Talking to the neighbours

Chris Kennedy joined Austrian mid-market investor Go Equity six years ago, but recently sold his interest in the firm to launch his own deal origination and fund placement business. The key to succeeding in Austria's mid-market, he says, is ?coffee house intelligence?, which involves building a close relationship with the small coterie of intermediaries and bankers who are plugged into Austria's overwhelmingly SME-based economy. (98 percent of Austrian businesses have turnover of less than €50m, according to research by Dun & Bradstreet).

?Large Austrian buyouts are no different from those found everywhere else in Europe, but the sort of systematic due diligence required for those deals is simply not applicable to the mid-market,? says Kennedy. ?Once you go down in deal size, it gets murkier and the only way you can make sense of it is through being plugged into a network.? This means that, in the mid-market at least, there is little immediate prospect of foreign firms being able to gain a foothold, and competition for deals is typically between domestic investors.

Unfortunately, there aren't that many scraps for the equity houses to fight over. According to EVCA statistics, 2000 was the most productive year for private equity in Austria ? but even then, the total amount invested was just €163 million ($206 million). In 2001, the total fell to €147 million and then in 2002, the latest year for which figures are available, there was a further small decline to €146 million. Between 2001 and 2002, the number of transactions fell from 212 to 171. To put these numbers into perspective, total Austrian private equity investment in 2002 was lower than in Denmark (€242 million) and Norway (€201 million), although higher than Ireland (€105 million) and Portugal (€69 million).

Austrian private equity has been remarkably slow to develop ? according to the Austrian Private Equity and Venture Capital Organisation (AVCO), more than 60 percent of domestic funds were launched from 1999 onwards. The most obvious explanation for this is the traditional tendency of family businesses to turn to their local bank for debt finance when requiring capital. Private equity firms are attempting to intrude on this cosy relationship, but it is a slow process. ?Owners have less suspicion about financial investors than they used to have but still lack information, so it's our job to educate them,? says Vijai Gill, a member of the investment team at Go Equity. ?When we talk to owners, they normally conclude that private equity is a viable alternative.?

Reinhard Jonke heads 3i's Vienna office, which was established in October 2000 following the firm's acquisition of Austrian venture capital unit Bank Austria TFV. He says 3i is frequently encountering family groups facing succession issues due to the next generation's reluctance to take over the running of the business. But he says this is difficult to exploit: ?There is still a negative image of financial buyers and because our organisation has its roots in Anglo-Saxon business culture, we have to explain that we are not sharks and are prepared to pay a fair market value.?

Consolidation prospects
The venture arena has traditionally been more populated with investors than the later-stage end. Austria has a greater bias towards early-stage investments than most European markets, with 20.3 percent of total investment in 2003 going into venture opportunities compared with a European average of 12 percent (EVCA). In addition, young companies undoubtedly receive a significant proportion of the 48 percent of total investment categorised as ?expansion? investment.

In the early-stage segment, the current situation seems rather bleak at first glance, with a number of market participants prepared to wager that consolidation will before long reduce the number of domestic venture firms to a core of perhaps half a dozen ? down from around 20 at present. Partly, this is because deal flow is held back by structural factors. One of these is a lack of capital, with most seedstage funds finding it a struggle to raise fresh capital in the current environment. The other is red tape, which of course is not unique to Austria but can be harsher than in other European countries. (One venture investor relates the story of how it took him nine months to register a new company, compared with a standard five days in the UK, for example).

But some argue that while the market has, unsurprisingly, suffered at the hands of the global downturn, many venture capital firms in Austria were formed at a time when the hype was already beginning to fade and will therefore not suffer to the same extent as their counterparts in other European countries. Proof that there is life in the venture market was the establishment of a new early-stage investor in June 2002, when Gamma Capital Partners was established to take over a fund managed by internet incubator iLab24, which had raised €20.4 million in 2000. Gamma then went on to achieve a first closing of its own Gamma II fund at €10 million in April 2003, and is currently working towards a final closing of up to €25 million. Investors in the fund, which targets the IT, medical equipment, life science and physical science sectors, include Investkredit Bank and Raiffeisen Landesbank along with other institutions as well as private investors.

Gamma believes its fundraising places it in a powerful position. ?The recent downturn has led to a severe funding shortage and there are deals galore,? says Burkhard Feuerstein, Gamma's managing partner. Adds fellow managing partner Oliver Grabherr: ?In addition to attractive valuations, competition has virtually withered away ? we get proposals from as far as Hamburg and Switzerland and appear to be one of the very few active tech investors in German-speaking Europe considering attractive smaller opportunities.?

Supporters of the venture market say there is still plenty of activity in the biotechnology sector, aided by Vienna's longstanding association with medical research and the global reputation of the Viennese School of Medicine. The sector came to prominence in November 2003, when Vienna-based vaccine developer Intercell raised $50 million (€40 million) in a third-round financing that was the largest seen in European biotech for two years. The deal was led by Boston-based MPM Capital and German fund Global Life Science Ventures and included Austrian investors Go Equity, Kapital & Wert and Wiener Stödtische Versicherung.

In terms of future deal flow, venture investors are anticipating numerous software and IT spinouts, for example from within Siemens, which now employs around 2,000 computer programmers in Vienna. There are also start-ups emerging from the automotive component clusters in Upper Austria and Styria, which between them are home to around 500 companies supplying synthetic materials, internal electronics and combustion engines to the likes of BMW, General Motors and Volkswagen. Austria's economy also has a strong reputation in areas like medical equipment, optics, environmental technology, plastics and composites.

Accession to fire growth?
With the strong technology base mentioned earlier, there is little doubt that deal volume will continue to grow along with Austria's status as a private equity market. But what really marks Austria out as a special case and potentially a more exciting prospect than many of Europe's other nascent venture capital markets is its proximity to the emerging EU accession countries of Central and Eastern Europe.

The country shares a border with four of the ten accession countries scheduled to join the EU in May 2004: the Czech Republic, Hungary, Poland and Slovenia. It enjoys eight percent of the EU's trade with accession countries despite only having two percent of its total population, according to the Austrian Ministry of Economics. Austrian companies generally are keen to exploit the accession countries' forecast growth rate of 3.5 percent in 2004, compared with one percent for the EU as a whole. And private equity firms are anticipating significant demand for capital and strategic advice from Austrian businesses seeking to expand into these countries.

?Accession could be a trigger for more deal activity,? asserts Jonke at 3i. ?It makes a market of 70 million people available for Austrian companies and we are looking at many expansion opportunities for businesses needing capital of between €10 million and €30 million.? He says the average size of companies will grow naturally as they are forced to respond to the growth plans of their competitors.

Captive private equity divisions are particularly well equipped to take advantage of opportunities in the region, given the strong position of Austrian banks in Central and Eastern Europe. BA-CA is the second-largest bank in the region and provides Austrian businesses with the capital to expand through its BA-CA Private Equity division, which has four funds catering for private equity and mezzanine for early-stage development, later-stage, acquisitions, MBOs/MBIs and expansion. ?The new EU countries provide a new source of opportunities and we are currently marketing to see how we can access deals there,? says Klaus Haberzettl, chief executive of the direct investment team at BA-CA Private Equity. BA-CA also has a fund of funds operation focused on the region.

Many Vienna-based investors say direct investment in companies based in accession countries is more difficult than providing capital for companies based in Austria to enable them to grow into the accession zone. Chris Kennedy points out that there are some long experienced and well respected investors in accession countries such as Enterprise Investors, Baring Private Equity Partners and Advent International, which make the competitive environment tougher than those unfamiliar with the region might imagine.

In addition, Go Equity's Gill points out that there are structural obstacles for new investors. ?Investing in Eastern Europe is a different asset class because of the different risks involved, particularly with regards to management, infrastructure, transparency and regulatory issues. A few years ago, for example, in Romania you would have had real difficulty in finding a top-class marketing director. That said, one must note that things have improved and that each country in Eastern Europe has a different risk profile.? All the same though, Gill thinks those firms anticipating using Vienna as a base for investments in the East are being optimistic and adds that Go Equity will remain Austria-focused for the time being.

Going local
Horizonte Venture Management, an early-stage investor based in Vienna, has attempted to overcome the geographic barrier to entry by establishing local offices. It launched its €8.4 million Slovenia Enterprise Fund as far back as 1994, which it runs from an office in Ljubljana. In 1998 it closed its Bosnia Herzegovina Enterprise Fund at €15.6 million and in 2001 achieved a €20 million first closing of a Croatia fund. The two funds are being managed out of Sarajevo and Zagreb respectively.

Says Horizonte managing partner Franz Krejs: ?The accession states are less developed than Austria and you have to be wary of political instability, but there is a good technology base that creates attractive investment opportunities.? He says low valuations help compensate for the fact that such companies normally require a high degree of management input. Horizonte's enthusiasm for the region shows no signs of abating ? it is keen to move into Slovakia, where it already has two investments, as well as Hungary and the Czech Republic.

Vienna-based mid-market firm Invest Equity is attempting to take advantage of a change in investors' perceptions of the region post-accession. It is currently raising the GEF Greater Europe Fund, which will invest around 60 percent of its capital in companies based in Austria and 20 to 40 percent alongside co-investors in companies based in accession countries. Invest Equity's Martin Prohazka believes promoting the concept of a new ?Greater Europe? region that includes Austria and neighbouring countries will enable the fund to access the deeper institutional pocket marked ?Western Europe? rather than the shallower one marked ?Eastern Europe?.

That said, the fund has a modest first closing target of €30 million to €40 million, following a €20 million initial commitment from two cornerstone investors including Investkredit, the sponsor of the firm's first €49 million fund, which was raised in 1998. Invest Equity is yet to make an investment in a company headquartered in an accession country, but has grown Austrian portfolio companies such as printing company Strohal and PVC additives producer Chemson into the region.

Limited competition
Despite signs that Austrian private equity firms are now taking the region seriously, Witold Symanski, chief executive of the €83 million Raiffeisen CEE Fund, says he rarely comes across Austrian competition when pursuing deals. His fund was launched in late 1999 to invest €3 million to €15 million in companies based in accession countries. Symanski says the fund has been ?particularly successful? in Hungary, where it was involved in the first ever public-to-private of a Hungarian company when jointly buying packaging firm Cofinec with Austrian packaging group Frantschach for around $50 million in February 2000. It has subsequently backed Intercom, a Hungarian cinema chain, as part of a consortium including GE Equity and ABN AMRO Capital that invested €21.6 million of equity in April 2000; and Stollwerck Budapest, the chocolate manufacturer, in August 2002. He says the fund has avoided Poland because it has become the primary focus of international investors targeting the region, as a consequence of which asset prices have become inflated.

A challenging consideration for Austrian investors thinking of tiptoeing tentatively into accession countries is Raiffeisen's preference for taking 100 per cent or near-100 per cent stakes through buyouts. When the fund was first launched it was with a strategy of taking minority positions in development capital deals, but Raiffeisen found that this did not provide it with sufficient leverage over management teams. ?We are now able to enjoy sufficient management influence and are able to put in place incentive packages for them, which we couldn't do as minority investors,? says Symanski.

Despite parent organisation Raiffeisen Zentralbank (RZB) being a Vienna-based bank, Symanski says it has a ?very limited? focus on Austrian companies due to the small size of the domestic market, its slow growth rate compared with accession countries and problems associated with scaling up and exiting investments.

Symanski's views help illustrate the irony that, at a time when the Austrian private equity market is beginning to curry favour over more traditional forms of company finance, all the excitement and hype seems to be focused on the emerging markets that surround it. No doubt the Austrian mid-market will enjoy steady growth while the venture market, like its equivalents all over Europe, will emerge from the downturn bruised but still alive. But that will not stop Austrian institutions from peering over the fence, wondering if the grass is greener on neighbouring patches.

Austrian LBOs: a recent history
The fact that large Austrian buyouts are a rare phenomenon is not at all surprising given the fact that just two per cent of Austrian companies have turnover of more than €50 million. When such deals do occur they are invariably led by pan-European or US private equity firms for whom the main concern is the quality of the business rather than the geography in which it happens to be located. But while Austrian LBOs have been small in number, there have been some interesting stories among them.

Steiner (1998): Perhaps the most publicised large Austrian buyout in recent years was notable for all the wrong reasons when UK private equity firm Duke Street Capital became a victim of fraud. The firm invested £22 million for a 31 percent stake in Steiner, a family-run plastic injection moulding business, in 1998. After Duke Street increased its stake to 61 percent a year later, Steiner went bust with debts of more than £200 million. Two members of the Steiner family were subsequently sent to jail for fraudulent activity.

There is no proof that the development of the Austrian buyout market was stunted by the Steiner deal and it seems unlikely that a single transaction would have that effect. What can be assumed is that the affair at least temporarily led to a greater focus on both the quality of Austrian management teams and the ability of purchasers to gain sufficient access to family firms' books.

Andritz (1999): When US private equity firm Carlyle Group exited its investment in Andritz, a maker of production systems for the pulp, paper and steel industries, in June 2003, it gave the Austrian buyout market a welcome boost to its image. Carlyle sold its stake on the Vienna Stock Exchange for €139 million, netting a 22 percent IRR following what was described by Carlyle Europe managing director Heiner Rutt as a ?very successful? investment. Carlyle was part of a consortium that invested €48 million in the business in 1999 alongside GE Capital, Unternehmens Invest and Custos Privatstiftung. In 2001, the consortium floated 15 percent of Andritz' shares, while last June's issue ended with nearly 62 percent of the firm in public hands.

KTM-Sportmotorcycle (1999): BC Partners completed Austria's first public-to-private with the €162 million acquisition of KTM, a manufacturer and distributor of high performance off-road bikes. (The only other PTP took place the following year when Permira acquired Austriamicrosystems, a semiconductor specialist.) Last year, KTM refinanced €76 million of a senior debt and mezzanine package put together at the time of the buyout. The firm has nearly tripled its turnover since the de-listing and is tipped to make a triumphant return to the stock market. (Austriamicrosystems was also expected to float at the time of writing).

Zumtobel (2000): Not many people would have predicted US leveraged buyout giant Kohlberg Kravis Roberts' acquisition of an Austrian family business, but that is what happened when it bought lighting group Zumtobel and merged it with the UK's Thorn Lighting to form Europe's largest light fitting business. Zumtobel was no ordinary European family business though: far from suffering the kind of internal difficulties that a private equity firm will turn its hand to fixing, it was acknowledged to be well-run but capital constrained. Zumtobel is still a KKR portfolio company.

Lenzing (2001): Private equity firm CVC Capital Partners proclaimed itself ?disappointed? when its planned €700 million acquisition of Austrian fibre maker Lenzing was blocked by the European Commission. The EC ruled that CVC's plan to merge Lenzing with the cellulosic fibre businesses of existing portfolio company Acordis would have ?eliminated Acordis' strongest competitor? in the European man-made fibre market.