Further, faster

Central and Eastern Europe is not as risky as you might think says Robert Conn, managing partner at Polish private equity firm Innova Capital.

Over the last two years, Central and Eastern Europe has seen a number of successful exits from deals put together since 2000. These exhibit very different qualities, by and large, to the 1990s deals immortalised in an EVCA report entitled “CEE Success Stories”.

Those 90s deals typically were either start-ups, early-stage deals or privatisations. Deal sizes have grown significantly since then and positive EBITDA is the norm. Innova’s average enterprise value (EV) now falls somewhere between €25 million and €100 million compared with less than €5 million when we began investing our first fund.

The transactions of yesteryear were, in the main, expansion capital with no leverage and the private equity fund often took minority stakes. That has all changed. Now the focus is very much on buyouts (six of the seven deals in our last fund were buyouts, and five of them used leverage), with investors taking controlling stakes. As companies mature, so they are increasingly capable of generating the levels of cashflow needed to support leverage. And at the same time, changes of ownership (including corporate restructurings and entrepreneur succession) are creating more and more buyout opportunities.

The biggest buyout to date has been Mobiltel, a €1.2 billion deal structured with €650 million of debt. Other recent deals included EBCC, a buyout by Innova that was subsequently recapped with €20 million in debt, and DGS, a €100 million buyout structured by Enterprise Investors that included 40 percent debt. A sure sign of the maturing of the market is the presence of a number of senior lenders (including PeKaO, BPH and Erste Bank), and mezzanine lenders (including Mezzanine Management and Darby) that have committed themselves to developing a buyout practice.

Exit routes were, until quite recently, unclear and remote. Now multiple exit routes are on offer. Trade sales continue, buoyed by heightened foreign direct investment (FDI) post-EU accession. Examples include the sale of Orange Romania to Orange by a consortium including Innova, Enterprise Investors and AIG-CET; and the sale of Mobifon/Oscar to Vodafone by Advent International – both of which delivered at least four times money.

A new development, however, has been the emergence of the Warsaw Stock Exchange as an attractive exit route, via IPOs and secondary placements. Examples here include Comp Rzeszow, and later this year, an anticipated €450 million offering at Opoczno. Also, in a welcome new development, we are seeing greater activity from local strategic investors buying into deals. For example, a consortium including Innova recently sold its stake in STK Cable to Vectra.

Increasingly…western European mid-market buyout shops will be buying from local players, as deals edge into their size range

Robert Conn, managing partner, Innova Capital

Last of all, secondary purchases are starting to come through as viable exit routes in some cases, the purchase of Fibernet by Warburg Pincus, and of Aster City by Hicks, Muse are both good examples of this trend. Looking ahead, trade sales and the Warsaw Stock Exchange will continue to be the most fruitful exit routes. Increasingly, though, western European mid-market buyout shops will be buying from local players, as deals edge into their size range.

As exit routes have opened, so holding periods have come down dramatically. Average holding periods for our 1998 fund were over five years. For our latest fund, the average has dropped to three years, with two deals likely to clock in at 12 months (at the same time generating over 2.5 times returns). This trend is graphically illustrated by the fact that this year alone, Innova expects to generate exits in an amount equal to our entire invested basis in our last two funds.

Back in the 1990s, there was a limited local chief executive (CEO) pool. Now, there is a sufficient supply of high-quality, experienced Central European CEOs. Instead of everyone – investors and CEOs – being on a tight learning curve from day to day, it is now all about selecting the best talent from a number of competent candidates. Indeed, there are now a number of Polish CEOs heading up significant European companies (including, for example, major divisions of  Danone and Wrigleys).

When Innova first got involved in this region in the mid-1990s, the market was highly fragmented, with around 65 fund managers active in Poland, Hungary and the Czech Republic. Our common denominator was a lack of experience. Now, with ten years and 25-plus deals under their belts, the leading players present a very different profile. As a result, deal making capabilities have grown increasingly skilful and, inevitably, the market has consolidated quite dramatically, to the extent that the 65 pioneers have been whittled down to eight players commanding between 80 percent  to 90 percent of the uninvested capital. Competition and entry valuations are, therefore, now very ‘rational’.

‘Further, faster’ really does sum up the way this market is heading. With lower risk and higher returns achievable in less time, the future for mid-cap private equity in Central and Eastern Europe will be exciting.