The rise of a new frontier

A record 290 companies in Central and Eastern Europe (CEE) received backing from private equity and venture capital funds last year as the region’s entrepreneurs increasingly tap the expertise of fund managers looking to capture a continuing growth story.

The total capital invested by private equity funds in CEE increased by 66 percent to €1.3 billion in 2014. Buyout equity investments led the way with a 120 percent year-on-year increase to €935 million. Meanwhile, the result in exits was the second highest on record at a value of €1.3 billion, measured at original investment cost, according to the Central and Eastern European Statistics 2014 report published by Invest Europe (formerly the EVCA).

The rise in deal activity demonstrates the continued opportunities in the €1 trillion-plus economic region and follows the positive trend for Europe overall, which last year saw strong deal activity across the board, including a 14 percent rise in total private equity investment from 2013.

It’s an indication of maturity in CEE countries like Poland and the Czech Republic, rising opportunities in developing states like EU candidate Serbia, and growing expertise in others, such as Hungary and Lithuania’s strong flow of venture capital opportunities.

Fundraising for CEE private equity funds has followed suit, increasing more than threefold year-on-year to reach €1.5 billion in 2014 – the highest total since 2008, although still significantly below the record years before the financial crisis. The uptick in 2014 fundraising reflects the fact a couple of larger CEE fund managers were in the market last year. However, CEE does not appear over-funded as total funds raised versus the region’s GDP was less than half of that seen in Europe overall.

Government agencies were the largest total source of capital for CEE private equity funds raised in 2014, accounting for €617 million, driven by a major commitment from a Chinese public source investing in the region for the first time. Investors from outside the EU accounted for 55 percent of the funds raised in 2014 – a significant increase from 15 percent the previous year. Sovereign wealth funds accounted for €241 million of funds raised, while an impressive €220 million came from US-based investors.

One reason for the global investor interest is the compelling macroeconomic story. According to the World Bank, the CEE region grew by an estimated 2.6 percent in 2014, with individual countries recording even stronger growth. The IMF forecast is for the CEE region to grow by 2.6-3.6 percent in 2015 and 2016, demonstrating the potential and consistency of these markets. Poland – the largest CEE economy – was the only EU state not to go into recession following the global financial crisis. In fact it has not seen recession since 1992, making it a consistent draw for investors and fund managers.

At 78, the number of Polish companies receiving investment in 2014 was again the highest of any of the CEE countries. Its position reflects a good flow of buyouts, growth capital and venture capital investments, as well as a strong track record for exits, mainly to strategic buyers. Last year saw a record €530 million of divestment, at original investment cost, accounting for
42 percent of the total CEE exit value.

But Poland is not the only country developing a strong reputation for deal flow. Hungary was close behind with 73 companies receiving investment. All but seven were venture capital deals, in part catalysed by the European JEREMIE (Joint European Resources for Micro to Medium Enterprises) initiative and a strong local entrepreneurial scene. On a similar scale, the three Baltic countries generated private equity investments in 72 companies in 2014. Again, venture capital deals led the way, with 39 companies in Lithuania. At the large deal end, Serbia recorded the region’s first €1 billion-plus enterprise value investment since 2009, which confirms the breadth of the region’s opportunities in both deal size and geography.

Behind the headline figures, the region’s businesses are developing serious international ambitions. Entrepreneurs are developing innovative products and services – in sectors as diverse as software, consumer goods, retail and industrial products – that can compete on a global stage. As convergence turns to integration and expansion, there is a strong bench of high-quality CEE company entrepreneurs and managers eager to showcase their talents to a wider international audience. These types of businesses and partners are increasingly attracting private equity financing in the CEE region, as fund managers with their eyes on global expansion seek to back local “hubs”.

Other conditions play in the region’s favour. Workers are well-educated but labour costs are relatively low. As a result, the region is becoming a favourable alternative to China for western European companies seeking to outsource manufacturing without the lead times of long-distance shipping. Service centres for international businesses are also exploding in CEE. All of this in turn improves employment prospects across the region and helps drive consumption trends. This creates new opportunities for private equity-owned companies to address the growing demand.

For private equity investors, it is also worth considering that the majority of investments are primaries – businesses receiving private equity backing for the first time, offering fund managers clear opportunities to add value. Overall investment activity versus GDP remains relatively low and competition for assets remains less fierce than in more mature markets.

The growth of the region’s venture capital, infrastructure opportunities and the active buyout market seen in 2014 confirms the development of a rounded investment environment, characterised by dynamic companies, ambitious entrepreneurs and skilled managers. The emergence of CEE as a source of businesses with truly global aspirations is a trend with momentum that, if managed well, can drive investment further forward and draw even more international investors into its growth story.

 

 

Robert Manz is chairman of the Invest Europe CEE Task Force and managing partner at Enterprise Investors. With contribution from Bill Watson, Invest Europe council member and managing partner at Value4Capital.