Turkey roundtable 2013: Maturing nicely?

Turkey has been tipped for some time to become a hotbed of private equity activity, given its geographic position between Europe and Asia and its strong supply of founder- and family-owned companies ripe for expansion. Now, nearly a decade since Turkish private equity got its start, and with GDP growth forecast to hit 5% in 2013, PEI talks to four of the market’s key players to find out if Turkish private equity is finally set to take off.

Meltem Akol is a partner at Akol Avukatlik Bürosu in Istanbul. Her firm, an affiliate of White & Case, is among the top ranked M&A advisors in Turkey. She has over 15 years’ experience in mergers and acquisitions, joint ventures, privatisations and real estate transactions. She is a graduate of the University of Istanbul’s Faculty of Law and has an LLM from Harvard Law School.

Jason McGibbon is the partner overseeing Bridgepoint’s investment activities in Turkey and also leads its consumer team. He currently sits on the board of TüvTurk and has completed investments in companies including  Safestore, Infinitas Learning and Hobbycraft. He has a degree from the University of Strathclyde Business School and is a qualified chartered accountant.

Kerem Onursal is a director and investment committee member at Turkven. Onursal has been closely involved with the firm’s investments in Roma, Pronet, Mavi, Migros, Golf and Dogtas/Kelebek. Previously he was with McKinsey & Co. in its Berlin office. Kerem has a degree in industrial engineering and economics from Northwestern University.

Kerim Turkmen is a partner at Mid Europa and head of its Istanbul office. Prior to joining Mid Europa in 2007, he was a principal with GMT Communications Partners. Turkmen received his B.Eng. in mechanical engineering from Imperial College and his M.Sc. in accounting and finance from the London School of Economics.

PEI: If someone asked why they should invest in Turkish private equity today, what would you tell them? 

Kerem Onursal: If you look at Turkey, the fundamentals are there. Over the next few years Turkey is expected to be a trillion-dollar economy. There are a lot of large companies that were established many decades ago, so you can see their track records. They were founded mostly with entrepreneurs and now need the support of institutional partners, so the right elements are there – it’s a perfect mix for private equity firms to come and bring their value added capabilities, to help Turkish companies grow and institutionalise. 

Kerim Turkmen: For Turkey, I think the biggest change came a decade ago with the new government and ensuing political and economic stability. Prior to that, when we had considered investing in Turkey, it was always a very interesting and attractive growth market – but it was also more volatile, with major ups and downs. In the last 10 years, Turkey has become much more stable, which is evident in the macro fundamentals such as inflation, interest rates, public debt and budget balances. All of these indicators have stabilised and improved.  

With this positive macro backdrop, Turkey is basically fulfilling its potential. It is a big market. We look at the entire Central & Eastern European region with over 15 countries, and Turkey within this region is the largest market both in terms of population and economy. It is a very diverse market with a wide range of investment opportunities. We also like Turkey because it sits at the centre of Europe, CIS, and MENA regions, which have low correlation with each other. So to the extent you have a slowdown in one of these regions, you can make up for it with activity from one of the other regions. For us, Turkey offers good diversification. 

Jason McGibbon: When we started to look at Turkey a few years ago and made the decision to open the office here, we felt Turkey had had a great 10 years – a great run from a macroeconomic stability perspective. The number of businesses where private equity can make a difference is increasing. There is a great deal of openness to international best practice. 

I think we are talking about a location that probably is already – or is certainly on the way to becoming – one of the world’s major economies. 

Meltem Akol: What’s puzzled me in the past was all the attention that CEE got. And with all due respect, looking around at various jurisdictions and benchmarks, I thought Turkey deserved just as much focus and attention as CEE did, if not more. I agree Turkey is fulfilling its potential. There are setbacks temporarily; some political instability may come here and there, every now and then. But absent major setbacks, the positive trend is going to continue. 

The Turkish people have an entrepreneurial spirit, that’s for sure. So the combination of that independent entrepreneurial thinking and spirit with the desire to grow a business, to do more with it, to become more international, to widen the horizons, the scopes, etc., has created this fertile environment for private equity investors. And I see quite a lot more eagerness and openness from Turkish entrepreneurs to listen to the terms offered by private equity firms.

PEI: How is that progression comparing to other regions? 

Kerim Turkmen: I think the development of private equity in Central and Eastern Europe and Turkey have been somewhat similar, although the Turkish market has probably taken off a little later in terms of activity and the acceptance of private equity within the region. We started our activities in CEE in 1999, and in Turkey we have been looking at opportunities for about five or six years.

Deal activity was slow to develop at first, but accelerated over time, due both to increasing macro stability and the acceptance of a partnership with private equity as a concept amongst business owners and entrepreneurs. There has been a positive feedback loop – because as deals get done, as people see certain levels of success and know more about private equity and how it works, then more opportunities become available. Also, as Turkey’s economy and the companies within it continue to grow, the universe of sizeable companies we can invest in also grows. It’s been a quick development in recent years.

PEI: Are deal types here different from other markets? 

Jason McGibbon: In every market that we are in, we have to be flexible and adaptive to open up the largest portion of attractive dealflow. I think here that means considering a wider range of deal sizes. It means flexibility around 50-50 stakes, minority stakes with the right governance conditions and actually, in most of the cases, it is about finding the right partner.

PEI: LPs say they need proof of concept before considering commitments; have they got it in Turkey?

Kerem Onursal: I think the proof of concept is in the exits and returns, and now that we’re nearing an 11-year history we’re showing results for the last five years. So far we have done five exits, of which four [were] to strategics. We have managed to return more than five times in these investments in dollar terms. 

PEI: Playing devil’s advocate, could an investor have made similar returns during the same period investing in Turkey’s stock market or other asset classes? 

Kerem Onursal: If you are comparing to the index, the index did not return 5x. Of course you could have made an investment in real estate, or picked a certain stock that could return five times. But it’s not ‘either/or’; most investors would consider all strategies.

Jason McGibbon: I think some of the challenge and possibly misperception [around ‘proof of concept’] comes from the fact that when you look at the absolute numbers – one of the more accurate industry surveys that came out for 2012 said on the widest definition there were 50-60 private equity deals – when you dig into that, a large number of them were small growth capital transactions that wouldn’t be representative of the firms in this room, which are all looking to write cheques larger than $10-20 million.

That same study said there were around 10 or so private equity exits. So therefore one or two transactions have a high impact on perceptions.  We are seeing an explosion in the development capital area. You’ve then got the mid-market base, where we are seeing good consistent progress and we are starting to see a much stronger pipeline of secondaries. And then at the top-end are the LBO funds that are coming in and out of the market for one or two $1 billion transactions a year.

Meltem Akol: If the lifespan of private equity in Turkey is 10 years, the last four years when you would have expected more exits to take place has not been the best environment globally for exits. But I am not aware of many Turkish private equity investments that are ready to exit and yet cannot because of factors other than global economic conditions. There are exceptions – a couple of investments where perhaps the acquisition price was not the right price, maybe the business was overvalued a little bit – but mostly people seem to be pleased enough with their valuations. So it is more about waiting for the right time for exit.  

PEI: How does Turkey’s risk/reward profile compare to other markets?
Kerim Turkmen: We think that on average Turkey offers higher growth and because of this you generally need lower leverage to achieve returns. Having said that, we do think that on average Turkey has a higher risk profile compared to some other central European countries such as Poland for example, which is also a large growing market with a large population. So the question is whether you have incremental growth and return prospects in Turkey that would compensate the incremental risk.

PEI: Why do you assign slightly higher risk to Turkey vs. Poland?

Kerim Turkmen: Because in Poland the institutional and regulatory environment matches or is closer to European norms, and the level of exogenous risk is probably lower in Poland compared to Turkey, which needs foreign capital flows to fund growth and is also located next to the MENA and CIS regions. Having said that, Turkey is also in the process of becoming an investment-grade country, and proximity to MENA and CIS regions provide upside and useful diversification.

PEI: How much are changing regulations impacting day-to-day operations?

Jason McGibbon: There are things we can do today that were not readily deliverable 12 months ago around corporate restructuring. The flexibility of the toolkit and depth of legal framework is quite important if you want to create a level playing field versus other countries.  
You can now sit in a room with your tax, your legal, your financial advisors and they can [discuss potential structures and] say actually that has been done in three or four cases, that has been validated. That is huge progress. 

PEI: Where do things stand with ongoing regulatory changes and updates to Turkey’s commercial code?

Meltem Akol: Since last year we’ve been in a transition period. The purpose of all these changes was to upgrade and improve the regulatory environment to get us much closer to what’s standard in the EU. So what’s been created should look a lot more similar to foreign private equity firms familiar with European jurisdictions. Most of it isn’t ‘new’ to us, because most of it, [for] those of us who are local and have been doing transactions here for a long time, actually we had been applying all those tools, but through more creative methods, let’s say, to make deals happen.  Now we do not need to be perhaps as creative to get to those straightforward structures – but have more tools to work with.

Obviously it takes time for people to get used to working with a new set of rules; but there is certainly a push by all key players to play by the new rules. We all have to.

PEI: What are some of the issues where there’s now greater clarity?

Meltem Akol: The introduction, for example, of conditional capital increases; or the squeeze-out rule, the ability to buy out minority shareholders in certain cases; those have just been introduced. Conditional capital increases – if a couple of other tax factors and the macro-economic conditions are right – will give rise to convertible bond issuances. Convertible bond issuances were crippled because of the absence of commercial code provisions, which have now been introduced. This was something that a number of investment banks were pretty eager to market, but had not been able to. I expect that to be introduced where you can actually issue those bonds and have them converted into shares. The problem [before] was that you could not guarantee that the shares would be there at the time of the conversion; now you can. 

Employee stock options, different classes of shares are now available… the capital markets law has also just changed… So pieces of the puzzle are just being put together. I could make a list of 50 material items that you can do now and that you could not do in the past. Having said that, we were doing maybe 50 percent of them anyway, it was just more [of a] grey area and with less clarity.

PEI: Are any of those 50 items already making a difference in day-to-day operations?

Kerem Onursal: Yes. Now, for example, companies can become board members. In other words, the company becomes the board member and you can represent the company and reduce your personal liabilities. 

Jason McGibbon: Really, there is no silver bullet within the 50. But they all go to improving cost, efficiency, ease of operation, relationships. I think changes around shareholders agreements are making it easier – and I say this as a Western European-based fund – to deliver the sort of structure and concepts that people are very comfortable and familiar with. You could create them here in the past, but in a way that was time consuming, and with questions of time over effectiveness and costing.  

So that’s [improving] in a market where we sometimes talk about a completion gap. A fair criticism I think of Turkey would be [that] it is a high-growth market, but the flipside of that is the entrepreneurs often don’t have to sell. So often processes take an extended period, and often for positive reasons – the business is growing fast, everyone is very happy to continue as shareholders. Straightening out some of the technical complexity just gives you a better chance of getting to the finish line. 

Kerim Turkmen: I think one additional benefit will be the increased transparency and reliability of financial reporting, because of the independent auditor requirement and requirement to follow IFRS. The initial draft of the new commercial code was somewhat draconian, however, because there was no size threshold for companies who had to comply with the various requirements. Companies below a certain size should not have to comply with all requirements due to costs. We will see to what extent all these rules are implemented in practice, although I do hope to see significant improvements in transparency and corporate governance practices.

PEI: What other challenges are there?

Jason McGibbon: I don’t think Turkey’s that fundamentally different. Its private equity market is at a very different place on the curve, but having worked across a number of markets for Bridgepoint over the last 12 years, they tend to face the same types of challenges as other markets. 

Kerim Turkmen: I would agree with [some criticisms] that in Turkey processes do take longer, and are generally not as well organised or structured. I also think on average you will see more growth capital or 50-50 or minority deals in Turkey, as opposed to leveraged control buyouts. I think this is reflective of the nature of the market, which very entrepreneurial, is at an earlier stage of development and much more dominated by growing family-owned businesses.

Meltem Akol: Going back to that culture shift… We come from an era where it was extremely difficult to convince a majority business owner or founder that he needed to appoint a CEO. Things have come a long way; but I still think it is difficult for the Turkish entrepreneur to let go, maybe a little bit more difficult compared to other jurisdictions…. Yet private equity has built confidence with Turkish entrepreneurs to a large extent in that respect. I do not think Turkish entrepreneurs who have given up minority or majority control to private equity partners have any regrets.

PEI: Is talent a key focus or concern for portfolio companies? 

Kerem Onursal: I think that’s the most important part of value creation. Our primary focus when we do a deal is to have the right management team – and often we have to recruit the first management team of the company, because an entrepreneur grows a company to certain extent and our role is to institutionalise the way things are done.

I think for all the deals we’ve done, we have actively looked for a CEO and then also mid-management roles. It very much helps to have done a lot of deals – because you can tap into a network of existing executives you have good relationships with. We also do events for managers and educate them about private equity. So it is probably the core of our business –because once you have the right management team in place, then you can build on that and start bringing in best practices from other markets. 

PEI: Is there sufficient talent locally for portfolio companies?

Kerem Onursal: Yes. In Turkey, you find companies such as Nestle, Deutsche Bank, etc. that have been present here for over 100 years. We have many industries where you’ve had many multinationals present for more than 50-60 years, so you can actually recruit people who have worked for, for example, P&G or Unilever, who are used to reporting to a multinational company and understand corporate governance. 

Kerim Turkmen: There is definitely a good deal of managerial talent in Turkey. I think what is also critical is that a lot of these managers are very receptive to working with private equity, because the professional environment and our equity incentive packages generally offer a step-up from other alternatives. The equity packages we use to align the mangers’ incentives with our own as shareholders do not usually exist in other settings. On top of that is the benefit of working in a professional and transparent environment where goals and performance benchmarks are clearly defined. Generally, private equity hasn’t had any trouble attracting good managers; managers are normally looking for private equity opportunities.