In 1995, Joanna James decided to have a career change. A call from Boston-based Advent International lured her away from the reassuringly familiar ways of Western European private equity and into the formerly Communist countries of Central and Eastern Europe – a region which, from the point of view of a risk capital investor, must have seemed pretty barren. At that time, the industry had barely established a presence east of Vienna, let alone an investment infrastructure or a track record.
Perhaps ‘lured’ isn't quite the right word, though. The way James tells the story is that by the time the opportunity to help Advent enter uncharted territory came along, she was ready to try something new. She had been with 3i and Kleinwort Benson Development Capital for 14 years, had invested in the UK, France and Spain, and her appetite for pizza at dawn following all-night deal negotiations in London boardrooms was on the wane: “I remember thinking: ‘I've done this before and frankly, I'm not bothered if I don't have to do it again.’”
At the time, colleagues and peers told her she was mad. Some still do “People I meet at conferences sometimes say to me, ‘oh, so you're still around then’,” she laughs, speaking from Advent's European headquarters on Buckingham Palace Road near Victoria Station in London.
I hope BTC will prove to have helped put Central and Eastern European private equity on the map for people who otherwise wouldn't even have thought about it
However, those expressing astonishment at James' staying power as Advent's head of Central and Eastern European investment activities are either not entirely sincere, or they haven't been paying much attention lately. For a start, Advent is one of the international investment firms that over the past decade have done much to promote private equity throughout the region. And the firm has closed some notable deals there too. James and her team recently carried to a successful conclusion the privatisation of Bulgarian state telecommunications carrier BTC – an eye-catching Eastern European private equity investment if ever there was one.
AGAINST THE ODDS
BTC possibly stands as Advent's most unlikely achievement in the region to date. The firm was first named a bidder for the company by Bulgaria's Privatisation Agency in June 2002. But even after it signed a draft contract to acquire the business in March 2003, it still found itself caught up in a major domestic political struggle over BTC's future.
More than once did the deal seem beyond resurrection. Before Advent finally clinched it in January this year, Bulgaria's coalition government, under pressure from opposition parties, trade unions and a rival consortium led by Turkish investors, changed its position on Advent's proposals so many times that some felt this would turn into one of those deals-that-neverwere. Commentators were perplexed to see Advent, its bankers and the management team it had lined up persisting in the face of what seemed to be mounting odds against landing the transaction.
With an enterprise value of €280 million and a €250 million funding package including acquisition finance and working capital, the investment was huge by local standards. James agrees that, given its size and the obstacles that needed to be overcome, BTC was a pathfinder for private equity not only in Bulgaria, but in the region as a whole. “I hope it will prove to have helped put Central and Eastern European private equity on the map for people who otherwise wouldn't even have thought about it. If it helps attract more funds into the region, that would be great.”
Still, James argues the saga says less about the investment climate currently prevailing in the former Soviet Bloc than it does shed light on the complexities of acquiring state-owned assets – regardless of where this is done. In her view this was not a deal necessarily made awkward by its geographic location. “Legitimately there was a very high level of interest and concern in the deal. BTC is an important company, not just some little factory. People worried about being able to afford phones in the future.”
The political dimension was obviously a major factor too. “Our difficulties were compounded by the fact that we were dealing with a coalition government that needed to create consensus all the time.”
No wonder it was a struggle. But James and her team kept at it. “Every few weeks, we'd ask ourselves, ‘do we want to continue with this? Is there still a good enough chance to succeed?’ But we always came to the conclusion that there was no reason to give up. So we didn't.”
James's suggestion is that BTC may in certain regards have been similar to some of the privatisations completed, say, in other European countries over the past few decades, but that it should not be regarded as a textbook example of what practising private equity in Central and Eastern Europe is like in general. That said, private equity practitioners need to be attuned to the region's recent history, and the dramatic transformation of the local economies that defines it.
On May 1st 2004, eight Central and Eastern European countries – the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia and Slovenia – will be joining the European Union, creating an integrated pan-European market place with nearly 500 million consumers and a combined GDP of 10 trillion dollars.
The historical significance of this date is obvious. But, as James points out, EU accession is not an event – it's a process. “These countries have been preparing themselves over the past five to eight years and adapting to the body of EU law. This has meant liberalisation, deregulation, privatisation. Both in economic as well as regulatory terms, the leading countries are already looking very similar to countries in the West. You can't overestimate how important that is in our area.”
Even the second wave of countries that are scheduled to join the Union in 2007 have already completed much of the convergence process at this stage – including Bulgaria. “Someone asked me the other day, ‘weren't you worried about regulatory risk in Bulgaria.’ But I was able to point out that they have already negotiated a telecommunications charter that is compliant with EU rules. They're in a box, and so they can't suddenly come up with anything wildly different.”
This, says James, is what makes the region so fundamentally different from Russia, where James and her team do not invest. The fact that Russia's development after the collapse of its Soviet empire has not been underpinned by efforts to adapt to Western European business practices means it remains an altogether more unpredictable location for investors.
What about corruption within Europe's Eastern extension – has that been brought under control as well? James says the mentality that developed under the patronage system of the old command economies is still widespread among bureaucrats, particularly those over 45. “If you need a licence or a permit, you may have a problem. We try as much as possible to keep away from having to rely on the authorities. But every government is being pressurised by the EU to step up its fight against corruption. We strongly believe there is a positive trend here as well.”
VALUE THROUGH GROWTH
Overall, from a private equity point of view, accession appears to have laid the ground for an important new phase both in terms of practitioners and fundraising. Groups including Advent and Warsaw-based Enterprise Investors, which recently announced a first closing on €200 million for its fifth regional private equity fund, are currently looking for fresh capital to take advantage of the opportunities that EU enlargement is likely to foster from hereon. Many are also predicting that more of the large international buyout firms will be setting up offices in the region soon too.
The way to make money in Central and Eastern European private equity has been, and still is, to find and back growth. At a time of economic stagnation in Western Europe, regional GDP is expected to grow by five percent per annum for the foreseeable future. Service industries such as entertainment, communications and financial services, fuelled by a profound increase in domestic demand, are tipped to grow even faster.
In addition, there are benefits directly deriving from EU membership that will further stimulate development in the region. For example, joining the union will give new members access to much needed EU infrastructure funds.
James says EU-funded infrastructure projects will not only bring long-term benefits to the region as a whole, but will also have a more immediate effect on certain local businesses. The example she uses is an Advent portfolio company in Southern Poland that has a contract to clean up the waste tip in a steel works. The company, situated in a part of the country that is slated for a major upgrade of the motorway system, is almost literally sitting on a pile of aggregate which will be valuable once the roadworks get underway and “everybody is going to need an awful lot of road stone.”
Before long, in other words, Brussels may feel a great deal closer to local enterprises in Krakow, Lodz or Lubin than would have been imaginable just a few years ago. To a veteran investor like James, who has witnessed practically the entire process leading up to this new reality from close range, it must seem an awesome conversion too.
Advent's initial focus as an Eastern European investor was on Poland, Hungary, the Czech Republic and Slovakia, although the 25 investments (including BCT, which is yet to complete) it has completed since 1995 have taken the firm into Romania, Bulgaria and Turkey as well. Following a multi-country approach was a deliberate decision, taken at the outset so as to give the firm enough flexibility to deal with the likelihood that some Eastern European markets would develop more quickly than others.
I think we would feel much more isolated if we had to make decisions on the basis of first principles
Established 20 years ago, part of Advent's mission has always been to take its investment expertise into new markets. The firm, which today has offices in 14 countries and manages several funds including a $2 billion global entity, was founded expressly as a global investment practice aiming to give investors – which, in the early days, were mostly US institutions – exposure to private equity in geographies they wouldn't otherwise have had access to. As a result, it has made a habit of entering markets it considers ‘emerging’. (The first such foray in the 1980s led the firm into the UK, which according to James was considered a “fairly racy” bet at the time).
Advent's expansion into Central Europe happened roughly at the same time as its push into Latin America, where it has been investing from dedicated funds since 1996. Both projects were backed by the International Finance Corporation, the Washington-based development agency that has been behind many emerging markets private equity initiatives around the world (readers can find out more about the IFC's key role in November 2003's Privately Speaking with its private equity head Teresa Barger).
Today, the group has dedicated offices in Warsaw, Budapest and Bucharest and maintains partnerships with local investment professionals in Prague and Bratislava. When James first arrived at Advent, this structure had to be built from scratch. That said, she did not operate entirely in a vacuum. As it had done when it first ventured into Western Europe ten years prior, Advent was already cultivating a network of locally based investment partners who helped it source deals and co-invested in the transactions that ensued.
Taking the plunge in the mid 1990s “was definitely a risk,” says James. “Private equity is a pretty sophisticated part of capitalism, so you had to ask was it too early to try this in areas that were just emerging from command economies? But it wasn't just a question of me turning up, sitting in a hotel room and wondering who to call. We were working with our local partners, co-investing with them and helping them raise their own funds. The deal was, we'd put them into the business, they'd put us into the country.”
A number of these early allies went on to become independently funded private equity managers in their own right. Advent's original Warsaw-based partner, Copernicus Capital, recently acquired Adriatic, a Zagreb-based group that now functions as the firm's local affiliate in Croatia. Genesis Capital is its partner in the Czech and Slovak Republic.
Other factors that helped the firm's Eastern European project get off the ground were Advent's already existing international resource base and its network. Indeed, being part of a globally operating entity remains as important to James and her colleagues today as it was in the beginning. “We're not a stand-alone operation, and we use and exploit that a lot,” she says.
The firm has teams of specialists dedicated to sectors including healthcare, media and telecommunications which the regional offices will turn to as and when their input is considered beneficial. “We're not trying to make decisions in isolation. We'll always call in the specialists to share views, do due diligence, introduce us to relevant people and companies. They also help us kill things earlier. I think we would feel much more isolated if we didn't have that and had to make decisions on the basis of first principles.”
It also means that, having assembled a team of young local investment professionals, it is essential for James and her two management partners in the team, Christian Mruck and George Swirski, to spend time in London every week and be physically close to other people in the firm. “Being here, talking to people, walking up and down the corridor and discussing things with them is absolutely critical. You can do a lot remotely, but it's not the same. You have got to be able to sit down and chew things over with people on a regular basis. We need to keep our links here.”
So far, this approach appears to be working well. The firm has invested $341 million of capital in the region. Two dedicated funds, Advent International I (1994) and II (1998), account for $139 million of this total, with the balance in funds managed by the group and its affiliates.
According to James, apart from a company depending on exports to Russia which during the Russia crisis lost its entire receivables book when the rouble collapsed, as well as what hindsight would judge an ill-conceived bet on an internet company during the tech boom, the Eastern European portfolio hasn't had any losses.
The group has also achieved a number of exits, mostly by way of trade sale to non-domestic buyers eager to acquire a foothold in the region. Given the average size of portfolio companies and the relatively modest scale of local capital markets, this remains the most obvious exit route for private equity. Among Advent's realisations are @Entertainment, a Polish TV company which floated on NASDAQ in 1997 before being acquired by UPC for $1.2
billion; Synergon, an IT services group in Hungary; Brewery Holdings, a Romanian brewery group; and Internet Securities International, an emerging markets data provider acquired by Euromoney Institutional Investor in 1999 for $43 million.
Realisations are obviously the ultimate test of any financially driven investment activity anywhere, but given the risk profile of an emerging market environment such as Eastern Europe, investors do expect more bang for their buck than they would in other parts of the world: “Investors expect to see a premium over what they get out of mid-market buyouts in other parts of Europe. So you may be able to do deals, but the real question is can you get your money out profitably.”
At this point in time, with EU accession moving forward, Advent is confident that the prospects for private equity in the region remain strong. James says competition in the firm's investment sweet spot of companies with an enterprise value of up to €100 million remains limited and consists mainly of local investment firms as well as corporates. Up to now, other foreign firms have been slow to enter.
Now that indigenous pension funds are developing for the first time, local managers are expected to be able to raise local capital aimed particularly at countryspecific venture and early stage development capital investments, leaving the larger buyout market to regional or pan-European funds. As one of the first movers into this area, Advent has most of the levers in place to remain one of the key players in what clearly is a fast changing part of the world. And it's the kind of change that has proved in other markets in earlier times to be particularly nourishing to private equity.
James herself certainly remains as enthusiastic as she's ever been. “Many of the people we work with are inevitably less experienced compared to Western Europeans, but they're extremely well educated, ambitious, and they absorb knowledge like a sponge. I am learning new things all the time as well. It's great fun.” To many private equity practitioners, that's what it should be all about.