Dealmakers remain confident about Central Europe in 2016, but they predict mergers and acquisitions (M&A) and initial public offerings (IPOs) may struggle in Southeast Europe after several high-profile transaction failures in 2015.

According to a survey in January by CMS and EMIS, dealmaking in Central and Eastern Europe fell last year for the fourth year in a row, though this was partly the result of the deep economic downturn in Russia and Turkey’s more turbulent political climate.

In Southeast Europe there had been high hopes of a bumper year because of the planned privatisation of state telecommunication companies in Slovenia and Serbia, which attracted global private equity groups such as Apollo Global Management, Cinven and Colbeck Capital Management. However, governments pulled the plug on the deals when bids didn’t meet expectations, amid a political backlash against privatisation, and the sales are unlikely to be re-started this year.

“These companies are crown jewels for these countries and have been viewed as such for the 25 years since the fall of communism,” explains Rob Irving, legal firm Dentons’ regional head of private equity. “It is very difficult for governments to sell these companies to less than tier one investors and at prices far below what they would have got 10 years ago. Politicians find it difficult to get expectations to where they should be. Their price expectations were completely unrealistic for these kind of deals.”

The governments’ rejection of the bids will cast a pall over the region this year, according to Helen Rodwell, managing partner of CMS in Prague. “Private equity may have reservations to immediately jump on similar opportunities when they arise,” she says. This will inevitably raise question marks over the success of this year’s planned privatisation programmes in Serbia and Croatia.

In Central Europe, where the privatisation wave is long since spent, there was more bad news for dealmakers, with the election in October of a populist rightwing government in Poland that threatens to follow the Hungarian example and penalise foreign investors in the banking and retail sectors.

At the same time, anti-refugee noises coming out of all four Visegrad countries in Central Europe, together with the chaos caused by the massive refugee flows further south in the Balkans, have created a very negative image of the whole region.

Together with the febrile global economic environment (and nervousness over emerging markets in particular) this has all put a dampener on M&A across the region, according to Edward Keller, M&A/Capital Markets partner at Dentons in Budapest.

For large private equity funds – which enjoyed a boom year in 2015 in Western Europe – Central and Southeast Europe anyway no longer provides enough big transactions to justify a network of offices or regionally-focused funds. For example Advent, which failed to raise a new regional fund in 2013, has recently closed its Prague office. “There is consistently enough deals in the lower and mid-market segments but a dearth at the higher end,” says Irving.

According to Roland Berger’s European Private Equity Outlook 2016, released on February 19, private equity professionals expect there to be just a 1.5% increase in private equity M&A activity this year in Poland, and a 1.6% uptick in the rest of Central Europe, well below the 3%-plus expected in Germany, Italy and the Iberian peninsula. Many of the large regional funds and their smaller local counterparts that were raised before the global financial crisis are already in disposal mode as they gear up to raise new funds. Some will not be able to raise finance, leading to a shake-out among private equity firms.

Time is ripe

In the short term at least, this could lead to a spike in deals, though in the longer term this will reduce funding supply. “There are a lot of 2007-08 vintage funds which have passed their investment period and the time is ripe for the investments to be exited,” says Irving.

There is also a falling off of interest by strategic investors in the region, and the wave of disposals and consolidation that followed the global financial crisis still has some way to run, according to Josef Kotrba, managing partner of Deloitte in Prague.

On the positive side, dealmakers say there is some opportunistic investment from big spenders such as UK infrastructure funds and in particular US private equity groups, propelled by the strong dollar. For example, TPG and Blackstone have been buying and flipping logistics parks across Central Europe. “The amount of interest from the US is unbelievable compared to two years ago,” says Keller.

Chinese money is also finally visible, notably CEFC in the Czech Republic and the China-CEE Fund in Poland and Romania. Keller says that Central Europe, particularly Poland, will be the centre of Chinese interest, and that they will take a long-term view and shrug off the current noise about political risk.

There is also more and more locally-based M&A from smaller PE funds, oligarchs, local financial and industrial groups, as well as the relatively new phenomenon of clubs of rich investors and successful entrepreneurs. The biggest local players, such as PPF Group, owned by Petr Kellner, the richest man in Central Europe, can often go head to head with global private equity or strategic groups, though they will rarely win on price in an open contest. “There are reasonable local players in all segments,” says Brian Wardrop of Arx Capital in Prague, a private equity firm focused on mid or lower mid-market industrial companies in Central Europe.

Transaction flow has been bolstered by easy liquidity, though not always at the lower end. Wardrop says there is if anything too much liquidity in the Czech Republic, which could lead to risky investments.

M&A activity has also been helped by more realistic valuation expectations from target companies across the region, particularly now in Romania, which Keller says was “the last holdout”. “Valuation expectations have come down tremendously,” he says, and the Romanian market is now “very buoyant” with severable sizeable deals in the offing.

All in all therefore, despite the slackening interest from regional private equity funds and strategic investors, dealmakers believe transaction flow will be resilient, especially in Central Europe. “There are still some good transactions out there,” says Irving. “They may not be headline transactions but there is still a good pipeline of tier one transactions. In Central Europe we are seeing an incredibly high level of activity”.

Doubling down

Breaking it down further, some dealmakers predict that Poland could be a very active market this year as foreign investors react to the election of the Law and Justice government. The finance and retail sectors in particular face turbulence because of the threat of punitive taxes, triggering disposals. Raiffeisen Bank International and GE Capital are already trying to sell their banking units, though these decisions predated the change of government and represent wider retrenchments. “The new government is probably encouraging some people to ‘double down’, [while other] people are not happy with the regulatory risk,” says Irving. “This will lead to a shake-out and we are seeing a lot of movement of assets.”

However, Rodwell of CMS argues that the market could “stall” because of a lack of buyers. “There are still many RFPs [requests for proposals] kicking around in the mid-market segment,” she says. “But the high-end deals in the market will simply wait. The reality is that when you have that kind of change of government there are very few eager buyers. A number of the foreign investors have found that they would have liked to exit and there is no chance to exit at realistic pricing. It just makes people pause until the dust has settled a bit.”

Hungary – where the populist rightwing Fidesz government has been in power for almost six years now – shows the path that Poland could follow. There was initially a slew of disposals by strategic investors, particularly in the banking sector, but that process is mostly over, and now the government is pledging to privatise some of the assets it bought. Dealmakers say bank sales such as MKB and Sberbank’s unit could attract some big global private equity investors, such as Advent and AnaCap. “We are seeing definite activity,” says Irving. “We are continuing to see some big multinationals selling to the government and now we are seeing the government privatisating some of the assets it has acquired over the last few years”.

He fingers banking, retail and energy as hot areas for deals throughout the region as they are “sectors that are going through turbulence, sectors that governments are targeting with regulations”

Rodwell agrees that Hungary “will have a much better year deal-wise”. “People stayed away for a couple of years, but people get used to a new investor environment and the level of investments will return,” she says. “The government has also relaxed somewhat,” she adds. “They are taking measures to engender more activity locally.”

Around five to 10 government sell-offs in Hungary could go through the Budapest stock exchange, which is tipped for a dynamic future. “Capital markets are increasingly attractive again as an exit option,” says Keller of Dentons, who is more bullish on Budapest than on the Bucharest bourse. “It is really a question whether the market is going to be there in terms of valuations.”

Nevertheless, some investors continue to look askance at Hungary. “As a location today its high-value manufacturing make it still pretty interesting,” says Wardrop of Arx. “But there is a risk premium to be attached to the country. It is just hard to make your numbers work. We tend to do the Czech deals as it’s just less risky.”

The Czech Republic is tipped to benefit from any potential shift away from the crowded and overpriced Polish market, or a more general shift away from riskier emerging market investment destinations. The neighbouring much smaller Slovak market, which the local big fish J&T Group and Penta Investments have made very much their own, is still very quiet. “The Czech Republic remains very buoyant,” says Rodwell. “It is also benefiting from other jurisdictions faltering.”

Investment bankers such as Kotrba at Deloitte and Alex Verbeek at KPMG in Prague say that the Czech market is very busy. “There has been an enormous shift in the market,” says Verbeek, with sellers being able to name higher prices than before.

There is even a danger that price expectations are  becoming too ambitious, especially in real estate, where yields are close to Western European levels. “There is too much competition in the Czech Republic,” says Rodwell. “The real estate market is outpricing itself. The pricing starts to resemble pricing in parts of West Europe.”