Full of Eastern promise

With its geographic position between Europe, the Middle East and Asia, an enviable recent economic track record and increasing political and financial stability, Turkey has become a market that’s hard for private equity to ignore.

It’s no surprise, then, that the country is seeing unprecedented levels of interest. A number of international firms have set up local offices in the last few years, and new funds are being raised to take advantage of limited partner appetite for this dynamic and fast-growing market. Local player Mediterra Capital recently reached a first close at $144 million on its maiden $360 million fund, which will invest in mid-market Turkish companies. Middle Eastern investor Global Capital Management is finalising documentation on a $350 million Turkey-focused fund, with a first close anticipated for late 2011/early 2012 at around $200 million. And Abu Dhabi’s Invest AD has teamed up with Japan’s SBI Holdings to raise a $100 million fund destined for investment in Turkey.

Turkey generating interest

Turkey has seen high levels of interest before (albeit not on the scale we’re seeing today): before the crisis, executives from international firms were flying in and out of Istanbul on a regular basis. The shock of the downturn put paid to that particular flurry of activity – but now, it seems, international private equity is back in numbers.

“Competition for deals has intensified over the last 18 months,” says Can Deldag, managing director at The Carlyle Group in Istanbul. “When we acquired Medical Park at the end of 2009, there were only a few players active in Turkey. Since then there has been a big rush towards the country, and now I could name you almost 50 firms that are looking for investments here. The international players are here – although they’re covering the market from London – there are a few local players and there are regional players. In fact, Turkey has become top priority for regional players from the Middle East, North Africa and Eastern Europe.”

“The actual level of PE activity in Turkey is still not as strong as in 2008, when it was at its peak,” says Mete Ikiz, investment director for NBGI Private Equity’s Turkey fund. “But 2011 has been very active in terms of new international funds either opening offices in Istanbul or putting Turkey at the top of their radar screens for deals. New local funds are also being raised, which is a first for the country – and will encourage other local talent to go and raise funds on their own”.

After steady and measured growth through most of the 2000s, Turkey’s private equity industry is starting to pick up speed. And it’s not hard to see why. It has a large and young population: two-thirds of its 73 million people are under 30. It is growing fast; faster, indeed, than had been anticipated at the start of the year. In Q1 2011, Turkey posted record GDP growth of 11 percent, well above the forecasted 9.6 percent and even higher than China’s 9.7 percent. Its political situation is relatively stable, as this year’s election results attest – prime minister Erdogan’s Justice and Development Party won a third term in power. And, vitally, its financial institutions are in good shape, having got their house in order following the country’s own banking crisis in 2001.

“Many of the indicators in Turkey are going the right way,” says Nikos Stathopoulos, managing partner at BC Partners. “GDP is growing strongly, inflation and interest rates have reduced and unemployment has stabilised. At the same time, the political environment is now stable and the government has put in place the right measures for sustained growth. Indeed, some of the emerging market risk in Turkey is now significantly reduced.”

While some economic issues remain – the government’s policy of depreciating the Turkish Lira is still making life difficult for foreign investors, for example – Turkey is clearly forging ahead. And private equity is looking for a piece of the action, with new investors lured by the potential for high returns. “The returns from Turkey have historically been good,” says Deldag. “Most deals done over the last five years have performed well, and that is attracting new investors to the country.” Indeed, TurkVen’s Seymur Tari says that his firm has generated returns in excess of 30 percent – and that’s without leverage, he says. “That’s a whole new lever we can use if growth ever does slow down here.”

The market is being boosted by a new willingness among local banks to provide acquisition finance – something that had previously been lacking in the market. “The banking system in Turkey is robust, balance sheets and capital ratios are strong and banks have liquidity,” says Ikiz. “They are looking for good management and strong companies to lend to. They have become more familiar with cash flow lending over recent times and want to work with PE.”

However, Turkish banks do have some limitations, at least for now. “The local banking market is strong, and understands private equity much more now than it used to,” says Stathopoulos. “Banks are willing and able to lend to LBO transactions and can offer more aggressive terms than international banks. This was the case when we acquired [publicly-listed food retailer] Migros Turk in 2008. However, they can only really provide senior debt. More complex structures, such as those including high-yield, are still the preserve of the international lenders.”

The local banking market is strong, and understands private equity much more now

Nikos Stathopoulos

And despite Turkey’s undeniable attractions, it remains a difficult market to crack. While some larger transactions have been completed – the largest being BC Partners’ aforementioned acquisition of Migros, which valued the company at $3.25 billion – restructuring of the country’s conglomerates is happening slowly. As a result, deals tend to be smaller than many of the international players are accustomed to and, crucially, have historically involved minority stakes in family businesses. “The prevalence of minority stakes in Turkey presents a challenge for investors,” says Deldag. “You have to make absolutely certain that both sides see the future of the business and the sector in the same way. Getting this understanding and alignment predictably takes time.”

There are some signs of progress, as families become more familiar with the private equity model, say local players. “Until very recently the potential of achieving PE partnerships with family businesses was very limited,” says Ikiz. “This is changing as they increasingly understand that a PE partner can strengthen the company’s corporate governance, and act as a strategic partner to create new markets for the company – as well as providing access to capital, which facilitates further growth either organically or through acquisitions.”

The supply of these opportunities is also steadily increasing. “Many family businesses here date back to the creation of the republic in the 1920s,” explains Ahmet Faralyali, managing partner at Mediterra. “We are now seeing transitions in a big way as second and third generations look to release some of the cash tied up in the business and those remaining are looking for partners to build the business further. Bank loans and IPOs can’t solve this issue, but private equity can.”

However, the time taken to complete deals remains an issue, not helped by the fact that many companies don’t have sophisticated business information systems. “One of the issues is that it can take a long time to get deals done; one can spend a year working on a deal with no guarantee it will be completed,” says Stathopoulos. “Often sellers aren’t fully prepared for a sale, company information is often not readily available and it can also take a long time to get on the same page as the owner on valuation.”

This issue of valuations is particularly salient in today’s Turkish market. High levels of competition for deals, together with the fact that vendors are pricing in future growth, have driven multiples up. “Valuations expectations are high,” admits Stathopoulos. “There should be a premium versus developed markets in many cases because of growth, but there is a fine balance to be struck. Ultimately, however, the valuations will be determined by how much leverage can be raised. If a vendor is asking for 15x EBITDA, but you can only raise 5x EBITDA in debt, the returns will be challenging for private equity.”

In fact, some players, such as NBGI, are worried that the market is overheating. “The present number of market participants is relatively high, leading to unrealistically high entry valuation multiples demanded by company owners,” says the firm’s Yannis Voyatsis. “It is likely that a market correction could result in a reduction in the number of market participants.” 

Others, however, continue to argue that the only way is up. “Turkish PE has had around $10 billion assets under management over its entire history,”  says Global Capital Management managing partner Rajiv Nakani. “That is minuscule compared to what the market can absorb over the coming few years.”

What’s more, most of private equity’s focus so far has been on companies based around Istanbul. “There is huge untapped potential in other parts of Turkey,” says Faralyali. “The issue is that it takes people and resources to reach out to the regions. We’d like to do this, but there is a limited number of experienced Turkish PE professionals and so there is only so much you can do.” 

Turkish people becoming more

However, this is slowly changing, says Tari. “One of the challenges has always been a lack of experience among Turkish people,” he says. “And you really need Turkish natives to do this work, particularly in mid-market companies where English isn’t spoken. But we are starting to see a greater pool of experience here.” And that is helping unlock deals. TurkVen, for instance, has completed four deals in the last 11 months.

The other significant development in Turkey this year has been BC Partners’ realisation of some of its investment in Migros. In April, it sold off a 17.4 percent stake in the business via an accelerated book-build, while in June it sold a subsidiary called Sok to Turkish food group Ulker for $380 million. One concern about the Turkish market has always been around the potential difficulty of exiting investments. Successes like this should give private equity a bit more confidence on that front. 

All told, it looks certain that the volume of deal flow will increase in the coming years as the in current interest in Turkey translates into action. The fact that more local talent is appearing in the market will open up the pipeline further, as they build bridges with family-owned businesses – while the slow process of restructuring Turkey’s diverse conglomerates will bring further opportunity. The growth in Turkish PE activity may not be quite as fast as some would hope or expect, given current levels of interest – but it’s clearly a market that’s on the rise.  

For more insight on Turkey as a growing private equity destination, see our upcoming PEI Turkey Forum