Investment banking in central and eastern Europe has been a game of two halves since the end of communism. In the first half, the 20 years after 1989, the away team had a clear lead. Western and Japanese banks poured into the region to handle privatizations and help international companies grab assets in exciting new markets.
Then the global financial crisis blew the half-time whistle. When play resumed, it was an altogether more muted affair – the international team had lost its edge. A lack of deals large enough to attract the bigger global players, combined with regulatory and capital pressures on parent banks and a general waning of enthusiasm for emerging markets, prompted a concerted pullback from the region.
With the internationals on the defensive, the way was open for firms with a more regional and even national focus to come to the fore. The shift of emphasis away from jumbo deals and towards the rapidly expanding mid market played to their strengths in local knowledge and networks, while a surge of bank liquidity in the region reduced the need for large balance sheets.
“In the past, investment banks in CEE were expected to provide a one-stop-shop approach with lending, corporate finance, advisory and capital markets services,” says Rafael Szczepaniak, head of CEE coverage at UBS. “Today our clients understand that credit can be sourced more easily and cheaply in their local markets from domestic commercial banks.”
For the regional players, the pullback by the internationals also created opportunities. The departure or downsizing of the big European banks that had dominated investment banking flows in the region pre-crisis – notably ING, UniCredit, KBC, Raiffeisen and Intesa – left both clients and staff up for grabs.
Uzbekistan is starting with the right approach, and the market holds huge potential- Irackly Mtibelishvily, Citi
A clutch of bankers from ING, UniCredit and in due course Credit Suisse found a new home at specialist regional investment bank Wood & Co, as did many of their clients.
“The departure of international investment banks from CEE after the financial crisis created a vacuum, particularly in the mid market, and we were able to fill it,” says Jaroslaw Derylo, head of investment banking for emerging and frontier markets at Wood & Co.
It also resulted in the creation of some new players. In Ukraine, a group of former ING bankers launched ICU in 2009.
Makar Paseniuk, head of investment banking at ICU, says: “The financial crisis worked out well for us because most of the foreign-owned banks stopped dealing in Ukrainian securities at that point and we were able to pick up most of the business that was left by ING as well as other banks, like Citi and Deutsche Bank.”
In neighbouring Russia, by contrast, the shift towards local players started later. As in central and southeast Europe, the pullback by the big European banks began soon after the financial crisis. The bulge-bracket players, however, remained in Moscow to take advantage of booming capital markets and a flood of inward investment until 2014, when western sanctions and the oil price collapse put an abrupt end to the party.
Once it became clear that a quick resolution to Russia’s stand-off with the west was unlikely, radical downsizing got under way.
With the exception of Barclays and Deutsche Bank, the global banks all maintained a foothold in the market. Staff numbers were cut dramatically, however, while client lists were pared back to the largest and least politically exposed names.
That left the market wide open for local players – that, in a country where balance sheet has become increasingly important to corporates as international lenders have reduced exposure, has largely meant the big state banks.
“To win investment banking mandates in Russia today you have to ideally position yourself as part of a bigger CIB [corporate and investment banking] institution that can provide the full range of banking, finance, derivatives and FX products,” says Alexei Yakovitsky, global chief executive of VTB Capital.
“People with a limited product suite have a much lower chance of being profitable than an institution like ours, where we have a comprehensive product range and as a result are able to price our services more competitively.”
This has made life particularly hard for independent local players in Russia.
Ruslan Babaev, co-chief executive of Renaissance Capital, says: “Usually firms will only choose one or two local banks alongside international partners, so this can make it tough to win mandates when you’re competing with the big state banks.”
Meanwhile in Turkey the broader pullback from emerging markets by global banks after the financial crisis was exacerbated from 2013 onwards as the country suffered a series of external and internal shocks, including the outbreak of civil war in neighbouring Syria, an attempted coup in 2016 and successive stand-offs with Russia and the US.
“The global banks still cover the Turkish market, but they have fewer people locally and more bankers flying in from London, which limits their coverage to a smaller percentage of larger corporates,” says Mahmut Unlu, chairman of Unlu & Co.
“Previously they would look at deals in the $300 million range, but now they only want to do $1 billion transactions, which in Turkey are few and far between.”
Of course, this is not to say that international investment banks have disappeared from emerging Europe. Some have been happy to go further down the size spectrum, particularly those with other businesses in the region.
UBS has leveraged its popularity among wealthy entrepreneurs to build a strong advisory franchise, while Citi’s dominance in corporate banking and flow business has enabled it to maintain a physical network across the region and keep its place at the head of capital markets league tables.
For most larger players, however, the days of local networks are over. Most of the US players and a few Europeans have maintained at least a small footprint in Warsaw, Istanbul and Moscow, but most product and sector coverage is provided on a fly-in basis from hubs in London, Frankfurt and elsewhere.
This suitcase banking model is often mocked by those on the ground, but one regional banker says it can be very effective.
“For product-driven business, you can do a lot on a fly-in basis – and in any case the fly-in people are there most of the week,” he says. “I would never underestimate the ability of the bulge-bracket firms – and of course they have the breadth of knowledge and resource that many people want.”
In central and southeast Europe these skills are much in demand by international private equity firms, which have cash to deploy and have become increasingly focused on the region over the last decade.
“There are very big funds being raised in western Europe,” says Gergely Voros, head of EMEA emerging markets investment banking at Morgan Stanley. “There are very few restrictions relating to CEE geographies these days, so part of that money can be allocated there and people understand that in terms of achieving their return targets the region offers very interesting opportunities.”
As he notes, however, finding deals with sufficient scale for international private equity firms can be challenging in a relatively fragmented region.
More recently, bankers also report concerns from potential private equity buyers about exit options in light of deteriorating or non-existent liquidity in local capital markets across the region.
The biggest market, Poland, has yet to recover from the partial nationalization of the second-pillar pension funds that formed the backbone of the local investor base and suffered another blow last year when the implosion of debt collector GetBack prompted a rush of outflows from local fund managers.
Combined with the growing obsession of international fund managers with liquidity, bankers in Warsaw say this has crushed previously healthy demand for mid-cap and smaller stocks. Piotr Chudzik, managing partner at leading Polish investment bank Trigon, cites the example of online shoe retailer E-obuwie, which shelved IPO plans in March 2018.
“Everyone thought that was a great company and a great story with big potential to attract foreign investors, but it was postponed due lack of sufficient demand and poor valuations in the market in Poland,” Chudzik says. “That shows that even good-quality companies have difficulty to come to market at present.”
At Wood & Co, Derylo says last year was worse than the post-Lehman period for the failure of equity capital markets transactions in CEE.
“The biggest casualties were smaller IPOs, which might cause one to revise one’s definition of the size of ECM deal that can appeal to international investors,” he says. “I think this is causing quite a few private equity funds, which were the main source of potential listings, to reassess their view of the public market as an exit option.”
On the rare occasions when capital market deals of any size do emerge, the bulge-bracket banks can be guaranteed to turn up. The likes of JPMorgan, Morgan Stanley and Goldman Sachs are still the first choice for any oligarch looking to cash out of their holdings, as well as for any government looking to make its Eurobond debut or launch large-scale privatizations.
Thirty years after the fall of the Berlin Wall, such sell-offs are few and far between – although a certain amount of wary excitement is being generated by developments in central Asia.
Kazakhstan’s much-delayed privatization programme is still in focus after the IPO in November 2018 of Kazatomprom. Despite the relatively muted international response to that deal, the promise of further listings – in particular that of state energy giant Kazmunaigas – is attracting interest from both bankers and investors.
It remains to be seen if changes in leadership following the resignation of long-serving leader Nursultan Nazarbayev in March will affect privatization plans – all eyes will be on presidential elections in early June.
Meanwhile, bankers have given a similar cautious welcome to the opening up of Uzbekistan, which has been on a reform path since the death of authoritarian president Islam Karimov in September 2016.
The new government of president Shavkat Mirziyoyev has promised mass privatizations and recently issued the country’s first sovereign Eurobond, raising hopes of opportunities for further deal flow for international investment banks.
“Uzbekistan has been closed for nearly 30 years, it has double the population of Kazakhstan and a reform-minded president,” says Babaev. “If they continue with what they’re saying, it will be a pretty interesting market where most players will want to be.”
Irackly Mtibelishvily, chairman of CEEMEA corporate and investment banking at Citi, agrees.
“Uzbekistan is starting with the right approach, and the market holds huge potential,” he says. “There is a relatively long road ahead before they can become a meaningful player in the market, but so far they are on the right track.”
Back in the heartlands of emerging Europe, the big question for investment bankers is whether it will be the local or international players that come out ahead over the next decade. At first glance, conditions look to favour the regional specialists. Some of the most promising opportunities in central and southeastern Europe relate to generational change as the first post-communist entrepreneurs reach retirement age.
So far, this long-awaited shift has not produced the wave of large transactions anticipated by hopeful bankers over the past decade.
“There is a looming wave of succession-related situations, which could wind up being IPOs or disbursals to strategic investors, but most of them seem to be taking much longer than expected,” says Derylo. “It’s the typical situation where the founding father took the decision to sell his baby but is having trouble letting go.”
Instead, many of these early entrepreneurs are looking for ways to monetize their assets without losing control, according to William Wells, executive vice-chairman for CEE at Rothschild & Co.
“People who were historically debt averse are thinking about changing the capital structure of their business so they can undertake dividend recaps and de-risk money from their businesses for themselves and their families,” he says. “Others are taking money out of the business where previously they would have reinvested it.”
This in turn is resulting in a proliferation of new investment vehicles, according to UBS’s Szczepaniak.
“The emergence of sophisticated family offices set up by first-generation entrepreneurs looking to diversify their investments outside their original sectors is a very new trend in a number of countries in CEE,” he says. “These entities are increasingly more visible, successfully competing for projects and transactions with traditional ‘western’ private equity buyers.”
Szczepaniak also notes that, rather than automatically investing in traditional western markets, a number of wealthy CEE investors are starting to look at opportunities closer to home.
“They are opting for expansion in more familiar and less competitive markets within the region, where valuations are more attractive while growth opportunities still abound,” he says. “We have not seen that before on such a scale.”
Local companies, meanwhile, are looking the other way. Bankers agree that one of the most striking developments in recent years has been the growing confidence and clout of CEE firms. Many are sitting on large cash piles and looking to expand, and are increasingly eyeing western markets.
“There is an increasing number of companies in CEE that have done very well on their home terrain and have either outgrown their local market or just feel confident enough to compete outside their home ground,” says Theo Giatrakos, head of investment banking for central and southeastern Europe at Citi.
Rothschild & Co
“The larger corporate players in CEE look carefully at their risk calculus,” he says. “They get big in their home markets and want to diversify, not least for anti-trust reasons. They also want to anchor themselves in a number of markets diversifying commercial and political risk.”
At present, this trend is working to the advantage of players with strong regional networks – particularly as, in terms of size, most of the deal flow is still mid market. If it continues, however, it will inevitably attract the interest of bulge-bracket banks.
Chudzik, however, is undismayed by the prospect.
“Polish companies that go global will be taken over by global players, but there will be more opportunities in the mid market as well,” he says.
“In the 1990s, the biggest locally owned businesses in central Europe were making €5 million to €10 million revenues, now there are plenty making €100 million to €500 million. These guys are too small to be serviced by the global banks, so they are coming to us.”
Unfortunately for both globals and locals, in Russia and Turkey the trend is going the other way. Local corporates that were starting to look abroad are now focusing inward as economic stagnation and, in Turkey’s case, currency volatility take their toll.
“With a few exceptions where people have existing positions they need to manage, there is close to zero interest by Russian firms for international assets today,” says Mtibelishvily. “On the contrary, a number of companies are looking at ways of exiting their positions outside Russia.”
In Turkey, Unlu reports a similar trend.
“We have seen a reversal of investments by Turkish companies,” he says. “Some groups have been selling the international assets they have built up over the course of the past 10 years to recapitalize their business in Turkey.”
Bankers in Istanbul are, however, more confident than their Moscow counterparts of an early revival of inward investment. Surprisingly, given the political and market volatility Turkey has experienced over the last five years, headline foreign direct investment (FDI) has held up well – annual inflows have been hovering around $13 billion since 2013.
“Obviously the figure should be higher, but with the exception of two good years at the height of global liquidity in 2006/07 we haven’t seen any better numbers,” says Unlu.
He acknowledges that the figure has been increasingly buoyed by real estate, which accounts for nearly half of FDI today versus around 10% in 2012. At the same time, he sees cause for optimism in the growing interest of Asian investors in Turkey, who last year accounted for a record 27% of all inward investment.
State-owned enterprises and private businesses from China are becoming much more visible in CEE- Rafael Szczepaniak, UBS
Unlu is also buoyant about the outlook for Turkish capital markets, given the continued interest in the market from international investors.
“The general consensus among portfolio managers is that Turkey is cheap and attractive,” he says. “The lira is undervalued, the stock market is significantly undervalued and interest rates are high.
“If investors believe that the government can get a handle on inflation and deliver on reforms, we’ll see a significant inflow into Turkish assets – and once multiples recover there will be plenty of appetite from issuers to come to market.”
Russia also has a strong IPO pipeline, including big names such as Sibur and Sovcombank. Despite signs of thaw in the equity markets in early spring, which resulted in a flurry of block trades by the likes of Tinkoff and Evraz, bankers say investors will need comfort that further sanctions are not on the table for confidence and valuations to recover substantially – particularly after the battering that names such as Rusal took after the last round of targeted sanctions in April 2018.
“As an investor, if you think any stock can go down 50% to 60% without warning, then obviously your risk appetite goes down very significantly,” says Babaev.
In the meantime, a backstop for domestic capital markets has been provided by Russia’s increasingly powerful domestic investor base, as well as a clutch of new international investors. Sovereign wealth funds from the Gulf and Asia have been turning up in public market listings and M&A deals over the last five years, along with vehicles related to China’s Belt and Road Initiative (BRI).
The spectre of China also looms large in the rest of the region, most of which lies on the direct line of the proposed new trade routes from Asia to Europe. Since the launch of BRI in 2013, Beijing has been at pains to cultivate leaders in key states, both bilaterally and through the 16+1 initiative.
“State-owned enterprises and private businesses from China are becoming much more visible in CEE,” says Szczepaniak.
With a few exceptions in the Balkans, Russia and central Asia, this has yet to translate into much in the way of inward investment. Indeed, Chinese buyers have earned a reputation in central Europe in particular for showing up on M&A transactions but never getting to completion, for reasons ranging from valuations to the difficulties of marrying domestic bureaucracy with western-style processes. Wells says this is inevitable given the nature of the BRI project.
“This is patient capital,” he says. “The downside is that it’s rather inflexible capital, which means it can struggle to compete with more dynamic western capital for investment opportunities. A challenge for global investment banks will be how to make Eurasian, especially Chinese, capital more flexible.”
The general consensus, however, is that China will play an increasingly important role in CEE in the future.
“Eurasian capital will be a major factor over the next decade, unless something structural goes badly wrong,” says Wells. “It’s the law of geography. Eastern Europe is inevitably more Eurasian than western Europe.”