FUNDS: Nothing ventured, nothing gained

By bne IntelliNews March 4, 2009

Robert Smyth in Budapest -

The recession and associated reduced credit lines don't spell bad news for everyone. Venture capital funds that were operating before the financial crisis broke will provide a lifeline to Central and Eastern Europe's best small businesses, which are now more realistically priced.

"Valuations have dropped significantly all over the world over the past year - and the valuation expectations of the potential 'investee' targets are also becoming more realistic," says József Kövér, investment director at 3TS Capital Partners. "That means more opportunities for investors and the investment outlook for the venture capital industry is positive."

3TS and US technology firm Cisco Systems in 2007 created the emerging Europe-focused 3TS-Cisco Growth Fund, which started at €30m and is expected to continue growing despite the current economic climate. It is the third fund under 3TS management, bringing the investment firm's total funds to over €200m, much of that earmarked for private equity buyout investments.

The 3TS Cisco Growth Fund in February struck its first deal of 2009, acquiring 16.77% of Bulgarian online media business for a reported €1.3m. "Investors will have to focus on sectors which are less sensitive to economic downturns or likely to emerge stronger than before once the economy starts to improve," Kövér tells bne just prior to announcing the latest deal. "In our opinion, online media is one of those sectors."

The deal follows investments made in two Czech companies in 2008: a leading regional online retailer called Internet Mall and BKS, a cable TV network operator. The first investment was a reported €2m into Romanian email server specialist GECAD-Axigen for an 11.76% stake in the autumn of 2007. "We're currently looking at interesting opportunities in several countries - including Hungary," says Kövér.


Budapest-based Euroventures whose diverse portfolio has included the likes of Sky Europe Airlines and the Royal Tokaji Wine company, will be launching its fourth fund, a medium-sized CEE growth fund this year, Thomas Howells, partner of Euroventures tells bne.

What's driving the opportunities is that the region's small and medium-sized enterprises (SMEs) are finally breaking across the borders. "While the big story has been intra-region expansion for some years, the reality has lagged behind the spin. But now we are finding that this is a real factor in SME growth," Howells says.

The prospects for venture capital - ie. funding for growing businesses, good ideas and hard-working people, as opposed to private equity buyouts which make their returns from leverage - have never been so good in CEE, argues Howells. "Growth, sectoral shifts and the untapped market opportunities that provide high-yielding investment targets are as still present in CEE as before," he says. "What is not present is the crazy debt and easy casino money that distorted the market and was easier than working."

In the buyout sphere where funds invest in bigger and more mature businesses, the industry in some segments is having a more difficult time, according to Craig Butcher, senior partner at Mid Europa Partners and board member of the European Venture Capital Association. "It's premature to write off the industry, because it is backed by permanent capital and there's a lot of dry powder out there. The model will change, but the model isn't broken and the industry has been good at straightening businesses out," he says.

"Now, separating the winners from the losers is a function of the quality of the portfolio and what sectors were invested in," he asserts, rating telecommunications as relatively stable compared to the likes of the auto, retailing and construction sectors. "People may not call overseas as often as they did in the past, but they still have to call friends and family, but they can put off buying a new car."

Butcher compares the current climate to that of 2001-2002 when "we did nothing." However, Mid Europa struck five deals in 2003, which Butcher rates as some of their best-performing deals. However, with credit lines restricted, a lot of deals going forward won't involve anything like the levels of debt seen in the recent past. "Maybe we'll do nothing for a half a year or a year and there will clearly be a fall off in transaction activity across the region as the debt market is in large parts closed and people will only sell if they really have to."

Maybe in the second half of 2009, but certainly in 2010 there is likely to be a lot of forced selling. "With the tide gone down, you'll be able to see who has problems. In the meantime, people hang on to the hope that it's getting better, but those who have capital will be ready to act when the time of reckoning arrives." For the time being, he adds, it's a good time for equity investors to strengthen their existing portfolio companies through bolt-on acquisitions, as well as buying back debt. Prospects depend on how much un-drawn capital that investors have, adds Butcher. Mid Europa partners raised €1.5bn for its latest fund in October before the financial hurricane hit. "Approx. €300m is committed, so we have €1.2bn to invest until October 2012."

The poor economic outlook does, however, mean an improved deal flow for VC investors, though not necessarily more investments, reckons Kövér. "Investors have to be very careful in making investment decisions in this climate," he says, adding that on the negative side it's currently more difficult to profitably exit investments than before.

Overall, Kövér expects less venture capital deals than before, as it isn't easy for entrepreneurs to come up with realistic and executable business models in difficult times like this. "I expect that investors shall be more cautious, commit less capital and part with cash more reluctantly."

In the more developed EU, CEE countries growth investments in such basic areas such as consumer goods, retail or telecoms may have had their day, according to Howells. "But there is still plenty of opportunity in the service sector; and we are actively looking in this sector."

Howells emphasizes that turnaround investing too will have its adherents. "This requires a different skill set from backing a successful management team growing a business, and investors seeking change their spots from leveraged buyouts to turnaround will no doubt be in for some disappointments."

On the question of whether the restriction of bank credit plays into venture capitalist hands, meaning that VC firms are for some the only option, Kövér notes that the credit crisis definitely means that more entrepreneurs are trying to find a strong equity partner than before. "That certainly improves the quality of the deal opportunities venture capitalists have."

However, he denies companies are so desperate for funding that venture capitalists can pick and choose whom they want. "This is not the case. An equity investment must be a win-win deal for both the entrepreneur and the investor, and the decision to make the deal is usually the result of long negotiations and careful consideration from both sides. Investors prefer confident and dynamic partners to desperate ones. A desperate partner is not a good partner for the fund."

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FUNDS: Nothing ventured, nothing gained

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