FUNDS: Nothing ventured, nothing gained in Bulgaria

By bne IntelliNews June 1, 2010

Nicholas Watson in Sofia -

Two of Karoll Capital Management's funds may have topped the ranking for best Bulgarian funds in the first quarter, with the Advance Eastern Europe Fund returning 17.6% followed by the Advance IPO Fund with 9.8%. But it's perhaps the Sofia-based investment manager's private equity fund that holds the greatest promise over the long run.

Karoll's Advance Equity Holding, Bulgaria's first domestic private equity fund, is a bit of a curiosity. Because Bulgaria doesn't have in place any legislation covering private equity, Karoll was forced to structure this venture capital fund in 2006 as a publicly traded vehicle so that pension funds and other institutions could invest in it. This means that while the assets of this fund are investments in privately held companies, the fund's almost 36m shares are listed normally on the Bulgarian stock market, giving it a market capitalisation of around €19m in May. "Blackstone did it after us," jokes Hristo Valev, investment manager for Karoll, referring to the 2007 IPO of giant US private equity house Blackstone Group.

However, while Valev says a sale of the entire fund is theoretically possible, he says Karoll is committed to the normal private equity route of exiting the investments one by one, either through a trade sale or an IPO, as only this will realise the targeted internal rate of return of more than 20% annually over a projected investment period of five years.

An IPO route has been made much harder by the global economic crisis. Bulgaria was actually one of the few countries of emerging Europe to have a vibrant IPO market before the crisis, with Bulgaria ranking only behind Poland and Russia in terms of IPOs in 2007. That year, Karoll launched its Advance IPO Fund, which invests in IPOs at home and elsewhere in the region. However, this IPO market came to a juddering halt when the crisis hit in the autumn of 2008.

This year, things have been looking up, with the value of the units of Advance IPO Fund rising by 11.7% in the first four months. According to Ernst & Young, during the first quarter of the year, 267 IPOs took place worldwide worth $53.2bn. This represents a massive increase compared with the 52 deals in the first quarter of 2009 worth only $1.4bn.

Many believe that this positive trend in IPO activity will continue for the rest of the year. However, Valev says it's probably still too soon to make the first exit of Advance Equity Holding's investments through a listing on the stock exchange. "Even if the crisis hadn't happened, we still wouldn't have exited any. The stage for our companies is still early - we are a [venture capital fund] so we need some time to grow the companies and organise them until they are stable in financial sense. However, we are entering the second part of the fund's life, and we are already fully invested, so the time for exits has nearly come," he says.

Nearer the exit

Valev says that some sectors are nearer the appropriate exit valuations than others. "The current market is not the best time to exit at the low valuations that are witnessed everywhere, but there are some assets attractive enough to sell right now," he says.

One of those is renewable energy, in which Advance Equity Holding is invested through the 100% owned vehicle Energy Invest. The first project in this field was back in 2006, when Energy Invest built a 2.4-megawatt (MW) wind farm close to the seaside. Now the vehicle is developing a project portfolio of overall 56 MW of wind power. In 2008, Energy Invest acquired 90% of a company building a photovoltaic plant of 1 MW peak capacity near Sofia. The project was partially financed with a bank loan under the special Bulgarian Energy Efficiency and Renewable Energy Credit Line, administered by the European Bank for Reconstruction and Development (EBRD), and received a €400,000 grant after it was put in operation in early 2009. "This is one of the sectors we could easily exit even now," says Valev.

The renewable energy sector in Bulgaria has boomed over past few years as lucrative incentive schemes to support such energy sources caused applications for new projects to soar over 12,000 MW. This capacity would go some way to helping Bulgaria meeting its EU commitment to raise its share of renewable energy to 20% by 2020 - the share of renewable energy rose 2.6 percentage points to 9.9% last year.

However, there's been a backlash, with the country's electricity grid operator warning that such new capacity exceeds what the grid can handle, which could end up causing blackouts. As such, The Bulgarian government has initiated some legislative changes to "tame" the growing investor interest in renewable energy projects by proposing in April a ban for building solar and wind power farms on quality arable land. This ban is part of amendments to the agriculture land law, currently pending parliamentary approval, that are aimed at keeping high-quality arable land available only for farming. However, Valev sees the hand of lobbies representing some farmers as well as conventional and nuclear energy proponents behind it, who are looking to benefit at the expense of the emerging renewables market. "There is a tangible risk that the renewables market in the country will be hit incurably hard at its infancy if certain clearly discriminative legislative changes are adopted," he says. "Renewable energy projects neither capture large sites nor damage the farmland in the neighbourhood. They can even be supportive of agriculture."

Having said that, Advance Equity is also invested in the agriculture sector, which Valev says has a bright future even in the complex environment of the EU's Common Agricultural Policy. Bulgarian agriculture is fragmented and lacks investment, so there is good scope for far-sighted investors to build up large modern farms, even from scratch. "We have invested in 2006 in a company that cultivates currently more than 5,000 hectares of wheat and sunflower, which uses new machines and farms in a modern and efficient way," he says.

Karoll's VC fund also has some high-tech investments, in particular its 87% stake in SEP Bulgaria, which is building a system for electronic payments via mobile phones in Bulgaria.

The fund has a total of seven investments that were chosen out of around 200 business plans received from entrepreneurs over four years, which Karoll calls a "decent ratio." While the crisis has undoubtedly led to the market being a buyers' one, Valev says it's no easier to find suitable investment candidates, as in the VC industry it's not just about the idea, but also finding a team that you can work with on an operational level. Given Bulgaria is still very much in its infancy in producing quality entrepreneurs, this will hamper the growth of VC funds just as much as any lack of special legislation.

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