09 September 2010

Save Bulgaria's Stock Exchange

Victor Papazov and Patrick Young take a look at the current initiatives of the Bulgarian government.

In the wake of the collapse of the Warsaw Pact, the arrival of free markets meant the foundation, or more accurately, re-establishment, of stock exchanges throughout Eastern Europe. In little more than 20 years, the progress of many nations has been marked by a broad growth in prosperity. Stock exchanges have been highly successful agents of that growth, raising capital for thousands of new companies operated by eager entrepreneurs throughout "New Europe." But today, the Bulgarian government is threatening the country's economic future with a bid to effectively nationalize its stock exchange at a knock-down price.

The aftermath of the credit crunch has marked the landscape throughout the region. Most central and eastern European economies have followed the West into recession. Governments, including Bulgaria's, have often overspent and are now becoming increasingly desperate to balance their books, having seen (and suffered in the wake of) Greece's debt woes.

In such times, governments must always balance the need to grasp what they see as low-hanging fruit against the danger of stifling the economy. The Bulgarian Ministry of Finance is about to wildly overstep that fine line at an Extraordinary General Meeting of the Bulgarian Stock Exchange on Sept. 13. On the docket for that meeting is a proposal to issue new stock that only the Ministry of Finance can purchase. The proposal would allow the government to increase its share in the exchange to 51%, from 43.6% today, at an absurdly low valuation. This would be a disaster.

Certainly the Bulgarian Stock Exchange does not remotely require central government control. The exchange is a robust business with excellent IT systems from Deutsche Börse. The exchange's value may be down from the up to €55 million estimated by a leading consulting firm at the height of the stock market boom in 2007. But the government's claim that the exchange is worth just €2.8 million today beggars belief. The exchange has some €3.7 million in cash on its balance sheet, not to mention €1.5 million in property.

Nevertheless, the government is seeking to take over the exchange at "par" value. How can this be possible? For starters, the majority of the exchange's current management is appointed by the government. Thus the government has been able to muscle through the story that it must increase its stake in order to protect the remaining shareholders from "hostile takeover" after the exchange goes public. Never mind that current securities law forbids anyone from owning more than 5% of the shares without special permission from the Financial Supervision Commission.

Even in the event of a liquidation break-up, the bourse is not remotely in danger of going out of business. The main risk of that happening, ironically, is from this impending, state-sponsored par-value acquisition. By seeking an exclusive right to buy a highly dilutive issue of new shares, the Bulgarian Ministry of Finance would be paying fraction of the exchange's market value to gain control of the nation's financial infrastructure.

We do not want to overstate the importance of exchanges to the overall economy. But a discount nationalization of the Bulgarian stock market will send out a deeply negative message to local investors. And from the perspective of foreign direct investment, this move could be catastrophic for Bulgaria, at a time when nations throughout "New Europe" are already competing intensely to secure foreign investment. What message does diluting stockholders at the stock market itself send to the global investment community?

Somewhat bizarrely, the September 13 shareholders' meeting will also present a motion to seek the listing of the Bulgarian exchange on its own platform. Will investors really rush to buy shares knowing that the previous owners were brutally diluted after spending many years supporting the fledgling market as it gained critical mass? We suspect that investors will turn instead to other areas of New Europe, where there are fewer threats to their portfolios from arbitrary acts of confiscatory government fiat.

The authors strongly urge the Bulgarian Ministry of Finance to rethink their stance on this short-term and ill-considered act. Nobody wishes to see capitalism being exploited by so-called "robber barons." But the Bulgarian government risks being seen as a new model of sovereign-wealth robber baron. This can only harm the nation, its economic development, and the well-being of the citizens. Even if this blunder is eventually undone, markets can have long memories and Bulgarian capital markets could be stigmatized for years to come. Neither the government nor the exchange's management can be regarded as credible capitalists, let alone agents of freedom if this "deal" is permitted.

© Wall Street Journal