CEE GPs use minority transactions to boost dealflow

Central and eastern Europe was the only European region to record an increased deal volume in Q2 2019 over the same period last year. GPs in the region inked 23 deals between April and June, up from just 18 in the same months of 2018.

Dealflow was down compared with Q2 last year in every other European region, resulting in an aggregate drop of 21% year-on-year. France saw the most dramatic decline, as only 87 deals were completed in Q2, down 45% from 158 last year.

Part of the reason for the relative resilience of the CEE market in Q2 was the historically low levels of investments seen in the previous quarter, as reported by Unquote in the June issue. However, dealflow has also been bolstered by the creativity of private equity firms, willing to team up or take minority stakes in order to complete difficult transactions.

Genesis Capital is a Czech Republic-based buyout firm that has had to slightly tweak its approach to access the best deals in recent years. "The number of minority transactions we have done in recent years has been very unusual, even for us," says Genesis partner Ondrej Vicar. "We had done some in the past, but not so many. It was not the strategy, but it has been a natural development. Part of this has been teaming up on larger deals, but it is also driven by a larger number of growth-orientated transactions alongside strong founders."

This has meant that minority stakes represented 60% of dealflow in 2017 and 48% in 2018. This is significantly above the average for the firm. Its previous vehicle, Genesis Private Equity Fund III, did just 30% of its investments in minority stake acquisitions. This is above the average for CEE, which is around 8%, according to an informal survey of the 20 most active private equity funds in the region – although this is skewed by funds that are mandated to do only majority deals.

Pros and cons
Market participants have previously told Unquote that this type of transaction can help bridge the gap in expectations when pricing levels are high. However, Vicar highlights another advantage: "A strong advantage to minority-stake transactions is that you don't run the typical risks of having to change things that are the underlying drivers of the company's success. If the company is on a growth path, has a clear development strategy and everything seems to be functioning, then stepping into minority rather than executing a buyout lowers the chances of endangering such favourable constellation. An accompanying effect of minority/growth deals is the fact that current shareholders, who are usually in charge of the development of the company, won't receive too much capital up front, so their motivation is less likely to be affected going forward."

Naturally, this comes with the downside that it limits the level of active involvement in value-creating initiatives. However, according to Vicar, this disadvantage is often overemphasised. "Whether you are in the majority or minority position should not really change your legal rights that much and your shareholder agreements should look quite similar in terms of the investor rights," he says. "We make sure we always have the right to change management and to change the capital structure and/or to exit, as those are the most important levers."

The main risk as Vicar sees it is the possibility of a macro event of economic slowdown, which would require a restructuring or renegotiation of debt terms. "It is possible that banks would take a different approach to companies where the sponsor is in the minority in the event of a downturn. The reputation of private equity firms with the banks is very strong, but with founder-led businesses it is less strong, so that could be an adjacent risk of minority structures." However, he thinks this is a risk worth taking to access the best companies: "It is always a trade-off. With minority transactions you achieve the full blossoming of the management's motivation, but you have to rely on them more to take the right decisions."

Another scenario that technically counts as a minority transaction is a club deal, such as the one Genesis did with Polish GP Avallon last year. The two GPs teamed up to acquire the Czech operations of Eqos Energie, backed by Triton Partners, each taking a minority stake that equalled a majority position combined.

In general, Vicar does not think that the dip seen in Q1 of 2019 is particularly representative of the market. "From our perspective, the number of opportunities keeps growing constantly," he says. "Last year, we evaluated 180 opportunities, and this year we will evaluate 200, which is nearly one per day. Of course it's a little bit random whether and when the most progressed deals in the pipeline would complete, but it does seem that quite a few are approaching signing now."

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• Topics
• CEE
• Investments
• Minority investing
• Unquote Data
• Genesis Capital