“For the last five years private equity investment in central Europe has been almost exclusively development capital,” says Joanna James who is based in London and leads Advent International’s efforts in this region. Typically these investments have acquired the private equity investor a minority stake that it has only increased to a majority stake where the investor has gone on to support an acquisition programme. Central and Eastern Europe is largely at the tail end of its privatisation programmes, which have been ongoing for much of the last ten years. With privatisation almost complete the private equity investment cycle has now in expansion finance mode plus the occasional buyout where management is endowed with a significant equity stake, but we are some way off perhaps five years from vendor initiated LBOs. Lisa Bushrod reports.
The reason for the slow development of the buyout market is simple: there is little leverage available in the region.
“We have started talking to banks in the region [about leveraged finance] and they are interested but we are really still at the beginning of the process,” says Joanna James.
For the time being there are just a handful of players actively seeking to provide leverage for buyouts. One is Erste Bank, which has a four-strong specialist leveraged finance team based in Prague. The team, which also has members based in London, invests off the bank’s balance sheet and has been largely providing debt and structured debt, and sometimes equity, for the last two to three years. It’s primary markets are the Czech Republic and Slovakia and to a lesser extent Hungary and Poland. In terms of its competition Chris Buckle, who runs Erste Bank’s Prague-based team, notes: “Local banks are nervous of leveraged transactions and foreign banks can still view this as a high risk region.”
Buckle’s team will consider taking a small equity sweetener if the risk profile of the deal warrants it, but often this is compensated for by the fee structure on the deal. These higher priced tranches are not mezzanine as such since, as Prague-based Buckle points out: “Legal structures here often don’t make it easy to have intercreditor agreements.” However, he goes on to say that it is hard to generalise about such issues across the region as a whole and consequently each deal raises its own issues. Buckle is confident that Erste Bank is seeing all the deals in the Czech Republic and Slovakia where its profile is strongest, but he says: “There is a limited number of deals to start with and of those there is a limited number that justify high levels of leverage.” He does note, however, that the market for these types of deals is growing.
Jacek Siwicki at Prague-based Enterprise Investors says of the general reticence towards leveraged transactions among the local bank market: “Banks here are used to lending against specific project financing.” For this reason Enterprise Investors had been forced in the past to invent some interesting structures in order to get its deals done.
In 1997 when it bought 100 per cent of FOB (Fabryka Opakawari Blaszanych), the metal can manufacturer, from the Polish government it did so by buying FOB’s debt from its bankers and suppliers at a discount and then swapped the debt into equity. Erste Bank and Fortis supported the deal with a $10 million debt package although Enterprise Investors was forced to guarantee the loan because the leverage on the deal was so high. High inflation in many of Central and Eastern European countries means borrowing in the domestic currency is expensive.
Another important component of the leverage equation, especially given the often inherently riskier nature of structuring transactions in this region, is the mezzanine provider. Players note a few noises about mezzanine funds being targeted in the region, but the only one to put its cards on the table to date is Mezzanine Management. It is in the process of raising a euro150 million fund, called Accession Mezzanine Capital, which will target investments in the Czech Republic, Hungary, Poland, Slovakia and Slovenia. For many players that are looking to get a foothold in this region the introduction of the euro next year and cheaper labour are very attractive incentives.
Private equity investors with funds raised for investing expansion and buyout capital in Central and Eastern Europe whose names continually surface include Advent International, Baring Private Equity, Enterprise Investors, Innova and Private Equity Holdings, (through a fund called 5E Holdings, which recently became independent of Bank Vontobel’s private equity operation.)
Although for the time being centred on expansion capital, types of activity among these players varies. Enterprise Investors, which, until recently, only invested in Poland, treated many of the privatisations that it financed in the early to mid 1990s as part buyouts. It did the first one, of a small energy construction company called Energoaparatura, in 1993. In accordance with Poland’s 1991 privatisation law management and employees were to get a 20 per cent stake enterprises sold at half the price paid by outside investors. Enterprise Investors added to this by giving the management team a further 20 per cent in options.
While Enterprise Investors has invested only in Poland until recently, Advent International has been investing across the region for the past decade. In 1993 it raised its first dedicated Central European fund of $120 million, some of which came from local funds run exclusively by affiliates. Then in 1998 Advent International raised a $180 million regional fund, getting in just before the Russian crisis put an end to fundraising in the region for the next few years. Last summer it, alongside co-investor Jupiter’s East European food fund, exited its investment in Brewery Holdings via a trade sale to the acquisitive Austrian brewing group BBAG (Oesterreichische Brau Beteiligungs AG). Brewery Holdings’ growth, through the acquisition of Romanian brewery company Bere Grivita, was supported by its backers.
Joanna James notes that the predominance is for exits on investments in this region to be made via trade sales. She goes onto cite another Advent International investment, in Synergon, which was floated on the Hungarian stock exchange. This was an acceptable exit route since Advent International was only a minority shareholder and so could sell its entire stake at IPO. Hungary has seen its stock exchange undergo significant development in recent years but it is unable to provide the necessary liquidity for it to be seen as attractive to venture capitalists and, arguably, to many companies in the region. Consequently, like its Polish counterpart, the Hungarian stock exchange has made know its willingness to consider a merger with another western European stock exchange in order to address these issues.
Of future sources of buyout and expansion activity Siwicki notes: “The privatisation pipeline is drying out but since private companies are becoming larger and larger you will see some of the same tendencies as in Germany, which has created a need for more expansion and buyout financing.” While the infrastructural issues – lack of easy access to bank debt and so forth – persist Joanna James notes that for management teams the will to make things happen is there. “There is huge entrepreneurial spirit, enormous ambition and a determination to succeed.”