Safer out east

While the traditional powerhouses of Western and Southern Europe struggle with tepid growth and the fallout from the eurozone crisis, all seems relatively calm further East. Though the knock-on effects of the upheaval in the likes of Greece, Italy and Spain cannot be ignored, the macroeconomic fundamentals of many Central and Eastern European economies still look surprisingly good. In fact, for those private equity firms equipped to operate in the region, these healthy, disintermediated markets may seem an increasingly attractive proposition.

Europe didn't get the message on competitiveness

Gordon Bajnai

As Gordon Bajnai, former Prime Minister of Hungary and now an economist and businessman, put it at the European Private Equity and Venture Capital Association’s recent three-day forum in Budapest: “Europe didn’t get the message on competitiveness, and globalisation had hit Europe very badly even before the financial crisis. Even if this current crisis is resolved, Europe faces major changes.”

But while Italy, Greece and other Western European markets are belatedly struggling with the pension and other reforms needed to make their economies more competitive, the CEE at least has an edge in one critical area: labour costs. As Bajnai points out: “Average wages in the CEE today are 700 to 900 euros per month, compared to four times that in Germany.“

Moreover, the CEE economies remain broadly strong (including their nascent financial sectors). Many are finally seeing the silver lining of the lengthy Warsaw Pact-related constraints on development, as well as the harsh post-Communist readjustment. “You’ll find growth across all of this region,” observes Thierry Baudon, founding partner at Mid Europa Partners. “Poland actually never went into recession during the crisis of 2008-09, and is now growing at maybe 3-4 percent. Most countries are growing reasonably fast.” This is changing the region’s risk/return profile, he suggests. “I’d argue that a number of Western European countries today are more risky. You’d have to look hard today to find a country that has better macroeconomic fundamentals than Poland.” 

This could have spectacular results in the coming years. “If you would like to identify what kind of role the CEE region will play in Europe, it will [be] similar to the Southeast Asian tigers,” suggests Bajnai.

If you would like to identify what kind of role the CEE region will play in Europe, it will be similar to the Southeast Asian tigers

Gordon Bajnai

Indeed, the region makes a strong case for the merits of that oft-neglected discipline, growth capital. “Our best years have been the last three-and-a-half. The growth of our portfolio companies has been over 20 percent,” says Michael Hoffman, chairman of Palamon Capital Partners. “If you have a chance to look widely across Europe, there are a lot of places to invest.” 

And, says Baudon, astute investors can rachet up growth further by focusing on “sectors that are growing at multiples of the underlying economies, mostly servicing urban consumers”. Examples would include “healthcare, retail, distribution, all kinds of personal and business service areas, to some extent the digital media space, and telecoms”, he says.

Bajnai agrees. “This part of the world is still significantly under-serviced compared to the West. That means a huge growth opportunity for the service sector.”

However, this doesn’t mean that investing in the CEE is easy, or that it’s an option open to everyone. EVCA data shows that only €1.3 billion was invested in the entire region in 2010, an amount easily eclipsed by some individual deals further west. 

Furthermore, the characteristics of CEE mean that GPs have to do a lot more of their own spadework. As Baudon notes: “The level of intermediation in the region is very low, even in the most mature markets.” As such, most deal sourcing is still proprietary: seven of Mid Europa’s nine deals in the past four years fell into this category. 

Equally, as Bajnai points out, “infrastructure is still very underdeveloped” in the region – which can hold back certain propositions. 

You need to react very fast to the rapid changes

Gordon Bajnai

It’s clear that dealmaking in CEE remains challenging. “You need to react very fast to the rapid changes on inflows between countr[ies] if you don’t have a pan-European platform,” warns Baudon. “This is becoming increasingly true. It wasn’t true five or six years ago.”