Struggles in East

Around 2006 to 2007, Central and Eastern Europe (CEE) was seen by many investors as a highly promising emerging market on the doorstep of Western Europe; with fantastic consolidation opportunities, pan-regional expansion potential and, above all, strong growth rates. But following the global economic downturn, the region’s buyout market has had a disappointing few years. It has struggled with sluggish deal flow and poor returns. As a result, it has been far from easy for managers to raise capital. The current instability in Ukraine and Russia hasn’t done CEE any favours either.

Deal flow has been a big part of the problem. Last year, 41 private equity deals were completed in CEE, roughly the same number as in 2012, according to data from Mergermarket – a big drop from the 75 deals completed in 2007. It appears that volumes have dropped further this year with only 35 investments made so far in 2014. What’s more, deal value has more than halved this year. Investments completed in 2013 had a combined value of $4.4 billion, while so far this year the total is $2 billion.

“Deal flow volume is approximately half of what it was compared to the pre-crisis years,” says Thierry Baudon, managing partner at Mid Europa Partners, one of the largest regional specialist. There is the odd large transaction in the region – earlier this year, CVC bought technology business AVAST for an enterprise value of $1 billion for instance – but it is more the exception than the rule. As a result of low levels of market opportunity, many regional funds have struggled to deploy capital in line with expectations, according to Roger Pim, managing partner at SL Capital Partners, the fund investor. “This has resulted in a significant fee drag on IRRs making it more challenging for managers to produce attractive net returns for investors.”

Unfortunately for GPs in CEE, this means many LPs have turned their back on the region. “CEE is not on the top of the LP’s list,” admits Brian Wardrop, co-managing partner at regional mid-market investor ARX Equity Partners. “The latest vintage funds have disappointed in the eyes of LPs and therefore the region is seen as less attractive as compared to the 2007 and 2008 era.” Baudon agrees: “The harsh reality is that the region is still quite unpopular.”

Thus, collecting capital for CEE has been far from easy lately. In 2013, only five funds were raised in the region, totalling $1.6 billion, according to PEI’s Research and Analytics division. In 2012, seven funds raised $2 billion, while in 2011 GPs raised $797 million across six funds. That’s a fraction of the combined $3.8 billion collected by 13 funds in 2008. Mid Europa, which closed its fourth fund this year, reached its €850 million revised target. “If I include the fund and the capital committed for co-investments then we have the same amount of money as last time,” says Baudon. “[But] the bad news is that we are effectively the only ones that have managed to raise a fund of that size.”


One of CEE’s issues is a lack of clarity regarding market definition, some GPs and LPs say. Some investors look at it as an emerging market – and therefore expect higher returns – while others view it as a European market. “I think investors recognise that CEE is definitely not like Western Europe due to the fact that the economic growth is much higher, the market is less commoditised, the number of secondary transactions is very low, the buy and build strategy dominates – all of which are the exact the opposite of Western Europe,” says Baudon. At the same time, LPs recognise that CEE is very similar to Western Europe in terms of its legal framework, he adds. Describing CEE as “emerging market light” would be quite accurate, says Wardrop. “Investors consider CEE as part of the European allocation bucket but, because of the slightly higher growth rates and higher risks, a GP in the region should have the capabilities to deliver some alpha over Western Europe.”

The definition also depends on the country in question. While Poland and Czech Republic can easily be seen as comparable with Western European markets, Ukraine is still viewed as an emerging market. “As you move east [investing] becomes more challenging,” says SL’s Pim. “We prefer to focus on countries with a strong rule of law, political stability and low levels of corruption. We have not historically been able to get sufficiently comfortable enough to invest in the Ukraine or Russia.”

The current political upheaval has meant many LPs are choosing to stay away from Ukraine. The current investment climate is quite difficult, admits Natalie Jaresko, founding partner and chief executive officer at Horizon Capital, which invests in Ukraine, Belarus and Moldova. “Export markets like Russia or parts of our domestic market like Crimea are not very open to business to put it lightly,” she says. “That said, we can see in our portfolio companies that the current situation has spurred our business partners to be much more creative. They are looking at alternative export markets in a much more creative and urgent fashion.”

What’s more, GPs and LPs have recently set up an industry body to enhance the image of the country and to push for better investor security. “Investor protection and shareholders’ rights especially need to be improved,” according to Jaanika Merilo, executive director at the Ukrainian Venture Capital and Private Equity Association (UVCA). Despite the geo-political uncertainties, there are attractive investment opportunities especially in the IT and agriculture sectors, she says. “There’s a dearth of capital in the country.”

The same is true for the rest of CEE, says Baudon. “A number of private equity firms have left the region, so we do see that competition from other PE houses has decreased.” Large auction processes are almost non-existent, he adds. “Therefore, the firms that are dedicated to the region have a competitive advantage.” Anne Fossemalle, director of the equity funds team at the European Bank for Reconstruction and Development (EBRD) agrees. “If you look at private equity penetration in Central Europe, there’s definitely room for investors and for GPs to be present.”

In addition, there are great deals to be found in CEE, according to Wardrop. “In Czech Republic specifically, we see a number of great niche manufacturing businesses that are attractive investment opportunities.” In addition, the exit climate is improving, he says. “We are seeing the emergence of local buyers [as well as] European trade buyers…so it is likely we will see the number of exits increase in the coming months.”

Demonstrating good exits is perhaps just what CEE-based GPs need to do to convince LPs that the region is a good bet after all. As with any market, local expertise is key, according to Pim. “It is difficult to invest from afar, you have to know the region well, understand the risks, the different countries, the different market opportunities. If you do that, there are still some interesting opportunities to be found in CEE.”

A resolution of the geopolitical problem would help the market, too.