CEE: Gearing up for a busier 2012

It took a Czech company to finally put an end to Europe's 10-month dry spell on the IPO front: Internet security software provider AVG, whose backers include Intel Capital, Enterprise Investors and TA Associates, raised $128m when it floated on NYSE in early February. Initial backers - including first institutional rounder Benson Oak - took out roughly $600m prior to the float, through dividends as well as $200m from TA's participation, according to sources close to the deal.

But despite its impressive growth track-record (its profits doubled between 2008 and 2010), AVG couldn't avoid the common affliction for private equity-backed IPOs these days. It priced at the lower end of its indicative price range, shares quickly sank by 15% within hours, and trading has been rocky since then.

But there is no such thing as bad publicity. Alpha Associates partner Richard Seewald reckons that the AVG float - alongside that of EPAM Systems, a US-based IT services provider focusing on the CEE market - will help draw eyes to the area.

"This brought attention to the region, which has been long recognised for talented engineers and scientists and now for global technology businesses with access to global capital markets," he notes. "This should have positive knock-on effects for capital formation and entrepreneurship in CEE. As a result, high-growth technology and media entrepreneurs should see more options to raise capital and expand markets."
The float comes nearly a year after CEE basked in deal-frenzy glory: 2011 Q1 saw €1.7bn clocked up, twice the sum of the whole of the previous year.

But like its Western European neighbours, the pace was not to last. Q2 displayed a steep drop in overall amounts invested - down to €436m according to unquote" data - and activity all but dried up from the summer onwards. Year-end figures are still encouraging, with the total value of deals nearly doubling to €2.6bn year-on-year, but remain a fraction of the €4.3bn recorded in a tough 2009.

"2011 was very much a story of two halves as far as activity was concerned. The first half was reasonably buoyant (although with sharp differences from country to country) and the second half was quiet," sums up Mid Europa Partners managing partner Thierry Baudon.

"In line with activity in global capital markets, we saw CEE private equity dealflow soften in Q3-Q4 2011 as vendors delayed the sale of assets. Some of this sentiment has abated in Q1 2012 and my sense is that pipelines have improved in certain deal segments," notes Seewald.

He adds that - crucially - the AVG float was not the only bit of good news for the CEE private equity industry. Mid Europa managed to navigate a tough credit market and raise CZK 9.125bn (c€370m) in a dividend recap for T-Mobile Czech Republic. Seewald says: "This transaction illustrates the resilience and attractiveness of high-quality assets in CEE, and the banks' willingness to finance them." This is indeed no mean feat considering that dividend recaps have not been winning popularity contests post-financial crisis.

Economic woes
Despite these recent successes, the CEE market didn't manage to avoid the macro-economic turmoil that rocked private equity activity across the Continent. Financing was the first collateral casualty, as was seen in the rest of Europe. But it may be worse in CEE since the vast majority of local lenders are owned by Western banking groups, which may be forced to downsize and potentially offload some of their CEE outposts.

Economic issues are likely to remain on the minds of deal-doers for the best part of the year. Baudon is one of them - despite Mid Europa currently having three deals in the pipeline - but remains confident that CEE will keep outperforming more established markets come rain or come shine: "My main concern remains the total lack of visibility on the European macro-economic environment. If the situation doesn't improve in Western Europe, we'll still do somewhat better in Central Europe, but we will feel the impact in terms of currency volatility and access to debt finance," he said. "If Western Europe stabilises, we should also benefit in terms of dealflow, as a number of potential sellers presently sitting on the sideline will put their assets on the market."

Financing issues aside, the deterioration of the market in H2 had another effect, according to Baudon: a high level of currency volatility, especially for the two currencies that are the most liquid in the region (paradoxically in Poland and Czech Republic, which are among the healthiest markets in CEE), created an unwelcome element of uncertainty that is still lingering in the New Year.

"If Central European currencies (and particularly the most liquid ones such as the Polish zloty and the Czech koruna) continue to experience short-term movements as pronounced as those witnessed over the last 18 months, it will negatively impact the level of private equity activity," adds Baudon. "It will add another layer of complication in the assessment of new investments, and potentially hurt the Euro-denominated performance on exit."

Silver linings
But local players still saw more positive developments last year. For a start, the mid-market showed resilience to adverse conditions: contrary to what was seen in 2009 for instance, buyout activity was entirely concentrated on the small- and mid-cap segments last year, without a single mega-deal to skew the numbers. Piotr Noceń, co-founder and managing partner of Polish-based GP Resource Partners, concurs: "In terms of activity levels, I don't see a lot of variation in the mid-market space where we operate."

If anything, deals in the €50-500m range enjoyed a nice uptick last year, according to unquote" data: the €2.2bn worth of transactions in this segment trumped the €883m recorded in 2010, and came close to matching 2009 levels. Notable mid-cap deals included the €428m buyout of Emitel by Montagu Private Equity as well as the €370m SBO of Zabka Polska by Mid Europa, which both took place in March 2011.

Furthermore, the uncertain macro-economic environment and its impact on vendor behaviours may have been a blessing in disguise for well-established local players. "Auction processes all but disappeared in the second half, so several Western European private equity houses who entered the region a few years ago and still have limited presence on the ground lost access to dealflow," notes Baudon. "For us and a few other local GPs, this slowdown was more a blessing than a curse, since the majority of our dealflow is still sourced outside of formal auctions."

Widening gap
Of course, not all CEE countries fared equally activity-wise, for the market still remains divided. "The game is changing with regards to which countries continue to perform and which do not," argues Baudon. "In that sense there is a yawning gap between the likes of Romania and Bulgaria on the one hand, and Poland, the Czech Republic or Slovakia on the other. This is not entirely new, but the differential is expanding rather than narrowing."

Currency volatility issues aside, Poland is still the darling of CEE private equity - understandably so, given that the country's GDP grew at 4.3% in 2011. "Activity-wise, Poland had one of the strongest years in history. For other countries in the region however, there were fewer deals happening and transactions were smaller," says Noceń.

He adds that Poland saw several deals that had been on the market for a very long time finally reach completion in 2011, bolstering year-end figures. A case in point being Emitel: "The first time I heard it was for sale was 2001, and then every second year they were rumoured to be back to the market," he recalls.

This sustained bifurcation in the market is likely to remain a feature in 2012, with most GPs expected to keep focusing on the most attractive areas.

Baudon adds: "We see significant activity in the Central European corridor (Slovakia, Czech Republic), in Turkey, and to a lesser extent in Poland and the Western Balkans (Croatia, Slovenia, Serbia) - but very little outside those specific countries."

Join unquote" on 18 April in London for its sixth annual CEE Private Equity Congress.

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