Despite poor conditions for the industry, central and east Europe continues to attract funds. In 2003 Austria’s Lead Equities made the first closing of its first fund, for E40m, while DBG Eastern Europe completed the first closing of its second fund. DBG’s Eastern Europe Fund II closed at E67m, close to its E80m target.
The first fund, Osteuropa, is already fully committed. Jaroslaw Horak, managing director of DBG Eastern Europe explains that with fund raising difficult in the current climate, DBG Fund II’s first closing had the backing of Osteuropa' partners, Deutsche Bank, European Bank for Reconstruction and Development, Mitsubishi Corporation and German private equity specialist DEG.
Compared with western Europe, the CEE region nevertheless has greater opportunities because of strong sustained economic growth, with the possible recent exception of Poland, and low existing private equity penetration. Their need has also greater. “There is an equity gap,” stresses Kimberly Romaine, manager of fund research at AltAssets. “After communism fell, those companies that lacked political connections and existing finance couldn't get bank credits because of high interest rates, and could not develop. Private equity is also a very good method of promoting corporate governance in the region.”
Funds are widening their scope in the region. For example, DBG Fund II, while focusing on the core Osteuropa countries of Czech Republic, Hungary and Poland, will also be investing in Croatia, Slovakia, Slovenia, south-eastern Europe and the Baltics. Fund investment activity stepped up last year for a number of players. Janusz Heath, head of Dresdner Kleinwort Capital’s (DrKC’s) central and east European group reports that his funds made two new investments last year, against one in 2001 – taking strategic control of the largest Polish-owned confectioner Mieszko, and providing expansion capital for Radio PLUS, the third largest Polish private radio network – as well as two follow-on investments in existing portfolio companies.
The market is beginning to resemble western Europe, with deal sizes getting larger – although there is still a shortage of specialist start-up funds – while EU accession for eight of the region’s countries in 2004 promises further opportunities. “We’re expecting another wave of foreign corporate activity, as well as higher interest from Russian companies, as well as corporations in the region themselves,” predicts DrKC’s Janusz Heath. “In addition some of the region's early private equity funds are creating exits for other financial buyers.”
The size of the region’s market in the region remains open to speculation. According to European Venture Capital Association (EVCA) data for 2001, funds raised E176m for Poland (while E102m was invested), E60m in Hungary (E143m invested), E24m in the Czech Republic (E26m invested) and E5m for Slovakia (E9m invested). Some local private equity and venture capital associations believe these figures underestimate the true size of the market as they class the funds by their domicile. The absence of a few respondents responsible for key deals in the CEE region can also lead to significant under-reporting.
In Poland, the largest market by virtue of its 39m population, Dariusz Stola, executive director of the Polish Private Equity Association (PSIK), estimates the size of the local market at E3bn, while PSIK’s 35 members manage more than E3.3bn, although this also includes pan-regional players. By contrast data from the Hungarian Venture Capital Association (HVCA) estimate that investments were around $64m (E60m) in 2001, rising to $120m in first 11 months of 2002. Although the number of transactions were similar (29 in 2002 against 28 in 2001), the deal size was larger, an average $4.1m against $2.3m.
Most of the transactions in terms of investment size were buyouts according to Central Europe Trust’s Julian Tzvetkov, the president of the HVCA. “Although the amount of capital invested in 2002 in Hungary was by far the largest, the amount of real money that went into Hungarian companies was not that much because of the buy-out effect,” notes Tzvetkov. These included Raiffeisen Private Equity’s takeover of the Stollwerck Budapest confectionary company, and Argus Capital’s buyout of Ster Century, a multiplex cinema company with chains in Hungary, the Czech Republic and Slovakia. One of the largest imminent buyouts is the forthcoming acquisition by GMT Communications Partners and AIG emerging Europe Infrastructure Fund of Vivendi Telecom Hungary, the local telecommunications arm of the troubled and over-extended French company's local telecommunications arm.
The preponderance of trade-sale buyouts follows the development of private equity in the region. In the early stages privatisations provided many of the transactions, which averaged US$5m-10m. By the late 1990s smaller, already private companies were seeking capital. By 2000, the Hungarian deals at least, 47 recorded by HVCA, had shrunk to an average $2.2m, the lowest to-date. This was the year when the dotcom bubble burst, casting a pall over 2001. “People got burned so they were careful in 2001. The following year, after the shake-up, the good companies survived but needed capital, so hence the large number of buy-outs,” adds Tzvetkov. These included companies such as GTS Central Europe, the region's largest alternative network provide, which survived despite the bankruptcy of its parent KPNQuest and which was bought out by Antel Holding, the subsidiary of Russia’s Group Menatep.
Poland largely escaped the effects of the dotcom collapse because of the more conservative and diversified structure of private equity portfolios, although valuations decreased because of the downturn in the Warsaw Stock Exchange, and lack of international interest dampened trade sale possibilities. The picture improved in the second half of 2002. “The number of exits grew, including on the exchange, and we noticed growing interest from overseas investors, probably because of EU accession,” notes PSIK’s Dariusz Stola. The Warsaw Stock Exchange, by far the region's biggest bourse, played a prominent role in last year's private equity transactions. Enterprise Investors, the leading Polish private equity firm, launched two IPOs –for food distributor Eldorado and jeweller W Kruk – and used the exchange to exit its investments in electrical engineering firm Elektrobudowa and aluminium producer Grupa Kety. Shares in the Kety transaction, the country’s first example of a full exit through an exchange, sold at $11.20, well above earlier trade sale offers, and received he support of the Polish pension funds industry. Local pensions funds, who could potentially play as important a role in the region as their west European counterparts, are currently heavily constrained in direct private equity investment. “We are lobbying for a change in the law so that they can invest in private equity vehicles,” adds Stola.
While the privatisation pipeline in Hungary has almost dried up, in other countries in the region there are still potential landmark deals. Advent International is bidding for a controlling 65% stake in Bulgarian Telecoms Company, while in Poland the local private equity house Enterprise Investors and UK-based Bancroft Group are bidding for a stake in Telbank, the telecommunications services provider for banks and financial institutions. In the Czech Republic the state still retains large stakes in major companies, according to Garret Byrne, director of transaction support services in Deloitte & Touche Central Europe in Prague. Last year saw an attempt to sell the majority state-owned telecom operator Cesky Telecom. A private consortium led by Deutsche Bank’s private equity arm and TDC of Denmark, emerged as the main bidder but the deal was postponed because of disagreements on price among the bidder, the state and minority shareholder Telsource. “Had the sale happened it would have been one of the biggest private equity transactions in Europe for 2002,” says Byrne.
In most countries the privatisation process is close to completion. “With the big privatisations behind us we're now seeing a consolidation of interests in the region,” adds Byrne. This has been particularly evident in cable TV. In 2002 Intercable CZ, the second largest cable TV operator, was acquired by the third largest, TES Media, which is now owned by Baring Communications Equity Emerging Europe, JP Morgan Partners and AIG Global Infrastructure Fund. In Poland a consortium of Hicks Muse, Argus Capital Partners and Emerging Markets Partnership acquired the cable TV assets owned by Elektrim Telekomunikajca and Vivendi.

Other trends include greater use of management buy-outs and buy-ins. DrKC has set up MBO/MBI clubs in Hungary, Poland and the Czech Republic to bring potential suitors together. “Looking forward, I believe there will be more use of leverage and mezzanine debt, especially on the larger deals where the targets have reasonable cash flows,” adds Byrne. In 2002 the region’s first mezzanine fund, Accession Mezzanine Capital, had its first closing at E76m. The fund is targeting Poland, Hungary, Czech Republic, Slovenia and Slovakia.
Leveraged finance has been eased by the privatisation of local banks, which now understand structured finance and are willing to lend for such transactions. The Bulgarian BTC deal, scheduled for completion in March, is set to become the first leveraged privatisation, with EBRD leading the bank syndicate. Joanna James, managing director for central and eastern Europe at Advent International, describes the heavily politicised deal as the most complex in her 22 years in the business. “It’s a window of opportunity for private equity investers until strategic investors, who blew their money on third generation mobile licences, return,” says James.
The old classics such as media, consumer goods, telecommunications and technology, old more than new, still predominate, but there are growing opportunities in sectors undergoing structural reforms, such as healthcare. The latter includes Medycyna Rodzinna, a Polish private healthcare provider, acquired by Enterprise Investor funds in 2000 to build outpatient clinics, and Euromedic, a Hungarian-based diagnostic services provider with centres in Poland, Romania and Republic of Srpska, co-financed by DrKC and GE.
And while EU accession dominates investor interest, NATO membership could potentially produce opportunities. Poland's recent agreement to purchase Lockheed Martin fighter jets from the US includes a $9bn offset component. “In the US private equity is the regular way of implementing offset components,” notes PSKI’s Stola.

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