From the perspective of private equity, central and eastern Europe is “at a dangerous age”, says Jacek Siwicki, president of regional fund manager Enterprise Investors. “People don’t know how to treat the region – we’re no longer a promising teenager, but nor are we a 35-year-old with a solid CV.” In human terms, he says, CEE is in its late 20s – “it may have achieved something but it’s not an obvious hire”.
Certainly, attitudes towards emerging Europe have changed dramatically in the past decade. Back in the mid-2000s, when GDP growth was running at 6% or more in all the main economies and the region seemed set on an inexorable path of convergence with western Europe, private-equity funds and investors flocked to CEE. In 2007, local specialist Mid Europa was able to raise a record €1.5 billion for its third fund, taking the total raised for the region that year to more than €4 billion, and the following year Advent International closed its fourth CEE fund at €1 billion.
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People don’t know how to treat the region – we’re no longer a promising teenager, but nor are we a 35-year-old with a solid CV. Jacek Siwicki, |
The convergence play, however, took a heavy knock in the financial crisis, as volatility returned to the region and a number of countries sank into deep recession. Hopes of a rapid, export-led recovery were swiftly crushed by the emergence of the eurozone crisis, and private-equity returns slumped as investments went sour and holding periods were extended. Investor enthusiasm for CEE waned to the point where, by 2013, even regional stalwart Advent was unable to drum up enough interest for a fifth dedicated fund.
Part of the problem, says Anthony Diamandakis, head of alternative assets group EMEA at Citi, is that once the excitement around big privatization programmes and European Union accession had worn off, CEE began to look fairly small by global standards, particularly from the point of view of ever-expanding international funds. Excluding Ukraine and Turkey, the region’s total population barely tops 130 million – “that’s six Chinese cities,” says one local fund manager ruefully – while at $1.6 trillion, the combined GDP of its 19 economies is less than that of Italy.
Taken in conjunction with the riskier operating environment in the region, says Thierry Baudon, founder and managing partner of Mid Europa, this has led many private-equity funds and investors to conclude that they can afford to simply ignore CEE – particularly since the start of the crisis on its eastern borders. “The main rationale for investing in CEE is the integration of Europe,” he says, “but events in Ukraine make investors wonder whether we have not gone back 100 years.”
Not all investors, however, have abandoned emerging Europe. In 2012, Enterprise Investors succeeded in raising €314 million for its Polish Enterprise Fund VII, which has a regional remit. More recently, Mid Europa closed its fourth fund in January 2014 at €800 million, with the same amount again in co-investment pledges, thanks to strong support from a core investor group of insurers, pension funds, sovereign wealth funds – including China Investment Corporation – and supranationals.
“The various shocks which have impacted the CEE private-equity industry over the last few years have flushed out the least committed investors, but the region still attracts large and sophisticated investors who understand the complexity of transition economies and take a multi-cycle view,” says Baudon.
A handful of global private-equity funds have also kept faith with the region. Bankers say around half a dozen are still making what one describes as “credible efforts” in the region, including Blackstone, Cinven, CVC, Bridgepoint, BC Partners and Warburg Pincus. Advent’s appetite for CEE also appears to have survived a big reduction in its regional presence, at least judging by its determination – in the face of regulatory and legal hurdles – to complete a planned €200 million purchase of the Balkan network of failed Austrian banking group Hypo Alpe Adria.
Emerging Europe has also attracted some new names, notably KKR, which last year made its first-ever investment in the region with the €1 billion acquisition of Balkan pay-TV and broadband provider SBB/Telemach from Mid Europa. Tomas Kubica, an associate at KKR, says a key part of the deal’s appeal was the still substantial scope for convergence between the former Yugoslav countries and western Europe in terms of pay TV and broadband penetration. “As the largest cable asset in the region, SBB is well-positioned to benefit from that trend,” he adds.
Increasing maturity
It is not only the Balkans, however, that still have some catching up to do, both in terms of the telecoms industry and the wider economy. Even in Poland, CEE’s largest market and one of its most developed, GDP per capita is still only around 70% of the EU average. This means, say CEE’s private-equity fans, that the convergence play is alive and well, particularly as growth rates in the region remain notably higher than in western Europe. Most of the leading economies are forecast to expand by around 3% this year, thanks to a combination of reviving domestic demand, increased export capacity and a further influx of EU structural funds.
What is more, while the region might have lost some of its early lustre, its increasing maturity is turning up some interesting opportunities for private-equity buyers as valuations recover from post-crisis lows.
The past couple of years have, for example, seen several disposals by multinationals such as E.On, RWE and Telefonica that bought into CEE in the early years of transition and have since refocused away from the region. Most of these sales have been in the energy, telecoms and financial sectors, but there have also been some consumer opportunities – in October 2013, Bridgepoint bought Polish biscuit maker Dr Gerard from France’s Groupe Poult. Harry Hampson, head of sponsor group EMEA at JPMorgan, says more disposals of this type of “orphaned asset” are likely in the next few years.
The promise of a new wave of privatizations in south-eastern Europe – most notably in Slovenia, Serbia and Croatia – is also generating interest among private-equity funds. Much more enticing for fund managers, though, is the prospect of getting their hands on successful firms set up in the early transition years by entrepreneurs who are now on the brink of retirement.
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The various shocks which have impacted the CEE private-equity industry over the last few years have flushed out the least committed investors, but the region still attracts large and sophisticated investors who understand the complexity of transition economies and take a multi-cycle view Thierry Baudon, |
As Baudon notes, when it comes to accessing this type of deal, funds with a regional network clearly have an edge over their pan-European counterparts. “If you’re a 60-year-old Czech entrepreneur with a mid-market company, you’re not going to hire a bulge bracket bank to prepare a multicoloured slide book and hold a full-blown auction, you’re going to call your trusted advisers or accountants and ask them: ‘Who is there in the region that I can work with?’,” he says.
Siwicki at Enterprise Investors, where succession-driven buyouts account for 75% of total deal flow, says it is a question of trust as well as proximity. “Most of these businesses are not in major cities, and when the founders sell out they stay in their home towns, so they care what happens to their firms and to their employees,” he says. “That means there is a major opportunity for us to present ourselves as people who will approach these firms with the care the founder would like them to receive.”
Local funds do not, however, have it all their own way, particularly when it comes to larger deals. As Kubica at KKR notes, while international players will be less likely to unearth a “hidden gem” in CEE, they can often offer important sector expertise, as well as the ability to leverage their global platforms to support a target company’s growth.
Jonathan Cheal, head of CEE M&A at JPMorgan, adds that a number of the bigger funds have been cultivating regional entrepreneurs for many years.
Strategic rationale
Funds’ main competition for these succession-driven deals, however, comes not from within the private-equity industry but from strategic investors. Some multinationals may be pulling back from CEE, but Ingo Bleier, head of group investment banking at Erste, says there is still a good selection of regional and western European corporates looking to increase their exposure. And, as Kubica notes, where there is a corporate buyer with a strong strategic rationale and synergies with a target, private-equity funds usually struggle to compete on price.
Another source of competition for CEE assets has emerged in the form of home-grown financial investors. Local groups such as Penta and PPF, as well as tycoons including Poland’s Jan Kulczyk and Zygmunt Solorz-Zak, have become increasingly active investors in recent years.
In 2013, PPF – the investment vehicle of Czech Republic’s richest man, Petr Kellner – won out over a number of private-equity firms in battles for two of the most coveted assets on the regional market: a €2.6 billion stake in Slovak gas distributor SPP and Telefonica’s €2.5 billion Czech operation.
As Cheal points out, such domestic buyers have a number of advantages over external players. “They have local funding, a different view of local risk, and are much better plugged into the origination of new opportunities,” he says.
The prospect of encountering local and strategic competition has not, however, discouraged private-equity funds from entering the lists for several assets currently on the market. Cinven, Apax, Providence and Bain Capital are all reported to be in the running to acquire Telekom Slovenije, due to be sold in February for around €1 billion as part of the Slovenian government’s long-awaited privatization plan, while the sale of the country’s partially state-owned – and heavily indebted – brewer Pivovarna Lasko is also said to be attracting considerable private-equity interest.
The success of KKR’s acquisition of SBB is also expected to ensure a strong private-equity bid for the Serbian government’s second attempt at the privatization of Telekom Srbija, due to get underway before the end of the year – although some bankers warn that financial investors could face local political opposition.
Meanwhile, in the private sector, several secondary deals are said to be on the cards. Serbian conglomerate Danube Foods, currently owned by Salford Capital Partners, is reported to be on the verge of being acquired by Mid Europa, while private equity funds are also said to be circling Advent’s Partner in Pet Food. By global standards the latter is on the small side, with an estimated ebitda of around €35 million, but Citi’s Diamandakis notes that funds will reduce their deal-size thresholds for the right deals in CEE.
Surprisingly, most of the assets in play are outside core central Europe, traditionally the main focus for funds of all stripes. Bankers note, though, that Poland remains the preferred jurisdiction for fund managers, thanks partly to its population of 40 million and partly to the ease of doing business there – a quality it shares with the smaller markets of Czech Republic, Slovakia and Slovenia. As Klaus Vukovich, head of CEE corporate finance advisory at UniCredit, notes: “These are developed countries with strong links to the German economy and are not seen by investors as having emerging-market risk attached.”
This means, say bankers, that fund managers are comfortable with lower returns in these markets than they would be in riskier jurisdictions. In Poland, for example, an IRR of 20% is said to be sufficient, whereas in the Balkans funds would look for closer to 30%. “We would look for similar risk-return characteristics in Poland and Czech Republic to those in western Europe,” confirms KKR’s Kubica.
The increasing popularity of the Czech and Slovak Republics with private-equity players is not, though, entirely due to their relative stability. “Both countries have a strong Mittelstand segment, plenty of entrepreneurs, some interesting industrial opportunities and also rapidly developing tech sectors,” says Cheal at JPMorgan. Indeed, Enterprise Investors’ most successful project to date was Czech antivirus software firm AVG, on which the fund made 12 times its investment after taking it public in New York.
Not all of central Europe is viewed so positively. Hungary, once seen as a hugely promising market, has been blacklisted by most funds since 2010 due to the Fidesz government’s policy of milking western investors in sectors from banking to telecoms. Other regional black sheep include Bulgaria, which is generally seen as ridden with corruption, and unsurprisingly Ukraine – although the sheer size of the latter, with its population of 45 million, means fund managers are unwilling to write it off altogether.
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The opportunities, especially for larger-ticket investments, are more limited than they were pre-crisis,” he says. “For a good business, however, even in the mid-sized segment, there will be a lot of interest. Anthony Diamandakis, Citi |
Many financial investors also remain wary of Romania, another of the larger countries in the region that has so far failed to live up to expectations. As Siwicki at Enterprise notes: “For some time we thought that Romania could be the new Poland due to its size and the rapid growth around EU accession in 2007 but that didn’t fully materialize.” Nevertheless, he says, while Romania may still rank behind central Europe in terms of transparency and lack of corruption, funds that are selective and apply rigorous management practices can make reasonable returns there.
Daniel Lynch, managing partner at regional tech-focused growth fund 3TS, says Romania’s tech sector offers particularly good opportunities. “It has some of the best and most available programming talent in the region, and the firms are usually only a few years old and are run by younger entrepreneurs than in more traditional sectors.”
Big investments
Further south, opinions are divided on the Balkans. For some investors, the combination of higher perceived risk and relatively tiny markets makes the region not worth bothering with. Mid Europa’s Baudon, however, argues that the strong cultural and linguistic ties between the former Yugoslav countries make them effectively a single market with a population of close to 20 million. “The same brands – often local ones which have survived the political split – appeal to consumers across the region,” he notes.
Kubica is also keen on the Balkans, noting that the region is on track for EU integration and offers higher growth than some of the more mature CEE economies. “At the same time,” he admits, “the macro backdrop can be more volatile, so one needs to be more selective in terms of sectors and companies.”Baudon is particularly enthusiastic about Serbia, where he hopes to invest as much as 15% of Mid Europa’s current fund. “There have been wars in the Balkans that set those countries back by a generation, but institutionally and educationally Serbia is still way ahead of Romania, for example,” he says. “We’ve made big investments there, some of which involved significant government compliance risk, and we have found the institutional set-up much stronger than one would expect.”
This highlights what many private-equity players cite as one of the key advantages of CEE as a whole, namely the extremely ready availability of funding from both banks and capital markets. On the bank side, this is mainly provided by a core group of international lenders with operations in the region, including UniCredit, Raiffeisen, Erste, Société Générale, BNP Paribas and ING. “These banks have been very loyal and very dedicated over the years,” says Baudon.The Balkans’ macro volatility does not, however, appear to be a bar to attracting international debt investors – as KKR proved with its buyout of SBB. The debt part of the deal was entirely financed with a €475 million bond, to the surprise of some bankers who felt that single-B-rated Serbia might be a step too far for high-yield bond buyers.
The funding environment is particularly favourable at present, adds Vukovich, as banks are looking to expand their balance sheets as they emerge from the shadow of the financial crisis. And, as he notes, a buy-out by a credible private-equity investor is a perfect opportunity for lenders to deploy capital in markets where the only alternatives would be large state-owned firms or private local small- to mid-cap companies. Erste’s Bleier agrees: “Banks are falling over themselves to provide debt to decent opportunities.”
Market participants agree that debt packages of €200 million to €300 million can easily be raised locally, although Baudon notes that funding terms for CEE remain slightly tighter than in western Europe. “Maturities will be one or two years shorter, leverage will be maybe half a turn of ebitda lower, we will likely have more amortizing debt, covenants are slightly tighter and fees are a bit higher.”
Cooling off
What is missing in CEE, say some bankers, is a viable equity market that allows for exits via IPOs. The only country in the region with an active primary market is Poland, and that has had its lustre dimmed in the past two years by the nationalization of its second-pillar pension funds.
The main concerns around the process were allayed last summer when more Polish workers than expected opted to remain in the private system – but, as Vukovich points out, there has still been a cooling off of the local market. “The privatizations are more or less over, the economy is slowing down, and the proximity of Ukraine is affecting sentiment.” This means, he says, that there is no plan B for exits, something that tends to put potential private-equity investors off the region.
Others are less gloomy, both about the viability of equity market exits and about the need for them. Siwicki at Enterprise Investors, which has listed a total of 29 companies in Warsaw, is confident that it will remain a viable IPO venue for firms from Poland and the wider region. As he notes, even in a difficult market last November, Enterprise succeeded in making a partial exit from asset-management firm Skarbiec via the Warsaw Stock Exchange.
By contrast, Mid Europa has yet to make an exit via the public markets and has found strategic buyers for 18 of the 21 assets it has sold to date. Baudon is confident that this trend will continue. “When you build companies which at the end of your holding period have become domestic market leaders, are fairly westernized and are in growing sectors, you will usually find a strategic to buy them, so why would we bother with IPOs?” he says. “An IPO is not really an exit, it’s a marking to market with partial liquidity.”
Kubica at KKR agrees that a sale to strategics is the goal for most private-equity funds. “You have a buyer who understands the business, may have some synergies, and thus could justify a premium valuation,” he says. “When investing in a new deal, funds have usually thought about potential strategic buyers for their exit, with a public listing often as a back-up option only. Compared to an IPO, an outright sale is less time-consuming and resource-intensive.”
Certainly, a shortage of IPO opportunities has not affected KKR’s enthusiasm for the region – Kubica says the US fund hopes to do a deal there every two to three years – and bankers confirm that, while the cohort of funds that cover CEE may have shrunk, those that remain are very keen to put cash to work in the region. “There is significant dry powder in both regional funds and global funds that have CEE as part of their investment perimeter,” says Vukovich.
Citi’s Diamandakis agrees that the main bar to activity is a lack of supply rather than demand. “The opportunities, especially for larger-ticket investments, are more limited than they were pre-crisis,” he says. “For a good business, however, even in the mid-sized segment, there will be a lot of interest. I think everyone wishes there was more to do in the region.”
CEE may be going through a difficult age, but it still has plenty of supporters in the private-equity community. As its economies continue to mature the region may yet regain its place among Europe’s rising stars.
