Turkey round-table: Back to school

PARTICIPANTS:

Ihsan Sancay, Bosphera Private Equity
Ihsan Sancay is a partner at Bosphera Private Equity Partners. Prior to establishing Bosphera, Ihsan headed the Istanbul office of Global Capital Management, where he led its Turkish private equity practice. Before setting up the GCM Istanbul office in 2008, Ihsan worked at IS Private Equity, the private equity arm of the Turkish bank.

Memet Yazici, TRPE Capital
Memet Yazici is the managing partner of TRPE Capital, a small-cap investment firm which recently spun out of Rhea Asset Management. Yazici was a co-founder of Rhea Asset Management, where he led the private equity and venture capital investment teams. Before Rhea, he spent 17 years in the US in various private equity investment management, operating and consulting roles.

Selim Kender, Turkven
Selim Kender is a principal with buyout firm Turkven Private Equity. He was formerly the head of Fortis Bank Leveraged Finance in Istanbul. He also worked as an investment banker with Finansbank and a telecom executive at NTL and CoreComm.

Asli Basgoz, White & Case
Asli Basgoz is a partner at law firm White & Case, based in Istanbul. Her practice involves a wide range of corporate and financial transactions with a particular focus on mergers and acquisitions for strategic and private equity clients. She has represented multinational and Turkish clients.

PEI: What has been the most important development in the Turkish private equity market in the last couple of years?

Ihsan Sancay
Turkey has a very active private equity landscape, which is rapidly changing both in terms of the size and strategy of Turkish companies, and the private equity players. Ten years ago, for example, the private equity industry here was investing amounts more in line with venture capital stage investment – $5 million to $20 million. But in the last decade, the market has grown from a few large players and international funds to a more segmented landscape: today, there are venture capitalists, mid-market funds, big-ticket funds… The market today is offering choices for different investor preferences.

Memet Yazici: 
For the first time, an LP is coming into the Turkish market and there is a menu of private equity strategies allowing them to access the market. That’s good for deals, because then companies that are looking for money can actually be matched with the right private equity firm. It’s also good for the capital that is trying to access those deals because currently there’s a one-size-fits-all modulator in terms of LP money finding a place to invest; that’s changing, and I think that’s really what’s best about 2012 and 2013 vintages.

Selim Kender: 
I agree there is more of a segmentation going on. There are funds that invest $5 million to $10 million, either taking minority positions in companies or doing small-cap; there are the mid-cap investors; [and] then you have the international large-cap players coming in like the KKRs, TPGs, Blackstones, what have you. They are obviously looking at equity tickets much higher than the numbers [domestic funds] are talking about – and that’s why these groups do their investing through London, because there is not a lot of deal flow in Turkey yet in the $300 million-plus equity cheque territory. Those deals happen once or twice a year if you are lucky, and for that you don’t need an office here. A $250 million to $300 million ticket is mid-cap in the US or UK, but for Turkey that’s large-cap investing.

Asli Basgoz: 
For those of us who remember the very, very early days, the evolution has been tremendous – in terms of the segmentation that others are talking about, in the ability to get deals done, in the ability to exit, in the perception of private equity and what private equity can bring to a transaction or to the country. The early days were full of suspicion and lack of knowledge, [of] ignorance on both sides. And that suspicion, I think, is largely gone. A lot has happened to make deals easier to execute, by and large. 

Memet Yazici: 
The market is becoming more efficient to enable the placement of capital and then deployment of that capital into portfolios companies [well matched with sponsors]. For example, we might invest in a dental clinic with four locations, and under our stewardship grow it to 30 locations – a $75 million to $100 million company. That’s then an opportunity for somebody like Turkven to take it regional, take it to Europe or merge it with a couple of other healthcare organisations to make it a $500 million organisation. We are seeing that dynamic happening more and more – capital is efficiently deployed by the right team first and then passed on to the second team. 

PEI: What challenges or growing pains have you been encountering? 

Memet Yazici: 
Five years ago, which was the beginning of my experience in the Turkish market, there was not enough knowledge across the board. Currently that has filled in; particularly [on] the legal and the advisory side there has been a tremendous improvement so our legal and other advisors are as good as the advisors that we can find in London or in New York. That’s good. 

What’s bad, [as] I experienced on Monday in Abu Dhabi, is [the misinformation out there]. I was with the president’s official visit there; the delegation was 100 business people and about 30 of them were large-caps, 70 of them were small-caps. And every single one of them had a multiplication table of EBITDA versus what their company was worth. And these are small town business owners – like a chicken coop manufacturer in the middle of Anatolia – who have a $20 million company, and think they know exactly where they are going to sell, what they are going to do. You can see their minds are filled with all kinds of wrong information. 

So five years ago there was no information – when I said, ‘We’re private equity players,’ I could have said, ‘I am an astronaut’; [the reaction] would not have been different. Now there is a lot of information [but] 75 percent of it is wrong.

Asli Basgoz: 
One of the big shifts for me has been [that business owners have come to regard private equity] not just as a source of capital, but as a strategic partnership that can add value to a business, that can help assure a successful sale or a successful exit.

Ihsan Sancay
I totally agree. In Turkey, all the deals are transformation deals. We don’t have the same sort of leveraged buyouts or hostile takeovers that you see in the US or Europe, we are not there yet as a market. We are still very fundamental in our approach, transforming businesses, making corporate structures more efficient, if necessary changing management. 

This next generation of private equity managers over the next 10 years will help the landscape of Turkish companies transform and grow – and GPs should keep their focus to industries they know best. I think this vintage is a critical vintage for the future of the private equity industry here. All of the people around the table here, and the industry generally, are responsible for ensuring Turkey’s private equity industry is a continuing success story. 

PEI: The fundamentals you describe – the focus on operational improvements – resonate globally given current market conditions make leverage and multiple expansion less likely routes to generating returns.

Selim Kender: 
One shouldn’t forget that this is an emerging market: the returns mostly come from the growth of domestic companies. Do we use a little leverage? Of course we do – finance theory suggests it’s always beneficial to use a responsible level of leverage instead of doing everything with equity. But the name of the game here is to transform Turkish companies, many of which are family-run SMEs, to professionally managed companies. 

Professional management and a good corporate governance structure is a catalyst for good exits. We’ve done four exits to date, all to strategic players, and especially when it’s an international strategic player entering the market it’s very important that you give them a fully functioning company with all its management functions intact.

Memet Yazici: 
Being cute about your capital structure [isn’t the way] to create value in Turkey. It’s on the operational side.

Ihsan Sancay
For us, the best part of our job is helping companies with their transformations. We try to make them more efficient, try to motivate them and are spending enormous amounts of time on them – we spend a minimum of 60 to 70 percent of our time working with portfolio companies – so it gives you a very important personal satisfaction to see a successful transformation and know that at one stage you were a part of that.

PEI: Conditional capital increases in companies are going to be possible thanks to the recent changes to the Turkish commercial code, allowing for formal stock option plans at portfolio companies. Are there other recent legal changes you think will impact private equity firms and their investments?

Asli Basgoz: 
We had a lot of legal changes this last year and coming up to the Turkish commercial code – most of which are positive, I would say, and most of which embody sound policy decisions. The policy decisions that are embedded in these changes are good: streamlining [the] operation of companies, defining some things that weren’t properly defined before, just bringing [the code] up to date. 

There are also some questionable policy choices, like the financial assistance rules, which just completely prohibit financial assistance from a company for the acquisition of its own shares. We had a developing acquisition finance market in Turkey that has just been completely shut down. So, where all across Europe you see different shades of grey in the prohibition of financial assistance, we go from it being completely allowed with no restrictions to being completely disallowed [because of] the introduction of new provisions. 

PEI: What are firms doing to confront that new challenge to acquisition financing?

Asli Basgoz: 
People are spending a lot of time trying to structure transactions to get around it, but it’s difficult because fundamentally you’re running the risk that your transaction is going to be invalid and no bank is going to be willing to take that risk.

Selim Kender: 
There are some things that are good with the new commercial code; most of its measures bring us up to date with global practices.

Ihsan Sancay
I think most of us are on the same page in that the changes were largely good, but there are some parts which [have gone to an] extreme stage. Your example, the shut-down of the acquisition finance market, is a very critical one. 

But at the end of the day, this is all about judgment and how you read the law. In the last couple of weeks, we received three or four lawyer briefs about the new changes – each with different interpretations of their impact – and after the fourth one, we talked together internally and concluded it’ll take some time to get clarity because the update to the code encompassed a number of big changes. 

Asli Basgoz: 
There are a large number of changes and lot of important changes: introduction of mandatory IFRS reporting standards, better transparency, better reporting. All of those things by and large are positive and there are many provisions that are easy to interpret, but there are a handful that are going to take time.

It’s similar to other changes that took place last year. The commercial code has been under development for a long time, but there’s been a relatively short period – given the number of changes – from when it was promulgated to when it takes effect in July 2012. 

So to take another example: the recent changes made to corporate governance rules for public companies at the end of December 2011. We went from a situation where for most companies you didn’t have to have any independent directors – it was not mandatory except for the top 30 companies – to a situation where it’s mandatory to have the number of independent directors pro rata to the public float of the company and [with a] minimum of two. 

And the definition of ‘independent’ has a long list of criteria, one of which would be a concern to me if I were in the businesses you were in – that you have to be tax-domiciled in Turkey to be an independent director. That is an example of something that’s totally inexplicable to me. 

The question is: is it a disincentive for people to go public? I mean even just convincing companies to put one independent director on the board has not been easy in the past. 

Memet Yazici: 
In this case, they didn’t give us any warning at all. We have two companies that are public – one is 90 percent public and the other one 35 percent – and both boards were not obsolete, but close. We are making changes in both of the boards, which has been sudden.

If you look at the ways public companies are managed, I think [Turkey typically ranks] second from bottom in terms of corporate governance – that needs to change. 

And on the Turkish commercial code… Being a private equity geek I wish I could quote a real number, but I think that’s going to really improve our returns because we’re competing with companies who are abusing all kinds of rules, who are not transparent, not paying taxes on time.

Ihsan Sancay
It will accelerate major – and some badly needed – changes in the economy, but it’s still too soon to understand what its real impact will be on the private equity industry.

Selim Kender: 
It’s open to a lot of interpretation, like the financial assistance prohibition value. You can get the loan up at the special purpose vehicle (SPV) and pledge your shares in the op-co, but we’ve always done mergers between the SPV and op-co to push debt down to the operating level; whether that is now possible is up in the air.

Asli Basgoz: 
It’s back to school for everybody. We went from a world where you had a set of corporate governance rules – almost none of which were mandatory and that very few companies were following – to a world where some critical ones are now mandatory kind of overnight. 

[Editor’s note: Subsequent to this discussion, the Capital Markets Board responded to objections from market participants by relaxing the proposed rules. The most important change was to the number of independent directors required in public companies, and to some aspects of the definition of ‘independence’ – particularly for those independent directors who must be tax-domiciled in Turkey.] 

PEI: Are potential investors worried about currency fluctuations and converting funds to lira? 

Selim Kender: 
It would be ideal if we were able to raise our funds in Turkish lira, but such a market does not exist. US dollar or euro funds don’t think it acts as a deterrent to the LPs – it’s something that they ask for. And if you look over the long-term, leaving short-term volatility aside, say from 2004 or even 2000, investing dollars or euros into Turkish lira and then converting back has actually been beneficial. You can pick certain windows of time where a devaluation like last year’s might have affected things, but over the long run – and we are medium- to long-term investors holding our position for three to six years – the currency is not that big a problem. Also, because of some of the fundamentals of the Turkish economy, the country is going through a productivity gain; it shouldn’t be too surprising [if] TL gains against euros or dollars in the long-term. 

What we need to be careful with is acquisition finance. Long-term financing exists in dollars and euros in the domestic market, and when you have Turkish lira operating underlying assets, sometimes through fluctuations there could be some problems in terms of tripping covenants or what-not. But we haven’t ever tripped a covenant, so I guess we have been lucky negotiating our headroom.

Mehmet Yazici:
Until about two weeks ago I was in full agreement with this. Turkish lira versus hard currency – I still agree with the fundamentals. There will be short-term fluctuations, but we’re long-term investors. 

But as far as the conversations with the LPs: we’re raising a euro-denominated fund and for my dollar investors it has now become a problem. I had a very serious conversation with one of them who said: ‘You need to give us a dollar option’. Whether or not we can do that is one question, but the implications of doing that even if you’re able to structure parallel vehicles… It becomes a nightmare.

Selim Kender: 
I agree, but this is not a problem regarding Turkish lira – this is a problem regarding the euro. Because of what’s going on in the eurozone, dollar-denominated investors especially are a bit wary. I mean, the money is committed for 10 years and I don’t think anybody on this table can say with certain conviction that euros will continue to exist in 2020. I don’t know. And that’s the challenge; it’s not FX against Turkish lira.

Ihsan Sancay
I personally cannot say currency fluctuations are a negligible risk that we should forget – because over the past 10 years, we’ve seen how harsh the consequences could be.  What we need to do while we are managing our companies efficiently, while we are developing our sector efficiently, we should play the space here as well. For example, if you’re taking out loans, you should analyse the company’s balance sheet to determine what part of it should be in Turkish lira, what part of it should be in US dollars. 

PEI: Are there other ways that the eurozone crisis is affecting portfolio companies and/ or new deals?

Ihsan Sancay
For some industries it’s a benefit, because most of the production centres in Europe are now becoming more problematic – [so] Turkey is gaining a very important competitive advantage. It’s a very good time for Turkish companies to tuck into their markets and also make consolidation plays in Europe as well. 

Mehmet Yazici: 
Overall it really depends on the type of company. We have a logistics company that serves Southern Europe and the volumes that are being shipped are just… Every month you say it can’t go any lower than this and it does. That company is trying to defend itself as much as possible. 

That’s the bad story. But the good story [with regard to] what’s happening in Europe is that the stress for larger and smaller customers is making either buying a Turkish company, outsourcing to a Turkish company, or buying more from a Turkish company, cheaper and more effective. And it de-risks some of their operating businesses. So that’s a window for us. 

Asli Basgoz: 
It’s also had a positive impact on outbound M&A from Turkey. We’ve had quite a few clients in the last two or three years buy a supplier [or] a distributor, sometimes out of bankruptcy or out of distress in Europe. 

PEI: One topic we haven’t discussed is valuations. Is there some froth in the market on the back of growing private equity activity?

Mehmet Yazici: 
If there is a perception that every deal in Turkey is very expensive and multiples are high, that’s a sign of not really having seen all the segments in the market – which ties back all the way to the first part of the conversation. The market is filling with managers who can execute different types of deals and deals that are on the value side. The only deal that we closed this last year was at a multiple of five-and-a-half, and there is already somebody wanting to buy that at 14. There are good deals to be had here, and it’s going to be like this for a while. So the irrational exuberance on the larger auction deals in Turkey is a bit of a misconception – and that misconception will also go away.

Ihsan Sancay
The reason some people might assume that, however, is not difficult to understand when you consider all the fundraising activity, as well as increasing levels of deal activity, in the past year. As I said before, this vintage is very critical. Large-cap, small-cap – all investors need to be thinking about the next 20 years, not just the next five, as we work together to make this private equity market more efficient. 

Asli Basgoz: 
I am very optimistic. We get some obvious deals, obvious sectors, obvious players, but some of the ones that get brought to us… They are finding opportunities where I wouldn’t dream there could be opportunities. So I think it’s far too soon to say we are out of deals, or [that] deal flow is slowing down.

Selim Kender: 
It’s exactly the opposite. I mean, Turkish private equity activity as a percentage of GDP is very, very low – not only compared to developed markets, but compared to a good chunk of emerging markets. Deal flow pipelines are going to increase in the coming years and I think we are looking at sustainable growth for about 10 to 20 years.

SPONSORED BY BOSPHERA PRIVATE EQUITY, TRPE CAPITAL, TURKVEN AND WHITE & CASE