Warsoaring: Poland and CEE back on the ascent

Last year was a strong one for CEE. Deal volume was fairly static compared with the previous year, though overall value was up strongly as international investors scoured the market for deals. Most importantly, a handful of very strong exits helped entice LPs back to the market.

And herein lies the success: more than €1bn was raised for investment in the region last year, with three final closes – two from relative newcomers – attesting to the region's allure. Another major fund announcement is expected this year from Mid Europa Partners as well as 3TS, which reached a first close on €103m in September, more than twice its €40m predecessor. A couple of mid-market firms are currently in the process of securing investments for fresh vehicles.

"It is crucial to get support from your existing LPs," says Zbigniew Lapinski, partner at 3TS speaking at the 8th annual unquote" CEE Private Equity Congress in Warsaw today. "It's very difficult to raise without support from EBRD and EIF at the moment; I'd even say it's 'mission impossible' without them." The firm also has a local LP, no mean feat in a region with extremely limited institutional money in private equity. "This was a real differentiator in discussions," Lapinski explains.

"Non-European LPs struggle to understand that there is more to the CEE private equity story than the consumer convergence thesis. The north/south divide in the region is not yet fully understood," says Brian Wardrop, co-managing partner at Arx Equity Partners. And dealflow potential is strong: Wardrop estimates the addressable lower mid-market (revenues of €10-50m) in Poland and Czech Republic at roughly 11,900 companies, with Poland accounting for three quarters of them.

Leon Hadass at Pantheon still deems CEE a separate market. "It is still an emerging market for us; therefore we need to see proof of concept in the GPs we back. The challenge this region has is that it's still a fairly small region in terms of GDP vis-à-vis Asia or the US. Thus it's crucial to generate exits of at least 3x in the portfolio. To reach this, GPs must grow businesses regionally and start operational improvements from day one to ensure they are attractive to international buyers." Hadass went on to suggest a critical mass of such exits was lacking in the region, even as GPs in other European regions were able to achieve them.

Nevertheless LPs are backing the region. "GPs pick up the best companies in the market and grow them; this adds to economic growth and so we want to support that. This is why we invest in private equity now," says Piotr Kuszewski, managing director at Bank Gospodarstwa Krajowego, which backs growth, buyout and venture opportunities. The Bank is one of the region's precious few local LPs.

Shaken but not stirred
While the convergence story remains in CEE, it is no longer fair to relegate the region to true emerging-market status. According to the EBRD, growth rates for CEE are now approaching levels of more advanced economies. Indeed Poland now looks west instead of east: when unquote" asked whether the Ukraine situation would put the brakes on continued success, deal-doers were nearly unanimous in their agreement that Poland was part of the EU; despite sharing a border, Ukraine was miles away politically, economically and socially. "There is significant increased economic and geopolitical uncertainty. But CEE is less affected due to low trade linkages with Russia," explains Alexander Lehmann, lead economist at EBRD.

Looking ahead, more corporates are needed to aid the market's development, since the overhang in private equity is increasing. According to figures from EY, there were 472 European investments sitting in portfolios for more than five years at the end of 2012; this is up from 428 a year earlier.

"Fortunately the IPO markets are re-opening so this can help the balance to return," says Brendan O'Mahony, managing partner at EY. "For 2014, we may see an increase in corporate activity with possible partnership between private equity and corporates. Their return is critical for a successful year."

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• CEE
• Industry
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• Poland
• Top story
• EBRD
• European Investment Fund
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• Arx Equity Partners
• Pantheon