Leveraging to maturity

It’s been over a year since the European Union welcomed ten new members, a year since this handful of emerging markets officially joined the ranks of their Western neighbours. While the region has yet to see a great influx of Western European or US funds, things are definitely changing. Tom Allchorne looks at the rise and rise of Central and Eastern Europe.

The past year since accession has vindicated all of us who have been working in the region,” says Gyuri Karady, managing partner at Baring Corilius Private Equity. “We have been vindicated in that we have been saying that this region is Europe and it has the same risk profile as Europe. The risk perception has greatly improved since accession, but it is a mindset change rather than a factual one.”

This change in risk perception has had a significant impact on the attitude of the investment banks. Prior to last year, leverage was always very hard to find for funds wanting to buy Central and Eastern European (CEE) companies. Global and regional banks were reluctant to give debt, and local banks were unsure as to how such deals worked.

While debt was available as expansion capital, for funds actually looking to own a stake in a company, it was hard to come by, and part of this was due to concerns on the part of the banks of the creditworthiness of businesses. This anxiety has gradually lessened and, combined with low inflation and interest rates, as well as a legal framework in line with the rest of the EU, LBOs have started to emerge as a very real and viable investment vehicle. “The ability to do a leveraged buyout now makes sense,” says Nigel Williams, chairman of Royalton Partners. “Many of the banks treat these as normal European countries. Whether you do a deal in Denmark or in Slovakia, it makes no difference, the risk premium is the same.”

Ali Artunkal, managing director of Argus Capital Partners, says: “Comparing Western European debt with Eastern European was like comparing apples and oranges. Now this has changed, and while we will never have the same levels of debt here, we will have debt of 60% to 70%. This means we don’t have to rely on financial engineering to the same extent as those funds in Western Europe.”

Karady says: “There has always been debt available for financing the growth of a company. We used leverage to grow the company not to buy it. Now the tenor has gone up and interest rates have come down, and the covenant and security pack have become vastly more commercial. They used to be quite draconian.”

Krzysztof Krawczyk, managing director at Innova Capital, takes a similar view: “The last 12 to 18 months has seen an increasing openness of local banks to produce these instruments, primarily because of the pressure from the private equity industry. We launched some initiatives last year designed to show local banks how leveraged buyouts worked, to show them some case studies and to solicit their input. We need to develop these acquisition techniques rapidly. In the West you had years to do this, we have to do it in months, and these initiatives are an attempt to speed up the education process.”

Regional banks too have

become more willing to back

LBOs, and Krawczyk says his firm

is due to make an announcement

on such a deal imminently. “The regional banks have been much quicker than the local banks in

providing leverage buyout

structures, a development which,

if it continues, will provide the

local banks with significant


Robert Manz, partner at Enterprise Investors and President of the Polish Private Equity Association, says: “The percentage of deals that are buyouts has been growing pretty fast and it is now the number one deal category here. There is more opportunity to complete leverage deals, and the banks have probably realised they have been missing out on some business.”

Aside from a lower risk perception, the increasing use of the

LBO is being driven from below,

by companies emerging that can now carry significant amounts of debt. Krawczyk says: “In the past companies were given money just for expansion. Now, a lot of these companies have grown to a stage where they can sustain leverage.

A lot of the owners can’t grow

their company anymore and

want to make some money after years of work and so are ready to sell. In the past they always saw

the growth opportunities and were looking two years down the line when the business will be worth more, but companies aren’t growing at 30% per annum anymore with the economy slowing down. The opportunities are starting to emerge and the owners are starting to think about how they can make their money work.”

Jacek Siwicki, managing partner at Enterprise Investors, says: “We have seen an increased willingness by managers to sell a big piece of their company, they are more comfortable now with having a private equity firm own a large stake of their business. They don’t lose the fun of running a company but they still get the cash.”


Last year saw the biggest LBO deal in CEE ever when a consortium led by CVC and ABN AMRO Capital bought MobilTel, the leading GSM mobile operator in Bulgaria, in May. The €1.2bn deal included €650m of debt, in which ING Bulgaria acted as lead arranger and bookrunner, together with ABN AMRO Bank and Citibank. BidCo, the consortium, also consisted of 3TS, Communication Venture Partners, Global Finance, Innova Capital and Sandler Capital .

The MobilTel deal is one of the few in the region that managed to attract non-Central European players, although the fact that dedicated investors like 3TS and Innova were present shows local knowledge still counts. The sheer size of the deal meant funds from Western Europe and the US were the only ones with the available capital to afford such an investment.

There have already been reports that BidCo is preparing to sell

the group to Telekom Austria,

which would see the consortium make a €160m return on its €450m investment, although little has been heard of this since the end of last year.

Further down the chain was another Bulgarian telecoms company, BTC, which was finally bought by Advent in the first half of last year. It was a rather painful exercise in buying a state-run monopoly, and took around 18 months to complete, during which time Advent agreed terms, saw the Government cancel the bid and open negotiations with a Turkish telecoms holding group, took the Government to court and, after improving some parts of the bid, finally won the day, taking a 65% stake for €230m. Part of the deal also saw Advent commit to paying a further €50m at a later date and agreeing that BTC spends at least €400m on investment in the next five years. As well as Advent, the other consortium members were the Abu Dhabi Investment Authority, the Dutch Development Bank, the EBR&D, Enterprise Investors, the National Bank of Greece and Swiss Life Private Equity PartnersThor Bjorgolffson . The Government retains a 35% interest.

Another significant deal, and again a leveraged buyout, was the €56m investment in Fibernet by Warburg Pincus. FiberNet is a Hungarian cable operator. In yet another sign of the growing maturity of the market, the deal was a secondary buyout, with Argus Capital Partners selling the company after investing in it in 1999. Argus was involved in another secondary buyout in January this year when it sold its 21% stake in Aster City Cable, a Polish cable television and broadband operator, to Hicks, Muse, Tate & Furst for an undisclosed amount. It was a good exit for the firm, which made a 3x return generating an IRR of 90%. Argus invested in Aster City Cable in March 2003 when it acquired the business from Elektrim Telekomunikacja, along with AIG Emerging Europe Infrastructure Fund and Hicks, Muse, Tate & Furst, for a total pf €110m. AIG, which took a 39% stake, sold its share to Hicks Muse in November 2004, is reported to have made a similar 3x return.


With the growing availability of debt, it might be expected that competition among funds for CEE assets would increase, but in fact competition levels have remained stable over the last year, if not dipped slightly.

Williams says: “At the bigger level it has become more intense because Western European funds will always look at a €300m plus deal, but with the smaller deals I think there is probably less competition. There’s been a bit of consolidation in the region, which means less competition in the smaller deal size.”

This last year has seen a number of funds either pull out of the region or significantly reduce their exposure. The most high profile case was that of Dresdner Kleinwort, which sold its Emerging Europe Fund to Darby Overseas Investments in February. Reasons for the disposal of the assets and the price of the sale remain undisclosed. Dresdner Kleinwort established the fund in late 2000 with initial capital commitments of US$220.6m. Major investors in the fund include the California Public Employees’ Retirement System (CalPERS) and Dresdner Bank AG.

Whether this is more to do with the fund’s disappointing performance or Dresdner’s attitude to the whole of private equity is open to debate. Coller bought a Dresdner 22-company strong portfolio for US$90m last year, and Reuters reported in January this year that the bank is in talks with US secondary buyers over divesting more than US$1bn of its private equity assets.

Another firm that seems to be reconsidering its CEE commitment is AIG. Of course, AIG currently has bigger problems on its plate, like the March resignation of CEO Maurice Green following pressure from the board, and the investigation by the US Securities and Exchange Commission into accounting irregularities, but it has been a long-time investor in the region. AIG did have two CEE funds, Emerging Europe Infrastructure and New Europe, but sources have indicated that the money for CEE investments is now being drawn from the Global Emerging Markets fund and that the Central European funds have been closed down.

Raiffeisen, the Austrian bank, launched a fund targeted on the region back in 1999 and is apparently not planning to make any further investments or raise a new fund. There have also been a number of smaller first-time funds that were launched around the same time, which have either disappeared or stopped investing, facing the same problems all first-time funds do.

At the moment, there is interest from the big guns rather than action. Krawczyk says: “I don’t see any global or Western funds coming here any more than they used to. They still look at the big deals. We obviously see this interest; we see them coming here and meeting the main players, but it is not very competitive; it’s a more amiable arrangement.”

Joe Schull, a partner at Warburg Pincus, agrees: “More people are open to the idea of investing but at the moment it is the same players doing most of the deals. Competition hasn’t manifested itself as much as it will do in the next couple of years. It takes time to acquire local knowledge. We’ve been in the region since 1997, so we still find the competition levels attractive.”

“No-one expected any major changes after accession,” continues Krawczyk. “We don’t generally compete with anyone; almost all the deals we do are proprietary, so we don’t actually find ourselves coming up against anybody when we approach companies. Most funds here have proprietary strategies. I can’t recall a competitive situation in any of our deals.”

Kevin Connor, a partner for law firm Squire Sanders & Dempsey, tells a slightly different story: “The Central and Eastern European funds all get a good deal here and there but there’s more competition than there was for those deals. There is more savviness in the market now among company managers. They are playing one fund off another. The competition between funds is still fairly gentlemenly though.”


Like the rest of Europe, funds in the Central and Eastern regions were particularly busy selling assets last year. Enterprise Investors (EI) sold nine investments, returning around €75m to investors. Its most successful divestment was the IPO of Comp Rzeszów, Poland’s second biggest supplier of software to the banking sector, on the Warsaw Stock Exchange (WSE). The float saw EI sell its 50% stake. The Polish Enterprise Fund achieved a 7.3x multiple on capital, returning €30m to investors. In 2005 EI plans two major IPOs; Opoczno, which will be the largest non-government offer in the history of the WSE; and Polish Energy Partners (PEP), which has already been approved for public trading.

The ability to float is one of the major trends that has emerged over the last year, especially in Poland, where 36 companies, four of which were private equity-backed, listed on the exchange. The market is still quite limited at the moment, it is generally only the large companies that float, but things could change soon.

Karady says: “The IPO market will really become important when Polish pension funds become interested in non-Polish companies listing on the Warsaw Stock Exchange, and when you can list more mid-market companies and not just the blue-chips. This will be a major development for private equity.”

There are some question marks over the IPO deluge in Warsaw, however. Because the Polish pension funds are strictly regulated as to what they can invest in, primarily quoted stocks, there is a fear that the pension fund managers are investing in anything. “The feedback I’m getting,” says Connor, “is that there is a lot of concern that the exchange is overheating. The money coming in there is not looking at the value of the company but because it has nowhere else to go. The pension funds have to go somewhere and there are a heck of a lot of pension funds.”

A high profile float that was not on Warsaw was Zentiva, the Warburg Pincus-backed pharma company that listed on the Prague Stock Exchange and offered GDRs on the main market of the London Stock Exchange. Zentiva is the result of a merger between previously Czech state-owned Leciva and Slovakofarama. Leciva was privatised in 1998 and Warburg Pincus backed a management buyout in May that year in which it took a majority interest. In August 2003 the company merged with Slovakofarama and began operating under the name Zentiva. Immediately after the float, Warburg sold 13% of its 67% stake, receiving almost €100m as a dividend and around €65m from the float. The offering was five times oversubscribed and priced at the top of it range at CZK485 per share (€15.24.) The market capitalisation was approximately €580m.

Trade buyers were also out in force, but their motivations have changed. Schull says: “There is a very welleducated and skilled workforce in Eastern Europe. The smart trade buyers are not just looking for cheap labour because the difference between East and West is closing. There is a skilled human capital base, which can be a source of technological innovation.”

The last 12 months have also seen the rise of the domestic buyer. Baring Corilius Private Equity, through its Baring Central European Fund, sold its investment in the Hungarian printing company Allami in April this year back to the company and its other major shareholder, Láng Biztonságtechnológiai Holding. Commenting on the exit, Karady said: “The sale to our fellow Hungarian shareholder confirms the growing ability of domestic capital to act in a strategic capacity, providing an additional source of exit opportunities for private equity investors.”

Other examples include the sale of Greek Bank Nova, owned by Charlemagne Capital, a UK-based investor in the region and Russia; and Southeast Europe Equity fund, a Soros-backed fund, to a Hungarian bank, OTP. The rise of the domestic buyer is a symptom of the strong economic growth CEE has experienced over the last five years; they have money to spend and the experience to do it, and they are able to act faster than the US trade buyers. Connor says: “The first generation of managers are now trained up. Instead of the ones being gobbled, they are now the gobblers.”

All in all it appears as if the private equity market could be on the verge of entering full-blown maturity before too long. Companies are there to be bought, banks are there to provide leverage, private equity funds are there to be invested, and the exit opportunities are plentiful. Obviously as the risk profile decreases so can returns, so the firms that are already operating in the region appear to be the ones most likely to benefit from the region’s continued economic growth. For those firms seeking an opportunity to get on board the CEE train, getting into bed with one of these firms seems the best strategy.

Facts and figures

It is estimated that, in the last 15 years, over €7bn of private equity has been raised for funds focussed on the CEE region, around 75% of which has so far been invested. There have been over 900 private equity investments and more than 400 exits. There are reckoned to be around 77 fund managers in the region.

The European Bank for Reconstruction & Development (EBR&D) is the largest investor in private equity funds dedicated to CEE and has a portfolio of around 800 companies. Since 1998, EBR&D funds have invested between €160m and €280m per year. Figures for 2004 are to be released in the summer, but according to Henry Potter, a senior banker at the EBR&D, 2004 was a record year for both investment and exits.