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CEE: Survived and revived

Robert Manz of Enterprise Investors
  • Kimberly Romaine
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Central and Eastern Europe (CEE) went from top of LPs’ wish lists in early 2008 to the bottom by 2012. A decade on from EU accession, is the region still worth backing? Kimberly Romaine investigates

When private equity was hot, CEE was on fire. So when European funds were doubling in size – Permira and Apax both raised more than €11bn at the peak of the bubble – some CEE funds managed to triple their predecessor vehicles, with Advent's dedicated team hitting €1bn to invest in the region in 2008. LPs that had missed out on that fund were queuing up with secondaries specialists offering top dollar for a piece of the action.

But that was then. The region now ranks bottom on LPs' wish lists on various sentiment surveys and Advent – for 18 years one of the region's top players – has absconded from its dedicated-fund approach. What happened?

The global crisis saw investors the world over pull out of exotic markets to seek safety in familiar turf and with virtually no domestic backers, CEE was left with few cheerleaders. "Too many investors have completely forgotten the CEE success story and lost perspective: the returns have been extremely good in the past 20 years," says Robert Manz, managing partner at Enterprise Investors.

A decade on from EU accession, is the region still worth backing?

Henry Potter, partner at fund-of-funds Alpha Associates, backs this up: "There are some pre-crisis funds that are not delivering and it creates a negative atmosphere. And because they tend to be the bigger funds, there are a number of investors that are now wary. While EBRD and Alpha can understand the great returns since the 1990s, and the continuing opportunity, many LPs newer to the region are disappointed and this chatter is amplified."

Indeed, returns data from EBRD reveals the outperformance the region can offer. Over 10 years, horizon returns in dollars stand at 21%, nearly twice the Cambridge Global Emerging Markets PE & VC Index (11%). In euros, the returns stand at 14% over 10 years against 6% for EVCA's comparable statistics.

"But now LP sentiment is driven by a very, very short-term performance," Manz points out.

The reasons for investor reticence are manifold. Perhaps the most striking is that so many investors in the 2006-2008 vintages were new to the region - and the bulk were left feeling disappointed by their foray. Says Manz: "The latest vintage of funds need more time before they realise their investments. So if investors new to the region, without a couple of CEE funds under their belts from prior cycles, are only looking at the latest quarter of statements, they may not yet be satisfied."

Not-so-fun raising
Pre-crisis, CEE had been sold well: a handful of stellar exits topped a decade of strong performance and eight CEE countries had just joined the European Union (EU). LPs enthused about "emerged market risk with emerging market returns". Back then, Mid Europa increased its vehicle from €655m from 26 LPs in Fund II to €1.5bn (surpassing its hard-cap) from a staggering 65 LPs – 42 of them new – in Fund III, and after just a five-month fundraise. Nearly a quarter of investors in Advent's €1bn ACEE IV were from the US, newly "awake" to opportunities in CEE, the firm's Joanna James said at the time.

Fundraising is doubly hard nowadays, and more so in CEE than in other regions. Whereas in most countries domestic investors make up a large proportion of LPs in private equity funds, Poland has none whatsoever.

Though a difficult market, success remains possible. Enterprise just raised €314m for its Fund VII. The raise took nearly a year, up markedly from the three months Fund VI reportedly took to close. While it is less than half the size of its €658m predecessor – which was 2x oversubscribed, according to LPs – the fall is gentler than some seen in western Europe. Permira, for example, has reduced its target from €6.5bn to €4-5bn - having raised more than €11bn for its previous fund. Enterprise's repute is strong, suggesting the backdrop for raising has never been so difficult. Founded in 1990, Enterprise has raised €2bn across eight funds and backed 130 businesses. Nearly 100 of these have been exited, generating €1.9bn (gross) – five of which in the past year alone.

At least one CEE GP managed to exceed its predecessor vehicle: earlier this year Abris Capital Partners raised €450m from 21 LPs for its second fund, up 50% on its debut vehicle. "Our largest challenge was convincing US investors," says Neil Milne, managing partner at Abris. "A number of LPs wanted to move away from Europe and towards Asia and Latin America. It is hard to sell CEE as an emerging market now." Indeed, half the LPs were from Europe with a handful from the US, including Harvard and two endowments, both new to Abris. Interestingly, European Investment Fund (EIF) and EBRD were notably absent from the latest vehicle, despite being relied upon more heavily by other CEE GPs in this difficult fundraising environment: the proportion of investments by international financial institutions (IFI) is at an all-time high in the region, representing more than half the LP base in 2009-2011 vintage funds, according to EBRD data. This is twice the proportion seen during the heyday of 2001-2008 (24%) and higher even than in CEE's nascent years in 1992-2000 (41%). "Through nobody's fault, some GP/LP relationships can go stale over time and we may have benefited from that," Milne says, suggesting some LPs may have defected to Abris from other more established CEE brands.

Enterprise VII had a strong re-up rate. "The investors who have invested here over the long term are still investing. This gives me hope that other LPs will join in," Manz says.

Pantheon is one of the global LPs convinced of CEE's merits. The investor has two fund-manager relationships in CEE, the same number as five years ago, though a new $41m emerging markets fund for Pantheon could see this number increase in the next year or two.

Filling the gap
A new fund-of-funds has been launched to try and fill the void of local LPs in CEE. Polish development bank Gospodarstwa Krajowego (BGK) and EIF have launched a vehicle to back CEE funds with a focus on Poland. A first close was held in April with €60m from BGK and €30m from EIF; a final close on €180m is targeted within a year with additional funding from institutional investors. To reflect the trend towards longer hold periods, the fund has a typical five-year investment period but an unusual 13-year exit period. "We hope that the fund will help make people more patient and less speculative," says Piotr Kuszewski, adviser to the president of BGK.

And there may also be a homegrown institutional LP in the form of Polish insurer PZU. The firm last year partnered with private equity to bid for Alior Bank when its Italian backer put it on the block. Reports linked the insurer to global heavyweights KKR and Apax, though ultimately the asset was listed, with EBRD purchasing an 8.8% stake for €78m. Says PZU's alternative investments director Wlodzimierz Beliński: "We had hoped the Alior deal would help us understand how private equity works. Then we could speak in a more informed manner about a general private equity investment programme."

PZU's internal deliberations resumed in April with a board decision expected by mid-summer that could see up to €250m (2% of PZU's assets under management) earmarked for investment in private equity, split into fund investments, funds-of-funds and co-investment. "We would pursue an opportunistic approach depending on who is closing, but we are generally more comfortable with CEE funds because we understand Poland," adds Beliński. Crucially, he feels that PZU's backing could pave the way for wider institutional backing of the industry: "PZU is a former state-owned business. So if we back private equity, the market gets a sign that it is okay to follow us."

Show me the money
Local GPs are putting paid to LP whinges that CEE doesn't deliver, with a number of outstanding realisations clocked up during the past 18 months (see table). The flotation of AVG and trade sales of StarBev and LuxMed all showcased the international interest in CEE assets. And there is more to come both because of ageing investees and GPs' need to refill LPs' coffers.

Arx, formerly DBAG's CEE outpost, in gearing up for a 2014 fundraise and so lining up the divestments. Approximately half of Fund II is exited, with another two exits slated for the next couple of months. They are significant: one is Fund II's largest investment, the other will likely represent its largest return. Fund III has one partial realisation done, with another – the consumer brands of Bochemie, a Czech chemicals business – signed for a sale to Unilever. And Abris has Jefferies running a sale process for Masterlease.

Despite the strong prospects the region offers, CEE is likely to undergo the Darwinian shake-up besetting the rest of Europe. Says Barbara Lundberg, co-founding partner of Enterprise Investors from 1990 to 1999 and now CEO of a European cable business: "The fundamental reasons to invest in CEE private equity remain, and growth due to EU accession will continue for many years in spite of the current slowdown. But the investment environment has changed and many of the solely CEE-focused private equity fund managers have not evolved. As a result, they have restricted themselves to quite competitive small- and medium-sized investment opportunities, while European and global funds dominate the large deal segment, investing more selectively."

Says Manz: "CEE has not performed worse than other regions in recent times; it has just performed below expectations. This indicates investors still expect a risk premium for investing here, but that is outdated; we are in the EU. The best is yet to come for the last generation of funds: extended time frames for divesting mean poor performers came out first, while the better businesses take longer to harvest. We have another 20 good years ahead."

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