Private market investors remain wary despite the apparent robustness of eastern Europe’s opportunities, writes Jennifer Bollen

When one of the world’s biggest buyout firms arrives in a region it often signals that good things are to follow. In October, US alternatives manager Kohlberg Kravis Roberts (KKR) secured its first direct investment in south-eastern Europe with its acquisition of cable television and broadband provider SBB/Telemach Group from the CEE specialist buyout firm Mid Europa Partners.

The deal delivers exposure to about 1.7m customers in Serbia, Slovenia, Bosnia Herzegovina, Croatia, Montenegro and Macedonia, according to a statement from KKR. It generated approximately a 3x return for Mid Europa, according to a separate statement.

Executives are hopeful the deal will lead to an upturn in investment in CEE following a period of uncertainty in its macro-economic situation this year.

“This may encourage other big ticket deal peers of KKR to take an increased interest in central Europe,” says Garret Byrne, a partner and private equity leader for central Europe at advisory firm Deloitte.

“A big US-based firm shows confidence in our core space,” says Thierry Baudon, founder and managing partner of Mid Europa Partners. “This is certainly helpful.”

Henry Kravis, KKRs co-founder and co-CEO, said in a statement that it was “a sign of our confidence…. in the region”.

Baudon says that CEE has suffered from its association – in many investors’ minds – with the rest of Europe and the sovereign debt crisis.

“The region remains a bit neglected,” he concedes. “I don’t think the improving fundamentals on the ground have translated to [CEE] being back in fashion. The community continues to be more focused on [other] emerging markets, despite what has happened in the last 6-12 months. This is particularly true of US investors who still seem to believe Europe is on fire. It is much less the case for the Europeans and particularly the Asian and Middle Eastern investors, who see the opportunity as the best in a long time. In our next fund, we will have a large proportion of Asian and Middle Eastern money.”

Figures from Dealogic reflect the broader uncertainty. The number of private equity deals in CEE dropped to seven in the third quarter, the lowest since there were seven deals in Q3 of 2009. Meanwhile, the total known value of buyouts in the region fell to $6m (€4.4m) – the lowest quarterly total since Q1 of 2002, when the total was just $1m.

Contrast that with the second quarter of this year, when buyout firms agreed nine deals worth a combined $563m; or Q3 of 2012, when there were 14 deals worth a total of $330m.

Nonetheless, the latest edition of Deloitte’s Central Europe Private Equity Confidence Survey, published in May, shows an increase in confidence in the region this year. Deloitte’s CEE confidence index rose by 30 points in the spring from 71 points in October last year, regaining ground it had lost over the previous period. Deloitte attributed the rise to a drop in respondents predicting further decline in the economic outlook, more optimism about the efficiency of financial investments and growth in the number of investors intending to buy more than they sell over the subsequent six months.

“The mood is better than it was a year ago, even six months ago, largely because at the end of the day the crisis in emerging markets was triggered by quantitative easing, which has clearly shown this region is much more resilient than most,” says Baudon. “When the Fed announced the potential end to the money printing machine, a number of currencies in [other] emerging markets went dramatically down, particularly the Indian rupee and Brazilian real.”

Byrne agrees that CEE compared favourably with less established private equity markets.

“Several central Europe countries are more stable, politically, economically and legally, than other emerging markets,” he says. “Given that most of the countries are in the EU, they have ‘familiar and predictable’ legal and tax systems. If a UK private equity fund comes over, the tax, VAT and legal systems would not be a million miles away from what they are used to. Prague, Warsaw and Bucharest can also all be reached in one to three-hour flights from most major European capitals, which makes them easier to manage than businesses further afield.”

A report on central, eastern and south-east Europe published by the International Monetary Fund in October is less optimistic, pointing out that the biggest impact of the US’s plans to scale back its QE progamme would be on Serbia, Turkey, and Ukraine.

Baudon sees a clear divide within CEE, with the urban middle class driving growth in the north. “We continue to have very differentiated groups divided between countries in the north of the region being seen as attractive and reasonably stable. Then we have the eastern Balkans  doing very poorly,” he says. “It is a net positive but we continue to have laggers and macro-economic difficulties in the south-eastern part of the region.”

The Fed’s decision in September to postpone tapering its asset purchases provided some relief to emerging markets, particularly central, eastern and southeastern Europe. However, the IMF warned countries in the region to prepare for renewed macro-economic pressure, since “domestically issued debt held by foreigners has increased significantly, and international issuance has been high”.

Household debt does not worry Baudon and for Deloitte’s Byrne, corporate and individual indebtedness is not too much of a concern, given that it is relatively low in central Europe and could provide investment opportunities.

“In a macro sense, targets which capitalise on the lower level of household indebtedness may be interesting plays,” says Byrne. “Infrastructure assets around the energy and telecoms sector are of increasing interest as some European corporates deleverage and retrench from non-core geographies.”

Czech gas transmission company Net4Gas, bought by Allianz and Borealis Infrastructure from German energy company RWE for more than $2bn in March, is the biggest buyout in CEE so far this year.

Other sectors generating interest among buyout firms include healthcare, where increasing privatisation is expected, according to Václav Jirků, an investment director at central European alternatives house Penta Investments.

Meanwhile, fundraising by CEE-focused private equity vehicles has remained patchy in recent years. According to data provider Preqin, 11 funds raised an aggregate $1.37bn in the first three quarters of the year, compared with 13 funds with $1.9bn of commitments in the same period last year and 14 funds with $1.1bn of commitments in the same period in 2011.

The figures compare with 36 funds with $8.3bn of commitments in the same period in 2007 and 29 funds with $3.3bn in the first three quarters of 2008.

“[Private equity firms in this region] have problems raising new funds,” says Jirků. “Except for Mid Europa [currently on the fundraising trail], many are facing a situation where LPs sitting in London do not consider this region attractive right now.”

Deloitte said in its report that while fund closings remained sparse, the slowdown may be due to a greater focus on wooing investors.

“Fast-forward one year and fresh pools of capital could translate into reinvigorated deal activity,” it said.