The traditional private equity model is faltering in post-communist Emerging Europe and will have to change if it is to have a future. So says Robert Chmelar, who last year left Mid Europa Partners, the region’s top local fund, to join Rockaway Capital, a Czech investment holding focused on e-businesses. He argues that Rockaway-style vehicles are more attractive for local investors and can be more effective at pursuing investment strategies in the region.
“I’m very sceptical of the traditional private equity business model for Central and Eastern Europe,” Chmelar tells bne IntelliNews in an interview at Rockaway’s hipster office in Prague, with swings hanging from the ceiling. “Something has to change for private equity to survive in Central and Eastern Europe.”
Private equity is not in crisis in terms of dealmaking – which remains relatively brisk, though well down from before the global financial crisis– but in fundraising. International fundraising specifically for the region, always spotty, is well below pre-2008 levels and, most fundamentally, local fundraising has never really taken off. A large chunk of private equity investment today instead comes from big global funds, which are now more confident about venturing into the region to make landmark transactions.
Private equity fundraising for CEE fell by almost three-quarters in 2015 to €418mn, one tenth of its peak of €4.25bn in 2007, according to a report in August by Invest Europe and law firm Gide Loyrette Nouel.
Local funds typically relied on international financial institutions such as the European Bank for Reconstruction and Development in their early post-communist years, and in countries such as Hungary, European Union Jeremie funds are still vital props. As Western interest cools, the few remaining big regional funds are today increasingly looking to Asian and Middle Eastern sovereign wealth funds. Mid Europa says more than a third of its funding now comes from them.
The lack of local investors is important because they tend to be more confident about the region. According to a survey last year by Prequin, 75% of local limited partners (LPs) want to invest in CEE and 77% prefer venture capital, which is inherently riskier. Without them, private equity funds are reliant on external funding, which varies depending on international sentiment and sometimes mistaken perceptions of the region. President Donald Trump’s election has already led to a swing against emerging markets. “PE, despite its track record, has not been attractive to local LPs,” says Chmelar. “Lack of local LPs makes the industry more volatile. In not so good times you need the support of local LPs.”
One might have expected local fundraising to have increased significantly over the 27 years since the collapse of communism as regional economies develop and inequalities widen, enabling local elites and middle classes to accumulate capital. But middle class investors remain very conservative, shunning even stocks, and regulators often forbid pension and other funds from investing in private equity funds anyway. Poland, because of its size and perhaps its entrepreneurial culture, is the only country where local private equity fundraising is thriving.
In the Czech Republic – arguably the most developed big economy in the region – some of the very rich there are beginning to commit funds to private equity, with Genesis, Arx and Credo successfully raising funds last year. But investors often prefer to commit their capital to ad hoc investment vehicles. If the rest of the region follows its lead, the omens look bleak for traditional private equity.
Keeping it in the family offices
The very richest Czechs – often post-1989 entrepreneurs who have sold their businesses – find private equity fees and investment periods unattractive, and want to have greater control of what happens to their money. Partly this reflects enduring suspicion of closed-end investment funds from the Czech Republic’s disastrous voucher privatisation experiment; partly it reflects confidence in their own business acumen.
Using family office-type structures, the richest Czechs invest by themselves in areas they understand, or commit money to vehicles run by serial entrepreneurs with a proven track record, such as Rockaway’s Jakub Havrlant, who made his fortune selling real estate website Bezrealitky to Polish auction website group Allegro. “They prefer groups that have a strategy they can identify with,” says Chmelar. “All the people who invest into Rockaway fully trust Jakub’s vision and they know his track record.”
These vehicles typically do not charge a 2% monthly fee or 20% carried interest on profits; they consult very closely with investors; they have less restrictions over how much, or in what, they invest or the structure of the deal; and they can avoid the closed end cycle and be more flexible over how long they invest for, and what internal rate of return they target. “PE is getting too restrictive for many investors,” says Chmelar, who stresses that this is not just a Central European problem, though it is more acute here. “Local investors in general don’t like situations where they don’t have control of their money. And they do not want to be restricted by the fund cycle.”
Ad hoc vehicles can be put together fast and the whole pot can be put into one investment and held for the long term. Local banks, flush with money and desperate for higher yields, are more and more ready to bankroll these deals.
Rockaway has a strategic division focussed on e-shopping that has been backed in several deals by several so-called Czech-Slovak oligarchs: Petr Kellner, Central Europe’s richest man, Daniel Kretinsky of energy holding EPH, and Patrik Tkac of Slovak financial group J&T. In October, Rockaway used their money to buy online retailer Netretail and price comparison site Heureka from South Africa’s Naspers for $201mn. “Out of almost nothing, Havrlant is now bidding against big PE players,” says a top M&A lawyer in the region.
As strategic investors step back, private equity funds are now therefore competing in transactions not only directly with local oligarchs, but also with family offices and local investment vehicles turbo-charged with cash. “Today, you see more and more deals where PE loses against private offices and investment holdings,” says Chmelar. “Traditional private equity funds have not managed to attract local capital. We failed to attract local money into our structures. As a result, we are competing with this money rather than investing with it.”