Swedish industry investor. A number of

28 SmENG Srmm Compmms Tro SnBmc INmsmrs, Vouim Two

smaller paper plants had also been sold. In July 1992 an 80 ding process developed between two blue chip potential in-percent stake in the Malta plant in Poznan was sold for vestars; and the sale of Kwidzyn represented the sale notUS$1.2 rnillion, while in August 1992 an 80 percent stake in only of potentially low cost high standard production assetsCiezynskie Zaklady Kartoniarskie was sold to a Polish com- but also of the majority of the Polish printing and writingpany, Synteza CMC, for US$312,000. paper market. This feature cannot be underestimated, as the

In termns of sales price and investment commitmnents re- still prevailing production mentality often relates avalue' toceived, the Kwidzyn - International Paper transaction can be potential production capacity rather than to market or salesdeemed a success. Among major reasons for this success are potential. It is also worth mentioning that the importance ofthe following. despite significant investment requirements the positive relationships among management, employees,Kwidzyn's core assets were of a good standard; a true bid- and the trade unions in this case cannot be underestimated.

CAM Snmr 5 PoLeNk Kwwi - bI1Eunoir P^Ax 29

POLAND

PORCELANA WALBRZYCH - S & K HOLDINGS

Enterprise Status before Privatization tors in Poland, only one of which (Porcelana Ksiaz) wasPorcelana Walbrzych was one of seven large state-owned privatized.porcelain producers. The enterprise's main products induded Porcelana Wlbrzych had only one factory, located indinner sets as wel as coffee and tea sets and were of average Walbrzych, in Lower Silesia. The enterprise imported 60 per-quality by European standards. cent of the ceramic day needed for production. Supplies

Porcelana Walbrzych was established in 1845 as a pri- were purchased priraarily from the United Kingdom, Spain,vate company owned by a German family. In 1945 the com- and Germany. At the time of privatization, the enterprisepany was nationalized and placed under the jurisdiction of employed 841 pecple.the Ministry of Industry. In the mid-1980s, as part of thegovernment's program to transfer the responsibility for me- Preparation for Saledium-size and smal enterprises to local govenments, author- The privatization of Porcelana Walbrzych was initiated byity for the enterprise was transferred to the Walbrzych local enterprise management and was supported by the workersgovernment (wvoiv'd), which became the founding organ of and the trade unions. According to the post-privatizationthe enterprise. management of Porcelana, the workers gave their support

Prior to 1990 Parcelana Walbrzych sold most of its prod- primarily because they expected higher wages to fo}lowucts on the domestic market. By 1992 exports had increased privatization, since the company would no longer be payingto 62 percent of sales. The enterprise's major export nar- the excess wage tax (popiwek) required of state-owned en-kets were Italy, the United States, Germany, and Sweden. terprises. The enterprise managers had a stake in privatizationPorcelana Walbrzych sold abroad mainly through Minex, a as well, as they were interested in acquiring the company.state-owned foreign trade organization. On the domestic In early 1990 the Porceanaalbrzych managment sub-market the enterprise's sales were generally handled haphaz- rmitted a formal request for transformation and privatizationardly The wholesalers in the sector were small and under- to the Plenipotentiary for Privatization, which operated un-capitalized, and the enterprise's distnbution system was un- der the Ministry of Fnance. Ihis application was handledderdeveloped. The enterprise had seven primary competi- by the Ministry of Finance until the establishment of the

Summary of Porcelana Walbrzych - S & K Holding Sharehokler stuctureAgreement perce1gr. of ownership

Type of Company: 100%Manufacturer of porcelain wareLocton: 1The company has one plant, located in Walbrzych in LowerSilesia, 20 km from the Czech borderDe of Sale:August 19,1992Sals (1992):ZI 118 billion (US$7.5 million)Employmntn at Date of Soers841 Shamholder Date of Sale 12:31/92Enployment (May 1993):860 E Polish State Treasury 30.0 30.0Name of Staeic Invstor: S & K Hoking Company 70.0 70.0S & K Holding Company (Poland) US&KHlIgCmay7.Price Paid by Suategic Investor.ZI 8.311 billion (US$527,000)Investm ComrnltentZI 12 bilron (US$761,000) to be invested within two years

CAs SruDY 6 PoLaND PORCELNA WHLmmn -S & K HoLIN 31

Ministry of Privatization in July 1990, following enactment The Ministry of Privatization had intended initially toof the Privatization Law. sel Porcelana Walbrzych through a public offering. After the

Although the initial contact between enterprise manage- appraisal, however, the enterprise was deemed inappropri-ment and the government was made in early 1990, transfor- ate for a public offering because its sales volume was rela-mation did not take place until February 1991, primarily be- tively low and it did not have sufficient name recognition.cause the newly formed Ministey of Privatization had not yet On the basis of the information provided by the consultants,decided on the documentation required to determiine the the Ministry decided to privatie Porcelana Walbrzych throughsuitability of a state enterprise for privatization. Ultimately, a public tender with a majority stake offered to a strategicthe Ministry decided that the application should include, investor.amongotheritems,financialstatementsforthepreviousthree In November 1991 the Ministry recruited NMB Con-years and a detailed business plan. sultants, who had prepared the valuation, to act as financl

On February 13, 1991 the enterprise was transformed adviser. NMB Consultants was responsible for identifyinginto a joint stock company, wholly owned by the State Trea- potential investors, preparing an information memorandum,sury. In !1ccordance with the Privatization Law of 1990, the and managing the bidding process under the direction of thetransformed enterprise came under the jurisdiction of the Ministry.Ministry of lrivatization, which drafted Articles of Associa- To prepare the company for the trade sale, a financialtion using the standard formiat for all commercial enterprises audit was conducted in early 1992 by an individual consult-but with input from company management. ant from the Economic Academy in Wroclaw. Two balance

In spring 1991, the Ministry of Privatization initiated sheetswere prepared: forFebruary 13, 1991 (the dateoftians-several preparatory studies. Korycka-Budziak, a Warsaw- formation of tie enterprise) and for December 31, 1991.based consulting firm, was hired by the Ministry, through a Porcelana Walbrzych financed the cost of this auditcompetitive tender, to conduct an appraisal designed to pro- No environmental audit was undertaken, since thevide the details needed for the Information Memorandum enterprise's operations were not considered to have a signifi-and the valuation. The scope of the work included financial, cant environmental impact. Porcelana Walbrzych was gener-market, economic, and legal analyses. The cost of the ap- ally in compliance with Polish standards on environmentalpraisal was shared by the Ministry of Privatization and pollution, although on two occasions the company had ex-Pbrcelana Walbrzych. ceeded the carbon dioxide emission standards and had had

A valuationwas completed in June 1991 by NMB Con- to pay a penalty of ZI 13 million (about US$1,400). (Everysultants, the consulting division of the Dutch bank NMB factory in the region pays a fixed annual fee to the(currently ING Bank). NMB Consultants was hired by the government's environmental agency. In addition, where finesMinistry of Privatization through a competitive tender and are required, they are generally so low that companies preferwas paid for by the Ministry direcdy. Two valuation methods to pay penalties rather than undertake expensive capital ex-were used: (1) net asset value and (2) discounted cash flow penditure programs. Independent audits of environmental(DCF). NAB Consultants established a wide valuation range damsage are conducted by goverrunent regulatory bodies.)between ZI 13 billion (US$1.2 mnllion) (book value) and ZI On February 28, 1992, announcements of the tender130 billion (US$11.9 million) (DCF). The valuations were were published in The Finacia Time and in the nationalnot released to potential irnestors. newspaper Rzeeospolta, stating the govefnmen's intention

Before proceeding further, the Ministry of Privatization to sell up to 80 percent of the shares of Porcelana*6lbrzych.wanted a legal due diligence and in mid- 1991 recruited PKO The only requirement for pre-qualification was that an inves-Bank, the largest commercial state-owned bank in Poland. tor be a private sector company. lutially, interest was ex-PKO completed the work with assistance from Porcelana pressed by several foreign investors, including Baum BrossWalbrzych's lawyer, the Warsaw Consulting Group, and Inports (United States), Ecodis (France), MDHBoniGmbHKorycka-Budziak The procedure was financed by Porcelana (Germany), S.PS. sx.L (Italy), Fabrizio (Italy), and SmithWalbrzych. EFTRAB (Sweden). However, zaone of the potential foreign

Among other issues, the legal due diligence examined investors prepared final bids. According to Porcelanapotential restitution claims, since Porcelana Walbrych had Walbrzych's management, these companies were concernedbeen expropriated from a Gennan family in 1945. The due about an apparently unstable political situation followingthediligence determined that there could be no restitution claims, change of goverrnent in May 1992, and about the reliabilitysince under the 1989 Friendship Treaty between Poland and and the quality of the company information that they hadGermany Pbland was not obliged to restitute property for- received.merly held by German citizens. It should be noted that a year had passed between the

32 SEuzNG STAim Compmus7o SmmGc INvwsous, Vom Two

date of transformation and the announcement in the press Timetable of Key Stepsof the tender. This was attributed to unnecessary delays,particularly fromJune to November 1991 (from the comple- Early 1990

tion of th valuation to the hiring of the ancial dviscr Porcelana Walbrzychs management submitted a request forion of the valuation to the hiring of the financial adviser), transformation to the Plenipotentiary for Privatization.during which time communication between the Ministry and July 1990the company at both the management and the supervisory The Privatization Law was passed and the Ministry ofboard level was poor. Privatization was established.

When bids were submitted in June 1992, the 'iral bid- February 13,1991Porcelana Walbrzych was transformed into a joint stock com-ders were all domestic companies: BRE (a state-owned bank), pany.Minex (a state-owned trading company that exported Spring 1991Porcelana's products); S & K Holding Company (set up by An appraisal was undertaken by Korycka-Budzlak.two local businessmen involved in exporting porcelain who June 1991

A valuation by NMB Consultants was completed.were members of the Silesian Stock Exchange); and the MW-1991Porcelana Walbrzych management (in a joint bid with the A legal due diligence was conducted by PKO Bank.Solidarity trade union). This joint bid was subsequentlywith- November 1991c*rawn, as th grop coldnoaffngeeneessayfian NMB consultants was hired as financial adviser to the Minis-drawn, as the group could not arrange the necessary financ- try of Privatization.ing. Thus, of the final domestic bidders, only S & K Holding February 28,1992met the pre-qualification criterion of being a private sector Announciments of the tender were published in The Finan-company. S & K Holding was viewed favorably, since the cial Times and Rzeczpospolita.June1992Ministry of Privatization anticipated that the Silesian Stock Final bids were submitted.Exchange could be a source of future capital for the com- August 19, 1992pany. However, it should be noted that the information The share purchase agreement was signed with S & K Hold-memorandum prepared by NMB Consultants was not made ing; new Articles of Association were registered.available to investors until aftertheyhad submitted their bids. ,The offers were therefore prepared based on limited infor-mation-the number of company employees, the share capi- the shares was set aside for purchase by workers on prefer-tal, and any information the investors could obtain from their ential terms. In addition, another 10 percent was retainedown research. by the Ministry on behalf of the State Treasury. Special pay-

On August 19, 1992 the share purchase agreement was ment termswere developed for the employee shares, indud-sined with S & K Holding. New articles of Association were ing a payment plan of interest-free installments over a periodregistered at this time, as well. of one year. Payments could be deducted from workers sala-

ries, if requested.Terms and Conditions of Sale Unlike most other share purchase agreements in Poland,The main issue during negotiations was the price. S & K the agreement with S & K Holding included no provisionsHolding agreed to increase the price from its original offer of for indemnification of the investors for undisdosed liabili-Zl 7 billion (US$444,000) to Zl 8.3 billion (US$527,000) for ties and did not indude any other warranties or indemnitya 70 percent stake. The final price reflected a value of Zl 12 clauses. A-cording to S & K Holding, it would have beenbillion (US$ 761,000) for 100 percent of the company. In possible to pressfor greater legalprotection, but theydid notexchange, the Ministry of Privatization agreed to reduce the do so because this would have resulted in additional delays.prohibition period on the declaration of dividends from threeyears to two years. Furthermore, S & K Holding agreed not Post-Privatizationto sell its shares to third parties and not to list the company ORGAN1ZAT,f NAL REsTRucruRING The most significant orga-on the Warsaw Stock Exchange for a two-year period. (This nizational cr,ange introduced by the new owners was the cre-clause was included to ensure a long-term commitment to ation of a X * dern sales and marketing department that hasthe company from S & K Holding.) enabled Porcelana '%lbrzych to reach a larger number of

S & K Holding made a commitment to invest Zl 12 bil- Westem customers direcdy rather than through Polish inter-lion (US$761,000) in the company. No details of the capital mediaries and also to develop new markets in France, Spain,expenditure program were stipulated in the contract. The and South Africa. The new owners also introduced com-company made a commitment to maintain the exingwork puter systems for inventory control and product costing.force for at least 18 months.

In accordance with the Privatization law, 20 percent of FNaAC.L POSMON Following privatization, S & K Holding

CASE Sninr 6 POLAND PoRceZi WAuLBvH - S & K HOLD=G 33

discovered additional liabilities that had not previously been Financil Infomd0ondisclosed (and, according to S & K Holding, that were not (In millions of z1oby)known to Ministry officials at the time of sale). In March1993 the investor found that in 1990 Porcelana Walbrzych 1989 1990 1991 1992had provided a guarantee for a ZI 250 miLion (US$26,300 in Income Statement1990). loan by a commercial bank to the local glass factory Net Sales 11.600 65,500 77.950 117,800

costs 6.500 39.000 62.900 107.150When the glass factory defaulted on the loan, the guarantee Gfss Profit 5,100 26,500 15,050 10,650

was caDed. By May 1993 outstanding principal and interest Taxes 3,500 13,800 10.950 5.850hau accumulated to ZI 850 million (US$39. !'n). In addi- Not Profi 1,600 12,700 4,100 4,800

tion, the investor discovered that more than half of the

company's ZI 4.5 billion (US$211,000) in accounts receiv-nble was uncollectible.

A significant liability remained on the company's booksfrom unresolved daims of local authorities. At the time of LABOR RELATioNS Relations among the company's new own-transformation, the state enterprise's management right was ers, its workers, and the labor unions deteriorated afterconverted into a perpetual usufuci, which is a form of lease privatization and eventually culminated in a strike. None offor a term of 99 years, with the ownership of the land re- the shares set aside for workers was purchased, even at themaining with the state. At the time of Pbrcelana Walbrzych's discounted price of 50 percent with interest-free loans fortransformation, the local governrnent had the right to claim one year. The Ministry of Privatization offered to transfer tocompensation for the company's land as well as the non-real- the workers at no charge all of the 30 percent held by theestate assets, that is, for its plant and equipment. lTe com- State Treasury. The offer was rejected by the trade unions;pany therefore incurred two debts to the voiuod, one for ZI the unions asked that 51 percent of the company's shares be14 billion (US$1.3 million) with respect to the value of the transferred to the workers at no cost.land and another for ZI 18 billion (US$1.6 million) with re- The workers expressed disappointment that wages hadspect to the value of the non-real-estate assets. Subsequent not increased after privatization as had been anticipated. Ihischanges in the Land Law removed the right of the voivod to dissatisfaction was further exacerbated by the actions of themake claims for non-real-estate assets, and thus the ZI 18 investors, who, while complying with the no-dividend provi-billion (US$1.6 million) debt was canceled. However, 20 sions of the contract, paid themselves exceptionally highpercent of the amount owed had already been paid to the monthly salaries and management fees.voivod and the company requested reimbursement of this On August 30, 1993, a two-month strike ended atmoney. The Zl 14 billion (US$1.3 million) debt for land was Porclana Wabrzych. According to the Radio Free Europeassumed by S & K Holding and remains outstanding. report, the settlement agreement did not meet the unions'

Additional liquidity problems arose from the perception demand to revoke the sale of the plant and cancel the sharethat Porcelana Wabrzych now had "wealthy owners" who purchase agreement but did award the workers a raise andcould ensure a more rapid payback of outstanding indebted- also cut monthly salaries for members of the board of direc-ness. Porcelana's banks wanted to shorten the term of exst- tors from several thousand dollars a month to just undering loans. Suppliers, believing the company to be cash rich, US$1,000 (ZI 20 million). The agreement also guaranteeddemanded shortened payment terms. As Porcelana was un- the unions the right to operate in the plant. The governmentable to pass on these shortened payment terms to its custom- also criticized S & K Holding for burdening the companyers, the company was forced to take out a ZI 9 billion with high management salaries rather than retaining earn-(US$422,000) worling capital line of credit. ings for future investment.

34 SEUG SmT COMPAWN TO STR=EGC IWMoY3s, VoLuzE TWO

II. HUNGARYOroshaza Factory - Guardian Industries

(Hunguard)Gardenia - GitcoLehel - ElectroluxZalakeramia - Hungarian Investment CompanyCsemege - Julius MeinlSzolnoki Factory - Brigl & BergmeisterDuna Hotel - Marriott

Map 2. Hungary

180 20 M.

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HUNGARYCROATIA * TRADE SALES

"m m i bo6. on* on. FED. REP. OF > o 46othnr inlormneon shown * \i NTONAL CAMAL

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HuNGARY

OROSHAZA FACTORY-GUARDIAN INDUSTRIES (HUNGUARD)

Enterprise Status before Privatization the management of Hungarian Glass Works decided to con-Oroshaiza was one of two sheet glass factories owned by vert one of its two sheet glass factories to float glass in orderHungarian Glass Works, a self-managed state enterprise op- to increase efficiency and to remain internationally competi-erating under the Ministry of Building and Builting Materi- tive. Ultimately, Hungarian Glass Works selected theals. Hungarian Glass Works had seven other factories which Oroshaza factory for conversion to float glass, since it wasproduced different types of glass. larger than the other sheet glass factory at Salg6tarjin, north-

The Oroshaza factory produced 200 tons of sheet glass east of Budapest.per day and exported 35 percent of its production to West- In order to create the new float glass factory, Hungarianem Europe. The remainder was sold in Hungary and East- Glass Works needed to involve a foreign investor becauseem Europe. The plant produced semi-finished products which the enterprise lacked both the estimated US$50 million re-it sold to other manufacturers that produced finished prod- quired for the investment and the needed expertise and tech-ucts. nology. Therefore, Hungarian Glass Works decided in 1988

By the mid-1980s technological advances in the glass to pursue a joint venture, the only method of privatizationindustry had rendered the sheet glass factory at Oroshaza available at that time.obsolete: its production method was inefficient and resulted In 1988 Hungarian Glass Works began identifying po-in lower quality products than those produced by the new tential foreign investors. The list of potential global investorsfloat glass method used elsewhere in the world. in float glass technology was small and wvas internationally

known and included Asahi Uapan), American Float GlassPreparation for Joint Venture (United States, now owned by Asahi), Guardian IndustriesIn view of the worldwide recession in the sheet glass market, (United States), and Glavelberl (a Japanese/Belgian joint

Summary of Oroshaza Factory-Guardian Industries Shareholder structure(Hunguard) Agreement percentage of ownership

Type of Company: 100%Float glass manufacturerLocation:The company is located in Oroshaza, 195 km south ofBudapestDate of Joint Venture:November 1988Saei (1992):Ft 3.5 billion (US$41.7 million)Employment at Date of Joint Venture:0 (Hunguard); 600 (former OroshAza factory) Shareholder Date of Joint Venture 1231/92Employment (May 1993):276 (Hunguard) * Guardian Industries 49.0 100.0Name of Strategic investor:Guardian Industries Corporation (U.S.) 1 Hungarian GlassWorks 51.0 0.0Price Paid by Staeic InvestonUS$15.2 million for an initial 49 percent stakeinvestrmnt Commitnmen50 percent of all net profits generated reinvested in the jointventure (until 100 percent ownership by Guardian)

CAsE STUDY 7 HUNWA: ORosHAzA FACroxR- GuAwRLN bIMusm (HUNGUMD) 37

venture), as well as Pilkington (United iGngdom). Of these Tlmebtbl of Key Stepsfive, threc were ruled out alnost immediately. According topresent company management, Pilkington and AFG wanted Mlid-1980uonly to license their technology and Glavelberl could not Transforme.tion was considered by Hungarian Glass Works.1986guarantee exports. Hungarian Glass Works began identifying potential foreign

The remaining two potential investors - Guardian and investors for a joint venture.Asahi - were evaluated on the basis of their ability to pro- Novem.bar 1986vide management skills, markets, and technology. Both The new limited liability company, Hunguard Float Glass Kft..

vi*e m g nks atwas established with Guardian Industries (49 percent) andGuardian and Asahi had previously converted factories from Hungarian Glass Works (51 percent) as co-founders.sheet glass to float glass production. After evaluating the March - April 1989offers of both potential investors, Hungarian Glass Works Competitive tenders were conducted for construction of thechose Guardian as the preferred joint venture partner. new float glass factory.June i969

Guardian had a well-established international reputation Construction of the new float glass factory began.and guaranteed the export of 45 percent of the joint venture's May 1990production to Westem markets. For Guardian, the Oroshaza The Oroshaza sheet glass factory was closed.

End 1 989factory would be a means of expanding its international op- Guardian increased its stake in Hunguard to 80 percent.erations into Central and Eastern Europe. Guardian already February 1991

had a presence in Westem Europe, with factories in Spain The float glass factory was opened.and Luxembourg. Mach 1992

Guardian acquired 100 percent of the total shares inTo further the joint venture process, Hunganan Glass Hunguard.

Works and Guardian jointly commissioned many of the stud-ies conducted in preparation for the joint venture. In the sum.mer of 1988, Guardian aad Hungarian Glass Works prepareda sector study. Kopint-Datorg, a Hungarian statistical com-pany, was consulted for information about the sector. Engi- Terms and Conditions of Joint Ventureneers from Oroshiza prepared a report on infrastructure is- The new joint venture company was capitalized at US$30sues, and Guardian's Planning Departmnent and the OroshUza million. Hungarian Glass Works received a 51 percent stakeengineers assisted in the preparation of the study. Hungar- in the joint venture in exchange for its contribution of part ofian Glass Works and Guardian also prepared various techni- the Oroshiza factory (including land, buildings, and someral studies, including an estimate of the costs required to equipment, but no liabilities or social assets), valued atconvert the plant to float glass manu . In addition, US$15.2 million. Guardian received a 49 percent stake inGuardian conducted the valuation of the assets to be con- the joint venture in exchange for US$14.8 million contribu-tributed by Hungarian Glass Works to the joint venture. An tion paid in cash.independent valuation was not required at that time (although At Guardian's request, the agreement stipulated that theit became a requirement after enactment of the Transforma- joint venture would reinvest 50 percent of the joint venture'stion Act in 1989). The preparatory studies confirmed profits. Guardian had a long-standing license agreement withGuardian'sviewthatthebest formnofinvestmentwouldbe a Pilkington (United Kingdom) which was transferred to thejoint venture. Only the facilities for sheet-glass production joint venture. This reportedly did not require any additionalwould be contnbuted to the joint venture, and these would payment to Pilldngton. However, a new 20 year icense agree-be entirely transformned for use in float glass manufacture. ment for Guardian float glass technology was induded in the

The value of the Oroshiza assets contributed to the joint joint venture agreement. Approval for the new license ar-venture was set at about US$15 million. According to the rangement was obtained from the National Bank of Hun-present company's management, this estimate was more than gary.twice the value of US$6.5 million given by Guardian. (At the When the joint venture took place, Hungarian law didtime, it was not possible to determine a 'market' value for not allow state enterprises to hold full ownership of real es-the assets.) tate. (At that timne, state enterprises exercised a manage-

In November1988a jointventure agreementwassigned ment right - which was less than a right of ownership -between Hungarian Glass Works and Guardian creating a over land on which the factory was located.) Therefore thenew limited liability company, Hunguard Float Glass Kft. joint venture obtained a lease for the land and also for theApproval for the joint venture was required from the Minis- buildings used by the factory. Later, the Land Law wastry of Building and Building Materials. (The State Pmperty changed to allow for the outright purchase of land from theAgency was not established until 1990.) municipalities. In preparation for the purchase, Hunguard

38 SEIIING Smm Comamms To Smnic INvEras, Vowum Two

hired Arthur Andersen to conduct a land valuation to deter- Rnancnal Informatlonmine a purchase price equivalent to 20 years of lease pay- (in thousands of fornt)ments. The valuation methods used were net replacementvalue of fixed assets and market comparison. The valuationtook about two months to prepare. Income Statement

Net Sales 78,343 205.376 1.878,586 3.514.121Post-Privatizationi costs 79,579 373,085 3,827,591 4.847.770PHsicAL sT zatioa Net Prot (1.236) (167.709) (1.949,005) (1.333,649)PHYSICAL RESTCrURINurG After signiing the joint venture agree-ment, Guardian dosed the factory and replaced virtually all Salance Sheetof the machinery and equipment. Competitive tende. for ,Plant & Equipment na. n.a. 6,338,539 6,031,392

ofthe machinery and equipment. Comprtitive tendlersfor Other FixedAssets na. na 189,648 182,467construction of the float glass plant were conducted from Totia Fixed Assets 1,648,958 5,541,860 6,528,187 6.213,859March to April 1989 and work began in June 1989. Produc-tion at the old sheet glass factory ceased in May 1990 and a C 1 4 7 2float glass production began in February 1991. The new fac-tory was equipped with mainly new imported machinery. The Note: In 1992 Inter-company loans enabled Hunguard to repay sometotal cost of the factory was US$ 125 miRion. of its bank loans, thereby reducing bank credits.

ORGNIZATnONAL REsThucTuRING During the 10 months be- 3.6 billion (US$57.6 million) from domestic banks (Budapesttween the termination of sheet glass production and the be- Bank and OKHB) as well as US$42 million fromginning of float glass manufacture, the 600 employees en- DeutscheBank. In 1992 Guardian provided Hunguard withgaged in sheet glass production were transferred back to the an inter-company loan at relatively low interest rates to allowportion of the Oroshaza factory stil owned by Hungarian Hunguard to repay some of its outstanding debt, indudingGlass Works. Only 10 to 12 engineers were employed to help the loan from DeutscheBank. In addition, to strengthen itsin the construction of the new facilities. Once construction working capital and to repay part of the local currency debt,of the float glass facility was completed, a new staff of 276 Hunguard initiated a Ft 15 billion (US$17.9 milion) com-employees was hired. About 60 to 70 percent of this staff mercial paper program, of which Ft 750 milion (US$8.9were employees from the sheet glass production line. The mfllion) was issued. The notes, rated Al, were backed byother employees were either hired locally or transferred from Guardian's guarantee and issued only in Hungary. The issueother Hungarian Glass Works factories. was underwritten by Credit Suisse First Boston and was the

In the first year of operations, Guardian personnel su- fifth forint-denominated commercial paper issue in Hungary.pervised all major aspects of the company's operations. By In December 1992, after having increased its stake inMay 1991, there was no longer a need for foreigners in the Hunguard to 100 percent in March of that year, Guardianproduction and engineering departments. By the end of 1992 invested another US$25 million in the company.the company had installed a new accounting system in line Hunguard management noted that Hungarian govern-with that used throughout the Guardian network of compa- ment regulations on transfers of foreign exchange limited thenies. company's flexibility in arranging financing on the interna-

tional capital markets. For example, the company could notSHARE STRucmRE At the end of 1989, Guardian bought an generally borrow on a revolving basis but was restricted toadditional 31 percent stake from Hungarian Glass Works for term debt. In addition, Hunguard was not permitted to main-US$10 million. This increased Guardian's stake from 49 to tain foreign currency in cash. The company was required to80 percent and decreased that of Hungarian Glass Works to convert all foreign currency revenues into forint, and then20 percent. convert it bck to foreign currency when paying foreign sup-

In March 1992 Guardian increased its stake to gain 100 pliers. Management felt that the foreign currency controlspercent ownership of Hunguard. By this time, the State Prop- increased costs and thereby reduced the company's competi-erty Agency had been established and had taken over the 20 tiveness.percent stake of Hunguard. With the support of HungarianGlass Works, Guardian bought the remaining 20 percent from MAmT POSmON In mid-1993, Hunguard was producingthe State Property Agency. 450 tons of glass per day Twenty percent of Hunguard's pro-

duction was sufficient to satisfy the domestic market, andFINCING To finance the construction of the float glass pro- therefore the company was obid to concentrate on exports.duction facility, Hunguard had borrowed approximately Ft Seventy percent of Hunguard's production went toWestern

CsiESTUY 7 HUNGARY: OosHkzA FAcroav - GuandLuN lnusrns (Huw&ouAm) 39

markets, indudin Germany,Greece, tIly,andAustria. Most gary as of mid-1993 and competed only with internationalof the remaining 10 percent of production was exported pri- firms. The glass producers in Germany, Belgium, formermarilytoPoland and Romania. InWestemEurope thecom- Czechoslovakia, Ukraine, and Russia were Hunguard's ma-pany was selling its products through Guardian's centralized jor competitors. Hunguard's ability to manufacture highEuropean sales network The major markets for Hunguard's quality float glass of a thickness between 2 and 10 mm madeglass as of mid-1993 were residential and commercial con- its products highly competitive on the intemational market.struction, the automotive indust, the funiture industry, and Twenty percent of Hunguard's production was 2 to 3 mmspecialty glass products. glass, used mainly by the automotive industry as an interme-

Hunguardwasthe only float glassmanufacturerin Hun- diate product.

40 SNmC Su CmAmNs O Smmc INwro, Vaute Two

HUNGARfY

GARDENIA- GITCO

Enterprise Status before Privatization with trmming and with ful patterns, all of which were inGardinia was the dominant textile manufacturer in Hungary. great demand in both domestic and international markets.Founded in 1912 as the Hungarian Lace Manufacturing Share Prior to privatization, Gard6nia was a self-managed state-Company, Garddnia maintained a strong position in the mar- owned enterprise with the Ministry of Industry and Trade asket by adapting its product lines and technology to changing its founding organ.market demands. The range of products expanded from the At the time of privatization, Gard6nia controlled 75 per-odginal cotton lace and bobbin net curtains to include em- cent of the domestic narket. The enterprise distributed itsbroideries and net and woven fabrics. At the time of productsthrough50GardEniaretailoutletsaswellasthruaghprivatization in 1990, the enterprise's main products were wholesalerssuchasBETEX,andtheSkiladeparnmentstorewarp-knitted fabrics, which accounted for approximately 90 chain and also exported to over 30 countries. The exportspercent of output, and emnbroidered fabrics,which accounted were distributed primarily through export trading companiesfor the remaining 10 percent Embroidered fabrics included operating on commission. Gardenia also had some directhome texdles, curtamins, garment accessories, and embroidered contacts with buyers such as wholesalers in the United Statesbedclothes. and mail order companies in Gernany, France, and Fsnland.

Beginning in 1978, the enterprise undertook a signifi- Gardenia ilnports its key raw materials from Germany,cantmodernitionproWaminordertokeeppacewithchang- the Far East, and Poland.ing mnarket demands. This plan involved adding new ma-chinesy and product lines as well as discontinuing obsolete Preparation for Saleproducts. Six new jacquard machines were purchased and P1UOR TO AUGUST 1990 The decision to privatize was madeput into operation in 1980. These machines allowed for the by Gardenia's enterprise counci in December 1989, foElow-production of fabric suitable for furniture and for curtains ing enactment of the Tlinsfonmation Act. Management saw

Summnry of Gard6nla-Gltco Agreemnnt

Shareholder structure (1) Shareholder structure (2)pewoentage of ownership percentage of ownership

100% 100%

Sharehkdder February 1991 Shareholder End-1 993

o Municipality 1.1 0 OTP1 0.2* Employees 1A U Employees 0.3

K + K Activities 2.8 [I Dunaholding2 0.6* Municipality 1.1

*GlTCO 947M Garddnia 17.5M Kontrollbankm 803

O2 Erst Osterreichische Sparkasse (36.9)E K + K AcUitles (43.4)

1 HwivMIwba'.L2 Hunarian holdng company.3 Krkalbsi ho*s this stske foru AutBan ka and ft Duth hodin MpanWn.

CM SrD8 Uir. GArhIaA - Grmo 41

privatization as a means of attracting fresh capitaL Gard6ida Summary of Gard6nltGltco Agreemnt, continuedwas initially interested in forming a joint venture, preferablywith a passive financial investor rather than an active strate- Type of Company:gic investor, because the enterprise needed capital for ex- Textile manufacturerpansion but the enterprise management felt that it did not Locaion:The company is located in Gytr, 120 km West of Budapestneed new technology as such, and also felt that the enter- Data of Sale:prise already had good access to sills and markets. The State February 19, 1991Property Agency became involved in the privatization pro- Sales (1993):cess only after its establishment in April 1990. t 1.6 billion (US$t5.9 million)

Three potential investors contacted the Gardenia man- 600agement: (1) Bohm (Austria), which distributes home tex- Employment (May1993):tiles through chains of brand namne stores; (2) Neusser (Ger- 600many), Gardenia's German distribution agent; and (3) GITCO (Austna)

GITCO (Austria) (a financial investor owned by Italtrade Price Paid by Inveor:GmbH of Vienna, which also owns a majority stake in the Ft 950 million (US$ 12.6 million) (including Ft 350 million, orretailers Fonix Rt., based in Debrecen in eastem Hungary US$4.7 million, in capital increase)and shares in the insolvent Gyori Textie Wbrks and Szaport Inv-osbnt Coemmnt:Rt.). Although GITCO was a financial investor, it was famil-iar with the textile industry and recognized Gard6nia's po-tential for growth. The other two potential investors werestrategic investors involved in various aspects of the texile privatization process in August 1990, when Gard&ida hadindustry. submitted its transformation plan. After using the full 90-

Gard&nia conducted formal negotiations with two of the day period permitted under the 1989 Transformation Act tothree potential investors. Negotiations were first held inJanu- consider this transformation plan, the Agency decided, inary 1990 with one of the two strategic investors from the November 1990, to conduct a formal bidding process rathertextile sector. These discussions focused on a possible joint than following Gardenia's recommendation to sel the enter-venture in which Gardenia would contribute only a portion prise directly to GITCO.of its assets. The potential investor recruited a firm to pre. The State Property Agency sent a request for proposalspare a valuation of the business, but before these negotia- to those potential investors that had previously contactedtions were concluded the Gardenia management decided Gardenia, telling them that the bids must be for the pur-against splitting the enterprise as the investor had requested, chase of Gardenia as a single entity and must include a com-and in March 1990 Gardenia cut off negoiaions. Gardenia mitment to maintain Gard6nia's existing product lines. Thereturned to its initial preference for a financial investor and major factors in evaluating the bids would be price and thebegan formal negotiations with GITCO stake to be acquired. As was common practice, the Agency

The Gardenia management hired Coopers & Lybrand released the net asset valuation (but not the discounted cashto perform an audit and a valuation. This work took six flow valuation) conducted by Coopers & Lybrand to the po-months. Two valuation methods were used: asset valuation tential bidders. The company's book value at transformtonand discounted cash flow. On the basis of the asset valua- was Ft 600 million (US$7.9 million).tion, Coopers & Lybrand estimated the value at Ft 950 mil- GITCO won the tender because it presented the mostlion (US$15.6 mlion). Thisvalue was used as the total share favorable offer, including the highest purchase price. Thecapital on the opening balance sheet. State Property Agency finalized its negotiations with GITCO,

After several months of negotiations, Gardenia and starting from the preliminary agreements that it had reachedGITCO reached a prediminary agreement, whickh was incor- with the Gardenia management On February 19, 1991,porated into a transformation plan submitted by the Gardenia Gardenia was transformed into a joint stock company.management to the State Property Agency in August 1990.The transformation plan included Gard6nia's financial state- Terms and Conditions of Salements for the first six months of 1990 and the results of the The company was sold fora total ofFt 950 mfllion (US$12.6Coopers & Lybrand valuation. mil}ion): Ft 600 million (US$7.9 million) as a cash payment

for the shares, and Ft 350 million (US$4.7 million) for anFRoM AUGUST 1990 The State Property Agency which had immediate increase in share capital. As part of the sale,been established in April 1990, became involved in the Gardnia's shares were to be distributed as follows: (1)94.7

42 SmEC STz CorAN.ues To SD&Umc INVzuzts, VaLuz Two

percent was sold to GITCO; (2) 2.8 percent was sold to K+K Timetable of Key StepsActivities, a Dutch holding company, (3) 1.4 percent was setaside for employees, and (4) 1.1 percent was given to the December 1989

Gard6nia7s enterprise council decided to initiate privatization.Gyor municipality (as required by law) as shares equal to the Januwy 1990value of the land in that municipal area. The sale of shares to First negotiations were held with a potential joint venture part-GITCO was finalized at the end of February 1991. In accor- ner.dance with the Transformation Act, the State Propert; Agency March 1990transferred 20 percent of the purchase price back to the corm- and Degan negotiations with drewTCOm the first negctiationspany, which was placed in capital reserves. August 1990

Gardenia submitted a transformation plan to the State Prop-Post-Privatization erty Agency, naming GITCO as financial investor.MARKET PosmoN After privatization, Gardenia incrased November 1990both the quantityandtequatyofitsproduction. Produ The State Property Agency decided to conduct a limited ten-both the quantity and the quality of itS production. Produc- der.tion grew 30 percent in the first year after privatization. By End 19901992, exports to Westem countries had doubled compared The State Property Agency signed a share purchase agree-with 1990 levels. Exports as a whole comprised 70 percent ment with GITCO. the winner of the tender.February 19,1991of sales in 1992. As of rnid-1993, exports represented 72 per- Gard6nia was registered as a joint stock company.cent of sales. The company's main export markets were Ger- End February 1991many, which represented 32 percent of Gardenia's export The sale of shares to GITCO was finalized.sales, followed by France at 16 percent and the United King-dom at 7 percent. In mid-1993 the company was trying toexpand into the Eastern European market.

Gardenia was still the domninant supplier on the domes-tic market as of mid- 1993, although its market share droppedfrom 75 percent to 60 percent following privatization, pri- Since privatization, the company has continued to ex-marily because of the recession in the domestic market and pand both its product range and ;- production technology.the liberalization of irnported textile products, particularly In 1993 Gardenia opened its firs;. ail store, the Denia Tex-those in the higher quality segment of its market. Gardenia's tile House in Gy6r, and also o' ed a new showroom ontwo principal domestic competitors (state-owned companies plant premises. By mid-I 994 the companywas selling its prod-with obsolete machinery) were in serious financial difficulty ucts throughout Hungary. In addition, during 1993, the com-as of mid-1993. pany developed a quality assurance system to conform with

Gardenia remained profitabk afterprivatization. In 1991 ISO 9001 standards. A quality assurance audit by TWYGardenia had an income of Ft 1.523 billion (US$20.1 riil- Rheiland Europa confirmed that Gardenia's new systern con-lion), with pre-tax profits of Ft 195 million (US$2.6 million) formed with ISO 9001 standards.and after-tax profits of Ft 161.7 million (US$2.1 million). Gardtniaplannedto introduce its shares on the BudapestGardenia paid out a 10 percent dividend in 1991. As of mid- Stock Exchange in the second half of 1992. By June 19931993 Gardenia had maintained employment levels since this had not been done and the shares were being tradedprivatization and was able to increase production by 30 per- over the counter in Vienna at a price of 20 percent premiumcent without adding manpower. to their nominal face value.

C&s Srunw 8 HUNGAW: GARDExnI- Gnrco 43

HuNGARl

LEHEL - ELECTROLUX

Enterprise Status before Privatization substantially after the collapse of the COMECON marketLehel was foundet in 1952 to produce gun barrels and car- in 1989. However, Lehel was not materially affected sincetridges. In the early 1960s the enterprise began nanufactur- such sales represented less than 5 percent of total revenues.ing household refrierators and it subsequently expanded itsproduction along sinilar lines. By the 1980s Lehel was Preparation for SaleHungary's only manufacturcr of refrigerators for commer- PRIOR TO SEP1EMBER 1990 Recognizing the need for addi-cial and residential use and was the country's largest manu- tional capital to upgrade their production facilities, Lehel'sfacturer of chest freezers, radiators, and cooling units. The management in 1987 began contacting possible investors.enterprise was headquartered in JLszbereny and operated Negotiations for a possible joint venture between Lehel andthree production plants thrughcut Hungmry In the mid- E!ectrlux of Sweden were opened, but an agreement could1980s LAehel became a self-managed enterprise, govened by not be reached and the negotiations broke down. In Marchan enterprise council. 1990 Electrolux re-opened negotiations with the Lehel man-

In 1991 Lehel produced 300,000 refrigerators for do- agement, but this time the discussions focused on the sale ofmestic sale and 395,000 for export to Western European lOO percent of the shares of Lehel rather than on a jointven-markets. The enterprise controlled 80 percent of the refrig- ture. Serious negotiations for the acquisition of Lehel byerator market in Hungary, the balance was supplied by im- Electrolux began in April 1990, following a meeting of bothports. Lehel also contributed a smal share of the market for companies in Vienna. A letter of intent was signed byfreezers; however, many Hungarians puhased freezers in Electrolux in May 1990.Austria since Lehel did not produce sufficient quantites for Electrolwc's interest in Lehed lay in the fact that Lehelthe domestic market. About 65 percent of Lehel's sales were was the largest producer of household appliances in Hun-domestic, with another 35 percent to Westem Europe. gary and was noted also for its relatively developed technol-

Lehel was the highest quality producer of household ogy and high level of technical sills. In addition, given theappliances in Eastem Europe. Eastern Bloc sales dropped saturated state of Western European markets, Lehel would

Summary of Lehol-Electolux Agreement Shareholder structurepercentage of owneshp

Type of Company:Manufacturer of durable household appliances (refrigerators,freezers, radiators)Locaton:Headquartered in Jfszber6ny. the comnpany has 3 produc-tion plants and a marketng division in BudapestDoa of Sale:April 1. 1991Saos (1993):R 13.5 billion (US$134.1 million)Employment at Daft of Sal:4,800 Shaeholder Date of Sale 12131192Enployment (May 1993):3.300 * eciux 100D 100.0Name of Stralegc InvestorElectrolux (Sweden)Primc Paid by Sraelc Invesor:See Terms and Conditions of SaleInvstment CommltentNone

CAs5 SNDY 9 HuA. T-- Emma=ox 45

provide Electro!ux with a means of tapping the underdevel- announced to the public in late September 1990. When theoped Central and Eastern European markets. State Property Agency took over the privatization of Lehel,

At that time, negotiations for the sale of Lehel were led, an agreement had not yet been reached between Lehel andon the Lehel side, by the enterprise management. However, Electrolux. Credit Suisse First Boston was recruited by thenot all members of the management team were in agreement Agency to act as financial adviser and open negotiations toon the privatization process. Some favored a rapid sale to a several potential investors, including those that had previ-strategic investor, while others preferred to wait until the vari- ously approached the Lchel management and others that wereous studies, particularly the valuations, were completed. identifi-d by Credit Suisse First Boston. In addition toAnother major issue was the distribution of shares to Lchel Electrolux of Sweden, the investors included Whirlpool andmanagers and employees. The Lehel management initially Maytag of the United States and Daewoo of Korea. Accord-intended to retain at least 37 percent of the shares for them- ing to the Lehel managerment, Electrolux was the only po-selves and the workers, even though Electrolux made it clear tential investor to express a serious and sustained interest.from the beginning that it was interested only in 100 percent Credit Suisse First Boston was asked by the State Prop-ownership and although the workers themselves were not erty Agency to prepare a second business valuation for Lehel.actively pursuing this issue. The Lehel management disagreed with Credit Suisse First

While negotiations were taking place, several prepara- Boston's valuation, particularly, according to the Lehel man-tory studies were conducted. In February 1990 Lehel's en- agement, with the broad range of values presented by theterprise council decided that a business valuation should be adviser, wliich had the Arthur 'Nbung value as the mid-pointundertaken to enable the enterprise to negotiate more effec- of the range. The broader range stermned from Credit Suissetively with foreign investors. Lehe recruited Arthur Young First Boston's treatment of wide fluctuations in Lehel's eam-to conduct this valuation. irgs. In 1989 Lehe's profits had fallen to Ft 310 million (US$5

A land valuation was conducted fromApril toJune 1991 million)) as a result of the introduction of the value-addedby the U.S. firm American Appraisal to determine any tax, for which the enterprise was not able to adjust pricesamounts that would be due to the local government for as- immediately. In 1990 Lehel adjusted its prices accordinlysigning to the privatized company the ownership of the land and profits increased to Ft 848 million (US$13.8 million).used by the company. American Appraisal first estimated Credit Suisse First Boston claimed that the 1990 eamningsthe land value at Ft 390 million (US$6.3 million), but this were unusually high whereas the Lehel management claimedwas adjusted down to Ft 300 million (US$4.9 million). that the 1990 profit level was sustainable, as was later evi-

In June 1990 Lehel and Electrolux jointly hired Price denced by the 1991 profits of Ft 600 million (US$7.9 mil-Waterhouse to conduct a preirminary audit of Lehel's finan- lion).cial statements and to restate the enterprise's balance sheet An environmental audit, carried out by Frensenious, aaccording to international accounting standards. The result West German environmental consulting firm, determined thato. the audit for the period ending June 1990 was to reduce Lehel's refrigerator production had contaminated approi-the enterprise's share capital from approximately Ft 3.8 bil- mately 50,000 cubic meters of soil with chlorofluorocarbonslion to Ft 2.48 billion (US$61.8 milion to US$40.4 million), (CFCs), through both off-site and on-site waste dumps.as write-offs were taken for overdue receivables and obso- Frensenious estimated the probable cleanup cost at DM 70lete inventory. Lehel and Electrolux shared the cost of the million (US$41.4 million) and the mamrnum cleanup cost ataudit equally. DM 100 million (US$59.2 million). This audit was financed

As a state enterprise, Lehel had a wide array of social by Lehel.assets (including a zoo) that were likely to be regarded nega- The State PopertyAgency agreed to Electrolux's require-tively by a foreign investor. Lehel tried to reduce this poten- ment of full ownership (100 percent) of LeheL The lack oftial burden but was able only to sell off some employee hous- strong worker support for employee shares was evidenced bying to workers. the ease with which the State Property Agency dropped the

issue once it took over negotiations.FROM SEFrEmBER 1990 The State Property Agency was cre- On March 31, 1991 Lehel was transformed into a lim-ated in September 1990, but in late spring 1990 the future ited liabiity company, Lehel Kft., and on April 1, 1991 theofficials were preparing the First Privatization Program, a companywas sold to Electrolux. InJune Electrolux took overprogram of 20 pilot privatizations which the State Property the management of Lehel.Agency initiated shordy after its creation and which initially At the time of negotiations, the State Property Agencywas to include Lehel. However, the Lehel management only was in its first few months of operation and had developedlearned of the State Property Agency's decision when it was few policies and procedures. The Lehel management later

46 Sruu Sun CammwEs TO SlAEaC INVbIws, VOUME Two

voiced the opinion that the AgFncy had been difficult to work Tlmsabh of Key Stepswith because it was new to its operations, and that the Agencyhad frequently changed its requirements. 1987

Negotiations were begun between Lehel and Electrolux for a.erms and Conditions of Sale joint venture.

Tenns and Conditions of Sale February 190The initial sale price of Ft 2.4 billion (US$31.7 million) was Lehel recruited Arthur Young to prepare a business valua-based on Lehel's book value, following a restatement of the tion.conmpany's financial statements, using international account- March 1990

Negotiations between Lehel and Electrolux for the sale of Leheling standards. Approximately 40 percent of the sale price were re-opened.was paid in cash, with the balance due in installments. The May 1990final price, however, was adjusted for: (1) treatment of costs Electrolux signed a letter of intent for the purchase of Lehel.related to environmental remediation; and (2) foreign ex- April-June 190

.American Appraisal conducted a land valuation.change provisions that protected Electrolux against the de- June 1990valuation of the forint against the ECU for the next several Lehel and Electrolux hired Price Waterhouse to conduct ayears. preliminary audit.

As a state enterprise, Lehcl had used bzoth on-site and September 27, 1990As a state enterprise, Lehel hadusedbothon-siteand The State Property Agency took over the negotiations withoff-site waste dumps. Initially the agreement was that the Electrolux from the Lehel management.State Property Agency would retain the off-site dumps and Fall 1990wouldbedirectlyresponsiblefortheirdeanup. Subsequently, Credit Suisse First Boston was recruited by the Agency to acthowever, it was recognized that the Agency lacked the neces- Mah 31 aisary funds. Electrolux agreed to finance the cleanup and the Lehel was transformed into a limited liability company.State Property Agency agreed to reduce the purchase price April 1,1 991with retroactive adjustments. According to the Lehel man- Lehel was sold to Electrolux.agement, the maximum amount estimated for the environ- June 1991mental cleanup, DM 100 million (US$59.2 million), was setaside as reserves in Lehel's transformation balance sheet. TheState Property Agency also agreed to indemnify Electrolux ifthe final costs were higher.

tering the market aggressively (as is evidenced byWhiripool'sPost-Privatization acquisition of a stake in Tatramat, the Slovak washing ma-MAEr PosinoN In its first full year after privatization, Lehel chine producer) and could provide additional competitionRefrigerator Factory Ltd. (Lehel Hut6gepgyar Kft.) sold for Lehel.670,000 refrigerators, compared with 695,000 in the previ-ous year. The company generated profits for 1992 of Ft 700 ORGANZATIONAL RESTRUCrURING Electrolux decided to shedmillion (US$8.3 million: 11.6 percent over 1991), account- non-core and non-strategic business such as the productioning for 10 percent of the total earnings of Electrolux. This of industrial heat exchanges and large compressor units. Therise in profits was attributable largely to inproved productiv- company had plans to invest Ft 1 billion (US$9.9 million) inity (output per employee/day rose by 70 percent). 1993 -94 to rationalize Lehel's product mix, introduce freon-

Lehel's domestic market share in refrigerators remained free refrigeratorproduction, and improve quality control sys-stable (at 80 percent) as of May 1993, but its share of the tems. As of mid-1993, Electrolux had introduced Westernfreezer market had risen from less than 20 percent to almost cost and financial accounting standards and had created over40 percent. Overall domestic sales, however, were off by 12 200 cost centers within the company.percent because of continued recession. Sales to the former Electrolux changed Lehel's organizational design dra-Soviet Union dropped by 11 percent. Lehel responded by matically from a traditional pyranid structure to a matrix,aggressively developing Western European markets. Lehel despite general resistance among the work force.formed a joint venture with a German distribution company Over an 18-month period following privatization, Lehelthrough which Lehel was to channel all Western European reduced the work force from 4,800 to 3,300. Many layoffssales. resulted from the termination of the production of industrial

As of May 1993, Siemens-Boschwas the company's prin- heat exchanges and large compressor units. In July 1992cipal competitor in Hungary. Elsewhere in Central Europe Electrolux commissioned a localmanagement consulting firm,other Western consumer durable companies have been en- Budapest Investment Rt., to redesign the company's struc-

CAE Smy 9 HuNGAnr: lEr - ELEcriouix 47

ture in order to improve the ratio of productive to non-pro- Finaneial lnfornanductive employees from 1:l to 2:1. As a result of this study, (in bilions od fodnt)Lehel decided to cut 470 further jobs by the end of 1993, 19o 1991 1992 1993 1994offering the laid-off workers severance pay that was two to (borcase)three times higher than the level mandated by law. Wageswere increased by 40 percent in 1991 and by 13 to 14 per- Not Sales 10.5 11.9 11.5 13.5 16.7Domestic 7.0 7.5 5.9 7.9 9.3cent in 1992. Export 3.4 44 5.6 5.6 7.4

The company had spun off some of its social assets bymnid-1993. It auctioned off vacation homes, and it transferred (Percent ot Net Sales)its kindergarten to the local church. Its zoo was transferred Gross Profitto the local government, although Lehel agrecd to continue (before financial

to suprtezoiaci oraoheorer. expenses) n.a. 92 10.8 11.3 12.8to sutpport the zoo financially for another four years. Proht BeloreIn November1993 Lehel established two separate com- Taxes 8.0 4.8 6.0 6.6 10.9

panies, Electrolux CR Ltd. and Radiator Ltd. Both were es- Net Profit 5.0 4.0 3.9 5.3 8.7

tablished to take advantage of tax regulations in Hungary. Asof October 1, 1994, the company will create a third companyto act as a Central European production and export centerfor absorption refrigerators (noiseless air-cooling units for billion (US$9.9 million) of new capital over the next two years.hotel rooms and for vehides such as buses). During 1993 Environmental issueswerestill, asof mid-1993, the larg-Electrolux invested a total of Ft 1 billion (US$9.9 million), est problem for Lehel. It was estimated at the time of saleof which half was invested in the household refrigerator divi- that the cleanup of the pollution caused by Lehel's refrigera-sion. From July 1994 on, Lehel will produce only environ- tor factory would cost Ft 2.4 billion. The process, which in-ment-safe refrigerators. vokves removing dangeous waste as well as cleaning 50,000

cubic meters of soil, would take frve years to complete. InF'INANcIA RESTmUCTNG Electrolux has written down ap- addition, the tax treatment of the cleanup costs was unclear,proximately Ft 125 million (US$1.2 million) in inventory In and as of June 1993 was the subject of a lawsuit between1993 Electrolux made a commitment of an additional Ft 1 Lehel and the Hungarian Tax Authority.

48 SmE1C Smu Co Omau r Smnuc wvrons, Vou TNo

HUNGARY

ZALAKERAmIA - HUNGARLAN INVESTMENT COMPANY

Enterprise Status before Privatization With headquarters in Zalaegerszeg, about 200 km south-Zalakerimia was the largest producer of ceramic tiles in west of Budapest, ZalakerAmia was the only manufacturer ofHungary and had a good reputation internationally for its ceramic tiles in westem Hungary. The enterprise had fourhigh qLality product. The enterprise had the capacity to domestic competitors. Following liberalization of themanufacture 2.4 million square meters of tiles per year. Wal economy in 1989, Zalakerariia faced increasing competitiontiles and floor tiles were the dominant product, accounting from foreign imports. Italy accounted for about 50 vercentfor about 80 percent of production in 1990. The enterprise of the imports into the Hungarian market; the remainderhad four facilities - three plants manufacturing iles and a carne from Germany, Russia, and Turkey Despite the abun-limestone quarry. An affiliated company produced tomb- dance of imports, Zalakeramia maintained a strong positionstones. The limestone was milled and used in Zalakerimia's in the market because it was able to sell its products for up totile production, with the excess sold to road construction 30 percent less than the prices asked by its foreign competi-companies, agricultural companies, and other domestic tile tors. In order to maintain its competitiveness, in the lateproducers. According to management, all of the affiliates 1980s Zalakeramia adopted a policy of continuous equip-except the tombstone factory consistently generated a high ment moderrization.profit margin. In the mid-1980s, ZalakerOnia had begun to concen-

Zalakerimia was founded in 1950 by the Zala County trate on exports in an effort to offset the decreasing domes-Council. Following several reorganizations, Zalakerania tic demand resulting from the recession in the Hungarianmerged in 1969 with a stove tile factory which had been es- building industry. Between 1988 and 1990, Zalakeraimia'stablished in 1889 and nationalized in 1951. Production was exports increased from an average of 14 percent per year.thus expanded to include bricks, ceramic tiles, concrete prod- Zalakerimia's main export markets were Germany, Austria,ucts, and tombstones. In 1985 Zalakerinia became a self- and Greece (comprising over 80 percent of exports). Themanaged enterprise governed by an enterprse council. enterprse also exported to the Middle East and Korea. The

Summary of Zalakeriinla-Hungarlan Investment Company Shareholder structureAgreement percentage of ownership

Type of Company:Producer of ceramic tiles and building materialsLocaeton: tHeadquartered in Zalaegerszeg, about 220 km southwest ofBudapest, the company has four production facilities_Date of Sale:May 31, 1991Sales (1992):Ft 1.3 billion (US$15.1 million)Employment at Date of Sale:l840 Shareholder Date of Sale 12131/92Employment (May 1993):840 Q Individual Investors 0.00 25.02Nam of Invedors: U Hungarian investment Co. 0.00 42.12IMI Securities (U.K.), Hungarian Investment Company Ltd. 2 Loca Governments 0.00 4.72(U.K.) P v State Property Agency 47.76 20.04Price Paid by Investors:US$10 million cash contribution to joint venture * IMI Securities S224 8.10Investment CommlmntNone

CASE SumD 10 HUINGA: ZALm=Am - HUNGARIN INLSTMENr CoMrMY 49

expansion of its exports contributed to Zalakerania's ability NEGOTIATIONS CONDUCTED BY THE STATE PROPERTYto maintain profitability and thus improve its competitive- AGENCY Negotiations with IMI werc managed by the Stateness on the domestic market, where the enterprise's market Property Agency in consultation with the Zalakerainia man-share increased to 20 to 25 percent from its previous level of agement. The Agency initially tried to establish a tender for10 to 15 percent. Approximately 15 percent of domestic sales Zalakeramia but canceled its plans when IMI threatened towas channeled through Zalakerainia's chain of retail stores. withdrawits proposal. According to IMI, there were no other

interested investors at the tirne.Preparation for Sale IMI selected International Valuation Services ofNEGOTIATIONS CONDUCTED BY THE COMPANY In 1989 Budapest from a list of firtms pre-qualified by the State Pcop-Zalakeramia recognized that it could not continue to mod- erty Agency. Work began in mid-March 1991 and the valua-emize its production facilities without new capital. As there tion report was submitted to the State Property Agency onwere no suitable domestic sources of capital, the manage- April 29, 1991.ment decided to consider a foreign investor. Intemational Valuation Services conducted both a fixed

Since investors had approached the enterprise as early asset valuation and a discounted cash flow valuation as ofas 1988, the Zalakerimia management did not need to ac- December 31, 1990. The former estimated the value oftively seek foreign investors. The first fornal negotiations Zalakerairnia's land, buildings, machinery, and limestone andwith potential investors were held with the Italian firm Olfa clay quarries at Ft 535.5 million (US$8.7 million). This wasand the Uudted States firm InterKiln, in 1989. significandy lower than Zalakeraimia's own original estimate

Neither Olfa nor InterKiln made proposals that were of Ft 722.9 million (US$11.8 million). The discounted cashacceptable to the Zalakeraimia management. According to flow valuation, which used an average discount rate of 20the Zalakeramia management, InterKiln wanted the newly percent, generated a value of Ft 676 million (US$11 mil-privatized company to take on a US$50 million debt in order lion). Both valuations assumed that title was clear and free.to make the necessaiy capital investments. Zalakeramia's The valuation report was accepted by the State Propertymanagement also objected to InterKiln's proposal to replace Agency and was approved by the relevant local governmentZalakeraimia's existing product line and to use InterKiln's councils. Only one local council initially disagreed with thetechnology, valuation of the land and claimed that the value was low in

In fall 1990, the Zalakeraimia management began to ne- relation to the real estate value in its district (which includedgotiate with a third potential investor, IM Securities, a Lon- . the resort area of Lake Balaton).don-based investment fund manager that focused on East- International Valuation Services was also commissionederm and Central Europe. IMI had approached Zalakeramia by IMI to conduct a survey of environmental issues. Accord-after its research staff had identified the enterprise as a good ing to the Zalakerania management, this audit was conductedpotential investment following a series of 1988 visits to vari- as a compulsory component of BII due diligence and notous Hungarian enterprises. because there were pressing environmental problems.

In November 1990, after initial negotiations with Zalakeramia's production did have a significant impact onZalakeramia, IMI hired the Budapest office of Ernst &)bung air pollution, but this pollution has been mitigated with mod-to perform a detailed financial audit of the enterprise. In ernization of the plants.February 1991 the London office of Ernst and Young com- Zalakeraimia's major environmental problems concernedpleted a financial due diligence report which provided a de- the stove tile division, then located in Zalaegerszeg. As a re-tailed explanation of Zalakeramia's Hungarian balance sheet. sult of air pollution created by this division, Zalakerania had

In addition, Ernst & Young was hired to restate beenfined approximatelyFt 1 million (US$16,300). In 1988-Zalakerunia's balance sheet in accordance with international 89, the company had spent Ft 16 million (US$256,000) onaccounting standards. However, this was not completed un- upgrading its sewage treatment facilities and Ft 40 milliontil July 1991, after the initial transaction had closed. (US$640,000) on the installation of air filter equipment, and

Zalakeramia prepared for privatization by sdling off its had also purchased several residential buildings near this planttombstone factory, which was its least profitable division, in to keep them unoccupied, and to avoid pollution complaints1991. In addition, although no formal restructuring program from nearby residents.was implemented, the company reduced its work force by IMI was aware of the environmental issues and the in-137 between 1988 and 1991. In spring 1991 Zalakerinia vestments required to address the problems, and these costssubmitted a transformation plan to the State PropertyAgency were taken into account when the purchase price was beingproposing a joint venture with IMI Securities. negotiated. In fact, when negotiating the sales-purchase con-

50 SELu STA-I CoMNAmS 1r STRmIWc INvRSORS, VowLum Two

tract, IMI insisted that funds be set "side to cover the costs from the State Property Agency to local governments; (3)of closing down or moving the stove tile division. sale of a 23 percent stake by the State Property Agency to

NI; (4) sale of a 42.12 percent stake by IMI to HungarianTerms and Conditions of Sale Investment Company Linited; (5) flotation of 25.02 percentThe joint venture agreement was signed on May 8, 1991. of the shares from 1MI through the Budapest and ViennaZalakeraimia was transformed into a joint stock company, Stock Exchanges; (6) issuance of new shares (to be offeredZalakerania Rt., on May31, 1991 under the Transformation to workers); and (7) divestiture of the StateProperty Agency'sAct of 1989, with the State Properry Agency and IMI Securi- remaining stake.ties as co-founders. The new company was capitalized at Ft After the joint venture was created, there were several1.416 billion (US$18.7 million) (share capital and reserves) transfers of shares. As per the joint venture agreement, thewith II contributing US$10 million in cash (52.24 percent State Property Agency transferred 4.72 percent of its sharesof total capital and reserves) and the State Property Agency in Zalakerimia to the local govemments. The Agency alsocontributingthe assets and liabilitiesoZalakerenia, atavalue sold 23 percent of the shares to IMD (thus increasing Imrsof Ft 676 million (US$8.9 million) (representing 47.76 per- stake in the joint venture o 75.24 percent).cent of total capital). Ten percent of the capital was classified As a fund manager, IMI had pre-sold some of theas reserves and the remainder as share capital. Tle shares Zalakeramia shares to one of its funds, the Hungarian In-were issued at a nominal value of Ft 1,000 (US$13) each. vestment Company Limited, a US$100 million closed-endImnmediately after the founding of the company, the State mutual fund established by IM1 for the purpose of investingProperty Agency contributed to the joint venture its share of in Hungarian securities (such as the Zalakerlmia shares).Zalakerimia's net profits during the first five months of the Thus inJuly 1991 IM lsold 42.12 percent of the Zalakeriniacompany's operations. This increased the State Ptoperty shares to the Hungarian Investment Company Limited,Agency's share to 48.20 percent and reduced that of IMI to thereby making the mutual fund the largest sinle investor in51.80 percenL ZaIalerdmia.

Aportion of MD's cash contributionwas used to pay off On August 1, 1991, IMI floated appraximately half ofpart of Zalakerimia's outstanding debt and to finance mod- its initial stake (25.02 percent of the total shares) on theernization. In the joint venture agreement, IMI agreed to Budapest and Vienna Stock Exchanges, thereby reducing itsmaintain exsting employTment levels. stake to 8.10 percent The decision to undertake the public

off cring was made at the General Meeting on May 29,1991.Post-PRivatization The company applied for a liting on the Budapest StockSHARE STRucnnUE Under the initial share structure, as has Exchange and on the Vienna Stock Exchange (Sonstigerbeen noted, the State Property Agency had a 48.2 percent Wertpapierhandel). The shares closed at Ft 1,518 (US$20)stake, whereas IM Securities held 51.8 percent. In accor- per share on the first day of trading (August 1,1991). Thedance with the joint venture agreement, the initial share struc- issues were fully underwritten by Kulturbank in Hungary andture of Zalakerimial Rt was modified as follows (as detailed Vmdobona in Austria. Kulturvest was the sole market makerinthetable andtext below): (1) increaseintheshareheld by forthe shares in Hungaryuntilthe first meeting of the Gen-State Property Agency reflecting the Agency's contribution eral Assembly in April 1993, after which time Creditanstaltof its share of Zalakeramia's net profits during the first five also began actingas abrokertoZalalcerimia.Vmdobonawasmonths of operation; (2) transfer of 4.72 percent of the shares the sole market maker in Zalakergmia shares in Austria.

Table 10.1: Rrst Fve Changes In the Shareholder Structhre of Zalakeminma, RL(percert

FoundatIon 1 2 3 4 5

* IMI Securites 52.24 51.80 52.24 75.24 33.12 8.10* State Property Agency 47.76 48.20 43.04 20.04 20.04 20.04* Local Govemments 0.00 0.00 4.72 4.72 4.72 4.72* Hungarian Investment Co. 0.00 0.00 0.00 0.00 42.12 42.12* Indiidual lrestors 0.00 0.00 0.00 0.00 0.00 25.02Total 100.00 100.00 100.00 100.00 100.00 100.00

CARs Snr 10 HUNGWcu Z4ALUM - HUrNGUN INzSNmr COuMPAW 51

In January 1993, in accordance with the joint venture T -- t.hwl of Key Stpvagrcement, IMI Securties and the State Property Agencyincreased the share capital with a capital injection of Ft 74 1Trmillion (US$735,000) (financed by the reserve component TnterKpin.of IMI's initial cash contribution) . In all, 70,694 mili'on sres Fall IMjwere isued and given to employees free of charge. Byjune ZalakerAmia began negotiations with IMI Securities.1994 Zalakeramia had bought back 14,287 million shares Novwnbw 1090

IMI Securities hired Ernst & Young (Budapest) to conduct afrom employees who had left the company. financial audit.

The State Property Agency placed some of its FPbeuay 1991Zalakeramia shares in the compensation coupon program. A financial due diligence report was completed by Ernst &This created problems for IMI and Hungarian Investment Young (London)

Compny Lniied. NU caimd tht th paticiatio of MId-March 1991Company Limited. IMI claimed that the participation of lnternational Valuation Services began a valuation ofZalakerinia shares in the compensation coupon program ZalakerAntia.created an "overhang' of additional shares. This had the Ap"l 29, 1991effect of depressing the market price for Zalakeraimia shares lnternational Valuation Services submitted its valuaton to theand thus reducing the market value of the Hungarian Ivest- State Property Agency.Mayll, 199ment Company Limited fund. In addition, IMI referred to The joint venture agreement for Zalakerania was signed.the difficulties of having the government as a joint venture May 31.1991parer. IMIwanted to finance needed capitalinproveents Zalakerarmia was registered as a joint stock company withpth nin . w,t,tPthe State Property Agency and IMI Securities as co-founders.through an issuance of new shares. However, the Satse Property Agency was reluctant to either allow a dilution of itsshareholding in Zalakernimia or provide cash to fund its shareof the capital improvements. In the end, IMI put pressureon the State Property Agency to divest all of its holdings ofZalakerimia shares.

PHnSICAL &D OGNzAoNAL RESThUCrURNG The capitalMAocEr PosmoN In 1992 Zalakeria increased its turn- influx from IMI Securities saowed Zalakerimia to continueoverby Ft 110 million (US$1.3 milion) (to Ft 1.266 billion, its modemization progra.rL In May 1994 Zalaeraimia in-or US$15.1 million). Pre-tax profits were Ft 217 million staUledanewproductionlineofceaamictilesatitsT6fej plant,(US$2.6 million) compared with Ft 102 mfllion (US$1.3 thus expanding the capaity of the T6fej site to 3 milion ce-million) in 1991. In 1992 exports increased to 24 percent of ramic tiles per year. The company intends to move its stovesales. By mid-1993, Zalakerimia's competitive position on tile production facility (a chronic poUuter) out of town bythe domestic market had improved to a 30 percent maket August 1994. Modernization alowed Zalakerfimia's produc-share, as its four domestic competitors fiaced serious finan- tion processes and products to comply with the standards ofcial difficuties, the European Union.

52 SEZCG SuAn CowaNns To SAmac IEsroU VouJm Two

HUNGARY

CSEMEGE - JUuUS MENL

Enterprise Status before Privatization Preparation for SoleCsemege was the owner and manager of the largest Hungar- PIOR To FEBRumyr 1991 Although the government had be-ian chain of supermarkets and delicatessens. (It was also the gun to plan for the privatization of the entire retail networklargest retail chain in Hungary.) The chain, which had been in the late 1980s, it did not play an active role in theconsistently profitable during the 1980s, was considered one privatization of Csemege. Prior to legislation introduced inof Hungary's better enterprises. In the late 1980s turnover August 1992, the Hungarian State Property Agency seldomrose dramatically, increasing by 18.6 percent in 1989 over initiated privatizations in the case of sef-managed enterprises.1988 and by 4.7 percent in 1990. Its 1990 turnover (Ft 15.4 Momentum for privatization within the enterprise in-billion, or US$251 million) was well ahead of that of its com- creased in 1989, with the arrival of a new general manager.petitors, induding KOZERT Vllalat. Csemege's new management realized that, although the en-

Csemege was established in 1952 as a state-owned en- terprise was currently profitable, capital investment and aterprise, with the Ministy of Trade as its founding organL strategic investor were needed to upgrade the enterprise'sOver the years the shops increased in both number and size, services.as small delicatessens were replaced by large supermarkets. Csemege was able to prepare the enterprise forIn the mid- 1980s the chain becarme a self-managed state en- privatization itself involving the State Property Agency onlyterprise, which brought greater control to enterprise man- to obtain its approval for the final deal. This approval cameagement and decreased the role of the founding organ. through the Agency's Company-Initiated Privatization Pro-

Before World War Il, about half of the Csemege stores gram, under which the transaction was conducted.had belonged to Julius Mcinl, an Austrian concern with a In mid-1990 Csemege hired the Financial Research In-history of business in Hungary. These stores were later na- stitute (also known by its Hungarian name, Pzdzgykusatdtionalized. Julius Meinl renewed its ties with the enterprise Int6zet) to act as financial adviser and assist the enterprisein 1989 by forming a joint venture with two Csemege shops. with its privatization. The Financia Research Institute, whichLegally prohibited from having a majority stake at the timc, was paid by Csemege directly (thugh a combination of fixedJulius Meinl had a ninority stake in this venture. fee and success fees), carried out a net asset valuation in

Summary of Csemege-Jullus Melni Agreement Shareholker structurepercentage of owners? p

Type of Company:Food and beverage retailerLocation:Headquartered in Budapest, the company has two nroduc-tion plants and over 160 retail outlets throughout thie countryDat of Sale:July 1.1991Sales (1991):Ft 15 billion (US$198.4 million)Employmnt at Date of Sale:3,873Employment (May 1993): Shmholder Date of Saie 12091 12131/92 121/933,460Name of Strategic Investor: a Comper=tion Coupon Program 0.00 0.00 0.00 6.58Julius Memnl (Austria) * Employees 0.00 9.98 10.32 9.99Price Paid by Straic lrnvestor Municipality 0.00 8.58 8.58 708See Terms and Conditions of Sale a Juliu M8 7Investment Commtment: JuliusMeinl 27.00 51.01 56.04 69.19Ft 3 billion (US$39.7 million) over five years * Stt Propety Agency 73.00 30.43 25.05 7.16

CASE SIUi 11 HUNGA: CSMGE -JuSMEINL 53

March 1991 and a discounted cash flow valuation in Apil Timeable of Key Stepe1991. The discounted cash flow valuation was higher thanthe net asset value, but as was standard practice, the asset 1969

Julius Meinl formed joint ventures with two Csemege shops.valuation was used in establishng the openig balance shet. MId 1990The valuation study was paid for by Csemege. The Financial The Financial Research Institute was hired by Csemege toResearch Institute also completed a financial audit of the act as financial adviser in the privatization.company. Jmnuary 1991

cpA ny. . . The announcement of intention to privatize Csemege wasA preliminary annoUnCement of the plan to privatize published in local newspapers.

Csemege was published in two local newspapers in January February 1991

1991. Following this public announcement, a number of Csemege presented a privatization proposal to the State Prop-potential investors approached the enterprise and began to erty Agency: the State Property Agency requested that a

conduct duedgence. During a period of about12wees, competitive tender be conducted to identify the strategic in-conduct due diligence. During a peniod of about 12 weeks, vestor for Csemege.Julius Meinl employees visited various Csemege stores to March 1991

assess the value of each store. Julius Meinl was interested in The Financial Research Institute distributed an Informationmaking a long-term investment and focused its assessment Memorandum and bidding documents to potential investors.on the investment that would be required to develop the AS 30 o 1991

Submission of bids was due.stores. A legal audit to identify title issues involved in trans- May 6,1991ferring the stores was carried out by Csemege's legal depart- Julius Meinl was informed of its selection as the winning bid-ment and was completed in March 1991. No significant res- der.titution issues were encountered. Ea.y June 1991The joint venture wi Julius Meml was signed.

July 1. 1991FRom FERuAuw 1991 In February 1991 Csemege approached Csemege was transformed into a joint stock company.the State Property Agency with a proposal to privatize the Csemege Rt., with the State Property Agency and Julius Meinlenterprise. The Csemege management proposed the sale of as co-founders.a 30 percent stake to a strategic investor.

Tle State Property Agency requested that a dosed ten-der process be used and approved the tender documents No weighting of the criteria was provided. The Financialprepared for Csemege by the Financial Research Institute. Research Institute established the evaluation criteria whichHowever, the Agency decided to seek the sale of a 51 per- were approved by both the State Property Agency and thecent stake to a strategic investor with the remaining shares to Csemege managemenL The bidding documents also indudedbe held by the Agency and Csemege employees. The sale a draft contract (in German).would be carried out in two stages. First the investor would Three investors submitted final bids: Julius Mcinl,contribute Ft 900 million (US$11.9 milion) (specified inthe Unigrow, and Pankd & Hoffman. Unigrow's offer was dis-bidding documents) into a joint venture between the State qualified because it did not include al of the informationProperty Agency and the investor; then the investor could requested in the bidding documents. Of the two remainingpurchase shares from the Agency in order to increase the bids, that of Julius Meinl was ranked higher. Julius Meinl'sinvestor's stake in the joint venture. bid was the most detailed and extensive and induded an in-

The Fnancial Research Institute identified and contacted vestment comniitment necessary to make the Csemege chainover 30 potential foreign investors from the companies that 'self-standing" (ie., independent ofJulius Mcinl in Austria).had already approached Csemege, as well as those known to Julius Meinl's purchase bid had also stipulated its commit-the Institute. An Information Memorandum and bidding ment to stock the Csemege stores (where possible) with lo-documents were distributed in late March 1991 with a cos- caDy produced products. In addition, Julius Mcinl had theing date of April 30, 1991 for submission of bids. Interested greatest familiarity with Csemege, because of 'ieir 1989 jointinvestors included Julius Meini of Austria, Unigrow of Bel- venture. The Financial Research istitute selected Juliusgium. Pankel & Hoffman of Austria, Spaar of Germany, and Meini as the winner, and the Institute and Csenege recom-Unilever of the United Kingdom and the Netherlands. mended Julius Meinl to the State Property Agency. The

The bidders were informed that their proposals would Agency gave its approval and informed Julius Meinl of itsbe judged according to purchase price, development plan for decision on May 6, 1991. Julius Meinl was not told why itsthe enterprise, payment terns, dividend policy, allocation plan bid was selected.of 10 percent of the shares for employees, and know-how Negotiations began about mid-May 1991 and lasted(ie., technology or transfer of financial management systems). three-and-a-half weeks. Responsibility for negotiating the

54 SEuImG STmE CorAN ETo STmRac IpvsrOis, VoLuE Two

deal with Julius Meinl was delegated to the Financial Re- stock company but has no members on the managementsearch Institute by the State Property Agency. The pace of board.negotiations was acceerated by the Meinl family (the own-ers of Julius Meinl), who had a strong interest in concluding Terms and Conditions of Salethe deal successfully. This interest potentially enhanced the As can be seen in the table below, the shareholder structurebargaining position of the State Property Agency. of the Csemege-Julius Meinl joint venture changed several

As the price had been determined through the tender times after the initial formation of the company.process, the negotiations revolved around legal issues such Immediately after the transfonnation, Julius Mcinl con-as investment commitments, the articles of association, and vetted its minority ownership stake of 27 percent into a r,ia-the shareholder's agreement. The negotiations were con- jority stake of 51 percent by purchasing a 24 percent stakeducted in German and the joint venture agreement was signed from the State Property Agency at a premium of 13 5 percentin German in earlyJune 1991. of book value. It should be noted that, at the time of founda-

Csemege was transformed into a joint stock company, tion,Julius Meinl's cash contribution for its initial 27 percentCsemege Rt., on July 1, 1991, with the State PropertyAgency was used to partially capitalize the joint venture, whereas theand Julius Meinl as co-founders of Csemege Rt. In all, 124 payment for the additional 24 percent stake (Ft 1.135 bil-shops were involved in the transaction. At the time of foun- lion, or US$1 5 million) was made in cash directly to the Statedation, the company's share capital was Ft 3.346 billion Property Agency. In the sales contract, the Agency gave as-(US$442 million). Of the total share capital, 73 percent surmnces that it would not predude Julius Meinl from pur-was held by the State Property Agency in accordance with chasing additional shares.the value of Csemege's assets which were contributed to the From the State Property Agency's remaining 49 percentjoint venture. Julius Meinl held 27 percent in accordance with stake, shares were distnbuted to the municipalties and em-its cash contnbution to the joint venture., ployces. Municipalities were entitled to receive shares for an

Of the Ft 1.215 billion (US$16.1 million) cash contri- amount equal to the value, in the u.terprise's balance sheet,butionofJuliusMeinl,Ft900milhion(US$11.9 million)went of the land that they were transferring to the new privateinto paid-in capital and Ft 315 million (US$42 million) was owners; therefore, municipalities had a strong interest in theplaced in reserve capital to be used for funding some of the valuation of the enterprises. There was no obligation for theemployee shares. municipalities to approve the asset valuation but they had to

After Julius Meinl had won the tender, the provisional be informed of the value. The 34 municipalities in which thebalance sheet that had been prepared for the tender (and Csemege stores were located received a total of 8.6 percentthat had been based on the asset valuation) was amended in of the shares from the stake held by the State PropertyAgency.preparation for transformation. The opening balance sheet The sales contract also stated that employees would bereflected changes in the accounts of the company as well as offered 10 percent of the shares. Shares worth Ft 371 milionJulius Meinl's equity injection and capital reserve. The com- (US$4.9 million) were issued to employees, for which 90pany statutes were prpared by Julius Meinl and Csemege percent was financed from Csemege's capital reserves andwith minimal input from the State Property Agency. The 10 percent was paid by employees. In accordance with theAgency has one person on the supervisory board of the joint Company Law, trading of employee shares was restricted.

Table 11.1: Changes In Shareholder Structure of Csemege-Jullus Uelni(percent)

DaE Of InmedatulyTransformation AtrTranaformaton 12a13191 12131192 1213193

* Julius Meinl 27.0 51.0 51.0 56.0 692* State Prperty Agency 73.0 49.0 30.4 25.1 7.1* Municipaltes 0.0 0.0 8.6 8.6 7.1* Employees 0.0 0.0 10.0 10.3 10.0* Compensaton Coupons 0.0 0.0 0.0 0.0 6.6Total 100.0 100.0 100.0 100.0 100.0

CAM STUDY 11 HUNcAXT: Csmmz -JULUS MEnU. 55

The sales contract warranted that the Hungarian state Financial hnformadonwas the owner of the property being sold to Julius Mcinl and (In millons of fodint)that no claims from third parties currently existed. Most ofthe 124 shops involved in the transaction werc wholly owned.The shops that were leased operated under standard Hun- Net Sales 15,458 15.175 16,474 17,973garian lease laws (i.e., open lease in perpetuity) and this was Gross Profit

(after financing costs) 450 395 624 719not considered a problem by Julius Mein]. Net Prolit 305 245 404 642

Post-PrivatizationMAMET PosmoN After privatization, the company increasedboth its market share and the number of retail outlets. Bythe end of 1993, the market share had increased outside of and the Directorate of the State Property Agency approvedBudapest. The company's market share remained stable in this policy.Budapest at about 12 percent, but was expected to rise asthe effects of a major renovation effort were felt. Csemege- ORGANIzAnoNAL RESTRUCrURING The Csemege managementJulius Meinl bought new shops and by the end of 1993 had was retained after privatization. Although approximately 300increased the number of shops from 124 to 150. people were laid off in conjunction with the closing of the

Sales rose dramatically in 1991 to Ft 15 billion (US$198.4 Intertourist shops, one of Csemege's subsidiaries, overallmillion) (a real increase of about 15 percent over 1990). employment had increased to 3,482 by the end of 1993, asCsemege-Julius Mienl eamed a profit in 1992, even though Csemege-Julius Mienl opened up new stores.the parent company, Julius Meinl (Austria), did not. InBudapest, KOZERT VaHlalat remained the company's larg- SHAmE STRucruRE In June 1992 the State Property Agencyest competitor, although foreign companies (Tengelmann and decided to set aside 5 percent of its shares for the compensa-Spaar of Germany and the Belgian company Louis Delhaise) tion coupon program (which was part of the government'shad entered the market. Tengelmann has an interest in Skaia program to provide compensation to those whose propertyTade, which in mid-1993 had some 75 stores across the coun- had been seized illegally by the former administration.) Ontiy. However, within these stores, sales of food products ac- August20,1992, Ft 185million (US$2.2million) of Csemege-counted for only 25 percent of sales. Julius Meinl equity became available for compensation cou-

As of mid-1993, the ownership structureof theHungar- pon holders subject to the following conditions: (1) thereian consumer retailing sectorwas changing and foreign inter- would be Ft 10,000 (US$119) registered preference shares;est in the sector remained high. In 1992 several hundred (2) there would be a minimum 10 percent dividend; and (3)retail shops were privatized, primarily via sales to individu- there would be no voting rights.als. The government's goal is to have 60 percent of all con- In November 1992 the Agency and Julius Meinl agreedsumer goods retailing outlets privately owned by 1995, with that an additional Ft 200 million (US$2.4 million) would bethe rest of the outlets remaining as cooperatives. By the end made available as employee shares but with voting rights.of 1993, approximately 40 percent of all retail outlets were In May 1993 Csemege was listed on the Budapest Stockprivate, 20 percent were state owned, and 35 percent were Exchange to facilitate the transfer of shares set aside forcom-cooperatives. pensation coupons and to pave the way for the future trad-

Csemege-Julius Meinl has plans for fiurther expansion ing of shares. There was some debate within the State Prop-in Hungary. Despite the establishment of Meinl shops in erty Agency as to whether the compensation coupon sharesBerlin, the Czech Republic, and Poland, Hungary remains should be sold directly on the Budapest Stock Exchange. AtJulius Meinl's major area of expansion. Julius Meinl has also the timethe shares were offered onthe StockExchange, theylooked at other investment opportunities and in 1992, through were oversubscribed by more than 10 percent. According toCsemege, acquired a 56 percent stake in Vas County retail- the press, a substantial portion of the Csemege shares solders Nyugat Kereskedelmi Rt., but has been deterred from initially on the Stock Exchange were bought byJulius Meinl,acquiring more retail food stores. The Ministry of lTade asked which had previously purchased compensation coupons onthat no more retail store chains be sold to foreign investors the secondary market at a significant discount.

56 SrICG STArz COM,Ar To SmGIc INEs=Rs, VoLumE Two

HUNGARY

SZOLNOK FACTORY- BRIGL & BERGMEISTER

Enterprise Status before Privatization factories produced a total of a million tons of pulp, card-The Szolnoki Paper Factory was one of the primary manu- board, and paper products.facturers of paper in Hungary, providing 70 percent of the The decentralization of economic decision-making thatcoated paper and 50 percent of the printing paper to the followed the Hungarian reforms of the 1980s gave the man-Hungarian market. Szolnoki's full range of products included agement of Hungarian Paper Works much greater autonomy.packaging paper, from supermarket bags to labels, as well as As a self-managed enterprise, Hungarian Paper Works, withcopy and computer paper. Exports comprised less than 20 the agreement of the Ministry of Internal Trade, was allowedpercent of sales. Szolnoki relied on imports for many of its to establish inJuly 1990 separate enterprises for the five sepa-supplies since most of the necessary raw materials were not rate units considered the most attractive to potential inves-available in Hungary. tors. Szolnoki became one of these enterprises, with its as-

Szolnoki had five papermaking machines, only two of sets and liabilities separated from Hungarian Paper Works.which were relatively modern and in good condition, the lat- However, when the separate enterprises were established,est one having been purchased in 1984. Szolnoki's opera- Hungarian Paper Works divided up its liabilities. In 1984tions were characterized by excess capacity and inefficiency. Hungarian Paperhad borrowed Ft 5.6 bilion (then US$109.4Had the operations been efficient, a third of the production million) largely to finance the purchase of new machinery forof Szolnoki's modem machines could have satisfied the do- the Szolnoki plant. The creditor was a state bank now knownmestic market, but the machines were frequently re-set to as the State Innovation Institute, and the loan was to be re-produce different paper products, and the resulting delays paid over a ten-year period from 1985 to 1994. At the timereduced total production. that the separate units of Hungarian Paper Works were es-

Szolnoki was one of 13 factories operatig under the tablished, Ft 4 billion (US$65.1 million) was assigned to themonopoly sector enterprise, Hungarian Paper Works, estab- Szolnoki factory, and by December 1991, Ft 2.5 billionlished in 1963 by the Ministry of Light Industry. These 1V (US$33.1 million) remained outstanding. Szolnoki manage-

Summary of Szolnokl Factory-Brigi & Bergmelster Shareholder structureAgreement percentage of ownersHp

Type of Company: 10x_%Paper manufacturerLocation:The company is located in Szolnok, 100 km southeast ofBudapestDate of Sale:December 30, 1991Sales (1993):Ft 353 million (US$3.5 million)Employment at Date of Sale:690 Shareholder Date of sale 12/31/92Employment (May 1993): Shareho_der _ Date_of_sale_______4 [ Local Municipalites 0.0 2.8Name of Strategic InvestorHBrigl & Bergmeister (Austria). a subsidiary of the Prinzhorn * Hungarian PaporGroup (Austria) Works Company 49.0 46.2Price Paid by Strategic Investor: * Erigi & Bergmelster 51.0 51.0DM 17.5 million (US$10.2 million) as part of joint ventureInvestment CommitmentDM 17.5 million (US$10.2 million) (conditional commitment)

CASE Su1m 12 HUNGAtY: SZOLNOx FACrORY - BEGL & BERGMESTU 57

ment considered it "unfair' that it was respousible for the tracted byArthurAndersen in tne fall of 1990, and a secondliability because the plant had parilly contributed substan- one by Credit Suisse First Boston. On the basis of thesetial cash flowto the sectorenterprise. Hungpan Paper Works valuations, the company's opening book value for tranfor-disagreed, daiming that in fact the other factories had fi- mation purposes was established at Ft 4 billion (US$65.1nanced Szolnoki. million).

Szolnoki's major domestic competitors were some of the Hungarian Paper Works established three main objec-other units within Hungarian PaperWorks, most notably the tives for the sale of Szolnoki: (1) a strategic investor was pre-Dunaujviros and Balatonftzfo paper plants. After the liber- ferred over a financial investor since Hungarian PaperWorksalization of trade in 1990, the Hungarian market was pen- believed that only a strategic investor would maintainetrated increasingly by imports from Finland, Sweden, and Szolnold's operations; (2) only a majority stake in Szolnoliother Western European countries. would be sold; and (3) Szolnoki would be sold as a whole.

Ealy in 1991, Credit Suisse distributed letters of invita-Preparation for Sale tion to 18 of the largest players in the paper industry SomeBy 1990 the worldwide recession in the paper industry, to- investors were later disqualified for various reasons, mostgether with low cost imports, particularly from Finnish firms, commonly because of their desire to maintain a passive rolehad dramatically altered Szolnoki's financial situation. The in the management of Szolnoki. Only 6 investors were in-company had incurred an operating loss of Ft 0.5 billion volved in the final negotiations (one Frenclh, one Swedish,(US$6.6 million) in 1991 and was going firther into debt. one Finnish, and three Austrian).The management of Hungarian Paper Works therefore de- Negotiations were conducted with the six potential in-cided to privatize Szolnold and to find a foreign partner that vestors in early June 1991. Credit Suisse coordinated thecould provide the capital and the access to new markets meetings, in which Hungarian Paper Works and Szolnokineeded to bring the factory through the recession. representatives participated. By the end of June 1991 only

Hungarian Paper Works recruitecdArthur Andersen in two final bidders remained, Frantschach AG and Brig! &preparation for the sale, paying for approximately 70 percent Bergmeister AG, both of Austria.of the cost with Szolnoki paying the remainer. An environ- The other potential investors were ruled out for variousmental audit was conducted by a Finnish firm hired by Hun- reasons. The French company was seeking a larger scale in-garin Paper Works; this audit identified a minor problem vestment than the Szolnoki factory could offeL The Finnishinvolving control of hazardous waste release (i.e., coolant) company opted for purchasing new paperaking equipmentand another relating to toxic fluids in the electrical system. rather than purchasing a foreign factory, whie the remaining

In summer 1990, Hungarian PaperWorks conducted a Austrian company was unwling to make lage investmentsector assessment to determine the best way to privatize the commitments.sector and ensure competitiveness. In addition, in Septem- The final evaluation of investors was based on the pur-ber 1990 Credit Suisse First Boston was hired by Hungaian chase price offered, the capital expendiue commitment, andPaper Works to act as its financial adviser and to find inves- the commitment to transfer technology and know-how. Hun-tors for both Szolnoki and another of their subsidiaries, garian Paper Works wanted to negotiate a five-year invest-IIbatdan, which produced tissue paper. Under the direction ment plan with the eventual investor including the reinvest-of HLngarian Paper Works, Credit Suisse First Boston was mnent of a large portion of dividends.responsible for: (1) preparing an information memorandum; The prices offered by Brigl & Bergmeister and(2) identifying potential foreign investors; (3) evaluating po- Frantschach were in the same range (Brigl & Bergmeister'stential investors; (4) faciitating the transfer of company in- offer was slightly higher), but their reasons for wanting toformation to bidders; (5) managing negotiations among Hun- acquire Szolnoki differed Both wanted tobuyonlySzolnd&i'sgarian Paper Works, Szolnoki, and the bidders; and (6) ad- best assets - the two modern machines, but not the threevisingon the selection of the winning bidder. Credit Suisse's older machines. Frantschach was interested, however, infee consisted of a minimum retainer and a success fee, with consideringa oneyeartrialperiod ofmanagng the three olderthe latter based on the cash proceeds received by Hungrian machinres. Brigl & Bergmster wanted the Szolnoki factoryPaper Works from the sale of factories. to complement its existing operations in Austia and Slovenia,

Late in 1990, Arthur Andersen conducted a financial and planned to use this -triangle- of production facilities toaudit in which it made an assessment that profits from the position itself for the emnerging markets in the CIS and theSzolnoki factory had been accumuating in Hungrian Paper rest of Central and Easten Europe. Szolnoli was especiallyWorks for years. Two valuations of the Szolnoki factory were important to Brige & Bergmeister for accessing these mar-prepared - one of them by American AppraisaL subcon- kets because Hungary had been the only country producing

5 SIUZN STun Coumis m STAUC larVrs, VomZ Two

coated paper in the old COMECON systenL Unlike Brig Ti meib of Key St& Bergneister, which was trying to cxpand its productionand mnarkets, Frantschach was a diversified paper company Fall 1919already and felt that Szolnoki's surplus capacity would b,e Hungarian PaperWorks decided to breakits operations downuseful to its operations. Frantschach was also capable of pro- into five enterprises, including Szoinoki.viding markets for 80 percent of Szolnoki's production of Five enterprises were established under Hungarian Papercoated paper. Works.

In the course of negotiations, both investors insisted on September 1990rescheduling the debt that Szolnoki had assumed from Hun- Credit Suisse First Boston was hired by Hungarian PaperWorks to act as financial adviser for two subsidiaries includ-garian Paper Works in 1989. By late 1991 the amount out- ing Szolnoki.standing was Ft 25 billion (US$33.1 million), induding un- Fall 1990paid interest and principal. To facilitate the privatization, Preparatory studies were conducted for Szolnoki by Hung ar-the Ministry of Industry submitted a debt restructuring plan ian Paper Works.to Parliament which was approved in December 1991. The Credit Suisse First Boston sent letters of invitation to 18 po-plan stipulated that Szolnoki would pay only interest in 1992 tential investors.and 1993, and would repay the principal in quarterly install- Late June 19g1ments between 1994 andJuly 1, 1998. (Technicalty, Szolnoki The potential inveslors were narrowed down to two final bid-would repay Hungarian Paper Works which would in turn September 1991repay the original creditor, the State Innovation Institute.) Brigi & Bergmeisterwas selected by Hungarian PaperWorksBefore privatization, Szolnoki had reduced its work force as a joint venture partner for Szolnoki.

from 800 to 690. ~~~~~~December 30,1991from 800 to 690. Szolnoki was transformed into a joint stock company withDuringthe evaluationof offers, Hungarian PaperWorks Hungarian Paper Works and Brigl & Bergmeister as co-

favoredBrigl&BergmeisterwhiletheSzolnokimanagement founders; Szolnoki was split into two companies: Szolnok Rt.favored Frantschach. Arguments in favor of Frantschach and Szolnohd Kft.were: the company's promise to rnaintain the current prod- November 20,1992

Szolnok Rt. ceased production, laying off virtually all staff.uct mix, its access to its own sources of pulp and paper, its May i1g9interest in maintaining the operation of existing production Szolnoki Kft. ceased operations.facilities, and the fact that the company would provide world- July 1993

wdmreacstitdsi eor Szolnok Rt. began trading activity.widc mnarket access to its distbution networkc July 27,1994Hungarian Paper Works, in tum, considered Brigl & At the General Meeting, no firm decision was taken on the

Bergmeister in a better position than Frantschach to future of Szolnok Rt. Liquidation procedures were later initi-strengthen the Hungarian paper industry, particularly since ated. but the State Property Agency was planning to eitherthe Prinzhom Group had made a number of other invest- offer the company to one investor or to transform it into a newments in the Hungarian paper sector. The Prinzhorn Group entity.had entered into two joint ventures with Hungaran PaperWorks: Halaspack Rt and Dunapack Rt Dunapack Rt. con- request of Brigl & Berg meister, which was interested only intained the assets of the Dunaujvaros subsidiary of Hungar- Szolnoki's modem machines. (It should be noted thatian Paper Works. Hungarian Paper Works controlled 60 per- Frantschach had requested a simlar split.) Despite its reser-cent of the Dunapack venture and the Prinzhorn group con- vations about the split, Hungarian Paper Works agreed to ittrolled the remaining 40 percent. In 1991, prior to comple- since it wanted to shed the debt burden associated withtion of the Szolnoki privatization, the Dunapack partners had Szolnokiplanned to start a major investment program tO expand the Before the privatization could be made final, Hungar-production capacity of the plant, which also manufactured ian Paper Works required the approval of both the Anti-white paper. This plan went ahead, despite the existng un- Monopoly Office and the State Property Agency. The Anti-der-utilized capacity at Szolnoki. Monopoly office provided a letter of no objection to the sale,

Hungaman Paper Works (not Szolnoki management) had citing liberalized imports as a counterweight to the Prinzhomthe authority to decide on the investor for Szolnoki. In Sep- Group's 50 percent control over the Hungarian paper indus-temnber 1991, Hungarian Paper Works selected Brigl & try. In late November 1991, Hungarian Paper Works pre-Bergmeister, which agreed to purcha 51 percent of the pared a written proposal for the State Property Agency Theshares in a joint stock company containing only the two mod- Agency gave its approval with minimal delay in mid-Decem-em machines. This splitting of Szolnold was done at the ber 1991.

CAn STUY 12 HuN -: Szouxo=FAcTomr - BDGL & BERGMsm 59

Szolnoki was transfortned on December 30, 1991. Upon Financhl Informationtransformation, Szolnoki was split into two new companies, in millions of fodnt)Szolnok Papfr Rt. and Szolnoki Papfrgyar Kft. Szolnok Papfr 1992 1993Rt, the joint venture between Brigl & Bergmeister and the 1992_t9s3Hungarian PaperWorks, contained the two modem machnes Net Sales 3.364 353and aU supporting infrastructure facilities comprising about Pre tax profit poss) (1,188) (880)two-thirds of Szolnoki's total assets. Szolnoki Kft., a limitedliability company wholly owned by Hungarian Paper Works,contained the three older machines and two conversion plants(not needed by the joint venture) which together comprised the Szolnok management on a part-time basis. The Szolnokone-third of Szolnoki's assets. managementwas restructured three times after privatization.

In addition, in the first year after privatization, Szolnok re-Terms and Conditions of Sale duced the number of employees from 690 to 520.Brigl & Bergmeister contributed DM 17.5 million (US$10.2million) in cash to the joint venture in exchange for a 51 per- MARKET PosMoN After privatization, Szolnok's operationscent stake. (The owners of Brigl & Bergmeister, the Prinzhom were strearnlined and it produced only white paper and someGroup, financed the deal through the East-West Fund, an packaging paper. Part of the company's strategic plan was toinvestnent fund guaranteed by the Austrian Government and increase coated paper production. After privatization, exportsestablished to support the privatization drive in Central and grew to 40 percent. Most of Szolnok's export sales wentEastem Europe.) Hungarian Paper Works contributed the through the Austrian partner's distribution channels.assets and liabilities of Szolnoki (with the exception of thethree older machines and the two conversion plants) in ex- FINANCIAL CONDMON These changes did not help the finan-change for a 49 percent stake. A 2.8 percent stake was subse- cial status of Szolnok Rt., whose losses increased from Ft 0.5quently transferred from the shares of Hungarian Paper billion (US$6.6 million) in 1991 to Ft 0.9 billion (US$10.7Works to municipalities. (Te local governments were en- million) in 1992. Prior to the suspension of Szolnok's opera-tided to shares equal to the value of the land in their jurisdic- tions in November, the company made a last attempt to savetion ) the factory and asked the Ministry of International Economic

Hungarian Paper Works wanted Brigl & Bergmeister to Relations (and other paper companies) to agree to strict pa-invest an additional DM 17.5 million (US$ 10.2 million) in per import quotas. Although the company was successful inthe joint venture, but Brigl & Bergmneister agreed only to a limiting imports, this was not sufficient to save the factory.conditional commitment under which the investment would On November 20, 1992, less than a year after privatization,be made dependent on the financial results of the first three Szolnok RL suspended production, laying offvirtualy al staffyears of operations. By December 12, the factory was dosed and al but two di-

Hungarian Paper Works provided full indemnity for en- rectors (and a secretary) of the total of 520 employees hadvironmental liabilities. been laid off

While there were no employment conurits in the Following the closure of its factory, Szolnok Rt. sold allshare purchase agreement, Szolnoki's collective bargaining its inventory and then began a limited distribution of importedagreement stipulated that workers would receive an average paper products from Slovenia, the Slovak Republic, Poland,three months' wages upon termination and would continue Gernany, Belgium, and Italy.to be paid for an average three months after termination. Given the closing of the factory, it was not anticipated asThese were standard provisions in colective bargaining agree- of mid-1993 that Brigl & Bergmeister would make the in-ments and have since been incorporated into the new labor vestrnent of DM 17.5 million (US$10.2 million), which wascode. Szolnoki employees wanted shares in the company but committed conditionally, on the basis of financial perfor-Brigl & Bergmeister would not agree to this measure. mance.

As of May 1993 Szolnoki Kft., the limited liability com-Post-Privatization pany that took the three older machines and the conversionOPERmoNAL RESRUCTUnG Szolnok Papfr Rt. purchased a plants, was shut down. According to Hungarian Paper Works,new dryer for the coating machine (valued at Ft 30 nmlion, Szolnoki KfL is a viable entity that generated earnings of Ftor US$357,000), and also brought new management skills 50 million (US$595,000) for 1992.and technical know-how. When the joint venture was first According to the Prinzhorn Group, the Szolnok factoryestablished, experts were brought from Austra to work with could have been re-opened if certain protectionist measures

60 SEULNG STuE CompAEs TO STxAEjc INYrEsns, VoLUw. Two

had been taken to improve the company's competitive posi- way to reduce this debt burden. In preliminary meetings intion, namely: closing the state-owned paper factory at November 1992, the Ministry of Finance was willing to for-Baletonffizfb, one of its competitors; canceling Szolnok's state give the debt if Brigl & Bergmeister would agree to severaldebt; and introducing duties on foreign imports. (Szolnok conditions, including guaranteeing employment at existinghad had to pay duties on imported intermediate goods and levels for five years. However, no final agreementwas reachedraw materials while imports of Finnish paper goods were not and negotiations broke down after the company stopped pro-subject to tariffs because of the Hungarian-Finnish free trade duction.agreements signed in the late 1970s.) None v {these propos- In mid-1993 Szolnok Rt. was technically insolvent andals was accepted by the govemment. was under the 90-day protection period (ending in Septem-

As of mid-1993, Szolnok Rt. was unable to maintain its ber 1993) provided by the bankruptcy law. At the tirne, thedebt payments. After making the first two quarterly interest outstanding principal of the debt amounted to Ft 1.9 billionpayments, Szolnok Rt. missed the next four payments. Even (US$18.9 million) while accrued interest penalty increasedafter privatization, Hungarian Paper Works tried to find a the total outstanding to Ft 2.7 billion (US$33.8 million).

d

CAs Snimr 12 HEWGw SzouonI FAcom- Buici & BERGMEE 61

HUNGARY

DUNA HOTEL - MARRIOTr

Enterprise Status before Privatization named as one of 20 enterprises selected to participate ni-The Duna Hotel, a five-star hotel located in central Bludapest, tially in Hungary's First Privatization Program; the Dunawas one of 20 luxury hotels in the HungarHotel chain, which Hotel was to be privatized with the rest of the chain. Themanaged a total of 44 hotels. HungarHotel was a self-man- Swiss Bank Corporation was hired as financial adviser to theaged state-owned enterprise under the Ministry of Industry. State Property Agency for the sale of HungarHotel. The StateThe Duna Hotel was established in 1969 as a franchise of Property Agency took an active part in the initiation of thethe Intercontinental chain. The franchise agreement was typi- privatization process and in the subsequent negotiations forcal for the hotel industry: it carried the right to use the Inter- the Duna Hotel privatization. The Agency determnined thatcontinental name but with minimal inv 'ement byIntercon- the HungarHotel chain was too large to be privatized as atinental in the operation of the hotel. whole and that a higher price could be achieved if

HungarHotel competed with two other hotel chains in HungarHotel's 20 luxury hotels were sold separately fromHungary: Danubius, which was slightly smaller than the chain. The 20 hotels, which represented about a third ofHungarHotel, and Pannonia, which was slightly larger. The the total value of the chain, were chosen according to par-HungarHotel chain had 3,800 employees by 1990 and was ticular criteria, such as number of staff, star rating, and sta-capitalized at close to Ft 10 billion (US$162.7 million). In tus. However, inthe fallof 1991,the NationnlB.--kof Hun-the late 1970s, the chain had received US$25 miHlion in hard gary decided to raise the interest rate on Austrian loans fromcurrency financing as part of a US$300 million-equivalent 6 percent to market rates of about 24 percent. This decisionloan for tourism-related projects that the Government of stalled the pending privatizationof HungarHotel because theTIungary had negotiated with the Government of Austria. chain had an outstanding Austrian debt of about Ft 1.6 bil-HungacHotel used some of the proceeds to invest in the Duna lion (US$212 million). HungarHotel could not sustain theHotel increased debt servicing costs and needed to sel some of its

hotels and restaurants quickly to reduce its debt load. ThePreparation for Sale government subsequently decided to remove the Duna Ho-PRIOR TO BIDDING IzB September 1990 HungarHotel was tel Erom the chain and sell it independently. The State Prop-

Summary of Duna Hotel-Marriott Agreement Shareholder structurepercentage of ownership

Type of Company:HotelLocation:The hotel is located in Central BudapestDate of Sale:March 10. 1993Sales (1992):US$9.2 million (10 montis)Employment at Date of Sale:Abcut 400 (plus an additional 100 contract workers)Employment (May 1993:):About 400 Shareholder Data of sale 12/31/92Name of Strategic Inveetors:Marriott Corporation (U.S.). GiroCredit Bank Consortium (Aus- z Marnott 49.0 49.0tria)Price Paid by Stregic Invetors: * GiroCredit Bank Consortium 51.0 51.0US$53.1 millionInvestment Comrnmitment:US$22.5 million

CASE STUDY 13 HuNGAry: DuNA HOT - MarjeTr 63

erty Agency agreed informally with HungarHotel that a por. The State Property Agency decided to sell the Duna bytion of the proceeds from the sale of the hotel would be used open tender and selected Swiss Bank Corporation (from 30to repay the chain's debt. interested advisers) to organize the tender. Swiss Bank Cor-

The State Propea-ty Agency's plan requircd immediatc poration prepared an Information Memorandum and distrib-transformation of the Duna Hotel, since transformation was uted it early in 1992 to potential investors. The HungarHotelnecessary to separate the Duna Hotel from the chain. The management was involved in assisting potential bidders tofirst step in the process was taken in November 1991, when evaluate the Duna. The planned tender had been announcedthe hotels in the HungarHotel chain were put under the di- in January 1992 in the Hungarian newspapers.rect control of the State Property Agency for a period of about The crucial criterion for the evaluation of bids would betwo weeks. This gave the Agency legal rights to extract prop- the purchase price. It was agreed that other criteria would beerty from the chain and prohibited the Enterprise Council examined only if there should be a tie in the purchase pricemanaging HungarHotel from blocking the Agency's plan to offered, in which case investment commitments would beseparate the 20 chosen hotels from the chain. The second compared. The investments themselves were to be madestep was the legal transfer, also in November 1991, of the 20 during an 18-month period after the purchase. The biddinghotels (including Duna) to the Agency and the entering of process was designed to go through several rounds (in fact,the Agency as owner in the Land Registry. HungarHotel was three rounds) with the lowest bidder dropped in each roundtransformed into a joint stock company (December 1991) and the remaining bids disclosed prior to the final round.and was given a temporary management contract to run Duna. The winner would have a fixed period to conduct due dii-

The third step, on March 1, 1992, was the establishment gence and to present payment to the State Property Agency;of a new limited liability company (Duna Kft.) by this period would end in November 1992.HungarHotel, which contributed the minimum Ft 1 million(US$11,900) in subscnbed capital that was needed under THE BIDDING PROCESS First Rownd. The first round of bid-Hungarian company law to set up a limited liability company. ding, which began July 15, 1992, did not require binding of-Although the State Property Agency was not legally forbid- fers but was intended to test the market. No offers were re-den to set up the limited liability company itself, it preferred ceived during the first round. The State PropertyAgency wasto have HungarHotel establish the company, since such ac- concerned that the lack of competing bids was due primarilyton was not specifically included in the Agency's statutes. to the perceived advantage of Intercontinental as party toThe State Property Agency then contnbuted the sole asset of the existing franchise arrangement. Therefore, the Agencythe Duna Hotel to the new company. As the final step in the decided to negotiate the early termination of the franchisetransformation, the State Property Agency bought out agreement with Intercontinental.HungarHotel's Ft 1 million stake, thereby gaining sole own- The franchise agreement had been extended only inership of the new limited liabiliy company containing the 1989, and earlytermination was thus only possible upon pay-Duna Hotel. The transformation had significant implications ment of a cancellation fee. It was agreed that the agreementwith respect to property rights. If the Duna Hotel had been would be terminated, at a cost of US$3 million, even if Inter-transformed as a state-owned enterpise, municipalities would continental were to win the bid. In this way Intercontinentalhave had the right to be compensated for the property trans- would not have an advantage over competitors when bid-ferred to the new owners during privatization, but under the ding on the price. The fee for liquidated damages would benew arrangement the State Property Agency would not have paid from the sale proceeds paid by the winning bidder, evento compensate the municipalities for the land or buildings. if Intercontinental were the winner.

During the transformation process, the State Property The new franchise termination agreement caled for theAgency financed a number of preparatory studies. An ap- cancellation of the existing franchise and the establishmentpraisal was conducted at the end of 1991 by American Ap- of a new one that could be termiinated with 90 days' notice.praisal. The Agency also recruited Coopers & Lybrand This new agreement was made available to potentialbidders,(United States) for a valuation in October-November 1991. but the fee of US$3 miDlion was not disclosed.The adviser indicated that, in v-luing a business such as a SecondRound. Sixinvestorsexpressedaninterestinbid-hotel, discounted cash flow and price/eamnings multiple meth- ding for the Duna in the second round, but only three sub-ods are not relevant because the true worth of the company mitted final offers: Intercontinental, Marriott (United States),is in the value of the real estate. Since there had been no and a Hungarian expatriate who had an agreement withprevious hotel privatization of that size, Coopers & Lybrand Ramada (United States) to act as a management contractorlooked at indicators such as comparable sites in Europe in- if he won the bid. Marriott had several hotels in Centraldexed by the relative value of real estate in Hungary. Europe (four in Gennany, one in Vienna, and one in War-

64 Srmnc ST CouPwm s To STIICic hNvusmas, Vowii Two

saw) and was looking for additional opportunities in the re- Timebble of Key Stepsgion. Marriott did not perceive a greenfield investment inHungary as a viable alternative because of the abundance of Sptembr 1990hotel rooms and the lack of attrctive sites. HungarHotel was named as one of the first 20 enterprises to

participate in the First Privatization Program. (This includedPrior to submitting their offers, the bidders negotiated the Duna Hotel.)

with the State Property Agency to change some of the terms End 1990for submitting bids. This included the US$5 million non-re- The Swiss Bank Corporation was hired as financial adviser tofundable deposit due upon winning the bid and payment of the State Property Agency for the sale of HungarHotel.Fall 1991the full purchase price within ten days of winning the bid. The National Bank of Hungary raised the interest rate on Aus-The Agency agreed to reduce the non-refundable deposit to trian loans to market levets.US$100,000 and to increase the time period for final pay- November 1991ment to three months. Hotels in HungarHotel were put under the State PropertyAgency to facilitate the independent sale of the Duna Hotel.

The bids were based on the draft share purchase agree- The 20 chosen hotels (including the Duna) were transferredment for l00 percent of the Duna limited liability company. to the State Property Agency.The offers included both price and investrnent comnuitments, December 1991but, as has been mentioned, price would be the only crite- HungarHotel was transformed Into a joint stock company.January 1992rion for evaluation unless there was a tie. Marriott offered a Privatization of the Duna Hotel was announced.purchase price of US$51 million and an investment commnit- Early 1992ment of US$12.5 million. Both Intercontinental and the An Information Memorandum was distributed to potential in-Ramada consortium submitted slightly lower prce offers than January to July s992Marriatt but with significantly higher investment commit- Pre-qualification of potential investors took place.ments. March 1, 1992

Ratherthan droppingthe lowest bidderafter the second The Duna Hotel was transformed into a limited liability com-round, as planned, the State Property Agency, without dis- July to Novembyr 199closing the bids, asked all participants if they would agree to Three rounds of bidding were conducted for the Duna Hotel.allow all bidders to continue to the third round. reaing that October 14,1992they would be dropped, all bidders agreed to this change . The share purchase agreement was signed with Marriott.

March. ,1993procedure. The State Property Agency then disclosed the Agreements were executed and payment was rmade in es-results of the second round. crow by Marriott and the consortium.

At this point, Intercontinental and Rmada argued that March 10, 1993the rules should be changed and the criteria for evaluating The escrow agent released payment e o the State Propertybids should be changed to give greater weight to investmentcommitments. They claimed that the size of their offer (in-cluding a proposed extension to the hotel) was much greater bid, Marriott conducted a five-day due diligence progran tothan that of Marriott. In turn, Marliott claimed that the pro- determine whether the company was worth the US$100,000posed extension was not legally permitted. non-refundable deposit. Marriott also hired a U.S. law firm,

Third Round. Despite these arguments, the State Prop- Arent Fox, to conduct a more thorough legal due diience,erty Agency did not change the results of the second round the purpose of which was to reveal problems that could ariseand all three bidders moved on to the third round. Accord- from third party daims and could decrease the value of theing to the predetermined procedures, the offer price, but not propertythe investment commitments listed in the second round, could The State Property Agency used its own lawyers as wellbe changed for the third round, which placed Intercontinen- as foreign consultants to finalize the sale. Marriott's lawyerstal and the Ramada consortium at an advantage since the tie attempted to revise the draft share purchase agreementsbreaker was the amount of additional investment. In the (which had been prepared from a standard form document)third round, Intercontinental offered approximately US$47 but the State Property Agency declined to make any changesmillion; the Ramada consortium offered US$50 million; and to the draft agreement. The share purchase agreement wasMarriott offered US$53.1 million. In accordance with the signed on October 14, 1992, and inDecemuber 1992 the Dunabidding procedures, Lhe bids were evaluated solely on price Hotel was registered as a joint stock company After winningand Marriott was declared the winner. the bid, Marriott carried out another valuation as a part of

the lenders' due diligence and confirmed its earlier assess-AFTER nHE B1DDING PRocEss Immediately after winnig the ment of the hotel's value.

CA=E Snrum 13 HuNGAmw: DuA HorEL- MAorTr 65

The issue of payrnent first became problematic when the Terms and Conditions of SaleNational Bank of Hungary initially refused to accept any The final price was unchanged from Marriott's final offer ofpayment by Marriott financed bycdebt. Marriott insisted that US$53.1 miDion. During negotiations, Marriott agreed tohighly leveraged purchases were the norm in the hotel sector, increase its original US$12.5 milion investment commitmentand threatened to withdraw if this was not permitted. by US$10 million. The additional funds would be used to

This issue was further complicated by the fact that the renovate and upgrade the hotel, and pay financing costs.State Property Agency wanted immediate payment for the Marriott's total commitment of US$75 million (the sales pricesalc of the hotel, while Marriott needed several months to plus US$22.5 in investment) was financed as follows: (1)assemble the financing consortium. (Such consortia are found equity of US$5 million; (2) a loan of US$49 million; and (3)in sales of large hotels in Western Europe and the United a convertible subordinated loan for about US$20 million (225States.) After negotiations, Marriott was able to get the pay- million Austrian shillings).ment deadline extended twice. The first extension was from The consortium of Austrian banks headed by GiroCreditNovember 20, 1992 to December 31, 1992. The next was Bank purchased 51 percent of the equity of Duna with thethrough the end of February 1993. To convince the State understanding that Marriott would later increase its owner-Property Agency to grant the second extension, Marriott of- ship stake. Marriott entered into a long-term managementfered to put US$1 million in escrow and pay interest on the contract with Duna to operate the hotel and a technical ser-purchase price effective retroactively to November 20, the vices contract to complete the renovation. Marriott, like mostoriginal deadline. The Agency agr-ed to these terms. large hotels, makes its profit in the management of hotels

The extension of the payment date allowed Marriott to and often does not tie up its money in real estate.negotiate a mix of debt and equity financing from a consor- No employment guarantees were provided in the con-tium of Austrian banks led byGir'jCredit Bank. However, a tract. In fact, since Duna was initially a new limited liabilityproblem arose over the sequence cf the exchange of title and company and the workers did not have the necessary three-payment between the State Property Agency and the loan year seniority, the workers were not entitled to the regularsyndicate. The Austrian banks would not release the money severance pay upon termination. However, Marriott agreeduntil their security over the title to the property had been in the sales contract to provide the appropriate severanceregistered, but the State Property Agency did not want to pay for any employees that might be laid off.register the investors as owners until after payment had beenmade. To overcome this problem, the State Property Agency Post-Privatizationagreed to use a local banker as an escrow agent; this banker As of May 1993, Duna Marriott, with an occupancy rate oftook possession of the signed contracts and registered the about 70 percent, had 340 single and double rooms plus 6land title - a process which itself took two days. (This was small and normal size suites. Its main customers were busi-exceptionally fast, since owing to the backlog in the registry ness travelers from Gernany, Austria, Italy, France, the Unitedin the Hungarian courts, full registration could typically take Kingdom, and the United States. Marriott planned to in-as long as six months.) This was the first escrow dosing in crease the room count and to undertake major refurbishing.Hungary. On March 10, 1993, Marriott paid the State Prop- Management was restructured, but other employees wereerty Agency for the Duna Hotel. maintained, and Marriott introduced a new organization chart

Due diligence reviews by Marriott and its lenders raised and new reporting channels.two possible problems concerning property rights. Both were The other two major state-owned hotel chains, Danubiusminor filing errors usually resolved administratively - in and Pannonia, have also been privatized. With the sale ofmarket economies. However, the State PropertyAgency felt the Duna, four of the five leading Budapest hotels are nowthat no outstanding issues existed regarding property rights privately owned. However, Duna-Marriott is the only hoteland was willing only to provide its standard warranty of one in Budapest that was sold entirely to foreign investors. Ali ofyear against third party claims. Marriott was wiDling to com- the outstanding debt of HungarHotel has been paid off fromplete the acquisition on the basis of this warranty. the proceeds of the sale of the Duna Hotel.

66 SEliNG STAE CoPANns To STRrECic IWEsoRs, Voum Two

III. THE CZECH REPUBLIC AND THE SLOVAKREPUBLIC

Czech RepublicCokoladovny - Neste & BSNKyje Plant - Coca-Cola AmatilSSZ - Entreprise Jean LefebvreSeverok'amen - Wimpey AsphaltCentropen - Novotny/ManagementElektrosignal - Management

Slovak RepublicTatramat - Whirlpool, QuasarJacobs Suchard Figaro

Czech Republic & Slovak RepublicPrior Stores - Kmart

Map 3. The Czech Republlc and the Slovak Repubflc

1 ? IAl 1 16 Ia,' 20 2Z

CZECH REPUBLIC AND SLOVAK REPUBLIC% N TRADE SALES

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CZECH REPUBLIC

COKOLADOVNY - NESTLE & BSN

Enterprise Status before Privatization Cokoladovny was a sector enterprise comprising all ofUnder the command economy, in former Czechoslovakia, the production facilities of the sector. It had been foundedCokolidovny was the monopoly producer of chocolates, by the Ministry of Agriculture. In 1990 the first step insweets, and biscuits. In 1969 Cokolidovny's operations in Cokolidovny's privatization was taken when it was convertedthe Slovak Republic were spun off into a new sector enter- from a sector enterprise to a state enterprise in accordanceprise, Bitu Figaro, the state trust forthe production of choco- with the 1990 Law on State Enterprises. The enterprise waslate, thus limiting Cokolidovny's market in the Czech Re- converted intact with all of its eight divisions, as the manage-public. After liberalization of the economy in 1989, mentof all the divisions decided in favor of remaining as oneCokolidovny faced growing competition from imports as well entity.as from new domestic producers. Despite losing market shareto these new competitors, Cokolidovny still controlled 60 to Sale Preparation and Negotiations75 percent of the domestic market prior to privatization. By 1990, with the increasing number of foreign competitors,

The enterprise generated sales of Kcs 6.7 billion the Cokoldovny management felt that additional expertise,(US$240.7 rnillion) for 1991. In addition to producing for particularly in the area of product marketing, was needed forthe domestic market, Cokolidovny exported some 5 to 6 the enterprise to compete effectively. Therefore,percent of its total production. Foreign customers included Cokoladovny requested that its founding organ, the Minis-wholesale firms in Finland, Canada, Saudi Arabia, Russia, try of Agriculture, designate it for privatization, and in falland Poland. 1990 Cokoladovny was listed among the enterprises to be

Cokoladovny was divided into eight divisions and had sold during the first wave of large-scale privatization.16 plants located throughout the Czech Republic. The Although support from the labor unionswas not requiredenterprise's product quality was considered of average West- to initiate privatization, the Cokoladovny management heldem European standard. (Cokolidovnyiimportedvirtually all a public relations campaign in all of its branches to informof its machinery, most of its raw materials, and some padkag- workers about the privatization program and obtained infor-ing materials.) mal approval from the labor unions.

Summary of Cokolidovny-Nestle & BSN Agreement Shareholder structurepercentage of ownership

Type of Company:Manufacturer of confectionery products (chocolates, sweets, 1O0%and biscuits)Location:The company has 16 plants, throughout the Czech RepublicDate of Sale:February 20. 1992Sales (1993):Kc 8.6 billion (US$287 million)Employment at Date of Sale:7,696 ___Employment (December 1993): Shareholder Date of sale 12131/928,079Name of Strategic Investor: a Employees 0.0 3.0Copart (50/50 joint venture between Nestle of Switzerland and [ investicni Bank (Czech) 3.5 2.8BSN of France) Restitutjon Func andPrice Paid by Strategic Investor:US$95.6 million Restitution Claimants 4.5 2.4Investment Commitment * EBRD 15.0 12.1Kcs 2.5 billion (US$ 86.5 million) in cash within five years 3 Voucher Holders 34.0 26.3

* Copart 430 53.4

CASE STUDY 14 CzEac REpusuc: CozOLADoVNY - NESn= & BSN 69

The Cokolodovny managemcnt hired the local consult- Tlmtable of Key Stepsing firm All-in (a subsidiary of the Komercni Bank of Prague)as sn initial adviser on privatization. Later in the process, Fail 1990

CokolAdovny was listed for the first wave of large-scaleCokolaldovny hired the Investcni Bank, a Czech bank with privatization. Nestle contacted Cokoladovny and expressedwhich they had had previous contact, to provide assistance interest In its acquisition. Nestle contacted BSN to establishin negotiations with the final bidder. a joint venture (Copart) which would bid for Cokoladovny.

Since the Cokoladovny management intended to sell March 29, 1991the cnterprise to a foreign strategic investor, an independent Cokoladovny was transformed into a joint stock company.the enterprise to a ~~~~~April 199business valuation was required in accordance with the The letter of intent between Copart and Cokoladovny wasPrivatization Law. In the fall of 1990 the transaction adviser, signed.All-in, subcontracted an Austrian firm, Niederosterreichische October 1991

Wirtschaftsprufungsund SteuerberatungsGesellschaft The basic privatization project and the competing projectsWirtschaftsprufungs und Steuerberatungs besellschatt vwere submitted to the Ministry of Agriculture and were then(NOPW), to prepare a net asset valuation. This valuation submitted by them to the Ministry of Privatization.was financed by Cokolidovny but the consultants reported November 1991/January 1992to the Ministry of Privatization as well as to the Cokoladovny Fnal negotiations took place among Copart, the Ministry ofmanagement. Privatization, and the National Property Fund.

January B, 1992On March 29, 1991, CokolAdovny was transformned into The basic project (calling for sale to Copart) was approved

a joint stock companywith an initial share capital of Kcs2.42 by the Economic Council of Ministers and the Governmentbillion (US$86.9 million). The new Articles of Association Resolution was issued.were prepared by Cokoladovny. January 31,1992The share purchase agreement was signed with the National

During 1990-9 1, several intemational chocolate produc- Property Fund.ers approached Cokolidovny, including Balsen (Austria), March 1992Haas (Austr4a), Nestle (Switzerland) and Jacobs Suchard Copart increased its stake from 43 percent to approximately(Switzerland). Cokolidovny's management established one 54 percent and offered employees a 3 percent stake ininformal condition in its discussions with potential investors: Cokoladovny.that the enterprise be sold as a single entity. The manage-ment did not want the enterprise split up, because it recog-nized that some of its operations were less profitable than letter of intent setting out the commercial terms agreed withothers and could not survive competition as individual com- Copart. These terms were then incorporated into the "basicpanies. Most investors, however, were interested only in pur- privatization project" prepared by enterprise management.chasing individual plants, and, in one case, only individual The basic privatization project that was submitted de-assembly lines. Nest1 was the only investor interested in ac- lineated the proposed share structure for the company, thequiring Cokolidovny as a going concern, but it lacked eper- commitments to be made by Copart, and a business plan fortise in the production of biscuits. Nesde approached the CokolIdovny's future development. The project was accom-French cookie manufacturer, BSN, which agreed to form a panied by written consents from the City of Prague and, be-50/50 joint venture with Nesde. Formal negotiations between cause Cokolidovny held a domestic monopoly, the MinistryCokoladovny and the Nestl6/BSN joint venture (named of Economic Competition. The letterfromthis Ministrystipu-Copart) began in the fall of 1990. It should be noted that lated that Copart must maintain employment and produc-the Czech privatization authorities played a largely supervi- tion levels for a period of five years and must increase pricessory role in this case; the basic terms of the transaction were only in accordance with increases in production costs. Thenegotiated between Copart and the Cokolidovny manage- purpose of these assurances was to ensure that the new in-ment. vestors did not shut down the company's production in or-

Since the Cokoladovny management had provided little der to open up the Czech market for themselves.information to potential investors aside from the results of In addition to the basic project, several "competing"the asset valuation, Copart relied on its own due diligence projects were submitted by outside investors, but all were forfor information on which to base negotiations and used its the privatization of individual plants rather than the entireown in-house experts for a technical evaluation of enterprise. One of the competing projectswas submitted byCokoladovny. In addition Copart hired Price Waterhouse the Austrian firm Haas, which initially thought that it had(United States) to conduct a financial audit and a Dutch firm valid restitution claims to one of Cokoladovny's plants. Un-to conduct an environmental audit. der the Czech restitution program, property expropriated after

In April 1991 the Cokoladovny management signed a February 1948, when the Comnunists took fill control of

70 SEUzNG ST= COtPNiS TO SMt&mEGIC INvEroS, VoLu3n TWo

the Czechoslovak Parliament, was returned to the original Flnancil InformauUonowners of the property. However, the claim by Hass was not pn mlllons of koruny)accepted since it was for property that was seized prior to1948. 1990 11 1992 1993

Throughout the process of developing the privatization Income Statementproject, the Cokolidovny management had consulted with Net Sales 4,319 6,670 7,276 8.554

Costa 4.125 5,215 6.271 7.262the various govenmment agencies involved (the Ministry of GrossProt 194 1,455 1,005 1,292Agriculture, the Ministry of Privatization and its USAID ad- Taxes 96 767 483 700visory team, and the National Property Fund), so that by the Net Proit 98 688 522 592time the project was submitted for review it was accepted by alance Sheeteach of the agencies without change. In October 1991 the CurrentAssets 1,509 1.641 3,049 3.303basic privatization project was submitted to the Ministry of Plantd& EquIpmeS 1.446 1844 2.029 2,311Ofter Fixed Assets 0 3 3 10Agrculture for its review and was then passed on to the Min- Total Assets 2.955 3.488 5.081 5,624istry of Privatization for its approval pr.or to submission tothe Economic Council of Ministers. Other Uabmlles 2,013 412 337 530

After the basic project was accepted by the Ministry of Long-Term Bank Debt 141 141 123 105Privatization, Copart finalized the share purchase agreement Total LiabIliffles 2,316 707 541 665with the Ministry of Privatization and the National Property Equlty Captal 639 2.781 4,540 4,959Fund. The agreement was drafted by Copart's legal adviser,Skadden, Arps (United States). (In later privatizations inthe Czech Republic, the draft contract was prepared in ac-cordance with the Ministry of Privatization's standard con- for Reconstuction and Development purchased 15 percenttract, but at the time of this transaction a standard contract of the equity and the Investicni Bank, Cokolidovny's finan-had not yet been developed.) Since most of the terms had cial adviser, purchased 3.5 percent of the shares.been agreed upon by the Cokolidovny management and Ile share purchase agreement included a warranty toCopart during the preparation of the basic project, the final Copart that the title was free and clear. Althoughnegotiations were concluded rapidly. OnJanuary 8, 1992, the Cokoladovny's operations had no known impact on the en-Economic Council of Ministers approved the recoumnenda- vironment, the share purchase agreement stipulated that thetion of the Ministry of Privatization and issued a Govern- NationalPropertyFundwouldbeartheresponsibilityforanyment Resolution authorizing implementation of the basic ea nmental damag that might be determined to have beenprivatization project prepared by the Cokolidovny manage- caused before privatization.ment and Copart. The sharepurchaseagreementwas signed Tberewasnootherrestucturingof Cokoldovnyaspartwith the National Property Fund on January31, 1992. of the sale of the comrpany, and all social assets remained

with the company.Terms and Conditions of SaleCopart paid US$95.6 million in cash for a 43 percent stake Post-Privatizationin Cokoladovny. The final price was set on the basis of the MARTr PosmoN Cokolidovny's sales increased to Kc 8.6valuation prepared by All-in and NOPW Copart paid 30 bilion (US$287 million) in 1993 and the company's domes-percent of the purchase price upon the closing of the trans- tic market share decreased to about 65 percent.action, with the balance due a year later, that is, by February1993. In addition, the share purdhase agreement caled for a SHARE STRUCTURE A portion of the Kcs 2.5 billion (US$ 86.5cash investment of Kcs 2.5 billion (US$86.5 milion) over milion) capital investment was made shordy after the sale.five years. This increased the share capital and raised Copart's stake to

Thirty-four percent of the company's shares was placed 54.1 percentin the first wave of the voucher privatization program, avail- After the increase in share capitl, Copart offered a 3able to Czech and Slovak citizens. Another 4.5 percent of percent stake to the employees. Half of the employee sharesthe company's shares was set aside forrestitution claims. This was given to employees at no charge, and the other half waswas larger than the standard 3 percent set aside for restitu- given at a 30 percnt discount. The shares were distributedtion because of individual claims that had been negotiated only to employees with a minimum tenure of two years. Em-(and signed) with Cokolidovny prior to the submission of ployee shares had to renainwithin the company and be soldthe privatization project In addition, the European Bank to Copart whe an employee left the company.

CA5sz Sun 14 Czan REuPvau ComxADov - Nm & BSN 71

As of May 1993 about 40,000 individual shareholders of marketing, the logistics of distribution, product manage-and40investmentfundshadinvestedinCokoladovnyshares ment, and finance. Under the direction of Copart,through the voucher program. Cokoladovny reduced its number of brands from 15 to 3

and centralized its marketing in one headquarters depart-ORGANIZATIONAL REsTRUCTURING After the privatization, ment (previously, each division had had its own marketingCopart sent a team of 20 employees, including four manag- department).ers, to work with Cokolidovny. According to the Cokoladovny The number of employees increased from about 7,700management, Copart's major contributions were in the areas before privatization to about 8,100 by mid-1993.

72 SEUNG SAT Comm= TO SmtaEIc IVEsroRs, VoLumE Two

CZECH REPUBLIC

KwE PLANT - COCA-COLA AMATIL

Enterprise Status before Privatization Sale Preparation and NegotiationsThe Kyie bottling plant was part of Prague Confectionery Following Czechoslovakia's economic liberalization, theand Soda Works (Prague Confectionery), a multi-plant state Coca-Cola Company (United States) sent representatives toenterprise that produced confectioneries and local soft drink explore opportunities for expansion in the region. In 1989brands. In the early 1980s Prague Confectionery began con- Coca-Cola initiated discussions with Prague Confectionerystruction of the Kyje plant within the city limits of Prague, at and the Prague City Council for a possible joint venture thatthe behest of the Prague City Council, which wanted a plant would involve using the Kyie bottling plant as a productionto provide purified soda water for babies. Although the found- site for Coca-Cola products. The Coca-Cola Company latering organ for the enterprise was the Ministry of Agriculture, turned over negotiations to its Australian subsidiary, Coca-the City Council provided land and funds for construction. Cola Amatil, which had been given the exclusive franchise toAs a result, the City of Prague was the founding organ for the distribute Coca-Cola's products in former Czechoslovakia.bottling plant. The Kyje plant, which was built primarily by Coca-Cola Amatil had had a presence in the region since itprison labor, took longer to complete than had been planned, had acquired a significant Coca-Cola franchise in Austria inand by 1992 only one production line had begun operations. 1982.As a consequence of the delay, much of the equipment was Coca-Cola products had been available in formerout of date and required additional investmnent prior to op- Czechoslovakia since the early 1970s, when individual bot-eration. tlers had been allowed to produce and distribute limited quan-

The carbonated beverage industry in the Czech and Slo- tities and brands of the Coca-Cola Company. However, invak Republics was relatively competitive, and had been so 1990 there was a general shortage of Coca-Cola throughoutbefore Czechoslova's transformation to a market economy Czechoslovakia, since the capacity of the bottling plants within 1989. Major soft drink brands and a plethora of local whichCoca-ColaAmatilhad establishedagreementswaslow,brands competed for a market share. Pepsi Cola, for example, and as a result, Coca-Cola was served only at hotels and ex-held a strong position in the region owing to its early involve- pensive restaurants. Pepsi Cola products (which were Coca-ment in Central Europe and, prior to 1989, had out-sold Cola's main competition), however, had a relatively wide dis-Coca-Cola four to one. tribution. Coca-Cola Amatil therefore felt that its top prior-

Summary of Kyle Plant-Coca-Cola Amatil Agreement Shweholder structurepercentage of ownership

Type of Company:Producer of soft drinksLocation:The plant is located in PragueDate of Sale:April 3,1992Sales:Not availableEmployment at Date of Sale:1 00Employmert (May 1993):250 Shareholder Date of sale 12/31/92Name of Stratgic Investor:Coca-Cola Arnalil (Australia) * Coca-Cola Ametli 100.0 100.0Price Paid by Stratgic InvestorKcs 292 million (US$10.1 million) (including Kcs 100 million.or US$3.5 million in liabilities)Investment CommltmwntUS$82 million (including purchase price) over five years

CAS STD 15 Czmcs REPnn Kyx Pur - COCA-CoLA AmL 73

ity was to establish a production facility as quickly as pos- when the time came to finalize the agreement Prague Con-sible. fectionery refused to sign. According to Coca-Cola Amatil,

In early 1990, Coca-Cola Amatil began negotiations with Prgue Confectionery took this stance because the Praguea number of independent bottlers, guaranteeing them pro. City Council was not fully in agreement with the arrange-duction volumes through toll-packing agreements, whereby ment and the Prague Confectionery management was reluc-the bottlers agreed to produce exclusively Coca-Cola Amatil tant to oppose the City Council, whose support was neededproducts and Coca-Cola Arnatil guaranteed to purchase the for the privatization of the remainder of Praguefull output of the bottlers. (These contracts involved a three- Confectionery's assets.party agreement among the Coca-Cola Company, Coca-Cola According to Coca-Cola Amatil, the City Council's ob-Amatil, and each bottler.) While Coca-Cola Amatil had built jections arose because they wanted, among other things,up a sizable network of bottlers, it wanted to strengthen its shares in the joint venture, representation on the manage-position in the market by establishing its own production fa- ment board, and a commitment to the effect that the plantcility in Prague. would continue producing water for babies. Also, according

Coca-Cola Amatil's primary consideration in initiating to Coca-Cola Amatil, some of the City Council memberswerea joint venture for the Kyie plant was the belief that invest- wary of foreign investors and wanted to maintain control ofment in an existing producer would be a quick means of in- the Kyje project, while others were too preoccupied with othercreasing production capacity. Acquisition of the Kyje plant issues (includingtheelectionsof May 1991)togivetheprojectwas selected over a greenfield investment because Coca-Cola sufficient attention. As negotiations were prolonged, the No-Amatil estimated that the latter would not be operational for vember deadline of the grandfather clause passed and Coca-at least two years while the Kyje plant could be in operation Cola Amatil changed its strategy to work within the large-within a few months and would entail a lower initial capital scale privatization program.investment. Under the new Privatization Law, approval of the

In November 1990, Coca-Cola Amatil submnitted a joint privatization of large-scale enterprises was the responsibilityventure proposal to Prague Confectionery and the Prague of the Ministry of Privatization and the Czech Cabinet ratherCity Council for the Kyie bottling plant, which was still un- than of the founding organ; in addition, the privatization pro-der construction. Coca-Cola Amatil proposed an ownership cess now included the preparation of 'basic privatizationstructure in which it would have a 52 percent stake in the projects" submitted by enterprise management, and "com-joint venture and Prague Confectionery would have a 48 peting projects" subnitted by outside investors. Coca-Colapercent stake. Te Kyie plant would be the sole asset con- Amatil was given assurances by the Ministry of Privatizationtributed by Prague Confect; *nery. Since negotiations began and its advisers, the USAIID advisory ttcn, that Coca-Colaprior to the enactnent of the Large-Scale Privatization Law Amatil would be able to submit a bid to purchase the Kyjein February 1991, Coca-Cola Amatil was eligible, under a plantwithoutthedirectinvolvementofthePragutCityCoun-.grandfather clause" applied by the Economic Council of the cil or Prague Confectionery. Therefore, in May 1991 Coca-Czech Republic, to negotiate the joint venture directly with Cola Amatil decided to submit its own competing project tothe Minister of Finance rather than going through the stan- the Ministry of Privatization, to be revieved against the ba-dard large-scale privatization process established by the new sic privatization project submnitted by the Prague Confection-law. One condition of the grandfather clause, however, was ery mnanagement.that the transaction had to be completed before November Initially, Coca-Cola Amatil's competing project caDled1991. for the purchase of 80 percent of the Kyje plant by Coca-

Once the initial joint venture negotiations were under Cola Amatil with the disposal of the remaining 20 percentway, Coca-ColaAmatil,Prague Confectionery, andthePrague (in preferred shares with no voting rights) left to the discre-City Council agreed to a valuation by an extemal consultant, tion of the Ministry of Privatization. The 20 percent was setand Ernst & Young was hired. In a valuation conducted in aside under the assumption that the Ministry would lookthe summer and fall of 1991, the Kyje plant's assets were unfavorably on transactions involving 100 percent foreignvalued atKcs 260 million (US$9.3 miUlion), only slightlylower ownership. However, later when it became evident that thethan the book value (Kcs 276 million, or US$9.9 million). Ministrywould not object to full ownership, Coca-ColaAmatilThe cost of the valuation was initially intended to be shared changed its proposal to caDl for its acquisition of 100 percentbetween Coca-Cola Amatil and Prague Confectionery, but of the Kyje plant.Coca-Cola Amatil eventually paid the entire fee. Coca-Cola Amatil assumed that it would be preferable

By spring 1991, Coca-Cola Amatil and Prague Confec- to have at least tacit approval for its project from the Praguetionery had reached an agreement on the joint venture, but Confectionery management and, in sensitive discussions, in-

74 SEuNG STm Commus Xro STCm1C INvEsts, VoLum Two

formed Prague Confectionery that it was submitting a com- -peting project and asked for its support. Prague Confection-ery agreed to supply a letter of no objection for the Coca- Novembor 1990Cola Amatil project. In its basic project, Prague Confection- Coca-Cola Amatil began negotiations with Prague Confec-ery also stated that, although the enterprise preferred its own tionery and the Prague City Council for a joint venture for theprivatization project, it would cooperate with Coca-Cola Kyje bottling plant.Amatil, if the latter project were selected. The Large-Scale Privatization Law was enacted. The law lim-

In October 1991, two privatization proects were sub- ited the role of founding organs in privatization and allowedmitted to the Ministry of Privatization for the Kye plant: the for competing privatization projects.

May 1991basic project subrnitted by Prague Confectionery and the Coca-Cola Amatil decided to prepare a competingcompeting project proposed by Coca-Cola Amatil. (Other privatization project for the purchase of 100 percent of theproposals were submitted for the rest of Prague Confection- assets of the Kyje plant rather than entering into a joint ven-ery, but no others were submitted for the Kyje plant.) The ture with Prague Confectionery.

basi pmectpreare bythePrage Cnfetioerymange- Summw/Fall 1991basic project prepared by the Prague Confectionery manage- A valuation of the Kyje plant was undertaken by Ernst & Young.ment proposed a joint venture with Coca-Cola Amatil- October 1991despite the fact that an agreement had not been reached. Privatization projects for the Kyje plant were submitted to theHowever the Ministry of Privatization did not consider the Ministry of Privatization.

manaemet's rojct alid beauseCoc-Coa Amtilhad February 1992management's project valid, because Coca-ColaAmnatil had The Economic Council of Ministers approved Coca-Colaindicated in writing that it was unwilling to continue to pur- Amatil's project.sue the joint venture with Prague Confectionery. The Minis- April 3,1992try of Privatization then examined the competing project of The asset purchase agreement was signed by Coca-ColaCoca-Cola Amatl and decided to accept. Amatil and the National Property Fund.March 19, 1993

Once the Ministry of Privatization informed Coca-Cola The refurbished Kyje plant opened for production.Amatil that its project was favored, final negotiations wereconducted with the USA1D advisory team and a representa-tive of the legal advisers to the National Property Fund, whichwould be the final signatory to the asset purchase agreement.The main issues in the negotiations included the final pur- Coca-Cola Anatil also agreed to retain the current em-chase price and the investment conditions. ployees and continue company operations as a going con-

Once agreement was reached, the Coca-Cola Amati cern for one year after the sale. In addition, Coca-Cola Amatilproject was sent to the Economic Council of Ministers, which agreed to assume all environmental liabilities.approved it in February 1992. The asset purchase agreement However, before the final contract could be signed, thewas signed on April 3, 1992. Prague City Council had to transfer the land title of the Kyje

plant to the National Property Fund, which would then sel itTerms and Conditions of Sale to Coca-Cola Amatil. Under the Privatization Law the CityCoca-Cola Amatfl paid Kcs 185 mifllion (US$6.4 million) to Council did not have the authority to block the privatizationthe National Property Fund and, in addition, assumed liabili- blit could delay its completion by postponing the transfer ofties of some Kcs 107 million (US$3.7 million), which con- the land title. The Council signed over the ownership rightssisted primarily of unpaid contractor bills incuTed in con- to the plant in the final hours before the signing of the assetnection with the construction of the plant Thus, the total purchase agreement. Coca-Cola Amatil demonstrated a com-price was Kcs 292 million (US$10.1 million) (including li- niitnent to the Prague community by offering to sponsor theabilities), itly higher than Coca-Cola Amatil's original offer bankrupt Prague Zoo with an investment of Kcs 5 millionof approximately Kcs 265 million (US$9.2 million), which (US$173,000) over the next five years.was made on the basis of Ernst &Ybung's valuation.

Coca-Cola Amatil agreed to invest US$82 million (in- Post-Privatizationcluding the purchase price) over five years according to the The refurbished Kyje plant opened for production on Marchfollowing schedule: 29 percent in 1992; 26 percent in 1993; 19, 1993. Employment at the Kyle plant had increased fromand the balance over the following three years. Coca-Cola 100 (prior to privatization) to 250 in 1993. In mid-1993,Amatil considered the connitmnent to applyto all investments Coca-Cola Amatil employed a total of 500 people in the Czechin former Czechoslovakia, and not exclusively to the Kyje Republic and the Slovak Republic. At the time the sale wasplant finalized, Coca-Cola Amatil believed that the plant could be

CASE STUDY 15 CZECa RmPUwUC: L PLANT -C0C&-CWA Am= 75

run by local management. However, the company later in- Fincial Intormationstalled four Australian managers on a temporary basis. As of (In milkions d koruny)May 1993, Coca-Cola Arnatil had invested about Kcs 5 ml- January31 1992lion (US$167,000) to clean up the grounds of the Kyje plant.

The other soda bottling and distribution operations of Balance SheetPrague Confectionery, including two operating plants, were Current Assets 20

Long-Tern Assets 304privatized through direct sales to domestc investors. The Tot Assels 404confectionery operation was privatized through vouchers. - - -

The sale of the Kyje bottling plant was one of the first Short-Tent Bank Debt 35sales to foreign investors, and many of the elements agreed Long-Tern Bank Debt 53to as part of the contract with Coca-Cola Amatil were in- Total UabilWtes 108

cluded in a standard contract developed by the Ministry of Equity Capital 296Privatization and its USAID advisory team. __

76 SzumG SunT Comoms TO Smmc ImvroRs, VoLUw Two

CZECH REPUUC

SSZ - ENTERPRISE JEAN LEFEBVRE

Enterprise Status before Privatization lization' program aimed at splitting up large state monopolyStavby Silnic a Zcleznic (SSZ) of Prague was a construction enterprises into smaller divisions that could potentially corn-enterprise building roads, bridges, railroads, and airports, in pete with one another.the Czech Republic. In 1991 SSZ generated Kcs 2.3 billion Primarily as a result of the spin-offs, the total number(USS82.6 million) in sales, with the highway and road con- of employees at SSZwas reduced from 8,300 in 1989 to4,200struction sector accounting for the highest proportion of rev- by 1991. Some of these employees were re-deployed, butenue (60.4 percent). The enterprise focused almost exclu- those that were laid off received compensation payments ofsively on the domestic market, where it competed principally three to five months' salary, as provided by law. All layoffswith nine major domestic construction enterprises. were approved by the trade union.

In 1988, SSZ was converted from a national enterpriseinto a state enterprise as part of the govermment's first at- Sale Preparation and Negotiationstempts to improve the efficiency of state enterprises. This In 1989, SSZ's management began working on a long-termconversion removed a layer of bureaucracy between the man- development strategy for the enterprise. The prinary focusagement and the Ministry of Industry, SSZ's founding or- of this strategy was to prepare the enterprise for participa-gan, but had little effect on the enterprise's operations. tionin a market economy. By 1990 the SSZ managernent felt

After the 1990 Law on State Enterprises was enacted, that a foreign strategic investor was needed to improve theSSZ spun off two.operating divisions and some non-operat- enterprise's competitive position and hired Creditanstalt (Aus-ing assets from the core of the enterprise. (Both divisions tria) to identify potential investors.that were spun off were later privatized to domestic inves- In September 1991, Creditanstalt distnrbuted an Infor-tors through vouchers - although one was later sold to a mation Memorandum to 32 companies and invited them toforeign investor that purchased shares from voucher hold- submit, by the end of November, proposals for the acquisi-ers.) Although the spin-offs were carried out at the request tion of a stake in SSZ. Discussions were held with severalof the managements of the divisions, the decentralization was firms but only two made concrete proposals: EntrepriseJeansupported by the government, which launched a de-monopo- Lefebvre (France) and Bau Holding (Austra). Evaluation

Summary of SSZ-Enterprlse Jean Lefebvre Agreement Shareholder structurepercentage of ownership

Type of Company:Construction of roads, bridges, railroads, and airportsLocation:The company is located in PragueDate of Sale: July 2, 1992Sales (1993):Kc 2.842 million (US$94.9 million) (plus Kc 3.074 million, orUS$102.6 million in projects with subcontractors)Employment at Date of Sale:3,977Employment (May 1993):3.759 Shareholder Date of sale 12/31/92Name of Strategic Investor. O n 3Entreprise Jean Lefebvre (France) 2 Other 3.85 3.57Price Paid by Strategic Investor: * Enterprise Jean Lefebvre 15.15 51.01Kcs 100 million (US$3.5 million) for 15.15 percent of shares Voucher Holden 81.00 45.42Investment Commitment:Kcs 726 million (US$25.1 million) over three years

CAsE STuvY 16 CzEcH REuuc- SSZ -ENtrRiS JLEA lmwn 77

or the bids was based on written evaluation criteria. Timetable of Key StepsCreditanstalt reviewed both proposals and recommended thatJean Lefebvre be selected. SSZ agreed to identify Jean 190Lefebvre as the strategic investor in the "basic privatization vestor and hired Creditanstizt toeide tifyeed for a foreign in-project' submitted by the enterprise management. July 1991

Jean Lefebvre is a large construction firm specializing Creditanstalt sent an Information Memorandum to 32 poten-in roads, especially in quaLity asphalt surfacing. The company tial investors.also manufactures hydro-insulators and operates a number September 1991Arthur Andersen was appointed by Jean Lefebvre to restateof quarries.Jean Lefebvre has over 10,500 employees includ- SSZs financial statements In cormpliance with internationaling 7,000 in France. Its annual revenues exceed F6.5 billion accounting standards.(US$1.1 billion). November 1991

jeanLefebvre appointedArthurAndersen to restate te . The basic privatization project was submitted by SSZ to theJean Lefebvre appointed ArthurAndersen to restate the Ministry of Industry, and recommended Jean Lefebvre as thefinancial statements of SSZ in compliance with international strategic Investoraccounting standards. Provisions wtre made to reflect a re- April 1992duction in accounts receivable for doubtful receivables, and The basic project was approved.a reserve (based on the estimate of the environrmental audit) Syas transformed into a joint stock company.was set aside for the costs of environmental cleanup. The June 4, 992combined effect of the revisions was to reduce the company's The share purchase agreement was signed by Jean Lefebvrebook value from about Kcs 870 million (US$31.3 million) to and the National Property Fund for Jean Lefebvre's acquisi-Kes 660 million (JS$23.7 million). The revisions for inter- tion of a 15 percent stake in SSZ. Jean Lefebvre increased

its stake. effectve July 2, 1992, through a capital increase, tonational standards included a reduction in book value for 51.01 percent.the 10 percent reserve fund required under the Czech corn-merial code.

Since SSZ's operations had a considerable impact onthe environment and since the responsibility for environmnen- tiations with the National Property Fund, the SSZ manage-ta liabilities was a contentious issue in most privatization ment, and Jean Lefebvre on the share purchase agreement.negotiations, Jean Lefebvre hired Coopers & Lybrand to con- When all parties had agreed to the share purchase, theduct an environmental audit. (In the early privatizations, an project was passed on to the Economic Council of Ministersenvironmental audit was conducted only if initiated by the who inApril 1992 approved the project and authorized imple-foreign investor. In later privatizations, new government mentation.policy required an environmental audit for all enterprises that SSZ was transformed into a joint stock company on Mayinvolved a foreign investor.) Coopers & Lybrand was se- 4, 1992. The transformation included the split of the assetslected from a list of four firms approved by the Ministry of and liabilities. The operational assets and corresponding li-the Environment. The audit estimated that Kcs 100 million abilities were transferred to the new joint stock company (SSZ(US$3.6 million) would be required to cleanup the existing A.S.), while the social assets and liabilities not directly re-environmental damage. lated to the onerational assets remnained with the state enter-

Once SSZ had selected Jean Lefebvre as its prer-erred prise. However, some social assets had been spun off prior toinvestor. the SSZ management negotiated the initial terms transformation, including housing for employees and a re-of the deal. These terms were included in the basic sort hotel. The housingwas transferred free of charge to theprivatization project along with the bidding docuumernts and municipalities and the hotel was transferred to the Nationalevaluation criteria that had been used to sedectJean Lefebvre. Property Fund for re-sale.

In November 1991, the SSZ management submitted The share purchase agreement between jean Lefebvrethe basic project to its founding organ, the Ministry of In- and the National Property Fund was signed onJune 4,1992,dustry, which in turn passed it on to the Ministry of withanincreaseof sharesbecomingeffectiveonJuly2,1992.PrivaXtiton. A number of competing projects were also sub-nitted by outside imvestors, but all were for the purchase of Terms and Conditions of Saleindividual divisions or assets of SSZ rather than for the pur- Jean Lefebvre paid Kcs 100 million (US$3.5 million) to thechase of the enterprise as a whole. National Property Fund for 15.15 percent of the shares of

The Ministry of Privatization decided in favor of the SSZ. This trunsaction reflected a price equal to the revisedbasic proiect. Before passing on its recommendation to the book value of Kcs 660 milion (US$22.8 million) for the com-Economic Council of Ministers, the Minitry finalized nego- pany. The share structure called for 81 percent of SSZ shares

78 SEUIN Sim ComANw s mO SnmGc INvEwuros, VoLumF Two

to be sold to voucher holders and 3.85 percent to be set aside lnmncial Informnulonfor claims, including restitution claims. The sale agreement (In millions of kDruny)provided forJean Lefebvre's shareholding to increase to 51.01 19percent through additional capital investment.

In addition, Jean Lefebvre offered to give 1 percent of Income Sttementits 51.01 percent interest to both workers and managers (at NotSalw 1.950 2.016 n.a.

coats 1.820 1.916 n.a.no charge). These shares were to be distributed among the Gross Profit 130 100 n.a.employees according to their current salaries. Taxes 72 42 n.a.

Regarding environmental liabilities, Jean Lefebvre as- Not Profil 58 58 na.sumed 2.5 percent of the cleanup costs. The National Prop- Balance Sheeterty Fund accepted responsibility for the remaining environ- CurrentAssets na. 1,345 1,882mental liabilities, up to the amount of the purchase price of Plnt & Eqtipment n.a. 771 8t5OfrLong-Term Assets n.a. 437 248Kcs 100 million (US$3.5 million). Total Assets n.a. 2.553 2,945

Post-Privatization Current Liabies n.a. 982 1,419Bank Debt * nma. 47 31On July 2, 1992, immediately after completion of the initial Other Long-Term Uabilitas n.a. 120 170sale toJean Lefebvre, the shareholders voted to increaseJean Total Liablites n.a 1.1 a.: 1.62DLefebvrc's stake in SSZ to 51.01 percent via an increase in En.404 =the company's share capital. As a result, the total stake of Equity Capt n.m1the voucher holders was diluted from 81 to about 47 per-cent. It was agreed that Jean Lefebvre would pay 33.5 per-cent of the required amount in cash and that the remaining At the end of the voucher bidding process in the spring66.5 percent would be paid in the form din-kind contribu- of 1993, 94 to 96 percent of the shares allocated to thetions, which would include training and technology transfer. voucher program were sold. The remaining shares not pur-A certificate of value was subrmitted for thc in-kind contribu- chased were transferred to the National Property Fund. Attions. Jean Lefebvre has the option to increase its stake to the end of 1993, Enterprise Jean Lefebvre held 51.01 per-59 peicent by July 1994 through Kcs 243 million (US$8.4 cent of the shares, voucher holders held 45.42 percent, themillion) in increases in the share capitaL Jean Lefebvre ex- Restitution Fund (and individual claimants) held 2.12 per-pects to invest a total of Kcs 726 million (US$25.1 million) cent, and the remaining 1.45 percent was retained by thewithin the first four years of privatization. National Property Fund.

CANZ Stmy 16 CzaaH RWWUC: SSZ - E.MWnMJEW IEnu 79

CZECH REPuBLIC

SEVEROKAMEN - WIMPEY ASPHALT

Enterprise Status before Privatization Principally as a result of the spin-offs, the work force atSeverokdmen was the leading Czech producer of crushed Severokamen fell from 1,100 to 530, although there werestone used primarily in the construction industry. Originally some layoffs (about 5 percent) that were intended to improvecomprised of 30 quarries and controlling 85 percent of the efficiency prior to privatization.Northern Bohemian market in the Czech Republic, the en-terprise generated sales of Kcs 337 million (US$12.1 rnil- Sale Preparation and Negotiationslion) in 1991, its last full year before privatization. SeverokimenwasselectedbythegovernmenttobeincludedSeverokamen's major customers were the domestic construc- in the first wave of large-scale privatization. Beginning intion industry and the mining industry (crushed stone is used mid-1990, several investors approached the company.to fill in old mines); the enterprise's exports were negligible. The first set of negotiations was with the American min-

Severokimen operated as a sector enterprise, compris- ing conglomerate Vulcan, which had initiated discussions ining all production facilities in the sector, until 1988, when it July 1990. At the request of the Ministry of Construction,was converted into a state enterprse. Its founding organ was the Severolkimen management hired WmpeyAsphalt Invest-the Ministry of Construction, which was later integrated into ments Ltd. (Wumpey) to conduct a technical assessment ofthe Ministry of Industry. Later, as was pemitted under the Severokimen for the Ministry's negotiations with Vulcan.1990 Law on State Enterprises, 5 of Severokaimen's 30 quar- However, after six months of negotiations, Vukan withdrew,ries were spun off, at the request of their managers, to form citing (according to the Severokimen management) difficul-independent state enterprises. Although Severokimen's top ties in negotiating uith the Ministry of Construction.management was opposed to these spin-offs, the Ministry of Wimpeywas a large multinational construction companyConstruction approved the requests of the divisional manag- based in the United Kingdom, and had been in contact withers, as decentralization was in line with the govemment polcy Severokimen since the time its chief executive officer vis-of de-monopolization. ited the Czech Repubtic with an official delegation of British

Summary ot Severokinen-Wimpey Asphalt Agreement Shareholder structurepercentage of ownership

Type of Company:Producer of aggregates (crushed stone) for construction 100%Location:Headquartered in Liberec. the company has 18 quarriesnearbyDate of Sale:August 10, 1992Sales (1993):Kc 310 million (US$10.3 million)Employment at Date of Sae:_1,100Employmont (May 1993): Shareholder Date of se 12V3192530 Shareho __r Date d sa e 12_3tl92Name of Strategic Investor: Q Other 0.08 0.06Wimpey Asphalt Investments, Ud. (U.K.) Other Restitution 1.92 1.53Price Paid by Strategic lnvstor:£1.1 million (US$1.7 million) in cash for an initial 17.2 percent G RestitutionFund 3.00 2.40stake e Local Municipalities 3.28 2.61Invstment CommItnent: * Wimpey 17.20 34.00£5.5 million (US$8.3 million) over 10 years in know-hovi and * Voucher Holders 74.52 59.40other non-cash contributions

CASEsrjD 17 CzEcaH Hswuau SuvuoLANNu - Waezysiu 81

executives. By early 1991, when Vlcan withdrew from nego- governmnent guidelines or policies because none existed attiations, Wimpey had established a relationship with the the time. Androsch was therefore responsible for preparingSeverokamen management and had begun discussing a pos- the bid and developing the evaluation criteria. (The Ministrysible joint venture. Wimpey was interestcd in a joint venture of Privatization later issued guidelines on the tender processwith Scvcrokamen because of the commitment of enterprise which included the use of public announcements and closedmanagement to privatization, the high skills level of the envelope bids, but Androsch did not modify the proceduresenterprise's management and workers, and the potential for at that point.) The Severok4men management worked closelystrong markets in former Czechoslovakia and Germany. A with Androsch throughout this process, and they jointly de-senior Wimpey official took up pcrmanent residence in formcr cided to conduct a private rather than a public tender.Czechoslovakia to negotiate the transaction and was joired Androsch distributed a detailed information memoran-by another official who would manage the venture. dum to major international construction companies, includ-

While negotiations with Wimpey were under way, other ing Wimpey, Entreprise Jean Lefebvre (France), Lafargeforeign investors expressed interest in Severokimen, and the (France), Lohja (Finland), and Basalt (Germany). The bid-Ministry of Industry (which had absorbed the Ministry of ders were asked to propose the number of shares to be ac-Construction) decided that the privatization should be con- quired, the price to be paid, future investment, and strategicducted through a competitive tender in order to select the plans for the company.best investor. Both the Ministry of Industry and the DetailedevaluationcriteriaweredevelopedbyAndroschSeverokamen management - who were cooperating closely and the Severokimen management. Strictly on the basis ofat the time - questioned the intentions of potential inves- the written evaluation criteria, Lohia's bid scored just abovetors, since .t was clear that some were interested in acquiring Wimpey's, but since the scores were so close Androsch rec-Severokarmen only for its real estate and were not interested ommended that Severokamen continue negotiating with bothin maintaining the enterprise as a going concern. However, firms.the Severokimen management was concerned with the fu- Severokamen agreed, and began two months of intenseture of the enterprise and wanted a strategic investor that negotiations with Lohja and Wimpey These negotiations werewould strengthen Severokimen's position in its markets. managed by Androsch in cooperation with Severokimen

In accordance with the general recommendations of the management but without the involvement of the MinistriesMinistry of Privatization, the Ministry of Industry suggested of Industry and Privatization. Severokimen's major consid-to the Severokimen management that they recruit a foreign erations during the negotiations were investrnent comrnit-adviser to manage the bidding process, and the Ministry pro- ments, employment commitments, treatment of environmen-vided a list of some 20 possible firms. From this list tal liabilities, and know-how and technology transfers.Severokamen selected an Austrian firm, Androsch Interna- Duringthis phaseof negotiations, both bidders increasedtional Management Consulting (Androsch). InJanuary 1991 their proposed investment commitments and purchase prices.the consulting contract was signed between Androsch and Both agreed to a two-step acquisition process. In the firstSeverokamen. Throughout the process Androsch worked step, the strategic investor would purchase a minority stakeclosely with the Severok&nen management and had only su- from the National Property Fund (with three-quarters of theperficial contact with the Ministry of Industry. remaining Severokianen shares set aside for voucher hold-

At the timne that Androsch was recruited, Severokimen ers). In the second step, the strategic investorwould increasealso recruited Consultacio, anotherAustrian firm, to conduct its stake to a majority position through investment commit-a valuation of Severokanien. Consultacio reported to the ments which would increase the share capital of the corn-Ministry of Industry and Severokimen management through pany.Androsch. (The Ministry of Industry contributed half of the The offers were very sinilar, but Wimpey was selectedcost of the valuation and Severokafmen contributed one-quar- as the winning bidder in October 1991, when it became dearter of the cost. Wimpey and the other potential investors that Lohia had pressures in its domestic market that couldeach induded in their letters of intent a commitment to pay inhiit its ability to focus on Severokimen's development.the remaining 25 percent of the cost of valuation upon win- Several studies were conducted at this tirne. AtWimnpey'sning the tender.) The valuation, which was based on dis- expense, financial statements in accordancewith internationalcounted cash flow and took four months to complete, esti- accounting standards were prepared and audited by Coo-mated Severokaim.n's value at Kcs 253 million (US$9.1 mil- pers and Lybrand, (United Strtes). The auditing firm pro-lion), slightly below the enterprise's book value of Kcs 260 posed a 33 percent provision for doubtful receivables, themillion (US$9.3 mrilon). elimination of the estimated profit component of the

The process of identifying investors did not follow any company's work-in-progress, and the write-off of certain fixed

82 Swmi Smm ComNMs TO SmTnuc INvEsToRs, VOLUME Two

assets that were no longer produetive. Coopers & Lybrandalso prepared a valuation of the know-how to be invested byWimpey in the company. July 190

Wimpey also conducted a sector assessment of the quar- Vulcan Initiated discussions with Severokamen.rying industry in the Czech Republic and Germany. Thc cost Late 1990was partially funded by the British Know-How E:und. Sepa- Wimpeywas approached by Severokdmen to conduct a tech-

was partially .unded by the British Know-How Fund. Sepa- nical assessment; Vulcan withdrew from negotiations; Wrimpeyrately, Wimpey prepared a technical evaluation that assessed initiated negotiations with Severokamen.the condition of Severokamen's operational equipment in January 1991order to deternmine the replacement cost of the plant and Androsch and Consultacio were hired by Severokamen toequipment. act as financial advisers.equipment. ~~~~~~~~~~~August 31, 199

A legal audit was conducted by McKenna & Co. (Lon- Bids of potential investors were due by this date.don) on behalf of Wimpey. The two principal legal issues in October 1991this case were: (1) the restitution claims of former owners of Wimpey was selected as winner of the tender.

prpryused by Severokimen and (2) mfining rights. With October 31, 1991propenty used by Severokarnen and (2) mininB nghts. Wlth The basic privatization project was submitted, calling for theregard to mining rights, there were discrepancies under Czech sale of 22 quarries to Wimpey.law between mining law and land law on a number of issues, January 20,1992including the categorization of land held by agricultural and Competitive projects were to be submitted by this date.

foretry rganzatins,and herewas ncetainy wih reard April 29, 1992forestry organizations, and there was uncertainty with regard The Ministry of Privatization accepted the basic project.to both surface rights and the right to extract minerals. Leg- amended to include the sale of only 18 quarries to Wimpey.islation intended to resolve these issues was expected to be June 1,1992introduced into Parliament in earlyJune 1993. Although the SeverokAmen was transformed into a joint stock company.

August IZ 1992land issues had not yet been resolved, Wimpey intended to The National Property Fund and Wimpey signed a share pur-make its scheduled investment of Kc 11 million (US$367,200) chase agreement and Wimpey acquired a 17.2 percent stakein August of 1993. A permit issued by the Mining Authority for £1.1 million (US$1.7 million).(operated under the auspices of the Ministry of Economic September 1992Development) allowed the company to continue its activities Wimpey's stake was raised to 34 percent.despite the lack of resolution on land issues. Furthennore,the issue received attention from the National Property Fund,which provided a certain level of assurance to Winpey's se- The Severokmunen management argued against the sepa-nior management. ration of the 4 quarries. The County Privatization Comrns-

Also, in the summer of 1992 an environmental audit was sion also supported Wimpey's bid and had recommendedperformed by Arthur D. Little. that all 22 units be sold to Wtmpey. However, the Ministry of

In October 1991 the basic privatization project prepared Industry forwarded all of the projects to the Ministry ofby enterprise management was submitted to the Ministry of Privatization with the recommendation that the 4 units beIndustry for review and subsequent submission to the Minis- spun off and sold to Czech investors and that the remainingtry of Privatization. The basic project included the final bids 18 units be sold to Wmpey. Wimpey and Severolkmen there-of both Winpey and Lohja, the evaluation documentation, fore amended the basic project and reduced Wumpy's offerand the rationale for selecting Wimpey. It called for the price by Kcs 3.7 million (US$128,000).privatization of Severokamen as a single operating company The Ministry of Privatization reviewed the projects andwith 22 quarries. agreed with the Ministry of Industry's recommendation. The

By the deadline for submission of competing projects Severokimen management was not invited to the Ministryon January 20, 1992, the Ministry of Industry had received of Privatization during its review process but was given, forseveral proposals from both domestic and foreign investors review and comment, some of the competing projects sub-that had not participated in previous negotiations with mitted by foreign investors. In addition, Severokamen's ad-Severokimen. Domestic investors submitted projects calling viser, Androsch, was invited to a meeting with the Ministryfor the individual privatization of 4 of Severokimen's 22 of Privatization's advisers, the USAID advisory team, to ex-quarries. The Mlinisty of Industry supported these projects plain the selection process and the terms of Wimpey's pro-and informed Severokimen and VWimpey that their project posal, and to present the argument for sdeling all 22 quarrieswould have to be modified to exclude the 4 quarries, which to Wumpey.would be privatized separately. According to Wmpey and On April 29, 1992, the Ninistry of Privatization ap-Severokimen management, these 4 included 3 of the best proved the project with the sale of 18 quarries to Wimpeyquarries held by Severokimen. and 4 quaries to domestic investors. ScverokAimen was trans-

CASE ST=m 17 Czua Rrunuc: SmoUoaN -WDnmAsnwre 83

formcd into a joint stock company on June 1, 1992 and the Financll Informaionshare purchase agreement was signed by Wimpey and the an mflons of koruny)National Property Fund on August 12, 1992. 1990 1991 1992 1993

Terms and Conditions of Sale Income StatementWimpeypaid £1.1 million (US$1.7miUion)incashfora 17.2 NotSales 252 337 289 310percent stake in Severokimen. Following Wimpey's purchase, cosot 245 3i22 263 33SeverokAmen's shareholder structu.e was as follows: (1) Taxes 4 15 3 0Winpey received 17.2 percent; (2) the Restitution Fund held Net PIoM 3 7 3 (33)4.92 percent (3 perment was required for all privatizations Balance Sheetand another 1.92 percent was transferred for specific land Plant & Equipment 355 365 268 279claims thatwereexpected to ariseforSeverok6men); (3) 328 OtherAssets 123 167 198 168percent was transferred to the local governments to cover TotalAssels 478 532 466 447

past and future claims regarding relocation costs incurred Bank Debt 73 21 41 33during the development of new quarries: (4) niscelaneous Other Liabiliftes 405 146 391 32parties received 0.08 percent of the shares; and (5) 74.52 Total Uabilffls 478 167 432 65percent was transferred to the National Property Fund for Eqtity Capital - 365 34 382

sale through the first wave of the voucher program.As part of the sale contract, Wimpey made a commit-

ment to invest a total of £5.5 million (US$ 8.3 million) overa period of ten years, particularly in the areas of capital ex-penditure and technology transfer, the latter including pro- chased for an amount up to 50 percent of the purchase pricefessional traiing for Severokamen management. This invest- paid. Expenditures as a result of environmental damage werement would raise Wunpey's shareholdings to 60 percent and not expected to exceed the sale price. As of May 1993,would thus give majority control to Wlnpey while diluting Wimpey-Severokamen had submitted one invoice for itsthe stake of other shareholders. The share purchase agree- deanup efforts to the National Property Fund.ment stipulated the fornula for crediting in-kind investmnent, Regarding employment comrnmitments, the contract stipu-which was to be valued by an independent fimi. lated that the total number of employees would not fall be-

According to Wimpey, the contract signed by the Na- low 450.tional Property Fund provided assurances to Wimpey thatSeverokimen held free and dear title to the property, and Post-Privatizationthat Severokamen had the requisite authority to develop the MARxET POSMON Sales increased in 1992. (The financialquarries. Wimpey could withdraw and abrogate the contract data show a reduction from Kcs 337 miElion, or US$12.1 mil-if the courts found either to be incorrect. In addition, the lion, in 1991 to Kcs 289 million, or US$10 million, in 1992,National Property Fund agreed to make every effort to en- but the 1991 results reflect the performance of the quarriessure that any person claiming restitution of land for which thatwereseparated.)Asof mid-1993,Wunpey-SeveroklimenWirnpey had a mineral extraction permit would be offered controed about 65 percent of the market for crushed stonealternative land under Article II of the Land Act No. 229 of in the Northern Bohemian region of the Czech Republic.1991. This represented a decrease of 20 percent from the company's

As Severokicmen's operations had a significant impact position before privatization. However, the company in-on the environment, potential environmental liability was i creased export sales to Germany, where the company ex-critical factor forWimpey. As part of the negotiations for the pected to seUl approximately 250,000 to 300,000 tons ofsale contact, the environmental obligations reating to the crushed stone. In mid-1993 the company was price competi-depleted quarries were retained by the original state enter- tive, but export viability would depend primarily on trans-prise - now controlled by the National Property Fund. The port costs which were rising.depleted quarries needed to be filed in and covered withgrass and trees. (Severokimen had estimated the cost of the SHUE INCREASE Within one month of the initial purchase (inemvirounental restoration at Kcs 10 million, or US$346,000.) September 1992), Wnipey had increased its shareholdingsIn addition, the share purchase agreement stipulated that the to 34 percent as a result of £1 million (US$1.5 million) inNational Property Fund would reimburse Wnimpey for any investment in the form of know-how.environmental cleanup costs relating to the quarries pur- By late 1992 the first wave of the voucher privatization

84 SzumG SmArs Commisso Smuwc b:v sromus Vowu= Two

program (which included the Severoksmen shares) was com- to restitution clairns had not yet begun to compile lists ofpleted. claims submitted, and Severokimen was of the opinion that

it might be several years before the restitution issues wereORGANIZArIONAL REsTRuCTURING Wtmpey organized train- finally resolved.ing programs, particularly in sales and marketing, asSeverokimenwas initially incurringlosses on its German sales OrR SEcTOR IssuES Asof mid-1993, the Severokimen stateby not implementing adequate credit controls. Less techni- enterprise responsible for restoring the three depleted quar-cal training was needed than had been expected because the ries had only one director and no other employees. The Min-high level of engineering skills in Severokimen. Technologi- istry of Industry, the company's founding organ, was negoti-cal change was not deemed necessary as long as labor re- ating with the National Property Fund for assistance in fund-mained relatively inexpensive. In addition, substantial im- ing the cost of cleanup.provements in efficiency were generated by more rational The four quarries not purchased by Wimpey weredeployment of assets. privatized: one was awarded to a restitution claimant, two

were sold to the Union of Local Entrepreneurs, and one wasRESlTr=rIoN CLAIMs The deadline for submission of restitu- purchased through a management buyout. According totion claims was January 1993. However, as of May 1993 the Wrmpey, as of mid-1993 not all were profitable and Wimpeysupervising body responsible for resolving disputes related was hoping to eventually buy the quarries.

CAsE STOD 17 CzECH REupuuc: SEVEoKhAN - WImY ASPHALT 85

CZECH REPUBLIC

CENTROPEN - NOVOTNY/MANAGEMENT

Enterprise Status before Privatization 'de-monopolized" and Centropen was established as an in-Centropen was one of the largest produccrs and importers dependent state enterprise with the Ministry of Industry asof writing instruments and office supplies in former Czecho- its founding organ. Centropen's separation from the parentslovakia and controlled approximately 90 percent of the mar- company came at the request of its management, which rec-ket in 1990. The enterprise had also developed a significant ognized that the companywas subsidizing less profitable firmspresence in Western markets, where its primary customers in the division, and which believed that Centropen could bewere regional wholesalers. Exports accounted for 55 percent a viable enterprise on its own. This separation procedureof Centropen's sales. The enterprise's primary export mar- involved Centropen's clearing all outstanding receivables andkets United Kingdom, France, Germany, Egypt, and pavables with the parent company. On December 1, 1990,Canadr itropen had representatives in over 20 countries Centropen was transformed into a joint stock company, 100and employed 600 people. percent owned by the state. (The remaining eight companies

In its last full year as a state-owned enterprise, Centropen in the Hardmuth division were privatized through the vouchergenerated Kcs i86 million (US$6.6 million) in sales. privatization program.)Centropen's products were considered of high quality. The No formal restructuring program was undertaken inenterprise imported many key supplies from Western Europe preparation for privatization, but Centropen transferred aand elsewhere: felt tips were imported from Japan and color kindergarten free of charge to the municipality and sold itsdyes from Germany. Centropen's market position began to employee apartments to the tenants.fal after the liberalization of the Czech economy in 1989and the subsequent entrance of foreign competitors, prima- Sale Preparation and Negotiationsrily from other Western European countries and fromJapan, After successfully establishing Centropen as an independentKorea, and Taiwan. state enterprise, the management decided to initiate

Until 1990 Centropen was one of nine frms comprising privatization in order to bring in new capital and to sharpenthe Hardmuth division of the state conglomerate Koh-i-Noor. the enterprise's competitive edge. Upon the reconmmenda-Under the 1990 Law on State Enterprises, Koh-i-Noor was tion of Centropen's management, the enterprise was named

Sumnary of Centropen-NovotnyAlanagement Agreement Shareholder structurepercentage of ownership

Type of Company:Manufacturer and importer of pens and other writing instru- 1 0%mentsLoration:One factory located in Daci^eDate of Sale:October 29, 1992Sales (1993):Kcs 269 million (US$9 million)Employment at Date of Sale:600Employment (May 1993): So600 Shareholder Date of sale 12131/92Name of Strategic Investor: 2 For Other Restitution Claims 2.5 2.5Mr. Milan Novotny (Czech Republic) and Management Nat' Property Fund-Restitution Fund 3.0 3.0Price Paid by Strategic Investor:Kcs 100 million (US$3.5 million) . * Mr. Novotny for Restitution Fund 3.0 3.0Investment Commitment: 3 Employees 5.0 5.0None * Mr. Novotny and Management 8665 86.5

CASE STUDY 18 CzBCH REPUBLC: CErmoPzN - NoVatNY/MANAGEMENT 87

by the Ministry of Privatization for the first wave of large- Timetable of Key Stepsscale privatizations.

The Centropen management decided initially to propose January 1, 1990.iaztntrgo. H r, t Centropen was separated from Koh-i-Noor and becamo anprivatization through a management buyout. However, the independent state enterprise.

management felt that the probability of having their project December 1, 1990approved as a management buyout was unlikely, as the pre- Centropen was transformed into a joint stock company.dominant public opinion at the time favored privatization October 1991

The basic privatizatlon project and two competing projectsthrough vouchers or through trade sales rather than sales to were submitted to the Ministry of Industry.existing managers. In addition, the management discovered January 1992that there were viable competing projects under preparation The Ministry of Industry submitted the projects to the Ministry-one by an Austrian competitor (Joly) and the other by a of Privatization with ? recommendation favoring the Novotny/

Management project.restitution claimant, Mr. Milan Novotny, an expatriate Czech May 1992businessman and the son of the original founder of The Novotny/Management project was approved by the Min-Centropen. istry of Privatization.

The Centropen management assessed the possibility of June 26,1992preparing a joint bidwithvatiousins , i g te The Novotny/Management project was approved by the Eco-

preparing a jomnt bid with various investors, including the nomic Council of Ministers.German firm Faber Castell and the two investors preparing June - September 1992competing projects. However, some members of the Final negotiations were conducted on the share purchaseCentropen management were not in favor of preparing a joint agreement.

September 1992bid with a strategic investor and preferred to privaize the The share purchase agreement was signed by the Nationalenterprise through the voucher program. Therefore, the 'ba- Property Fund and Novotny/Management.sic privatization project" submitted by Centropen proposed October 29,1992the sale of 97 percent of Centrpen's shares to voucher hold- Novotny and Management made full payment to the Nationalers with the standard 3 percent to be retained by the Restitu- Property Fund.tion Fund.

However, not all of the Centropen managers were inagreement and some favored a sale to a strategic investor In October 1991 the basic project and the two compet-over privatization to numerous voucher holders or invest- ing privatization projects were submitted to the Ministry ofment funds. The privatization legislation allowed for 'com- Industry, Centropen's foundingorgan. During the Ministry'speting projects," or proposals separate from the basic project review, Mr. Novotny and the Centropen managers were in-submitted by the enterprise management. vited to discuss their proposal. The Ministry of Industry sub-

Those Centropen managers who preferred a sale to a mitted the projects to the Ministry of Privatization in Janu-strategic investor decided to submit a competing project ary 1992, with a recommendation favoring the Novotny/joindy with one of the strategic investors. The managers de- Management project.cided to work with Mr. Novotny, primarily because they felt After reviewing the three projects, the Ministry ofthat a domestic investor was preferable to a foreign one and Privatization agreed with the recommendation of the Minis-that collaboration with Mr. Novotny would give them rela- try of Industry in favor of the Novotny/Management project.tive managerial freedom. The Novotny/Management project The Centropen management felt that their proposal had beeninduded a business plan and a shareholder structure in which accepted over the Joly proposal for several reasons, incdud-Mr. Novotny would have the majority stake. A second com- ing concem thatJoly intended to use the Centropen facilitypeting project was prepared by the Austrian firm Joly. injoly's other operationswhich had high envirornmental risks.

The company's financial statements were audited by a While it is not dear if this was the case, the Novotny/Man-local independent audit company, but a fuU valuation was agement project was accepted and the Ministry ofnot conducted, since the sale was to local investors and the Privatization forwarded the project, without change, to thesale price was determined on the basis of Centropen's book Economic Council of Ministers, which approved it on Junevalue. Centropen paid for the financial audit. 26, 1992.

In addition, Centropen's labor unions, after reviewing After the project was approved, final negotiations werethe privatization proposals, held a general meeting with the held with the National Property Fund, the Ministry ofemployees to discuss the proposals. The unions gave com- Privatization, Mr. Novotny, and Centropen management. Thements on the proposals but did not express support for ei- purchase price was determined onthe basis of the enterprise'sther proposal. unadjusted book value, since the buyer was a domestic in-

88 SEruu STATE COMPANES TO S1maEGIc IwsroiS, VOLUME Two

vestor. Under the policy of the Ministry of Privatization, do- Financial Informationmestic investors were permitted to buy privatized companies (In millions of koruny)at book value, while foreign investors were required to pay.market value," which often turned out to be lower than book 1991 1992 1993valuc. Centropen raised this point, arguing that the purchaseprice should have been reduced to reflect uncollectible re- Income StatementNet Sales 186 245 269ceivables and other assets of marginal value. However, the costs 143 204 243Ministry of Privatization adhered to a price based on the Gross Proft 41 41 26company's book value. Taxes 23 23 11

!nitially, Centropen was informed that the Ministry of Net Profit 18 18 15Economic Competition would have to review the company Balance Sheetand the project and provide a letter of no objection to the Current Assets 80 207 96Plant & Equipment 84 100 105privatization, but this requirement was later dropped, per- Other Fixed Assets 0 0 100haps in part because of existing competition from other plants Total Assets 164 307 301of the former Hardmuth divisions and from imports. Bank Debt 31 52 57

In September 1992 the share purchase agreement was Payable to State Enterprises 5 9 0signed by the National Property Fund and the Novotny/Man- Other Current Uabilities 6 12 20

Bank Debt 15 109 87agement consortium. On October 29, 1992 the consortium Other Long-Term LUabilities 6 7 4made full payment to the National Property Fund. Total LiabilIties 63 189 168

Terms and Conditions of Sale Equity Capital 101 118 133The Novotny/Management consortium purchased 86.5 per-cent of Centropen's shares for a total of Kcs 100 million NOTE: The pu.chase of the company was financed by a bank loan.(US$3.5 million). Since the investors were Czech, no mini-mum investment commitment was required. The acquisitionof Centropen was financed by a loan taken from a state-ownedCzech bank and payable over six years. The new owners of Centropen also agreed to continue

The Novotny/Management group acquired 86.5 percent the operation of a network of natural gas distribution linesof the shares with Mr. Novotny holding a majority stake. The built by the company in the 1980s for its own needs and thoseremaining shares were distributed as follows: 3 percent to of the municipality. In addition, the company cafeteria, withthe Restitution Fund; an additional 3 percent to Mr. Novotny a book value of Kcs 12 million (US$415,200), remained asfor his restitution claim; 2.5 percent to otherrestitution claims; part of the company's assets.and 5 percent to employees. No shares were ;ct aside for No warranties were included in the contract regardingsale to voucher holders. clear tide of land or property, but the Centropen manage-

The transfer of 5 percent of the shares to employees was ment did not consider this a issue.the maximum amount allowable by the Czech CommercialCode. The employee shares were reserved for 30 key em- Pos-.Privatizationployees and managers who were agreed upon at a sharehold- As of May 1993, Centropen's domestic market share for writ-ers' mreeting after privatization. As was specified in the Com- ing materials and office supplies had fallen from 90 percentmercial Code, these employee shares were not tradable out- to 60 percent, as the company lost market share to foreignside .f the company. competitors.

CASE STUDy 18 CzEcH REPUBUC: CENtopEN -NovoTY/MAwNmN 89

CECICH REPUBUC

ELEKToSIGNAL - MANAGEMENT

Enterprise Status before Privatization Pardubice. In 1990, under the Law on State Enterprises,Elektrosignal was the monopoilyproducerof civilian and mili- Elektrosignal became an independent state enterprise withtary airfield lighting and signaling systems for the the Ministry of Industry as its founding organ.COMECON market. Almost half of its sales were to the No formal restructuring program was undertaken informer Soviet Union. During the past 30 years the enterprise preparation for privatization, but between 1990 and 1992had supplied over 600 airports in the former Soviet Union. the total number of employees declined by 30 percent, fromAccording to the Elektrosignal management, the enterprise 500 to 350 (primarily as a result of attrition).was perforfming well and had a strong financial position upuntil 1990. Sale Preparation and Negotiations

Elektrosignal's financial position began to deterorate The Elektrosignal management's privatization strategy waswith the onset of economic liberalization in 1990. The topurchasetheenterprise themselvesthroughamarkagemententerprise's market share in the Cormonwealth of Indepen- buyout and then enter into a joint venture with an alreadydent States (CIS) fell to about 45 percent by 1990 and to 5 identified foreign partner. This would allow management topercent by 1992. This decline was primarily due to the break- purchase the enterprise at book value rather than the higherup of the former COMECON narkets and the growing pres- "market value" that a foreign investor would have to pay Allence of foreign competitors, primarily Siemens (Germany), of the enterprise's equipment had been fullydepreciated andIdrnan (Finland), and Thorn (United Kingdom). Sales were the book value was therefore very low (Kcs 45 million, orako significantly affected by the steep reduction in domestic US$1.6 million). In addition, the creation of a joint venturemilitary spending. would allow an investor to put capital directly into the enter-

Elektrosignal was founded as - -ivate company in the prise rather than into the state treasury. Finally, this strategynineteenth century but was nationalized followingWorldWar conformed with the demands of the potential investors, whoIIand operated asa division of a large sector enterprise, Tesla were not interested in acquiring all of the assets of

Summary of Elektrosignal-Management Agreement Sharhioder structurepercentage of ownership

Type of Coampony.Manufacturer of airfield lighting devices, traffic signals. andaudio equipmentLocaion:One factory located in PragueDate of Sale:December 1. 1992Sales(1993):Kcs 164 million (US$5.5 million)Employment at Dat of Sale:350Employment2(May993): Sharehoder Dateof Sale 12(31/92 12131/93

Name of StrategIc Investor 2 VEGA 0.0 0.0 25.04Elektrosignal A.S. (Czech Republic) * Individual Investors 0.0 0.0 50.00Price Pald by Strategic InvestorKcs 31.5 million (US$ 1.1 million) U Elektrosignal A.S. 100.0 100.0 24.96Investment Commitment:None

CASE STUDY 19 CzECB Rmwuc: EURmOSIGNAL- MANACEMENT 91

Elektrosignal but wanted to create a joint venture in which Timetable of Key StepsElektrosignal would contribute only its technical expertiseand its access to Eastern markets. 1990

In 190 svera Euopea fim hadshon aninteest A letter of Intent was signed for a joint venture betweenIn 1990 several European firms had shown an interest Telefunken and Elektrosignal.in establishing a joint veirure with Elektrosignal. The enter- spring 1991prise management had decided to work with a German firm, Elektrosignal was selected for the first wave of large-scaleTelefunken Systemtechnik GmbH, which signed a letter of privatization.

intet in199 forthe reaion f a oin venure ith October 1991intent in 1990 for the creation of a joint venture with Privatization projects were submitted to the Ministry of Indus-Elektrosignal, with majority control to be held byTelefunken. try.This joint venture was expected to build new production fa- July 1992cilities. Telefunken withdrew from the proposed joint venture with

Since Elektrosignal was to be sold to Czech citizens, a Elektrosignal.Since ~~~~~~~~~~~~October 1992valuation was not required by law and the book value was The project calling for direct sale to Elektrosignal A.S. wasused as the basis for the sales price. However, during its joint approved by the Council of Ministers.venture negotiations with Elektrosignal A.S., Telefunken had Deember 1, 1992

The share purchase agreement was signed with the Nationalrequested and paid for an asset-based valuation of equip- Property Fund.ment, land, and buildings. Although the land was considered Mamh 15,1993far more valuable than the book value of the firm, This date was given as the initial deadline for payrment to theElektrosignal faced the possibility of being forced to leave its National Property Fund.Prague premises because of the municipality's plans to build ne 0 to this date was given for payment to the Na-a highway through the site. In addition, an environmental tional Property Fund.audit was prepared by a local Czech firm. They estimated August 30,1993the cost of the cleanup of soil damage at Kcs 1.7 million New investors were found for the company. Share capital was

increased to Kcs 15.2 million (US$507,000).(US$61,100). January 5, 1994In spring 1991, at the request of the Elektrosignal man- An agreement was signed with the National Property Fund

agement, the enterprise was chosen by the Ministry of on payment terms. Payment was to be made in four annualPrivatization for the first wave of large-scale privatization. As installments beginning on October 31. 1994.was required under the privatization legislation, theElektrosignal management prepared a 'basic project." How- In October 1991 the Ministry of industry reviewed theever not all of the enterprise managers were in agreement as basic and the competing privatization projects and passedto the best management buyout strategy. The basic project them on to the Mdinisty of Privatization. The Ministry of In-submitted by the enterprise called for the transfer of 47 per- dustry recommended the selection of the competing projectcent of the shares to the enterprise management, 50 percent and the Ministry of Privatization agreed. According to theto the voucher holders, and 3 percent to the Restitution Fund. Elektrosignal AS. managernent, the Ministry of PrivatizationSome of the managers felt that they could still obtain major- agreed with management that future negotiations with a jointity control of Elektrosignal if the basic project were imple- venture partner would be facilitated by a smal number ofmented, since privatization by vouchers would represent the shareholders rather than the a large number of individualsale of shares to many individual investors, and to invest- voucher holders and investment funds.ment funds. Since the project was a direct sale, it had tobe approved

However, other Elektrosignal managers felt that it would by the Economic Council of Ministers. The final review andbe better to create a new joint stock company, which would approval were delayed because projects containing voucherpurchase the enterprise. All Elektrosignal employees and sales were given priority over direct sales, and the vouchermanagers were offered the opporunity to participate in the program was to be launched in the spring of 1992. In mnid-establishment of the new company, but only 50 chose to do 1992 the review process was further delayed by the replace-so. They were joined by 10 investors from the community. ment of the Economic Council of Ministers with the CircleThese 60 Czech citizens equally contributed to the Kcs 1 of Ministers (comprised of fewer ministers) and the intro-million (US$35,900) that was the minimum capital base for duction of new guidelines for direct sales.a joint stock company. It was intended that the new joint However, between this time and the completion of thestock company, Elektroignal A.S., ubould purchase all th- sale, Elektrosignal's export markets had declined and its fi-shares of the state enterprise. This alternative proposal was nancial situation had deteriorated, and the company wasprepared as a 'competing project." unable to meet all of the conditons in the letter of intent. In

92 SEmNG ST= Comp mas Iro STaIxc INvEsroRs, Vouia Two

July 1992 Telefunken withdrew from the proposed joint ven- Financial Informationture. (in rillions of koruny)

Nevertheless, the salc was finally approved in October 1 1 1 19931992 by the Circle of Ministers. Negotiations were finalized -_ _____t992_1993with the National Property Fund and, on December 1, 1992, Income Statementthe share purchase agreement was signed. Net Sales 86 79 70 164

Costs 74 76 65 161Gross Profit 12 3 5 3

Terms and Conditions of Sale Taxes 9 3 1 2Elektrosignal A.S. bought the assets of Elektrosignal for Kcs Net Profit 3 - 4 1

31 million (US$1.1 million). The value was determined by Balance Sheetsubtracting Kcs 14 million (US$484,400) of unsalable inven- Current Assets 123 127 125 133tory of military equipment from the book value of the com- Plant & Equipment 2 1 1 1

Other Long-Term Assets 2 27 25 25pany (Kcs 45 million, or US$1.6 million). The initial pur- TotalAssets 127 155 151 159chase was financed in part by a commercial bank loan, forwhich the first payment was due March 30, 1993. Payable to State Enterprises 20 58 67 57

Current Bank Debt 57 1 0 7 0Although the National Property Fund initially wanted Other Current Uablllties 20 11 49 61

the ful price paid at once, an agreement was reached allow- Bank Debt 0 32 27 21ing Elektrosignal A.S. to pay in installments, with the full Other Uabilities 0 0 0 2amount due by March 15, 1993. The share purchase agree-ment called for penalties and nullification of the contract if Equty Capital 30 44 1 18the payment was not made by that date.

The purchase agreement stipulated that the cleanup costbased on the environmental audit would be covered by theNational Property Fund.

liquidated or returned to the National Property Fund.Post-Privatization During this time, Elektrosignal's production continuedIn December 1992 Elektrosignal entered into a joint agree- to decline, primarily because of the dramatic cuts in militaryment wi.h another investor - a former German client. The spending on the part of the former COMECON countries.German firm was interested in having access to Elektrosignal's Accordingly, the company was forced to discontinue produc-technology to enable it to compete with Telefunken and Si- tion of its mobile airport lighting systems, which reduced ca-emens, particularly in the German market. The agreement pacity utilization even further. By mid-1993 declining salescalled for the German firm to invest DM 2 million (US$1.2 had forced Elektrosignal to reduce employment from 350 inmillion) to cover the purchase price paid by Elektrosignal 1992 to 230.AS., and a further DM 3 million (US$1.9 million) to reduce As of June 1993, identification of a strategic investor -Elektrosignal's debt and to finance needed investment. the crucial second step in Elektrosignal's privatization strat-

However, in March 1993, before completion of the joint egy - had not yet been achieved. The Elektrosignal man-venture, the potential investor withdrew from the transac- agement was involved in negotiations with two potential in-tion because of Elektrosignal's deteriorating financial condi- vestors, one Czech and the other Russian. However, in Au-tion, which would require a total investment of DM 7 to 10 gust 1993, company management completed negotiationsmilion (US$4.1 to 5.8 million), and also because of the with several investors. Company management sold 25.043company's unclear title, resulting from the impending high- percent of the company for Kcs 3.8 million (US$127,000) toway construction, for which Elektrosignal could incur sig- VEGA s.r.o., a Czech trading company specializing in distri-nificant relocation costs. bution of magazines, and another combined 50 percent to

On March 15, 1993, Elektrosignal AS. was unable to four Czech and two Russian individuals, who individuallymeet its payment due and the National Propety Fund granted bought shares in the company. The company founders re-an extension to June 30, 1993. If Elektrosignal could not tained the remaining 24.95-i percent. On January 4, 1994secure an investor or alternative financing before June 30, the company signed a revised agreement with the National1993, it was at risk of being unable to make its payment to Property Fund for four annual payments beginning on Octo-the National Property Fund and the company could then be ber 31, 1994.

CASE SrUDIr 19 CzEcH REmnuc ELEKIROSGNAL - MNAGEmENT 93

SLOVA< REPUBLIC

TATRAMAT - WHIRLPOOL, QUASAR

Enterprise Status before Privatization The first step was to privatize the entire state enterpriseTatramat was a state enterprise that manufactured and dis- through the voucher program, whereby shares in Tatramattributed several types of products: washing machines, dish. would be available for purchase in exchange for voucherswashers, and microwave ovens; water heaters; and tools and held by *ndividuals or domestic investment funds. (Vouchersdies and hot and cold drink vending machines. The com- could be purchased by all resident nationals for a nominalpany was based in the Slovak Republic and operated with administrative fee.) The process would allow the Tatramatthe Ministry of Economy as its founding organ. management to maintain effective control of the company,

Tatramat supplied 75 percent of the markets in the Slo- owing to the widespread ownership of vouchers. and enablevak Republic and 60 percent of those in the Czech Republic. enterprise management to implement the second step, whichDomestic competition was limited to five small companies, was the creation of joint ventures with strategic investors.one in the SlovaK Republic and four in the Czech Republic. However, preparation for the voucher privatization occurredIn 1991, the enterprise's last year before privatization, simultaneously with the negotiations over joint ventures.Tatramat's sales amounted to Kcs 1.126 billion (US$40.4 Initially, the enterprise was interested in negotiating sepa-million). Tatramat exported 22 percent of its production to rate joint ventures for each major product line: (1) washingthe former COMECON market. machines, dishwashers, and microwave ovens; (2) tools and

dies and vending machines for hot and cold drinks; and (3)Sale Preparation and Negotiations electric and gaswaterheaters.Asearlyas 1990, the TatramatTatramat's management began preparation for privatizaucn management had contacted several foreign investors regard-of the enterprise in 1990. Their goal was to negotiate wit}, ing possible joint ventures. However, after initial discussionsforeign partners as a private entity rather than through the with potential investors, the Tatramat management decidedgovernment. Therefore, in preparing its basic privatization that the company's assets should be divided into its threeproject, the Tatramat management designed a two-step main product lines. Production of washing machines wouldpnrvatization strategy. be spun off into one joint venture and manufacture of spe-

Summary of Tatramat-Whiripool, Quasar Agreement

Shareholder structure (Joint Venture 1) Shareholder structure (Joint Venture 2)percentage of ownership percentage of ownership

100% 100%

Shareholder Date of sale 12131/92 Shareholder Date of sale 12/31/92

a Quasar 18.0 18.0 0 Whiripool 22.0 43.0* Tatramat A.S. 82.0 82.0 * Tatramat A.S. 78.0 57.0

CASE SrTU 20 StovAIC RE'unuc: TATAMAT - WHILPOOL, QU5As 95

Shareholder structure (Tatramat A.S.) Summery of Tatramat-Whiripool, Quasr Agreementpercentage of ownership Type of Campmny:

00% I IManufacturer of washing machines. water heaters, tools anddies, and vending machinesLoction:The company is located in Poprad in the High Tatra Moun-tainsDate of Sale:May 12. 1992, joir.t venture with Whirlpool: Ju., 1, 1992. jointventure with QuasarSalas (1992):Kcs 667 million (US$23.1 million)

Shareholder Date of sale12/31/92Employment at Date of Sale:Shareholder DRt ofsale 12l31192 1.300

F Company Management 0.0 16.0 Employment (May 1993):2 Restitution Fund 3.0 3.0 Tatramat A.S.: 790; Whirlpool Joint Venture: 570; Quasar Joint

Venture: 95* National Property Fund 18.0 0.0 Names of Strteglc Investors:* Voucher Holders 79.0 81.0 Whirlpool (U.S.), Quasar (Italy)

Prices Paid by Strategic Investors:Both Whirlpool and Quasar contributed "non-cash assets'such as technology and licenses for their shares in the jointventures

cialty tools and dies into another. Tatramat decided to retami Investment Commitment:the manufacturing of water heaters since it felt that it ceuld None

manufacture the water heaters competitively on its own.

Tlatramat also decided to retain the parts manufacture and Terms and Conditions of Saleservicing for all of its former products. VOUCHER PRIVATIZATION For the voucher privatization, the

Outlinecd below is the final structure for Tatramat AS. company hired Coopers & Lybrand to conduct a financial

and its joint ventures. audit covering Tatramat's operations. The book value of the

company was established at Kcs 445 million (US$15.9 mil-

(1) Tatrarnt A.S. lion), calculated on the basis of an initial book value of Kcs

Water heaters and servicing 535 million (US$19.1 million) less Kcs 90 million (US$3.2

50% of assets million) in 'non-productive" assets.

On October 1, 1990, the enterprise was transformed into

(2) TatramatA.S. /Whirlpool a joint stock company, Tatramat A.S., with a share capital of

Washing machines, dishwashers and ovens Kcs 445 million (US$15.9 million), based on the Coopers &

35% of assets Lybrand financial audit.

In fall 1991 the Tatramat management submitted its 'ba-

(3) Tatramat LS. / Quasar sic privatization project" for apprwval by the Slovak Ministry

Tools and dies,vending machines of Privatization and the Slovak National Property Fund. The

15% of assets plan called for 79 percent of Tatramat's shares to be sold to

voucher holders, 18 percent to be held by the Slovak Na-

Since Tatramat was one of the first enterprises desig- tional Property Fund (for various purposes, including envi-

nated by the Ministry of Economy for inclusion in the first ronmental liabilities), and 3 percent to be given to the Resti-

wave of large-scale privatization and was one of the first tution Fund.

privatizations initiated in the Slovak Republic, the The retention of shares by the National Property Fund

privatization came at a time when the Ministry of Privatization as compensation for assuming environmental liabilities was

and the National Property Fund were just becoming estab- related to the past production of washing machines. This ar-

lished. Therefore, when Tatramat approached the newly rangement was determined during the negotiations for the

formed Slovak Ministry of Privatizationwithits proposal, the Whirlpool joint venture. It was anticipated that, if the Na-

enterprise management had litde difficulty in getting its 'ba- tional Property Fund were obliged to pay any cleanup costs,

sic project" approved. Furthermore, both government insti- the Fund would sell its shares on the stock market. In the

tutions agreed to let the Tatramat management represent the interim the Fund had assigned to the company the right to

interests of the state in negotiating the transactions. represent the Fund as owner of the minority shareholding.

96 STaUNG STATE CoMrANIs TO STRATEGIC INvEsTois, VOLumz Two

On May 18, 1992 the frst round of bidding for vouch- Timetable of Key Stepsers began, with Tatramat included in the voucher program.(The Tatramat/Whirlpool joint venture had been signed just 1990

sixday calic, o My 1. n jont entrchad received Tatramat's management became interested in privatizing andsix days earlier, on May 12. The joint venture had received finding foreign Investors.national publicity the week before when the President of Fall 1990Czechoslovakia visited the plant.) Tatramat was selected for Inclusion in the first wave of large-

Fifty percent of the Tatramat shares was sold to local scale privatization.investrnent funds and the balance to individuals. In 1993, Octobr 1, 1990Tatramatwas transformed intoaiointstockcompany(Tatramatcompany management bought the 18 percent holding from A.S.).the National Property Funrd (paying the amounts owed in Early 1991installments). To partially finance the purchase, management Tatramat hired financial and legal advisers to assist in thesold 2.25 percent of the shares to investment funds. negotiation of joint ventures.Fall 1991

JOINT VENTURES Whirlpool Joint Venture. Initially, Tatramat submitted a basic privaization project to the SlovakTatramat hired Interconsult, a Slovak state-owned firn, to Ministry of Privatization and the Slovak Naftonal Property Fundprepare a valuation of the assets to be contributed to the calling for privatization through vouchers.washing machine joint venture. Interconsult estimated the May 12,1992Tatramat entered into a joint venture with Whirlpool Interna-value of Tatramat's contribution at Kcs 261 million (US$9.3 tional for the manufacture of washing machines.million) on the basis of discounted cash flow analysis. How- May 16,1992ever, in early 1991, after Tatramat had been transformed into The first round of bidding for vouchers started. Tatramat A.S.a joint stock company, the company hired Credit Suisse Frst was included in the voucher program.July 1, 1992Boston (London) to conduct a second valuation. The sec- Tatramat entered into a joint venture with Quasar Electronicsond valuation, also conducted on the basis of discounted cash for the manufacture of vending machines and specialty toolsflow analysis, estimated Tatramat's contribution at Kcs 320 and dies.milion (US$11.5 million), higher than Interconsult's valua- Spring 1993Shares in Tatramat A.S. were issued in exchange for vouch-non and more than twice the book value (Kcs 156 milion, or ers. By buying shares on the Bratisava stock exchange. theUS$5.6 million) of the assets to be contributed. company was able to buy back 25 percent of the shares sold

After completin, the valuation, Credit Suisse prepared to voucher holders.an information memorandum on Tatramat and forwarded it June1994

Recording a net profit of Sk 20 million (US$621,000) for 1993.to approxmately 20 potential investors along witharequest Tatramat A.S. paid dividends of Sk 11.2 million (aboutto bid for a joint venture for the production of washing ma- US$348,000) to its shareholders.chines. These potential investors included Electroluxof Swe-den, Whiripool and Maytag of the United States, and theEuropean manufacturers Atlantic (France), Anstriaemail(Austria), Siemens (Germany), and Merloni and Zanussi a base capital of Kcs 410 million (US$14.2 million). Tatramat(both of Italy). However, Whirlpool International was the A.S. controlled a 78 percent stake, corresponding to its con-only investor to submit a concrete proposaL Tatrarat then tribution of Kcs 320 million (US$11.1 million), whereashired Skadden Arps (United States) to act as its legal adviser Whirlpool's contnbution entitled it to a 22 percent stake.in negotiating the joint venture agreements. The day after the agreernent was signed, Whirlpool purchased

The joint venture agreement negotiated between the from Tatramat A.S. an additional 21 percent of the shares inTatramat management and Whirlpool Intemational called for the joint venture for Kcs 85 million (US$2.9 milion), bring-Tatramat to contnbute al assets directly related to the manu- ing its shareholding to 43 percent According to the joint ven-facture of washing machines. These assets constituted ap- ture contract, it was anticipated that Whirlpool would makeproximately 35 percent of Tatramat's assets and were valued capital investments of an estmated Kcs 430 million (US$14.9at Kcs 320 million (US$11.5 million) (in accordance with million) that would raise its shareholding to 72 percent bythe valuation of Credit Suisse). The assets were transferred the end of 1993.free of any liabilities. Whirlpool's contribution consisted of The environmental liabilities for past damage caused byknow-how, which the joint venture partners valued at Kcs 90 the production of washing machines were one of the majormillion (US$32 million). (Credit Suisse and Interconsult had issues in the negotiation of the joint venture with Whirlpool.valued the assets within a range of Kcs 90 million, or U S$3.2 An environmental audit conducted by a Slovec firm estimatedmillion to Kcs 129 million, or US$4.6 million.) the cleanup costs for soil and water contamination to be be-

The joint venture was established on May 12, 1992 with tween Kcs 20 million (US$692,000) and Kcs 25 nillion

CASE S`Unw 20 SLOVAK REPUUC TATuabr -WHIUOO, QUWSAR 97

(US$865,000). In the final joint venture agreement, Whirl- Financial Informationpool agreed to pay cleanup costs of up to Kcs 23 rnilion (in millions of koruny)(US$796,000), with any excess covered by the Slovak Na-tional PropertyFund (forwhich about lOpercentof the shates 199j 1991 1992 1993 1994of Tatramat A.S. had been set aside).

Quasarjoint Venture. After agreement was reached with Income StatementWhirlpool, the Tatramat management intensified its joint Net Sales 1,027 1.126 667 n.a. n.a.venture negotiations with Quasar Electronics (Italy) on the costs 966 1.083 674 n.a. n.a.vending machines and tools and dies. (Serious joint venture Gross Profit 61 43 (7) n.a. n.a.vending machines and ~~~~~~~~~~Taxes 44 24 23 n.a. n.a.discussions for the vending machine and tool and die opera- Net Profit 17 19 (31) n.a. n.a.tions were conducted only with Quasar.) Balance Sheet

To this joint venture, Tatramat contributed assets repre- Plant & Equipment n.a. n.a 288 337 311senting about 15 percent of the total assets of the former Other Assets n.a. n.a. 523 578 546state enterprise. All liabilities relating to the assets were re- Total Assets n.a. n.a 811 915 857tainedbyTatramatA-S.QuasarcontributedKcs 10.1 million Bank Debt n.a. n.a. 92 165 113(US$349,000) in non-cash assets, primarily, the license to Other Liabiltiles n.a. n.a 55 75 66produce, under the Quasar trade name, vending machines Total Liabilifies n.a. n.a 147 240 179for hot and cold drinks. Equity Capital n.a. na. 664 675 678

The joint venture was established on July 1, 1992.Tatramat AS. controlled an 82 percent stake in the joint ven-ture, corresponding to its contribution of Kcs 55.5 million Quasar joint venture. Recording a net profit of Sk20 million(US$1.9 rnillion), whereas Quasar's contribution entitled it (US$621,000) for 1993, Tatramat a.s. paid dividends of Skto a 18 percent stake. 11.2 mifliGn (about $348,000) to its shareholders

Under the terms of the agreement the new companywould not pay any dividends for the first three years of its FINANCuAL REsTRuctuRING As of mid-1993, both the Whirl-existence. Quasar was granted the right to increase its pool joint venture and the Quasarjoint venture had arrangedshareholding by transferring manufacturing licenses for ad- loans from Slovak banks in order to fund the companies'ditional products to the joint venture. capital expenditure programs. Whirlpool borrowed Kcs 140

million (US$ 4.4 million) and Quasar Kcs 20 millionPost-Privatization (US$625,000). Both loans were taken on by the joint ven-MARKET POSmON According to the Tatramat management, ture companies.the combined exports of all three finns that were formerlypart of Tatramat dropped to below 20 percent of total sales. CArnL IN%TEsTMENT As of February 1994, Whirlpool hadBoth Tatramat a.s. and the Whirlpool joint venture were prof- completed the capital investment program and increased itsitable in 1992. No financal information was available on the shareholding in the joint venture to 72 percent.

98 SELuNG STAE CoiNms To SaECic lwsroms, Vowi Two

SLOVAK REPUBLIC

JACOBS SucHARD FIGARo

Enterprise Status before Privatization competitors were the other three Bitu Figaro trust membersFigaro Bratislava was an established chocolate producer, op- and CokolAdovny of Prague, but Figaro Bratislava was fac-erating in the Slovak Republic and selling its products both ing increasing competition from the foreign producers thaton the domestic market and abroad. The company was es- entered the market following the liberalization of trade intablished in 1896 by a German family as a private business 1990.under the name Stollwerk, the family's name. Figaro remained Figaro Bratislava's product was considered of averagein private hands until 1945, when it was nationalized. Figaro Western European quality, which enab:ed the enterprise toBratislava became part of the Cokoladovny sector enterprise, export 5 to 6 percent of its production to Western Europecomprising all production facilities for the chocolate sector and the Middle East prior to privatization.in both the Czech and Slovak Republics of Czechoslovakia.In 1969 Cokoladov ,y's operations in the Slovak Republic Preparation for Salewere spun off aito ,. new sector enterprise, Bitu Figaro, the The management of Figaro Bratislava fel that the presencestate trust for the production of chocolate, which operated of a foreign strategic investor would be the best way of secur-under the Ministry of Agriculture. Bitu Figaro was in turn ing the improved technology and the wider product rangesplit up into four state enterprises in 1990, as part of a "de- necessary for their enterprise to remain competitive. There-monopolizatio'' pi-ogram authorized by the Czechoslovakian fore, they requested that the enterprise be included in theGovemment. At the time of this split, thework force of Figaro first wave of large-scale privatization, which followed theBratislava was reduced from 739 to 619. enactment in February 1991 of the Large-Scale Privatization

Figaro Bratislava was the largest of the four enterprises Law.spun off from Bitu Figaro. In 1991 Figaro Bratislava's sales In preparation for privatization, Figaro hired a local firm,were Kcs 659 nillion (US$23.7 million).The enterprise's main TEUTOP, to prepare a financial audit On the basis of the

Summary of Jacobs Suchard Figaro Agreement Shareholder structurepercentage of ownership

Type of Company:Manufacturer and marketer of chocolate and 100%other confectionery productsLccation:The company is located in BratislavaDate of Sale:August 28. 1992Sales (1992):Kcs 792 million (US$27.4 million)Employment at Date of Sale:619Employment (May 1993):680 Shareholder Date of sale 121 31/92Name of Strategic Investor: a Restitution Fund 3.0 1.2Kraft General Foods International represented by Jacobs 2 National Property Fund 32.0 6.8Suchard (Switzerland)Price Paid by Strategic Investon r Strategic Investor 32.0 66.7Kcs 99.2 mi!l;on (US$3.4 million) (estimate: price not available) * Voucher Holders 33.0 25.3Investment CommitmentKcs 100 million (US4 3.5 rmillion) (estimate: amount notavailable)

CAs SEwY 21 SLOrAx RmUc: Ji'cas SUCARD PFIGOg

1992 audit, the enterprise's book value was established at Timeable of Key StepsKcs 310 million (US$10.7 million). In addition, a valuationwas conducted by Coopers & Lybrand, based on the market Spring 1991replacement value for assets and discounted cash flow esti- Rgaro Bratislava was included in the country's first wave of

,, . ~~~~~~~~~~~~~large-scale privatization.mates of future earmings. Fall 1991

Following completion of the valuations, Figaro's man- Figaros basic privatization project was submitted by the Min-agement prepared its 'basic privatization project" laying OUt istry of Agriculture to the Ministry of Privatization.the proposed progmmr for privatization of the compp It April t, 1992tpo pgc ny I RFigaro Bratislava was transformed from a state enterprise intotook the Figaro manauement about four months tc develop a state-owned joint stock company.the basic privatiation project and to have the project reviewed August 21, 1992by its founding organ, the Slovak Ministry of Agriculture. The share purchase agreement was signed.There was some initial delay owing to confusion over the in-formation required fir the submission of a basic projecL Oncedetailed regulations were reeased by the Slovak Ministy ofPrivatization, the management completed the preparation of Terms and Conditions of Salethe basic project, which included a detailed listng of the PRicE The price paid by acobs Suchard for a 32 percententerprise's asses and liabilities aswdl as a valuation. Enter- stake in Figaro was not released to the public, but it can beprise management was able to prove clear title to all but 33 estimated at about Kcs 992 million (US$3.4 million), basedsquare meters out of a total of 3.3 hectares of land. This clar- on the fact that the purchase price was determined accord-ity in land tide accelerated the privatization process. ing to the enterprise's total book value of Kcs 310 mfllion

When, on Apil 1, 1992, Figaro Bratislava was tram- (US$10.7 mPion).formed into a state-owned joint stock company, al of thedetails of its privatization had been worked out other than SHME STRucruRa At the time of the privatiztion of Figatv,the identity of the foreign ivestor. Ftgaro's managemnt had there was strong public opposition in the Slovak Republic toinitiated talks with sevenl potential ivstors including Hoff the sale of a majority stake to a foreign investor lThrefore,Bauer (Austria), Stolwerk (Germany), and Kraft General only32percentofFgaesshareswassoldtoJacobsSucharLFoods Intenaional represented by Jacobs Suchard of Swit- Although they wanted a majority stake, Jacobs Suchard ac-zerland ('Jacobs Suchard"). Inftiall* Hoff Bauer appeared cepted a 32 percent interesLt The remainder of the sharesto offer the best terms, but as negotiations proceeded it be- (except for the standard 3 percent reserved for the Restitu-came apparent to Figaro that Hoff Bauer was experiencing tion Fund) would be sold to voucher holders, which wouldfinancial difficulties in its domestic narket and there was somne result in widespread ownership. In addition, the project woulduncertainty as to whether it could meet the required com- allow for the investor to acquire more shares through an in-.- inments. Stolwerk, Figaro's pre-War owner, subsequently crease in the share capital.dropped out of the bidding process of its own accord. Otherpotenial investors were considered too smal and financially PROPEXrwRIGHIS Restitution was not an issue, since the Res-weak by the Figaro managemett and the Ministry of Agricul- titution Law allowed for restitution only of property expo-ture. priated after 1948 and the StoOwerk business had been na-

In spite of its apparent financial difficulties, Hoff Bauer tionalized in 1945.continued to negotiate with the Figaro management and theMinistry of Agriculture. During the final preparation of the INVESTMENT COMMITMENT The Slovak Ministry ofbasicproject,thecompetitionbetweenHoffBauerandJacobs Privatization, recognizing that Jacobs Suchard would beSuchard was intense and resulted in improvements to both making additional investments in order to control a majorityoffers. The Ministry of Agriculture chose Jacobs Suchard as stake, did not place any formal investment commitments onthe best investor, which will be able to guarantee the further the investor.development of Jacobs Suchard.

The project recommending the sale to Jacobs Suchard Post-Privatizationwas sent to the Economic Council, which accepted the Min- MARKET POSmnON By mid-1993, Figaro's market share in-isty ofPrivatization's recormnendation and authorized imple- creased to approximately 20 percent of the Slovak domesticmentation of the project. The share purchase agreement was market in spite of rapidly increasing foreign competiton.signed byJacobs Suchard and the Slovak National PropertyFund on August 28, 1992. SHARE SmUCIUR The Economic Council's resolution au-

100 srU.G STE COMPANIES TO SAaEGIC INVEsRS, VOLUME TWo

thorizing the sale of Figaro to Jacobs Suchard also required Suchard's stake to 66.7 percent and enabled the investor toJacobs Suchard to make a capital investment into the com- change th company's name to Jacobs Suchard Figaro a.s.pany in exchange for new shares, which had the effect of (in order to better leverage the Figaro" brand).increasingJacobs Suchard's shareholding in percentage terms. After the issuance of new shares, the shareholder struc-At the first shareholders' meeting of the newly privatized ture was as follows: Jacobs Suchard held 66.7 percent;company, a decision was taken to increase the share capital voucher holders held 25.3 percent; the Restitution Fund heldby approximately Kcs 100 million (US$3.5 million) by selling 1.2 percent; and the Slovak National Property Fund held 6.8all of the new shares to Jacobs Suchard. percent (comprised of the shares that were not purchased

This expansion in share capital increased Jacobs during the voucher process).

CASE SnTUD 21 SLOVAK REUMUC- JACOBS SUCAxM FIGAo 101

CZECH REPUBLIC ND SLOVAK REPUBLIC

PRIOR STORES - KMART

Enterprise Status before Privatization pany that would benefit from centralized purchasing andPrior State Trading Company was the largest retail depart- administration. The government said it would not object -ment store network in forner Czechoslovakia. Prior's found- if the store managers agreed. However, after the decentrali-ing organ was the Ministry of Trade. Priorwas engaged in the zation of the 1980s, the store managers were effectively man-distribution of many consumer goods. In the late 1980s the aging directors of small companies, and were thus initiallyindividual stores had been spun off, and operated as stand hesitant to become part of a large ccrporation. To gain theiralone entities. support, Kmart took a number of store managers to visit large

Combined employment in the 13 stores decreased from retail stores in the United States, Canada, and Western Eu-roughly 8,000 in 1989 to 6,000 by the time of privatization. rope. These retail stores included Kmart stores and othersThis reduction was due, however, to attrition rather than to such as Target and W'almart. The purpose was to demonstrateany formal restructuring program. the economies and efficienLies of operating as a centralized

department store chain in a market economy.Sale Preparation and Negotiations Kmart's interest in the Czech and Slovak stores stemmedThe privatization process in this case was initiated by poten- from its interest in maintaining a high level of growth, whichtial investors, as they approached managers of Prior stores until recent years had averaged over 10 percent each year.with privatization proposals. The investors were vying for The company was looking to expand its international activi-selection by the Prior store managers as the strategic investor ties, as well as its operations in high volume discount depart-to be identified in the managers' basic privatization projects. ment stores (known as Super Kmarts) and in specialty retail-Among the investors visiting Prior stores was Kmart (United ing. Kmart already had intemational stores in Canada,States). Mesico, and Australia.

Although other foreign investors were also vying for Following a preliminary visit in Febniary 1991, Kniartmanagement support, Kmart was the most successful in sell- installed, in April 1991, a permanent representative in Pragueing itself to the Prior store managers and to the government. who was responsible for negotiations with the governmentKmart's objective was to combine the stores into one com- (All together, two representatives of Kmart spent a combined

Summary of Prior Stores-Kmart Agreement Shareholder structure (Joint Ventures)percetage of ownership

Type of Company:Department store chain for general merchandise 100%Location:Major cities in the Czech Republic and the Slovak Republic(6 stores in the Czech Republic, 7 in the Slovak Republic)Dates of Sales:May-August, 1992Sales:Not availableEmployment at Date of Sale:About 6,000Employment (May 1993):About 6.Q000 Shareholder Date of sale 12313/92Name of Strategic Investor FrMi 2MKmart Corporation (U.S.)Price Paid by Strategic Investor: E National Proprrty Funds 3.5 3.5US$100 million (estimated - including interest expense on * Kmart 96.5 96.5installment payments)Investment Commitment: For all stores except MamKcs 450 million (US$15.6 million) over three years. Kmart 100.0 100.0

CASE S5r 22 CzEcH RBuc & SLovAx RsmUc PhoX SWm - KiAc 103

total of 24 months working on the purchase of Prior stores.) local firn to conduct a new valuation. The local firm's valueKmart began identifying cities in which it wanted to invest was a third higher than that the prior valuations, but becameand targeted stores from the Prior chain in those cities. the basis for price negotiation s for the stores in the SlovakKmart's criteria were the location of the stores, the volume Republic.of sales generated by the stores, and the condition of the Kmart also asked one of its U-S. financial advisers, Bearbuildings. Initially, Kmart identified 14 stores, but 2 were Stearns, to provide a 'fairness opinion" on the terms andsubsequently dropped from the list and 1 was added at the conditions of the transaction. (As corporate policy, Kmart'srequest of the Slovak Ministry of Privatization. Of the stores Board of Directors required an independent opinion beforethat were cdropped, the flint was dropped because it was sub- approving major acquisitions.)ject to restitution claims and the second because the Czech Kmart also hired Skadden, Arps (United States) to con-Ministry of Privatization limited Kmart's purchases to only duct a legal audit that included a title search. According toone of the two dominant Prague stores: either Maj or Kotva. the Kmart management in Praguc, the audit found sorneKmart chose the Maj store because negotiations were fur- minor problems which, although not resolved, did not createther advanced with its management than with the Kotva any problems 'or the transaction. Skadden, Arps also pre-management. pared draft legal documents for the transaction.

Of the 13 stores selected by Kmart, 6 were located in Kmart encouraged the management of several stores tothe Czech Republic and 7 in the Slevak Republic The stores submit combined "basic privatization projects," with Kmartin the Czech Republic held a market share of about 6 per- as the strategic investor for each group of stores. Althoughcent and the Slovak stores held a market share of about 20 the store managers initially wanted each store to be privatizedpercent. individually, tney eventually agreed with Kmart and worked

Transformation of the stores was not nececsary, sine they together to prepare a total of three basic privatization projects,could be acquired through sales of 'assets" rather than sales which were submitted in October 1991. The managementof equity shares. Accordingly, 12 of the 13 stores were never of five of the stores located in the Czech Republic submittedtransformed. Transformration occurred only in the case of the one joint project, as did the management of the seven storesMaj store, which had recently been transformed into a joint located in the Slovak Republic, both recommending Kmartstock company as part of a debt for equity swap in which as the strategic investor. A third privatization project, alsoInvest icni Banka (a state-owned commercial bank) acquired recormmending Kmart, was prepared by the largest store, Maj,18 percent of the shares. located in Prague. Maj was included under a separate project

Kmart hired Price Waterhouse (United States) to pre- because it had previously been transformed into a joint stockpare valuations of the 13 Prior stores in both republics, that company and was thus acquired as a share purchase whileis, to prepare the real estate valuation and to provide account- the other stores were acquired as asset purchases.ing and tax advice to Kmart. Price Waterhouse's valuations Prior's founding organ, the Ministry ofTrade, supportedfor the buildings were based on depreciated replacement the three basic projects and passed them on to the Ministrycosts. Because of the lack of comparable cost indicators in of Privatization with a favorable recommendation.the Czech Republic and the Slovak Republic, Price After the privatization projects had been submitted,Waterhouse began by looking at comparable costs in major Kmart began negotiations with the Ministries of PrivatizationWestem, European cities. They chose Madrid, Spain, as a of both republics. These negotiations were protracted andproxy for Prague and Bratislava, and estimated the cost of involved many changes before final agreement was reached.b-.ilding stores of a sirnilar size in Madrid. They then reduced The Ministries felt that some shares should be set aside fortne raluation for depreciation on the basis of the amount of the voucher program, whfle Kmart wanted maximum con-estimated wear and tear on the building. The valuations for trol over the stores. As a corporate policy, Kmar. insisted onland were set by the government on tne basis of prior sales of majority control of the stores, which, owing to the voting re-comparable parcels of land. In addition, the government hired quirements in the Czech and Slovak legal codes, meant two-Deloitte and Touche (United States) to prepare valuations thirds ownership. However, after six months of negotiations,for the stores. Deloitte's valuations were based on discounted Kmart pushed for 100 percent (or near 100 percent) of thecash flow projections, which Kmart felt were not accurate assets - or shares in the case of Maj Agreements werereflections of the stores' value. reached after lengthy negotiations with numerous officials in

Nevertheless, the different valuation methods created the Ministries. However, in the Czech Republic negotiationsapproximately similar values for the stores. The Czech Min- were re-initiated by the USAID advisory team, acting as ad-istry of Privatization accepted the valuations but the Slovak visers to the Czech Minister of Privatization. Kmart com-Privatization Ministry rejected them as too low and hired a plained that, after a new agreement was reached with the

104 SELLNG ST&nE CompANtEs To STtATICc NwSrOxs, VoWMa Two

Minister's advisers, and the Czech Ministry of Privatization Tlimetable of Key Stepshad officially submitied Kmart's proposal to the Council ofEconornic Ministers for their approval, a senior government February 1991

official tried to make Kmart ina,,ase its.bid by suggesfing Kmart visited the country tG look into investment possibilities.offiial tried to rnakce Krnart icrease its bid by suggestng April 1991

that an unnamedGerman investorwasoffering ahigherprice. Krnart installed a permanent representative in Prague andKmart refused to increase its offer. Subsequent press reports began identifying viable stores.indicated that no formal eompeting offers were submitted. October 1991

Three basic privatization projects were submitted by PriorAfter approval by the Councils of Ministers of both re- management, recommending Kmart as the strategic inves-

publics of the three projects that had been agreed on with tor in a total of 13 storesKmart, the three sales agrcerrents were finalized by the Na- June l,1992tional Property Funds of both republics with no further The Councils of Ministers of the Czech Republic and the Slo-

chagesIlfrstag m signed on May 1, 1992 (sx* vak Republic approved the three projects.changes. The first agreement was slgnea on asay 1, 177- tSIX May - August 1992months after the expected dosure date of December 1991) Kmart signed three sales agreements for Ihe purchase of 13and the remaining two were signed by August 1992. stores located throughout former Czechoslovakia.

Terms and Conditions of SaleKmart purchased 100 percent of the assets and assumed allof the related liabilities of all the stores except Maj. For theMaj store, Kmart purchased the shares held by Investicni store management and agreed to a three-year employmentBanka and all but 3.5 percent of the shares held by the Czech contract for managers. This issue had been negotiated withNational Property Fund. The remaining 3.5 percent was re- Prior managers in the initial negotiation phase and, accord-tained by the National Property Fund for restitution issues. ing to Kmart, played an important role in persuading the

The results of the valuations were used as the basis for managers to favor Kmart, since none of the other potentialthe purchase price. Kmart paid an estimated USS100 mil- investors would agree to such a dause.lion, of which two-thirds was paid in 1992 and the rernainingone-third was to be paid in installments over the following Post-Privatizationtwo years. The price was paid in local currency, with exchange The press later criticized the sales price, alleging that the pricerates set at the time of payment. paid by Kmart was less than the value of the real estate of the

The sales agreements induded an investment commit- stores, especially that of the Maj store in downtown Prague.ment of Kcs 450 million (US$15.6 million) over the next threeyears, including some very specific investments such as new NEw INVETsmNrr By the end of 1993, Kmart had retrofittedair-conditioning systems and new elevators in specified stores. 5 of the 13 stores, in most stores complete ly gutting the buAd-Kmnart was required to prepare an audited statement show- ings and leaving only the original (often marble) floors. Dis-ing completion of the minimum investments. play space was constructed for Westem style retailing, which

The Ministry of Privatization agreed to indemnify and allowed for most items to be sold through self-service.compensate Kmart against undisclosed liabilities. Kmart had In addition, the heating and air conditioning systems,attempted to indude a provision for compensation ip the elevators, and escalators were repaired. However, accordingevent of missing inventory, but the Ministry would not ac- to Kmnart, the need for renovation was limnited because of thecept this. high quality of the original mechanical equipment.

Restitution issues did not play a major role in this case. Kmart has listed for sale all the social assets and inven-The National Property Funds provided warranties of clear tory warehouses.title land and property. Social assets (such as a power plant,limited medical facilities, vacation resorts, and a residential ORGANcuATioNAL REsTRuCrURING Since privatization, Kmarthotel for hourly employees) were included in the acquisition. has provided extensive training in areas ranging from tech-Inventory warehouses were also sold with the stores. niques of centralizing purchasing to methods of in-store pre-

The sales agreement stipulated that Kmart would main- sentation of retail goods to use of computer technology intain current staffing levels "unless major restructuring was inventory control. Beginning with the largest stores, Kmartnecessary." (Later contracts required maintenance of staff- reorganized the "work flow." Previously, sales staff were re-ing levels for a minimum period of time.) The contract also sponsible for individual product lines, and, beyond a certaincalled for Kmart to offer extensive staff training. minimum, had to pay from their own wages for any losses

In accordance with its corporate policy, Kmart retained due to shoplifing. Krnart established departrnent managers

CASE STUmy 22 CzEx REPuBc & SLovAx REPuBuc: PRIOR STORES -KMArr 105

(covering several product lines) with a sales staff assigned to management. Nevertheless, Kmart expects that within fivethe department manager. Sales staff were directed to focus years they wfll have built a local management team, with lo-on customer service - rather than on preventing theft. cal staff managing the company.

Kmart established centralized buying through the Pragueand Bratislava headquarters. Employees from the Prior stores SHARE STRucrIRE Kmart offered 3 percent of the Maj shareswere given training in Kmart's buying methods, which in- to employees at a discount but with no financing assistance.cluded working with vendors and manufacturers to meet Of the total shares offered, only one-third was purchased.Kmart's standards, especially in packaging of retail goods. For the 3.5 percent of shares held by the Czech National

Both changes have reduced the need for some positions, Property Fund for restitution chlims, Kmart intends to offerbut there have been no layoffs of personnel and any reduc- a tender to buy the shares.tions have been accomplished through attrition.

As of mid-1993, Kmart indicated that itwas having some SECOR STRucruRE As of end- 1993, the Kotva store in Praguedifficulty with employees adapting to 'customer-first' ser- had not yet been privatized, and the govermnent was consid-vice and with having its management style accepted by local ering placing the store in the voucher program.

106 SELNG STAE COMPANEs TO Smwac INvEsTORs, VoWuNE Two