CEE: Less capital chasing fewer opportunities

After a year and a half out on the road, Mid Europa held a final close on its Fund IV in early August, €200m short of its original €1bn target, highlighting decreased dry powder for CEE investments. From its inception, the fund was always going to be smaller than its predecessor, which closed on €1.5bn in 2007.

Speaking to unquote", Mid Europa founder and managing partner Thierry Baudon explained that the latest fund's size was reduced at the request of LPs, due to poor dealflow in the region.

Indeed, according to unquote" data, deal volume across the entire CEE region (including Russia, Ukraine and Turkey) has averaged at around six deals per month from May to July, from an average of nine deals per month in 2013.

Furthermore, looking back at deal volume since the start of 2013, the bulk of CEE deals have taken place in Russia – with nearly 60 deals over the past 18 months – with Poland the next most active market seeing just 32 deals over the same period. Given that Mid Europa does not invest in Russia, the decision to reduce this most recent fund size appears prudent.

Fortunately, Mid Europa's latest fund has an option for co-investment if dealflow in the region does pick up. And the GP has been an active co-investor over the years, having facilitated around €750m's worth of transactions in these sorts of deals.

Market exodus
Alongside Mid Europa's shrinking pool of capital with which to invest, Advent notably pulled out of the market last year, having previously raised a €1bn CEE-dedicated fund in 2008.

Another major development in the market is the recent reform of the Polish pension industry, whereby, in a bid to quickly reduce escalating levels of government debt, private pension funds have been forced to transfer all bond holdings to the state, leaving commercial pension pots heavily exposed to public equities. For 2014, private pension funds must now have a minimum of 75% of total assets invested in public shares. This will decrease to 55% in 2015; 35% in 2016; and 15% in 2017.

Pension probability
With these factors in mind, could the reform create an opportunity for private equity in a fairly quiet environment? According to Dariusz Prończuk, managing partner at Enterprise Investors, the outlook is good, but there is no reason to rejoice quite yet: "In the near term there will be no opportunities, but there might be in the future. Pension funds will cease to be buyers and holders of public stocks and will have to be much more active managers of their portfolios. So we can consider some of the mid-cap Polish companies, where the shareholders are mid-sized and smaller pension funds."

Prończuk points out that pension funds will need time to adjust to the new conditions. "It will require a lot of effort because pension funds are not experienced in selling companies." However, Enterprise Investors is planning to engage with private pension funds and is already looking into potentially interesting companies. "But we do not expect any investments until 2016," says Prończuk.

While Mid Europa's contracted fund size, coupled with Advent's exodus, means less available capital for large-cap transactions, in the mid-market where Enterprise Investors operates, there appears to be more potential activity. "There are a lot more opportunities but we are questioning the quality of the deals. There are a number of 'good' companies out there but not 'fantastic' ones," says Prończuk.

Prończuk believes vendor price expectations are not reflective of current market conditions: "For sellers, the number of options available is much smaller today; the cash isn't there. They need to accept there is less capital available and this will be the case for the next few years."

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