Nicholas Watson in Warsaw -

Innova Capital's acquisition of a controlling stake in Poland's smallest private bank Bank Wspolpracy Europejskiej (BWE) caps a remarkable ride for one of Central Europe's oldest private equity firms, which launched its first fund in 1994 and its fourth fund one in 2006.

Worldwide there have been few acquisitions by private equity houses of controlling stakes in banks and certainly none in Central Europe, so Innova's announcement in June 2007 that it had agreed a reputed €24m deal with Polish business tycoon Aleksander Gudzowaty, his son Tomasz and the family-controlled company Bartimpex is something of a coup - especially given the attractiveness of Poland's extremely profitable and fast-growing banking sector.

The reason for the Polish government's acquiescence to Innova taking a controlling stake in the bank probably had as much to do with the credibility of the bank's former owners as it did about Innova's turnaround credentials. Typically, regulators want banking institutions to run banks, but with BWE under a cloud due to disputes between the various owners - which include the Treasury and the insurer Cigna - private equity took on the role of buyer of last resort.

Although classed as a distressed deal, Innova sees it as anything but. "We bought it at 1.4 times book," says Steven Buckley, managing partner at Innova. That's a very low multiple considering that the country's other banks have been sold off to foreign institutions for book values of 3-4 times. Those multiples reflect the dynamic growth in Poland's bank sector. In 2007, client loans and deposits increased substantially, growing by 29% and 14% respectively. The combined profit of Poland's commercial banks in 2007 increased sharply by 29% to €3.4bn.

What are Innova's plans for BWE? The first thing the private equity group did was to install new management and pledged to make a large capital infusion to recapitalise the bank, something the banking regulator KNB had been insisting on since 2006. "This year we will be going out to speak with other institutions to attract more equity. Our management team is first rate - they now need more ammunition to grow like a weed," says Buckley.

The growth strategy for the bank is to create a specialist bank providing technology-driven services rather than the traditional "bricks and mortar" services. "It's our intention to introduce new products including mortgage products, which is a growing area, as well as personal loans," Buckley says, adding that the bank's also looking to expand its small and medium-sized enterprise and municipal banking segments. "We think we can grow the business by between three and five times."

Size matters

Though a private equity buyout of a bank is unusual, the deal is actually very much in line with Innova's overall strategy, which is to focus on financial services, business-to-business services, telecommunications and manufacturing, with deal sizes typically in the $25m-75m range - what Buckley calls the "sweet spot." The other companies so far acquired for the fourth €225m fund certainly fall into those categories: La fantana, a water-cooler supplier to businesses; Expander, Poland's leading independent financial advisor; GTS Central Europe, an alternative telecom service operator with operations in the Czech Republic, Poland, Hungary, Romania and Slovakia; and United Foundry Holdings, a holding company that will be used to consolidate EU foundry production based around the Polish foundry Zaklad Mettallurgyczny.

"Our biggest differentiator from other private equity players in the region is the size of deals we do. We've planted our flag squarely in the mid-market of Central Europe: we may not be the biggest, but we have a better-than-even chance of delivering the best returns."

Indeed they do; Innova's third fund returned 4.2 times the invested capital in the period since it was launched in 2002. "Our Innova/3 fund will be one of the top-performing funds in Central Europe ever - if not the best," says Buckley. "It's a testament to applying the learning the lessons of failure, and to focusing on the mid-market segment of deals."

What boosted the return of the third fund was what Buckley calls the "home-runs" - defined as more than 5 times the invested cash. "Any good fund has usually one deal or maybe even two that light up the fund." The two standout investments in the third fund were a 30.1% stake in Voxtel, Moldova's largest mobile telephone operator, which realised 10.4 times the cash invested, and ACE Group, a leading supplier in Europe of automotive components for braking systems, which returned 5.8 times.

That third fund crystallised everything that Innova had learnt over the previous two funds. Innova began with essentially a venture capital fund in the early 1990s, which invested $65m in very early stage ventures focused on the rapidly changing consumer market in Central Europe. That fund eventually returned about 1.6 times the invested capital, but Buckley says "it took five years of some failures and some successes" to realise they needed to head in another direction. "That happened smack in the middle of the second fund, which is why we call it the transition fund."

The second fund eventually returned 2 times the capital invested, but that disguises the much better second half than the first. "From the worst point - after the doctom bubble burst and Nasdaq re-rated - we almost quadrupled the net asset value of that fund. I can assure you our investors in that fund during the 2002 period were not thinking that would be the end game in 2008," says Buckley. "Frankly, we got it wrong, then got it half right, and our third time was a charm."

The outlook for the fourth fund looks good. Aside from the lessons that Innova has learnt and the now very experienced team it has assembled, the underlying fundamentals for private equity in Central and Eastern are strong. According to the Emerging Markets Private Equity Association, in 2007 private equity funds operating in CEE raised some $14.7bn for investment, which was 300% more than in 2006. This is part of a massive fund-raising effort for emerging markets in general, which over the last three years has seen more than $118bn flow into private equity coffers, versus only $13bn in the three years prior to that. "Central Europe has been the best performing private equity region worldwide for the past two to three years. We're back as the flavour of the month for the third time in my career," says Buckley.

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