H1 Review: Fundraising and local capital herald CEE buyout revival

Buyout activity started off slowly in CEE this year, with only five completed in the first quarter of 2019 for an aggregate value of around €319m (including one deal with an enterprise value north of €260m). INVL Asset Management's Deimante Korsakaite has a possible explanation: "As the economic expansion continued for nine years, the private equity industry was booming - making deals, succeeding with exits and fundraising at a historic pace. However, with a downturn expected, firms may have been more cautious at the beginning of the year."

Czech Republic-based Arx Equity Partners' Brian Wardrop says the picture is similar there: "One of the challenges we are facing at Arx is a combination of seller expectations in terms of valuations and questions over the medium-term economic outlook."

However, with record amounts of capital to invest, local firms cannot just sit and wait until a downturn comes, Korsakaite says. "The funds have their life pace and schedule. Therefore, the dealflow returned, potentially focusing more than in previous years on the downside scenarios and how it will be managed successfully if the downturn hits." This observation is backed up by the H1 statistics recorded by Unquote, which revealed 17 deals were completed by the end of June, with an aggregate value of more than €1bn.

The Baltic private equity market stood out particularly in this resurgence, recording a higher than usual share of the wider region's dealflow: 17% for the first half of 2019, just behind the 19% record set for 2018. Korsakaite puts this expansion down to several factors: "Valuations are relatively low compared with western Europe and are still lagging slightly behind the giants of the CEE region, such as Poland," she says. Combined with high-quality assets, the opportunity to consolidate fragmented industries, and the political and economic stability of the region have been the main drivers of private equity investment in the region, according to Korsakaite.

Local capital
Another standout performer was the Czech Republic. Arx's Wardrop hypothesises about potential drivers: "A phenomenon we see gaining momentum is an increasing level of participation by local capital. By this I mean local capital in all forms, with local family offices competing with firms such as Arx for transactions, and smaller buyout funds formed entirely of local LPs. It is a phenomenon we have seen across the CEE region, but it appears most strongly in the Czech Republic." Firms fitting this description include Jet Investment and Sky Limit, both of which have transacted this year.

Livonia's Kaido Veske sees this phenomenon as well, but highlights that there is still a long way to go: "The underpenetration of available private equity capital relative to CEE and the Nordic region is drastic," he says. "The industry will only keep growing as more players and more capital comes to the market." Veske adds that Livonia is predicting its highest ever activity for H2 and the biggest challenge the firm currently faces is deciding in which deals to invest.

Arx's Wardrop shares Veske's optimism, but highlights some potential slipping points: "One area of uncertainty is labour shortage. The Czech Republic has the lowest unemployment rate in Europe, so for companies that are more labour intensive, it is not only a question of cost but of technically skilled labour availability. When we price a deal, factoring in substantial wage growth, it can be difficult to execute at a value that is acceptable to the vendor."

This issue of pricing expectations is a commonly cited challenge by GPs operating in the CEE region. Wardrop suggests that a slight correction could be beneficial to private equity: "On the positive side, the theme of generational change is still very much relevant for the region," he says. "Our belief at Arx is that when the next macro hiccup occurs, hopefully a minor one, that will be a catalyst that causes some of these ageing owners to seek transactions."

INVL's Korsakaite is less optimistic: "Negative events in the macroeconomic environment, a downturn and negative global political changes could affect dealflow." However, her general outlook is in line: "Otherwise, we do expect it to keep to the current pace, if not to pick up."

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