EU accession of eight central and east European (CEE) countries is contributing to the growth of the region’s private equity market. It is still small by west European standards and difficult to quantify as many of the funds are regionally focused, and many of the deals not announced. Kurt Geiger, business group director, financial institutions, at the European Bank for Reconstruction and Development (EBRD), estimates that in the region covered by the bank, which includes Russia and the Commonwealth of Independent States, it has reached E11bn, including E8bn of publicised funds. The bank itself has committed E1.3bn in some 80 funds over the last eight years.
Activity across the region last year varied. In Hungary, according to a survey by the Hungarian Venture Capital Association (HVCA) for the year up to early November, total investment in euro terms declined by 11% year on year to E113m. However, a relatively number of deals involved the third or fourth follow-on investment. “That is significant feature of the Hungarian private equity industry as it illustrates the positive economic impacts of venture capital on corporate growth and proves the the venture capital-backed Hungarian companies trust the asset class,” says Szabolc Soos, scientific associate at HVCA. As in western Europe, the picture was skewed by a few large transactions: three large deals by four investors represented 86% of the total value of private equity activity in 2003. These included the equity portions of the E30m buy-out of the Hungarian commercial radio station Danubius Radio, alongside equity funding from Advent International, and of the acquisition of Vivendi Telecom Hungary, the country’s second largest fixed-line operator with 12% of the market, by AIG EEIF and GMT. Valued at E325m, this currently ranks as the region’s biggest private equity deal.
In Poland the fund-raising climate has improved significantly after the turndown following September 11, 2001, according to Robert Manz, partner at Enterprise Investors (EI - the country’s largest private equity firm), president of the Polish Venture Capital Association and chairman of the Central and East Europe Task Force of the European Private Equity and Venture Capital Association. EI itself is close to closing its fifth fund, at around E300m, in the country. Polish private equity investment recovered dramatically in 2002, growing by some 40% to E150m purely on EVCA data, and Manz estimates a further 15-20% increase in 2003.
In the Czech Republic, DBG Eastern Europe, Czech Venture Partners, Bancroft and Genesis Capital held first fund closings, while investment events included the leveraged buyout (LBO) of the paints manufacturer Primalex for an undisclosed sum. “We expect more LBOs in the future because of the improving quality of the management teams and more sophisticated debt financing available, with local banks developing structured financing tools,” notes Jaroslaw Horak, chairman of both DBG Eastern Europe’s management company and of the Czech Venture Capital Association (CVCA).
One of last year’s regional events was the final closing, by the London-based provider Mezzanine Management, of Accession Mezzanine Capital, the first such fund for the region, at E115m. The fund targets companies in Poland, Hungary, Czech Republic, Slovakia and Slovenia, and can also selectively invest in Romania, Bulgaria and Croatia. It has since invested in the Danubius Radio buy-out, and Lux-Med, a chain of out-patient clinics in Poland.
At the EBRD, which participated in the fund, Geiger is enthusiastic about the potential that mezzanine financing, standing between debt and equity, offers private equity targets. “It will provide a new type of financial instrument, allowing growth and financing transactions for healthy medium-sized enterprises,” he explains. “It’s largely not offered by local banks yet, and it’s also very useful for companies with private equity because it helps leverage the equity while providing financing to allow the companies to grow.”
According the Geiger, of the exits executed in the EBRD’s portfolio, trade sales have accounted for two-thirds and stock market flotations a further quarter, with returns of around 100%. “This is in line with industry standards and experiences in western Europe 10-15 years ago when private equity started to become used by enterprises.”
“In Poland you also saw the first classic leveraged deals in 2002-03,” reports EI’s Manz. Among EI’s five new investments in 2003, it used an LBO to purchase the Nomi chain of DIY stores from Kingfisher. Poland is also unusual in the region for having a stock exchange large and liquid enough to effect public exits. In September 2003 EI exited its 72% stake in Polfa Kutno, the country’s second largest pharmaceutical company, for $80m (E63m), in what was the largest secondary offering to-date on the Warsaw Stock Exchange (WSE).
“Another trend is the development of mid-sized entrepreneurial companies, which already have professional management in place and are becoming more attractive to private equity investors,” adds Manz.
For small companies looking for seed capital or start-up investment the picture remains depressed. “Around 90% of private equity money in Poland is going to later-stage investment, while the small companies face an equity gap. We’ve been trying to encourage the government to sponsor fund management into this area,” says Manz. Hungary has taken the lead here. Last year the state-owned Hungarian Development Bank (MFB), together with the European Investment Fund (EIF) and launched its Development Capital Investment Program for SMEs. “As the MFB entered into the bottom-end of the market uncovered by other investors, it does not compete with the existing private equity and venture capital funds that focus on larger companies that do not carry the high risk associated with start-ups,” explains HVCA’s Soós. The state-owned Regional Development Holding Company is committed to financing SMEs by mobilising state funds, private funds and EU funds.
The region’s industry remains hampered by tax and other legal constraints. Hungary is currently in the process of overhauling the 1998 Venture Capital Act.
The present act is designed to protect the interest of small investors. It provides some tax relief to venture capital investors, and to prevent tax fraud, it places a number of restrictions, including minimum requirements on the percentage of issued capital invested over specified periods. “Currently the majority of private equity investors in Hungary don’t use the act, as it is too restrictive,” reports Soós. “We have started negotiations with the legislators and we’re optimistic. The association has been working to make the VC act more flexible and adapted to the real nature of the industry.”
Ultimately EU membership will erode what is in effect an artificial distinction of east and west hanging over from the Cold War. “You will see fewer country-focused and regionally focused funds,” predicts EBRD’s Geiger. This is already happening. Hungary-only funds are being wound down according to the HVCA. Meanwhile, this January Austria’s Invest Equity launched the Greater Europe Fund, with an initial commitment of E25m, which the fund aims to double by its first closing later this year, and which will target companies in Austria, southern Germany, Czech Republic, Hungary and Slovenia.