‘Still playing catch-up’

In what sort of shape has Central and Eastern Europe emerged from the crisis?
In press reports earlier this year, Central and Eastern Europe (CEE) was seen as overleveraged. But the numbers cited were often inaccurate and failed to reflect country differences. While the effects of the downturn in the economy have hit certain industries hard and particular countries in the CEE region have overextended themselves to their detriment, the region's problems are not quite as serious as portrayed. The key reason being that the larger economies in Central and Eastern Europe were never engaged in the credit boom and bust cycle.

Poland and the Czech Republic, the region's two largest economies, didn't overextend themselves and penetration of credit in these economies remains well below Western Europe and the US. You could add Slovakia to this group as well. You have the competitive advantage of a well-educated and highly skilled workforce supporting strong productivity growth and substantial foreign investment and flexible exchange-rate systems where currencies have already fallen to fairly competitive levels.

Once global credit conditions improve, these countries should be able to resume their convergence trajectory towards the standards of Western Europe. This catch-up phase remains a compelling part of the thesis for investing in private equity opportunities in these countries.

How has the CEE private equity market changed as a result of the crisis?
The crisis is accelerating changes in the CEE private equity market, but many of these changes are a result of natural evolution. One of the key areas will be the continued consolidation around indigenous fund managers.

As less disciplined private equity buyers are largely removed from the market, the better firms that have built private equity businesses in CEE during the 1990s and early 2000s will again have the opportunity to take advantage of attractive entry valuations. Deals completed in the post-crisis years of 1998 and 2001 yielded very attractive returns and I believe a similar opportunity is present today for investors able to adapt their investment approach and business model to address the constraints of the current market.

Has investment in 2009 been concentrated in core markets such as Poland and the Czech Republic?
Much of the deal activity in CEE in 2009 at the mid market and lower end of the market has been concentrated in these countries where, in my view, risk-adjusted returns presently are the most attractive. Valuations in completed deals seem to have compressed to reflect current market conditions and the regional banks have continued to lend to select deals. Attractive deals completed in other CEE countries have primarily been in defensive sectors, smaller in size, and requiring greater amounts of equity capital.

Where is capital still being targeted?
The healthcare space – where consolidation began to accelerate pre-crisis – is likely to receive increased amounts of private equity capital going forward, particularly in sub-segments where several deals were completed this year. I think that the telecoms sector broadly offers investors continuing opportunity as various segments like cable television and IPTV continue to offer consolidation in certain countries. Cable television deals completed in Bulgaria by EQT and in Slovenia by MidEuropa Partners illustrate the resilient nature of the thesis and have been among the largest deals completed recently in CEE.

Looking at where opportunities are from a top-down view, the imbalance of supply and demand of private equity is particularly acute in the mid market and lower mid market in CEE where less money has been committed than at the high end and where arguably a greater number of growing companies can be addressed by private equity capital. This size of company has historically achieved the fastest growth and, as fund sizes have progressively got larger with a greater focus on larger deals, inefficiencies in the mid-market space have created interesting opportunities.