Baltic boasts Nordic nuance

"There is ever the debate whether the Baltic region classifies as an emerging or emerged market," says Kaido Veske, an investment manager at Livonia Partners (previously LHV Capital). "From an investment climate perspective – property rights framework, legal enforcement and the tax system – the region is emerged. From an investment opportunity perspective, the region is emerging."

Despite positive sentiment from local players, the Baltic countries remain an untapped market for the asset class. Private equity investment makes up just 0.046% of GDP in the region, according to Veske, citing data provided by EVCA and PEREP Analytics: "Private equity investment as a percentage of GDP in the Baltic states is more than 7x lower than the EU average and more than 20x lower compared to the UK."

Development finance institutions (DFI) such as the European Bank for Reconstruction and Development (EBRD) and the European Investment Fund (EIF) have been active in the region for a long time and, alongside the governments of the three countries, are making efforts to establish a healthy private equity industry. EIF's €100m Baltic Innovation Fund, a fund-of-funds established in 2012, includes €20m investments from each of the three Baltic countries' governments.

"In terms of a bridge between east and west, the Baltic region is very well positioned, and it's getting more and more integrated into the Nordics and the rest of Europe in terms of its export market," says Anne Hutton, a senior banker in EBRD's equity funds team. "The Baltic states have taken the difficult decisions early, gone through a tough time with fortitude, and they are now emerging to benefit from the growth that the economies are on track to go through."

The region's close ties with Scandinavia, as well as its positioning within the CEE region and trading relations with larger markets in both the east and west, all mean that an ideal ecosystem for private equity investment is on the horizon. According to BaltCap managing director and CEO Peeter Saks, the region looks likely to emerge as a "New Nordics" for the asset class in only a few years' time.

New blood
"We hope that within one to three years there will be five to seven new funds active in the market," says Margus Uudam, chairman of the Estonian Private Equity and Venture Capital Association (EstVCA). "We're already seeing new teams coming to market, and they're really cross-border teams with partners from eastern European countries and Scandinavia.

"Out of the five to seven new funds expected, maybe four to five will be new teams with sufficient experience to set up a fund."

EBRD began efforts to establish a sustainable private equity industry in the 1990s, but a lack of previous experience from firms and poor investment climate meant that mistakes were made. However, a second wave of private equity firms is already emerging in the Baltic region, with a greater understanding of the industry and teams made up of more seasoned players.

Local presence and a local track record are fundamental to attract LPs, says Veske, "but at the same time you want people with the discipline of the west – from western investment banks or private equity funds."

Baltic Tigers
After the Baltic countries regained independence from the Soviet Union in 1991, their governments embarked on a mass privatisation initiative. State-backed assets were sold off in droves, becoming private entities as well as listing on the public market.

EBRD took part in the privatisation process, establishing the Baltic Post-Privatisation Fund in 1996 to invest in the growth and restructuring of these privatised companies. "EBRD's post-privatisation fund was quite similar to the early funds of BaltCap – Baltic Investment Funds I-II," says Saks, who served on the board of EBRD's Baltic Post-Privatisation Fund.

The first Baltic Investment Fund was established around the same time. In those days, Saks managed pan-Baltic investment bank Suprema Securities, which helped both funds seek investments. "Suprema people became part of both fund management companies, but my focus ended up on the Baltic Investment Fund side that eventually grew into what BaltCap is today."

The emergence of the Baltic Tiger economies in 2000 got the ball rolling for the private equity industry in the region. Year-on-year GDP in Estonia, Latvia and Lithuania grew by 9.7%, 6.1% and 12.3% respectively in 2000, according to the EU's official statistics body Eurostat. This economic boom continued until 2008 – with all three countries joining the EU in 2004 – but crashed when the financial crisis triggered one of Europe's most severe recessions through the collapse of the region's property market.

Phoenix rising
In 2011, Estonia once more became a Baltic Tiger when GDP skyrocketed by 8.3% – more than five times that of the EU as a whole. Latvia and Lithuania were not far behind, however, with GDP growing by 5.5% and 5.9% in the same year. All three countries have experienced the fastest growth rates in the EU following the economic crash.

And as the economies continue to grow, Baltic companies have begun seeking capital and an opportunity for equity release, as businesses established in the nineties begin to look at succession plans. "There is a constant demand for growth equity, and there are also more and more buyout opportunities," says BaltCap's Saks. "Some foreign owners are restructuring their business to focus on core or domestic markets and are looking to sell, while others would like to enter.

"Also, there are financial investors seeking to exit the investments of their older funds, and local private investors who, having built their companies to certain size, would like to sell now. So there are plenty of deals to be done."

Look out for the second instalment of our Baltic series tomorrow.

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