Why Poland is top of the league

Central and Eastern Europe offers some intriguing opportunities. Tim Chapman tells good from bad

When the West's buyout market was first cramped by the credit crunch, Central and Eastern Europe (CEE) was widely seen as a relative safe haven. Deals there had never been as dependent on leverage, and investment prospects still looked good as the region's states moved, at varying paces, towards European integration.

But now the global downturn is hitting even the most stable of the region's diverse economies. With economic growth in reverse, the prospects look less promising for the growth capital specialists the region is noted for.

Buyout statistics from information provider Dealogic show that deals in the core CEE region reached a high in 2007, with some 80 buyouts worth a total value of just over $5 billion. The numbers held up well in early 2008, but dived towards the end of the year.

Joanna James, co-head of Central Europe for Advent International, says the region's macro economy was solid until the start of 2009. “Everyone goes through stages psychologically,” she says. “Central Europe investors are still in the denial phase but will soon be in the “it's looking worse than we thought” phase,” she says. “As far as demand is concerned, it'll get worse before it gets better.”

The CEE region is a highly diverse one in terms of its constituent economies. Most states have enjoyed very strong growth over the past decade – but for many the bubble has now burst. Most investors identify a core of countries, led by Poland, which account for the bulk of activity and which will continue to provide the strongest opportunities. Despite currency fluctuations and falling exports, growth prospects in these countries are relatively strong.

Poland's government forecasts at least 1.7 percent GDP growth this year, although most analysts are less optimistic. The gloomiest prediction of a 3 percent contraction is still better than predictions for most Western states, and Poland's $20 billion credit line with the International Monetary Fund (IMF) has been perceived as a wise precautionary move rather than an emergency measure.

“Poland is at the top of the league,” says Nigel Williams, managing partner at Royalton Partners, which focuses its investments on the European Union accession states from its offices in Poland, the Czech Republic and Romania. “It's a large country with a large enough internal economy that it's less affected by what's happening globally than some of the smaller, more open economies.”

The Czech Republic as well as the Eurozone states of Slovakia and Slovenia are also seen as relatively strong. “For particular types of deals, these envi ronment s are more favourable than those in Western Europe,” says Jaroslav Hascak, managing partner at Prague-based Penta Investments.

At the other end of the scale are the Baltic states and Hungary, which are suffering a severe hangover from the credit-fuelled boom years. Latvia, for example, is facing a 13 percent contraction this year and, like Hungary, Ukraine and several Balkan states, has had to call on the IMF for a bailout.

Hungary, however, received significant private equity investment in 2008, with the €800 million buyout of he a l thc a r e g roup Euromedi c International by Merrill Lynch Global Private Equity, Montagu Private Equity and Ares Life Sciences, and Penta taking a juicy stake in meat processor Debreceni Hús.

Ukraine is not part of the core CEE region, but is often handled by the same investors. Advent International opened a Kiev office in 2007, but hasn't seen much activity yet. “Ukraine is a law unto itself,” says James. “But unless there's some universal collapse, we'll reach a point where there'll be very good opportunities there.”

The various currencies across the region have brought extra uncertainty, with even the Polish zloty down some 20 percent against the euro over the past year. As well as frustrating growth predictions, that can cause problems in financing a deal. “We're very cautious about the idea of funding a buyout with euros where the operating business is driven in local currency,” says Brian Wardrop, managing partner at Arx Equity Partners, which has four offices in the CEE region.

For the acquisition of Czech eye clinic chain Lexum announced in April, Arx secured senior debt from LBBW Bank CZ (a Prague-based subsidiary of a German parent). “Lexum is a Czech koruna-denominated business and because the Czech base rates are fairly low, we were able to secure a debt package in the local currency which completely mitigated any financing structure risk,” Wardrop notes.


Announcement Date Deal Value ($m) No.
2006 Qi 23 12
2006 Q2 28 9
2006 Q3 1334 13
2006 Q4 2256 15
2007 Qi 1274 13
2007 Q2 2467 21
2007 Q3 156 18
2007 Q4 1115 28
2008 Qi 1903 16
2008 Q2 193 15
2008 Q3 423 9
2008 Q4 72 7
2009 Qi 20 6
2009 Q2 8 2

The smaller buyout market remains more active. As well as the continuing availability of single-source debt of around €20 million, some deals can be done entirely based on equity. The potential for value creation can also seem more appealing.

“In virtually every investment we make, we're the first institutional owner of the business,” Wardrop says. “The ability to identify the opportunities for value creation and implement them is, in our view, often more straightforward than in larger transactions.”

The economic crisis has also restricted access to small amounts of growth capital. A few years ago, SMEs could readily tap angel investors or public exchanges for a few million in equity.

“Right now, the stock market is nowhere and local investors have lost a lot of money,” says Rafa Bator, head of Enterprise Investors' new €100 million Venture Fund. Launched by the veteran Polish investment house in September 2008, the fund provides €1 million to €5 million of expansion capital. Initial investments include direct marketing firm Dystrybucja Polska and medical reseller Bio-Profil.

Although the Venture Fund will target ICT and media opportunities, there's currently little appetite for the riskier propositions. “There are a lot of opportunities in IT, but it's very hard to predict the future for these businesses,” says Bator. “Everybody is focusing on service businesses with good visibility of revenue.”

Fundraising is also taking a hit during the downturn. Many players raised substantial funds during the growth years, but only a handful are currently chasing limited partner capital. 3TS Capital Partners, a regional specialist, is raising a new €200 million buyout fund, and has lined up a €40 million investment from the European Bank for Reconstruction and Development (EBRD).

The EBRD also backed the third CEE fund from Arx Equity Partners, alongside the European Investment Fund and Alpha Associates. Arx announced a first €83 million closing in October 2008, and is still working towards its €125 million target.

“Fundraising is difficult now,” says Wardrop. “There are LPs that have taken the view that when the eventual upturn comes, Central Europe should benefit disproportionately. Our big challenge is trying to differentiate our deal size segment versus the upper end of the market.”

Central Europe still offers huge potential, but its increasing integration with Western Europe means it's questionable whether it can be considered an emerging market any more. “If you compare the private equity market to that of three or four years ago, it's a different world,” says Hascak. “We have a very sophisticated market here, and from a process point of view I don't think there's any difference between Central and Western Europe.”

The region does retain its own culture, however, which makes a local presence all the more important. “With a relatively low level of intermediation, you have to rely a lot more on proprietary networks – if you don't know the right people in the right places, you don't get anywhere,” says Baudon. “This will most likely continue to be true for another 10 to 15 years.”