Harvest time
While it is too early to pass judgment on the performance of the industry as a whole, managers agree that this year will be the time to sort the wheat from the chaff.
Several firms are in the process of fundraising with two of them, DBG Eastern Europe and Riverside Central Europe Fund, delaying their second closings. Both the funds failed to meet their January deadlines, though managers insist that this is a a common occurence.
"Had we thought we couldn't raise the funds, there would have been no point [in extending the deadline]," says Jacek Korpała, managing director at DBG Eastern Europe, adding that investors have shown an interest but asked for more time before committing their capital. As another fund manager points out, the fundraising "cannot go on forever," but a few months' delay is far from unusual. DBG is looking to raise zł.383 million (€80 million), of which zł.321 million (€67 million) was raised by the first closing, and expects to meet its target by April. Last year, the firm made the first investment from the new fund, acquiring a controlling stake in Ergis, a Warsaw based plastic goods manufacturer.
The region's largest private equity (PE) firm, Enterprise Investors (EI) with zł.2.963 billion ($770 million) in committed capital, was also planning to raise a new fund, its fifth, by the end of January. A recent press report stated that this closing would also miss its deadline, though Jacek Siwicki, EI's managing partner, pointed out last week that the month was not yet over and the new fund would be closed, "in a matter of days."
Siwicki was confident of the success of the fundraising effort, pointing to the company's track record and, "the wind in our sails, that is EU accession." He said that it would make future exits easier, since, as of May 1, strategic investors will have to include this country in their Europe-wide strategies. The prevailing attitude of 'let's talk about serious stuff and Poland might get a mention, if we still have time in the evening' is fast disappearing from boardrooms across the continent.
Public market emerging
According to Siwicki, the Warsaw Stock Exchange (WSE) has finally become a credible exit route, as EI's track record of a major initial public offering every six months demonstrates. Investors, he said, are impressed by the zł.45 billion in funds under management by pension funds, a third of which is invested in equity.
"Surprisingly, there is not much difference between the Polish and German markets in the segment of small- and medium-sized enterprises (SMEs)," says Piotr Misztal, a partner at Riverside Company, "though the billion-euro deals are lacking in the country and CEE region."
While all these factors may facilitate fundraising, not all fund managers can sleep easily.
"There can be no doubt that the next year or two will be the critical period when successes will be sorted from failures," says EI's Siwicki. "We will see who will be able to raise their fourth or fifth fund and who will have to stop at one, or two at the most." Last year, EI raised zł.560 million ($150 million) from its two IPOs and, with rates of return of more than 25 percent per annum, is well poised to benefit from the warming economic climate in the region. When it comes to realizing the stock market's potential as an exit route, "other funds have missed the bus," Siwicki says, though he expects the floodgates to open this year, pointing to American Investment Group's (AIG) plans to list Żabka, a convenience store chain, as an example.
Slowly does it?
By some measures, in fact, the local private equity market compares favorably with its more mature counterparts in Western Europe. While write-offs accounted for 30 percent of all exits Europe-wide in 2002, in this country the figure was just six percent, while IPOs represented nearly a third of all exits in that year.
Last year's listing of pharmaceutical company Polfa Kutno brought EI more than zł.1.15 billion (zł.300 million), representing a 500 percent dollar return on the transaction, despite the exchange course fluctuations eating into the profits. The figure is impressive, though the fact that it took about eight years before the fund could exit its investment makes the picture somewhat less rosy.
That time horizons of investments in the region are longer than in the more developed economies, is a point raised by many industry insiders. DBG's Korpała says he "hopes" that this is not the case, but Misztal is less optimistic.
"Generally speaking, many funds have stayed in their investments for an extended period of time," he says. That is a problem, as a private equity firm's performance is judged by the returns on its exits and that is difficult to do with many funds in this country, which are still holding on to their investments. Now, however, some of the funds raised in the 1990s are fast approaching maturity and managers must be contemplating speedy exits, hardly a situation conducive to maximizing returns.
While Enterprise Investors is often portrayed favorably as a trend-setter, its performance last year may have set a trend that is perhaps less welcome. The fund invested zł.270 million ($70 million), or less than half the value of its exits, and many industry insiders worry that net flows this year could be negative in the industry as a whole.
Siwicki points out that such an occurrence in a single year is not a problem, as it is more important that funds raised and invested exceed in value those returned to investors over a longer period. Nevertheless, the prospect of the value of PE investments actually shrinking this year is hardly welcome for the industry, even if it were to purge the industry of unsuccessful funds.
Size matters
But a shortage of finance is not something managers will be losing sleep over this year. What is difficult is finding the right companies to invest in. Ever since the burst of the bubble, when dotcom start-ups were all the rage, managers have been risk-averse, avoiding early stage financing. A survey of the industry by the Polish Private Equity Association (PPEA) shows that, while one deal at the seed stage managed to sneak past the vetting nets in 2001, there were no such deals in 2002, the last period for which comprehensive data is available. Similarly, the proportion of capital invested in start-ups fell from 15 percent in 2001 to just eight percent a year later and managers agree that it is unlikely to have grown significantly in 2003, or to do so this year. The PPEA's report indeed complains of the growing 'equity gap', which can stifle entrepreneurial growth.
Siwicki says that the gap would have to be closed with the participation of public-sector entities, as private equity firms could not lower their investment limits beyond a certain point.
Most of the larger funds have a minimum investment limit of zł.14.25 million (€3 million), while it is practically impossible to get private equity investments of less then zł.4.8 million (E1 million). That is a problem for many managers, who say that a large number of highly promising projects prove too small to profit a private equity fund. As last year's European Bank for Reconstruction and Development (EBRD) report on its PE investments in the region demonstrates, larger deals tend to generate higher rates of return. A variety of explanations for this is offered, ranging from the extra fixed costs of reporting requirements imposed by private equity investors to, "our excessive optimism as an industry," as DBG's Jacek Korpała puts it.
"In general, early-stage projects have not been successful," he says. "That is partly because, when a business model was imported from the more developed markets, we often failed to appreciate that the demand was too weak to allow for expected growth rates." Often, he says, businesses grew at an appreciable pace, but failed to meet the expectations of funds that had overpaid for their stakes.
Still fretting
The relatively cautious attitude of post-bubble private equity funds is also seen in the sectoral structure of investment activity. The interest in telecommunications and IT has not returned to anywhere near pre-2001 levels and most funds keep their focus squarely on the more traditional sectors.
Jacek Korpała says that DBG was looking for opportunities in, "the more dynamic segments of the Old Economy," pointing to packaging as a high-growth market. He also points to the budding economic recovery as likely to drive up demand in the sector of business services and wistfully remarks that, "we are obviously also interested in consumer goods manufacturers, but how many more deals like that can you find?"
Riverside, on the other hand, does not have a sectoral outlook, seeking opportunities in niche markets with high barriers to entry. The profile of its new fund's two investments to date, in a Czech paint and varnishes manufacturer and a durable consumer goods maker in Switzerland, also suggests that fancy technologies are not the stuff of fund managers' dreams anymore, unless they are nightmares.
Arrival of the giants
Last year saw, however, a spectacular deal in the high-tech sector. The zł.522 million (€110 million) acquisition of Aster, a cable TV operator, by a consortium of Hicks Muse Tate & Furst, Emerging Markets Partnership and Argus Capital Partners, could set a trend that could change the landscape of the market in the years to come, thinks EI's Jacek Siwicki.
Hicks Muse is a U.S. based global player, the first of the kind to invest in a CEE country. An even larger deal may be in the works across the southern border, if the authorities put the sale of national fixed-line operator CŠesky Telekom back on the fast track after a halt last year. The deal would have been a landmark, as a number of funds, including Doughty Hanson and Warber Pincus, are said to be preparing bids.
According to Siwicki, the arrival of the giants could bring about a sea change in the industry, giving the lie to skeptics such as Michael Rostock of Venture Investors, a London based firm focusing on the region.
"Central Europe is not the place to do landmark deals," Rostock says. "It's a place where you either make the money or lose your shirt while investing."
"If, say, ITI's owners decide to sell in a couple of years, I'm sure there will be buyers among private equity funds," Siwicki says, in reference to a media holding whose interests include one of the country's top two commercial TV stations, TVN. Such deals, whose value would be far in excess of zł.480 million (€100 million), could happen once or twice a year, but their sheer size would change the landscape. That is not, however, to say that global players would be likely to crowd the local funds out of the market, as they would probably seek cooperation with smaller players with intimate knowledge of the market. In the case of the Aster deal, this role was performed by Argus Capital.
Wooing pensioners
Even as the foreign funds are slowly arriving on the scene, locally based funds are looking to tap into domestic sources of finance. The success of such projects would put an end to perhaps the biggest anomaly of the local private equity market. While in Europe about one half of finance is raised domestically, the figure in this country is close to zero. This can be a problem at a time of exchange rate fluctuations and at least one firm says that the weakening dollar has eaten 40 percent of the returns of one of its funds.
The expected new law on pension funds, relaxing restrictions on their investment policy, is one of the hottest topics among industry insiders. Three institutions are currently working on vehicles that would allow pension funds to gain exposure to private equity.
Copernicus Partners plans to set up a locally incorporated fund of funds, which would raise money from pension funds and invest in CEE private equity institutions. This would remove the obstacle of caps on pension funds' exposure to foreign assets, as most funds in the industry are incorporated in such offshoring centers as the state of Delaware.
Baring Private Equity Partners is working on a more straightforward investment vehicle, which would be a locally incorporated fund investing in tandem with a traditional fund. The latest arrival on the scene is the investment bank CA-IB an investment-banking arm of Bank Austria Creditanstalt (BACA), where Adam Cąkała, formerly of Innova Capital, is in charge of setting up a fund that would tap into pensioners' money. CA-IB's parent bank would be the only foreign investor in the fund with local pension funds' money representing most of the capital.
Cąkała admits that, "pension funds would be very cautious in exposing themselves to this asset class," though, "in theory, at least, there is enough money for all three projects." He points out that Western European pension funds invest around seven percent of their money in private equity, but adds that the local institutions would surely invest no more than one percent of their assets in the foreseeable future. This would mean that nearly zł.500 million could be up for grabs but Cąkała admits that, "this is a very optimistic projection."
Should it materialize, private equity in this country might have a bright future. But don't expect all the players on the market to be around to enjoy it.
Several firms are in the process of fundraising with two of them, DBG Eastern Europe and Riverside Central Europe Fund, delaying their second closings. Both the funds failed to meet their January deadlines, though managers insist that this is a a common occurence.
"Had we thought we couldn't raise the funds, there would have been no point [in extending the deadline]," says Jacek Korpała, managing director at DBG Eastern Europe, adding that investors have shown an interest but asked for more time before committing their capital. As another fund manager points out, the fundraising "cannot go on forever," but a few months' delay is far from unusual. DBG is looking to raise zł.383 million (€80 million), of which zł.321 million (€67 million) was raised by the first closing, and expects to meet its target by April. Last year, the firm made the first investment from the new fund, acquiring a controlling stake in Ergis, a Warsaw based plastic goods manufacturer.
The region's largest private equity (PE) firm, Enterprise Investors (EI) with zł.2.963 billion ($770 million) in committed capital, was also planning to raise a new fund, its fifth, by the end of January. A recent press report stated that this closing would also miss its deadline, though Jacek Siwicki, EI's managing partner, pointed out last week that the month was not yet over and the new fund would be closed, "in a matter of days."
Siwicki was confident of the success of the fundraising effort, pointing to the company's track record and, "the wind in our sails, that is EU accession." He said that it would make future exits easier, since, as of May 1, strategic investors will have to include this country in their Europe-wide strategies. The prevailing attitude of 'let's talk about serious stuff and Poland might get a mention, if we still have time in the evening' is fast disappearing from boardrooms across the continent.
Public market emerging
According to Siwicki, the Warsaw Stock Exchange (WSE) has finally become a credible exit route, as EI's track record of a major initial public offering every six months demonstrates. Investors, he said, are impressed by the zł.45 billion in funds under management by pension funds, a third of which is invested in equity.
"Surprisingly, there is not much difference between the Polish and German markets in the segment of small- and medium-sized enterprises (SMEs)," says Piotr Misztal, a partner at Riverside Company, "though the billion-euro deals are lacking in the country and CEE region."
While all these factors may facilitate fundraising, not all fund managers can sleep easily.
"There can be no doubt that the next year or two will be the critical period when successes will be sorted from failures," says EI's Siwicki. "We will see who will be able to raise their fourth or fifth fund and who will have to stop at one, or two at the most." Last year, EI raised zł.560 million ($150 million) from its two IPOs and, with rates of return of more than 25 percent per annum, is well poised to benefit from the warming economic climate in the region. When it comes to realizing the stock market's potential as an exit route, "other funds have missed the bus," Siwicki says, though he expects the floodgates to open this year, pointing to American Investment Group's (AIG) plans to list Żabka, a convenience store chain, as an example.
Slowly does it?
By some measures, in fact, the local private equity market compares favorably with its more mature counterparts in Western Europe. While write-offs accounted for 30 percent of all exits Europe-wide in 2002, in this country the figure was just six percent, while IPOs represented nearly a third of all exits in that year.
Last year's listing of pharmaceutical company Polfa Kutno brought EI more than zł.1.15 billion (zł.300 million), representing a 500 percent dollar return on the transaction, despite the exchange course fluctuations eating into the profits. The figure is impressive, though the fact that it took about eight years before the fund could exit its investment makes the picture somewhat less rosy.
That time horizons of investments in the region are longer than in the more developed economies, is a point raised by many industry insiders. DBG's Korpała says he "hopes" that this is not the case, but Misztal is less optimistic.
"Generally speaking, many funds have stayed in their investments for an extended period of time," he says. That is a problem, as a private equity firm's performance is judged by the returns on its exits and that is difficult to do with many funds in this country, which are still holding on to their investments. Now, however, some of the funds raised in the 1990s are fast approaching maturity and managers must be contemplating speedy exits, hardly a situation conducive to maximizing returns.
While Enterprise Investors is often portrayed favorably as a trend-setter, its performance last year may have set a trend that is perhaps less welcome. The fund invested zł.270 million ($70 million), or less than half the value of its exits, and many industry insiders worry that net flows this year could be negative in the industry as a whole.
Siwicki points out that such an occurrence in a single year is not a problem, as it is more important that funds raised and invested exceed in value those returned to investors over a longer period. Nevertheless, the prospect of the value of PE investments actually shrinking this year is hardly welcome for the industry, even if it were to purge the industry of unsuccessful funds.
Size matters
But a shortage of finance is not something managers will be losing sleep over this year. What is difficult is finding the right companies to invest in. Ever since the burst of the bubble, when dotcom start-ups were all the rage, managers have been risk-averse, avoiding early stage financing. A survey of the industry by the Polish Private Equity Association (PPEA) shows that, while one deal at the seed stage managed to sneak past the vetting nets in 2001, there were no such deals in 2002, the last period for which comprehensive data is available. Similarly, the proportion of capital invested in start-ups fell from 15 percent in 2001 to just eight percent a year later and managers agree that it is unlikely to have grown significantly in 2003, or to do so this year. The PPEA's report indeed complains of the growing 'equity gap', which can stifle entrepreneurial growth.
Siwicki says that the gap would have to be closed with the participation of public-sector entities, as private equity firms could not lower their investment limits beyond a certain point.
Most of the larger funds have a minimum investment limit of zł.14.25 million (€3 million), while it is practically impossible to get private equity investments of less then zł.4.8 million (E1 million). That is a problem for many managers, who say that a large number of highly promising projects prove too small to profit a private equity fund. As last year's European Bank for Reconstruction and Development (EBRD) report on its PE investments in the region demonstrates, larger deals tend to generate higher rates of return. A variety of explanations for this is offered, ranging from the extra fixed costs of reporting requirements imposed by private equity investors to, "our excessive optimism as an industry," as DBG's Jacek Korpała puts it.
"In general, early-stage projects have not been successful," he says. "That is partly because, when a business model was imported from the more developed markets, we often failed to appreciate that the demand was too weak to allow for expected growth rates." Often, he says, businesses grew at an appreciable pace, but failed to meet the expectations of funds that had overpaid for their stakes.
Still fretting
The relatively cautious attitude of post-bubble private equity funds is also seen in the sectoral structure of investment activity. The interest in telecommunications and IT has not returned to anywhere near pre-2001 levels and most funds keep their focus squarely on the more traditional sectors.
Jacek Korpała says that DBG was looking for opportunities in, "the more dynamic segments of the Old Economy," pointing to packaging as a high-growth market. He also points to the budding economic recovery as likely to drive up demand in the sector of business services and wistfully remarks that, "we are obviously also interested in consumer goods manufacturers, but how many more deals like that can you find?"
Riverside, on the other hand, does not have a sectoral outlook, seeking opportunities in niche markets with high barriers to entry. The profile of its new fund's two investments to date, in a Czech paint and varnishes manufacturer and a durable consumer goods maker in Switzerland, also suggests that fancy technologies are not the stuff of fund managers' dreams anymore, unless they are nightmares.
Arrival of the giants
Last year saw, however, a spectacular deal in the high-tech sector. The zł.522 million (€110 million) acquisition of Aster, a cable TV operator, by a consortium of Hicks Muse Tate & Furst, Emerging Markets Partnership and Argus Capital Partners, could set a trend that could change the landscape of the market in the years to come, thinks EI's Jacek Siwicki.
Hicks Muse is a U.S. based global player, the first of the kind to invest in a CEE country. An even larger deal may be in the works across the southern border, if the authorities put the sale of national fixed-line operator CŠesky Telekom back on the fast track after a halt last year. The deal would have been a landmark, as a number of funds, including Doughty Hanson and Warber Pincus, are said to be preparing bids.
According to Siwicki, the arrival of the giants could bring about a sea change in the industry, giving the lie to skeptics such as Michael Rostock of Venture Investors, a London based firm focusing on the region.
"Central Europe is not the place to do landmark deals," Rostock says. "It's a place where you either make the money or lose your shirt while investing."
"If, say, ITI's owners decide to sell in a couple of years, I'm sure there will be buyers among private equity funds," Siwicki says, in reference to a media holding whose interests include one of the country's top two commercial TV stations, TVN. Such deals, whose value would be far in excess of zł.480 million (€100 million), could happen once or twice a year, but their sheer size would change the landscape. That is not, however, to say that global players would be likely to crowd the local funds out of the market, as they would probably seek cooperation with smaller players with intimate knowledge of the market. In the case of the Aster deal, this role was performed by Argus Capital.
Wooing pensioners
Even as the foreign funds are slowly arriving on the scene, locally based funds are looking to tap into domestic sources of finance. The success of such projects would put an end to perhaps the biggest anomaly of the local private equity market. While in Europe about one half of finance is raised domestically, the figure in this country is close to zero. This can be a problem at a time of exchange rate fluctuations and at least one firm says that the weakening dollar has eaten 40 percent of the returns of one of its funds.
The expected new law on pension funds, relaxing restrictions on their investment policy, is one of the hottest topics among industry insiders. Three institutions are currently working on vehicles that would allow pension funds to gain exposure to private equity.
Copernicus Partners plans to set up a locally incorporated fund of funds, which would raise money from pension funds and invest in CEE private equity institutions. This would remove the obstacle of caps on pension funds' exposure to foreign assets, as most funds in the industry are incorporated in such offshoring centers as the state of Delaware.
Baring Private Equity Partners is working on a more straightforward investment vehicle, which would be a locally incorporated fund investing in tandem with a traditional fund. The latest arrival on the scene is the investment bank CA-IB an investment-banking arm of Bank Austria Creditanstalt (BACA), where Adam Cąkała, formerly of Innova Capital, is in charge of setting up a fund that would tap into pensioners' money. CA-IB's parent bank would be the only foreign investor in the fund with local pension funds' money representing most of the capital.
Cąkała admits that, "pension funds would be very cautious in exposing themselves to this asset class," though, "in theory, at least, there is enough money for all three projects." He points out that Western European pension funds invest around seven percent of their money in private equity, but adds that the local institutions would surely invest no more than one percent of their assets in the foreseeable future. This would mean that nearly zł.500 million could be up for grabs but Cąkała admits that, "this is a very optimistic projection."
Should it materialize, private equity in this country might have a bright future. But don't expect all the players on the market to be around to enjoy it.
