Emerging Europe: The growing pains of CEE private equity

Successive crises have taken their toll on the private-equity industry in emerging Europe and enthusiasm for the region has waned. Nevertheless, its combination of strong growth and opportunities for convergence with western Europe continues to attract a hard core of supporters.

From the perspective of private equity, central and eastern Europe is "at a dangerous age", says Jacek Siwicki, president of regional fund manager Enterprise Investors. "People don’t know how to treat the region – we’re no longer a promising teenager, but nor are we a 35-year-old with a solid CV." In human terms, he says, CEE is in its late 20s – "it may have achieved something but it’s not an obvious hire".

Certainly, attitudes towards emerging Europe have changed dramatically in the past decade. Back in the mid-2000s, when GDP growth was running at 6% or more in all the main economies and the region seemed set on an inexorable path of convergence with western Europe, private-equity funds and investors flocked to CEE. In 2007, local specialist Mid Europa was able to raise a record €1.5 billion for its third fund, taking the total raised for the region that year to more than €4 billion, and the following year Advent International closed its fourth CEE fund at €1 billion.

Jacek-Siwicki
People don’t know how to treat the region – we’re
no longer a promising teenager, but nor are we a 35-year-old with a solid CV.

Jacek Siwicki,
Enterprise Investors

The convergence play, however, took a heavy knock in the financial crisis, as volatility returned to the region and a number of countries sank into deep recession. Hopes of a rapid, export-led recovery were swiftly crushed by the emergence of the eurozone crisis, and private-equity returns slumped as investments went sour and holding periods were extended. Investor enthusiasm for CEE waned to the point where, by 2013, even regional stalwart Advent was unable to drum up enough interest for a fifth dedicated fund.

Part of the problem, says Anthony Diamandakis, head of alternative assets group EMEA at Citi, is that once the excitement around big privatization programmes and European Union accession had worn off, CEE began to look fairly small by global standards, particularly from the point of view of ever-expanding international funds. Excluding Ukraine and Turkey, the region’s total population barely tops 130 million – "that’s six Chinese cities," says one local fund manager ruefully – while at $1.6 trillion, the combined GDP of its 19 economies is less than that of Italy.

Taken in conjunction with the riskier operating environment in the region, says Thierry Baudon, founder and managing partner of Mid Europa, this has led many private-equity funds and investors to conclude that they can afford to simply ignore CEE – particularly since the start of the crisis on its eastern borders. "The main rationale for investing in CEE is the integration of Europe," he says, "but events in Ukraine make investors wonder whether we have not gone back 100 years."

Not all investors, however, have abandoned emerging Europe. In 2012, Enterprise Investors succeeded in raising €314 million for its Polish Enterprise Fund VII, which has a regional remit. More recently, Mid Europa closed its fourth fund in January 2014 at €800 million, with the same amount again in co-investment pledges, thanks to strong support from a core investor group of insurers, pension funds, sovereign wealth funds – including China Investment Corporation – and supranationals.

"The various shocks which have impacted the CEE private-equity industry over the last few years have flushed out the least committed investors, but the region still attracts large and sophisticated investors who understand the complexity of transition economies and take a multi-cycle view," says Baudon.

A handful of global private-equity funds have also kept faith with the region. Bankers say around half a dozen are still making what one describes as "credible efforts" in the region, including Blackstone, Cinven, CVC, Bridgepoint, BC Partners and Warburg Pincus. Advent’s appetite for CEE also appears to have survived a big reduction in its regional presence, at least judging by its determination – in the face of regulatory and legal hurdles – to complete a planned €200 million purchase of the Balkan network of failed Austrian banking group Hypo Alpe Adria.

Emerging Europe has also attracted some new names, notably KKR, which last year made its first-ever investment in the region with the €1 billion acquisition of Balkan pay-TV and broadband provider SBB/Telemach from Mid Europa. Tomas Kubica, an associate at KKR, says a key part of the deal’s appeal was the still substantial scope for convergence between the former Yugoslav countries and western Europe in terms of pay TV and broadband penetration. "As the largest cable asset in the region, SBB is well-positioned to benefit from that trend," he adds.

Increasing maturity

It is not only the Balkans, however, that still have some catching up to do, both in terms of the telecoms industry and the wider economy. Even in Poland, CEE’s largest market and one of its most developed, GDP per capita is still only around 70% of the EU average. This means, say CEE’s private-equity fans, that the convergence play is alive and well, particularly as growth rates in the region remain notably higher than in western Europe. Most of the leading economies are forecast to expand by around 3% this year, thanks to a combination of reviving domestic demand, increased export capacity and a further influx of EU structural funds.