Private equity finds solace in Central Europe

By bne IntelliNews April 21, 2008

Nicholas Watson in Warsaw -

While the global credit crisis, controversy over colossal salaries and now a potential class-action lawsuit against Blackstone Group for failing to disclose information during its IPO has taken some of the shine off private equity in the West, in Central Europe the buyout business is in great shape.

On April 17, Advent International, one of the world's biggest global buyout firms, announced it had closed its fourth fund for investment across Central and Eastern Europe at €1bn. The fund, ACEE IV, will invest in companies in the €30m-100m range that are heading for cross-border expansion - a trend that is set to pick up as more and more companies in the region outgrow their home markets.

"Central and Eastern Europe is now on the map for investors who are attracted by its combination of high growth and stability," says Joanna James, managing partner at Advent. "This has served to raise the profile of the region, which is to the benefit of us all."

Advent certainly won't be alone. Reports say that Bridgepoint is looking to raise another fund that will invest around €500m in the region, while Poland has attracted the attention of global giant Kohlberg Kravis Roberts. Nils Melngailis, the former head of Lattelecom and now working for Blackstone, claims the US group is interested in investing in several industries in Latvia and the other Baltic states. 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 veteran Central European private equity investor Steven Buckley, who's managing partner at Innova Capital.

Back to the future

Why's Central Europe back in favour? A look at the returns of Innova's third fund, which returned 4.2 times the invested capital in the period since it was launched in 2002, shows why. "Our Innova/3 fund will be one of the top-performing funds in Central Europe ever - if not the best," says Buckley.

As well as the hefty returns, the region offers global private equity players the chance to put their money to work in smaller cash deals now that the credit crunch has effectively shut down the large-scale purchase of publicly traded Western companies by ending the leveraged buyout boom. On April 8, TPG Capital announced it's buying half of SIA International, the largest pharmaceutical distributor in Russia, for $800m. The deal, the largest-ever private equity transaction in the country, is notable because TPG is paying cash for the stake, rather than borrowing much of the money. "The big classic leveraged buyout is gone for the time being... two years at least," Mark Shafir, global co-head of M&A at Lehman Brothers, told CNBC.

While the credit crunch may be affecting the private equity business in the US and Western Europe, experts say any impact from the tightening of the global credit markets has yet to be seen further east. "The markets need time to adjust to this new environment, but it's unlikely we'll see the same level of difficulties in getting deals done relative to the US and Western Europe, primarily because the use of significant leverage is less prevalent in private equity deals in the emerging markets and, when debt is used, it can often be provided by local banks that aren't affected by the credit squeeze," says Sarah Alexander, president of the Emerging Markets Private Equity Association.

Even so, Buckley notes that a big change in the CEE market has been arrival of more classical buyouts with the use of a significant amount of debt as part of the capital structure. "This has enabled many of us to go into slower growing assets. If you have stable assets but want private equity returns, the answer is to introduce leverage," says Buckley.

Another positive factor for private equity in the region has been the long overdue development of a decent stock market that enables private equity firms to exit via an IPO rather than through a straight trade sale to another firm. Despite the recent mayhem in the world's markets, the head of the Warsaw Stock Exchange, Ludwik Sobolewski, told bne he expects about 70 new listings this year, which would again put the WSE at the forefront of European exchanges when it comes to drawing in new business. Last year was a record breaker for the WSE with 81 entrants, second only to the London Stock Exchange with 99 IPOs. Its regional rival in Vienna had just seven IPOs last year and expects another seven this year.

Further down the private equity ladder at the venture capital level, Central Europe is looking good too. Tomas Bohrn, chairman of ChipInvest, a Czech-based very early stage funder of technology companies - "we're a start-up of start-ups," he quips - says business has actually improved since the credit crunch struck last summer. "The downturn has been good for us," he says. "People in big companies are not taking their ideas inhouse because they know they won't get funding so they're more willing now to step outside the company and find funding from people like us."

In general, Bohrn says he's noticing a sea change also in the attitude of entrepreneurs and innovators. Whereas before they would sit on their ideas, unwilling to let go until their ideas became obsolete, they are shedding this risk aversion and are more willing to give up some control in order to the financing necessary to take advantage of the market opportunity.

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