Full of eastern promise
The private equity market in central and eastern Europe remains small by the standards of western Europe. However, the potential for growth is exceptionally good in the eight countries that joined the EU in May 2004, as well as in Romania, Bulgaria and Croatia, which are next in line for accession.
‘Central and East European Success Stories’, a study prepared by the Central and East European Task Force of the European Venture Capital Association (EVCA) last year, estimates that more than E7bn has been raised in the region since the first country-specific PE funds were launched in 1990, with some E5bn invested in over 900 companies.
Multilateral bodies continue to play an important role. The European Bank for Reconstruction and Development (EBRD) remains the biggest private equity investor in the region. By the EBRD’s own estimates, the $5.3bn (e4.1bn) of capital it has committed since the early 1990s accounts for nearly half the funds raised in the region, including the former Soviet Union. “Multilaterals such as EBRD are still very important players, giving substance to equity funds, and investors appreciate our participation,” says Kurt Geiger, head of financial institutions at EBRD. “We remain committed because the transitions are not completed. Our role is to finance transactions and develop products not available in the private sector, such as credit structures, but we do not compete with the private sector.”
EU accession has been a major factor in recent private equity fund-raising, investments and exits. The region’s economies have grown at an average 2.5% above that of western Europe over the past decade, with the European Commission expecting this differential to widen by up to 4.6%. “Investors are realising that they are getting the benefit of growth with the security of being within EU structures,” says Robert Manz, partner at Warsaw-based Enterprise Investors (EI) and president of the Polish Private Equity Association (PPEA).
An additional factor is that many of these countries have followed Ireland in lowering their corporate tax rates to stimulate business. Nevertheless, even for the eight countries that joined the EU in May 2004, the private equity industry remains the preserve of specialist houses, in some cases focusing on specific geographical areas. For example, BaltCap is the largest fund targeted specifically at Estonia, Latvia and Lithuania, and has invested E40m in 27 deals over 10 years.
The notable number of successful exits in 2004 shows that PE investment in the region does yield results. “Exits were slow in the previous two years, but picked up in 2004, and we’ll see more this year, including more stock exchange listings, with good prospects for medium-sized companies to list,” predicts Geiger. According to data from the Hungarian Venture Capital Association, as of the first 10 months of 2004 there were 20 exits.
The largest Hungarian PE exit, with an enterprise value of $53.5m, and the country’s first secondary exit, was the sale of Argus Capital’s stake in cable TV operator FiberNet to Warburg Pincus. FiberNet, an operation formed from the consolidation of 64 local operators, netted Argus a return 2.6 times its original investment.
Other regional secondary sales included Argus Capital partners’ sale in January of a 22% stake in Aster City, Warsaw's leading cable TV and broadband operator, to Hicks Muse; in November 2004, Hicks Muse had bought Emerging Markets Partnership’s 39% stake in the Polish company.
While trade sales predominate, stock exchange listings have become more frequent. The region’s stock markets have been among the world’s strongest performers, with prices rising further in the run-up to EU accession. In June, Warburg Pincus floated the Czech pharmaceuticals company Zentiva on the Prague stock exchange, marking the exchange's first IPO. The issue was five times oversubscribed.
In Latvia, IT service company MicroLink, one of the investments of the BaltCap fund, divested its share in the wireless telecommunications manufacturer SAF Tehnika on the Riga Stock Exchange, marking the first private sector Baltic IPO since the 1990s.
The Warsaw Stock Exchange (WSE), central and eastern Europe’s largest bourse, had the third highest number of IPOs in Europe after London and Euronext. EI, the region’s largest and oldest private equity firm, has floated some 20 companies on the WSE.
“Over the last four years we’ve generated some 65% of our exit proceeds through the WSE,” says Robert Manz. In 2004, these transactions included EI’s exit of its 50% stake in Comp Rzeszow, one of Poland’s largest banking and financial software companies. The $37.7m raised represented a 7.3 multiple on EI’s initial investment in the company in 1998.
WSE’s investor base includes local pension funds, most of which are owned by international players for whom private equity represents an asset class elsewhere. However, legal constraints prevent central and east European pension funds from investing in private equity, an issue the local PE and venture capital associations are addressing with their respective regulators.
“In Estonia local pension funds can't invest in practice in PE because the venture capital funds tend to be registered in the Channel Islands as limited private partnerships,” notes Peeter Saks, CEO of Suprema Securities, one of BaltCap’s co-investors. “We need a local structure, but one that suits international investors. The finance ministry is looking at this issue.”
The regional market is already resembling western Europe’s, including the emergence of a skilled management class, says George Collins, partner at the Prague office of Argus Capital. For instance leverage, either as acquisition finance or recapital-isation, is also more readily available, and its increased use in 2004 was one of the features of central and eastern European private equity investment. “There are a number of banks in the_region, primarily controlled by west European banks, that understand private equity investment and are willing to provide leverage,” adds Collins.
One of the hallmark leveraged buyout deals of 2004 – and one of the most protracted – was the E280m sale of 65% of state owned Bulgarian Telecommunications to Viva Ventures, a consortium led by Advent International, which won the tender in 2002. One of the largest deals in heavy industry was the purchase of the Czech mining group Karbon Invest – including the Czech Republic’s largest coal mines – by RPG, a Cypriot-based vehicle.
Recent leveraged recapitalisation deals include those of the Czech printing company Svoboda, and Palace Cinemas, a regional multiplex operator. Mezzanine finance is also available, allowing for more sophisticated capital structures. “Two to three years ago most deals were entirely financed with equity,” Collins says.
Additionally, there are increasing numbers of corporate divestures by conglomerates that are providing buy-out opportunities, and new companies seeking to cash out or seeking additional expansion
capital. This is in contrast to the situation two to three years ago when most PE deals were driven by privatisations or early-stage expansion, says Collins.
Privatisation, as an investment pipeline, is inevitably shrinking, although occasionally an attractive company does emerge. EI’s Manz says that 18 of the firm’s 96
investments have been privatisations. EI’s E300m Fund V, which made its final closing in June 2004, and is one of central Europe’s largest, was part of the consortium that acquired the Bulgarian Telecommunications stake. In
January it acquired a 25% stake in Zelmer, Poland’s leading small domestic appliance manufacturer, as a special tranche during the firm’s flotation. Unlike stock
market investors, EI is committed to retain its stake for at least
What is still missing is start-up
capital for new businesses. “As in western Europe, there is an equity gap in seed and start-up investments,” Manz observes. According to EVCA data, in 2003 start-up
capital accounted for 5.6% of the region’s private equity investment, and 7.4% in western Europe. “There is also a lower level of angel investment. At the PPEA we’re trying to work with the Polish administration to find ways of incentivising that part of the market. EU funding is a possibility here," Manz says.