In 1994, Advent raised a $105 million family of funds for Central Europe, consisting of a regional fund and three country funds. The regional fund will soon be fully invested, and a second fund is about to have its first closing.
How do typical investments in Central Europe differ from the standard Western European model?
Western Europe is increasingly a buyout market. In Central Europe, the great demand is for development and expansion finance. These countries have suffered from years of under-investment, and are hungry for new capital.
We have found a tremendous entrepreneurial spirit in Central Europe, particularly among the younger generation. People are highly-educated in scientific and mathematical subjects: they have just not had the opportunity to do their own thing in the past.
The opening up of the whole region in 1990 was like taking a cork out of a bottle – there was an explosion of start-up businesses, and some of these have now grown to quite a significant size.
Now they are looking to expand, by adding capacity or building new distribution networks. Some are making acquisitions.
All this is beyond the capacity – or the desire – of the local banks to finance, and people are seeing the benefits of private equity.
There is another model, which is based on pre-existing businesses. One of the characteristics of central planning was that any industry tended to be dominated by one or two huge companies. These were often split up on privatisation, but the best of their successors were able to grow quite rapidly, whilst those with poor management declined. Now the winners are again consolidating the market, and this has given us the opportunity to back a number of companies in basic industries as they acquire market share by acquisition.
But what about privatisations – surely there must have been buyout opportunities there?
At the outset, we thought that would be the case, but we found that in fact privatisation and private equity did not go well together. The process turned out to be political, complex and extremely time-consuming. Different countries have taken different approaches: companies have variously been sold to foreign strategic buyers, given away to their managers, or distributed to the population in the form of vouchers. Very few private equity investors have been successful bidders.
How are returns from Central European investments likely to compare with Western European benchmarks?
To justify the perceived country and currency risks, we have offered our investors returns several points higher than they would expect to achieve in established markets. Our realisations to date have easily outperformed our targets, but it is of course still early days. Nevertheless, I would say that the combination of strong demand and limited competition makes it seriously possible to achieve exceptional returns. We had one company that went to the market at a price that represented ten times our cost. I would like to think we could repeat that – I also wish we had taken a bigger stake in it!
So if it’s that easy, why isn’t everyone doing it?
I didn’t say it was easy! Companies may need capital, but the market needs to be educated about the benefits of having investors such as ourselves. Then theres the difficulty of doing due diligence: a company may have one year’s audited accounts if you’re lucky, and the internal systems are usually incapable of producing financial information in a form we would find useful. It’s not only risk that’s the problem, but developing an approach which enables you to judge the risk on the basis of limited information.
Despite what I said earlier about entrepreneurial spirit, there is of course a whole generation of management in Central Europe who were brought up on the central planning system. They are great engineers, but they never had to sell anything in their lives – someone just came and took the product away. Nor did they need to worry about negotiating prices or credit control: either the State paid or it didn’t, and there wasn’t a lot you could do about it. So marketing and financial skills are in particularly short supply. It’s a great time to be a Polish chartered accountant, or a Czech with a few years’ experience in brand management in a multinational. The trouble is, they tend to command a salary that’s double what you’re paying the managing director.
As a result, our type of investment is both extremely time and labour-intensive. Companies need a great deal of support – you can’t just put the money in and then leave the management to carry on.
So you feel there is a real potential for adding value?
Absolutely. Managers in the region, particularly the younger generation, are highly-educated and show exceptional entrepreneurial spirit. Where we are often needed is to help them develop their strategy at Board level, recruit new management to fill the gaps, and make sure the internal systems are adequate to support the company’s development. It’s a very hands-on process.
Surely you can’t do all that from London – particularly covering five countries?
Actually, with the new fund it will be six countries: Hungary, Poland, the Czech and Slovak Republics, Romania and Croatia. But you’re right, of course we couldn’t succeed if we were remote from our markets – mind you, our team does pretty well in the Air Miles stakes. The way we operate is that in each country we have a local affiliate. This is the company which manages the local fund which is part of our programme. Its staff is almost exclusively made up of local people, with all the necessary language skills and understanding of local market conditions. We work closely with them, bringing the support of Advent International’s worldwide network and the investment experience of our Central European team based in London.
How has deal flow developed since Advent entered the region?
Our first few investments were in very early-stage companies founded by expatriate management – often American citizens who had family links with the region. They were “serial entrepreneurs” who had been successful in their home countries and had come to repeat the experience in Central Europe. Most of the deals were fairly small – a few million dollars – and in the area of “infrastructure” – warehousing and distribution, cash machines, cable television – taking advantage of the underdeveloped state of the region.
Now we find we are in a new phase, and are making investments in the $10-20 million dollar range, backing local management in basic industries such as food processing, as well as in the new growth industries of IT and telecoms.
Are local intermediaries an important factor in deal sourcing?
Much less so than in the UK, for example. As always, our best leads come from personal contacts and cold calling. The investment banks, and even the accountancy firms, have so far tended to concentrate on their multinational clients, and have not become a force in advising the medium-sized firms.
Do investment conditions vary greatly between the different countries in the region?
There are some very clear distinctions. Over the last three years, we have found our best opportunities in Poland and Hungary. Since 1989, a whole class of entrepreneurs has developed in these countries, and legislation was quickly brought in which made it easy for foreigners to invest, and to take their money out of the country on exit. They have also developed transparent and well-regulated stock markets. The Czech and Slovak Republics have proved more difficult: the methods they chose to privatise companies have not led to good corporate governance, and a large part of their economies is still in the hands of State-owned banks. Romania is showing huge promise since the election of a new reforming government a year ago.
And Russia?
One day, Russia will be the big prize, but it is a step beyond where we or our investors feel comfortable at present. Successful private equity investment depends on being able to rely on contracts and the rule of law. Russia cannot yet offer that sort of stable and predictable system.
You mentioned exits: are clear exit routes developing?
So far we have floated two investments on NASDAQ: Euronet, an ATM business, and @Entertainment, Poland’s largest pay TV provider. One more is in the process of preparing for a listing on the Polish Stock Exchange, and we are merging another into a listed Hungarian company. There is a huge appetite for new stocks from the listed emerging market funds and in the case of Poland and Hungary, at least, a listing on the local exchange is a genuine possibility.
It’s true that you have to be even more acutely conscious of the exit at the time of making the investment. We try to pick either market leaders that will be attractive acquisition opportunities for incoming multinationals, or companies that will have a particularly good “story” for the stock market.
Has institutional investor sentiment towards Central Europe changed since you raised your first fund?
Two of the key investors in our first fund were EBRD and IFC, who have a “political” role in bringing financial support to the region. They plan to follow their money in the second fund, but we are pleased that this time we are seeing much more interest from the purely “commercial” investors such as US and Dutch pension funds. I think that demonstrates that they see the region as attractive simply from the point of view of return on investment. The early returns of our first fund, as well as our ability to deploy the funds quickly, have in a sense proved the market. Central Europe is definitely on the map for the experienced private equity fund investors.
How do you expect the Central European private equity market to develop during the lifetime of your new fund?
We shall no doubt experience more competition – there are some large funds being raised in the US at present. But the people who had the enterprise to set up companies as soon as the Wall came down will increasingly be looking for capital to finance expansion and acquisitions. In fact, two of our portfolio companies are already in the process of merging with competitors.
Banks will eventually become more sophisticated in lending to medium-sized companies, but this will take time. The stock markets should continue to grow, particularly since governments are encouraging the setting up of privately-managed local pension funds.
There are bound to be some difficult times along the way, and the different countries of the region will certainly not all develop at the same pace, but for private equity investors who have a well-developed local network, I think the next few years will be very exciting.
Key Market Statistics for Central Europe
Czech
Poland Hungary Republic Slovakia Romania Croatia
GDP Growth* +6% +4% +1.2% +5% -4.5% +4%
Per capita GDP* $5,939 $6,828 $10,101 $7,997 $4,614 $4,557**
Inflation 14.5% 18.4% 10.3% 6.0% 159.1% 3.5%
Unemployment 10.6% 10.3% 4.8% 13.0% 6.9% 16.5%
Stock Market $14bn $9bn $15bn $3bn $0.6bn $5bn
Capitalisation
*official – does not include significant black/grey economies
**1996 figure
Source: Advent International
If you do not receive this within five minutes, please try and sign in again. If the problem persists, please
email: