Mid-market consumer deals drive Turkish PE activity

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Despite a handful of large-cap deals and exits in Turkey this year, the bread and butter of local private equity firms continues to fall in the mid-cap segment, with Abraaj Group's and many other players' strategies clearly committed to mid-market companies. "GPs targeting the segment find a breadth of opportunities and can be very selective," says Anne Fossemalle, EBRD's director of private equity funds. "Because the supply of investable companies still exceeds demand from private equity, even in spite of recent growth in the number of GPs, they can still take their pick."

According to Abraaj managing director Omar Syed, the mid-market is by far the largest sector: "More than 90% of companies are SMEs and more than 75% of employment is created by them." He adds that the country is still under-penetrated by private equity: "It comprises less than 0.4% of GDP." Abraaj backs local businesses that have the potential to expand regionally. An example is dairy products producer Yörsan, which the GP acquired in 2014. Due to the government's investment in infrastructure, main roads connecting the remote factory in Susurluk Balıkesir with other parts of the country have made expansion much easier, according to Syed.

Consumer in the lead
It is businesses such as Yörsan that investors in Turkey are most positive about, with the consumer sector being the most popular. "This could be anything from food staples to casual dining chains, anything that targets low and middle income consumers," says Mediterra managing partner Ahmet Faralyali. The statement is in line with the most recent additions to his firm's portfolio. In December 2015, Mediterra acquired a 51% stake in restaurant chain Tavuk Dunyasi, via its subsidiary Global Restaurant Investments, with aspirations to expand the business into other countries. Earlier that year, it also bought flour producer Söke Un.

Other notable deals in the consumer sector in 2016 included Bridgepoint's buyout of Peyman, a producer of packaged dried fruit, nuts and seeds. In a recent deal in September, Taxim Capital bought a 40% stake in casual dining chain Big Chefs. The deal was noted outside the country as the first larger private equity transaction inked after the coup attempt.

There has been a price decline for assets. Potential sellers are willing to accept lower valuations compared to two or three years ago, but very good assets still go at very good valuations" – Ahmet Faralyali, Mediterra

Faralyali says it is especially the everyday goods segment that investors are looking for, rather than businesses affected by discretionary consumer demand, as consumer confidence has experienced hits due to the political and security uncertainty in recent years. "A lot of private equity firms also talk about investing in export-driven-manufacturing," Faralyali says, but adds that getting those deals presents difficulties, as Turkey has few companies that have a competitive advantage that enable good returns.

Besides the consumer segment, demand for financial services companies is expected to be on the rise, highlighted by deals such as Abraaj's acquisition of Fibabanka. EY partner Demet Ozdemir adds that local technology companies are also starting to catch the eye of investors.

Uncertainty about pricing
It is still too early to say whether the coup attempt has had an impact on asset pricing. However, it could be argued that the general uncertainty affecting the country has a downward effect. Speaking of the past few years, Mediterra's Faralyali says: "There has been a price decline for assets. Potential sellers are willing to accept lower valuations compared to two or three years ago, but very good assets still go at very good valuations."

Fossemalle disagrees, arguing she has not witnessed a drop in prices: "It is too early to say whether there will be longer-term consequences for pricing after the coup attempt, but, for now, the prices have been steadied by the recent growth and the fact that, coup or not, GPs still have significant investable capital to deploy."

EY's Ozdemir has a slightly different view: "Until now, the valuation expectations have been high and Turkey was a sellers' market. I expect that to change to a certain extent. The reason for that is not only the valuation expectation, but also the growth opportunities, as businesses have to attract foreign consumers in their growth scenario."

What now?
Abraaj's Syed expects the biggest challenges for Turkey in the months to come will be the country's credit rating, consumer confidence and the currency situation.

Rating agency Moody's downgraded Turkey's credit rating to Ba1 (junk) in September, naming worries about the rule of law following the coup attempt and the potential risks of a slowing economy as the reasons behind the downgrade. This could have a negative impact on investment activity from players outside the country and heighten the cost of borrowing money in international markets. Turkey's government called the decision highly unfair.

According to a survey by the Turkish Statistical Institute and the Central Bank of the Republic of Turkey, consumer confidence eased marginally in September. The consumer sentiment index fell slightly to 74.3 from 74.4 in August, after climbing up from 67 in July. It hit a six-year low of 58.5 last September.

It is going to be a busy year, because of the total high number of private equity houses that have already raised funds to be deployed in the Turkish market" – Demet Ozdemir, EY

The Turkish Lira, meanwhile, hit a record low against the dollar in October due to fears over the political uncertainty and the US Federal Reserve's possible interest rate hike.

Despite the turmoil in recent months and years, EY's Ozdemir expects the situation in Turkey to pick up in 2017: "It is going to be a busy year, because of the total high number of private equity houses that have already raised funds to be deployed in the Turkish market. Also, a number of expected exits in the months to come should bring good returns and increase the appetite of all players."

Mediterra's Faralyali, on the other hand, expects struggles to continue in 2017: "We are still dealing with terrorism on three fronts and don't know whether the Fed will raise interest rates. Also, the outcome of the US election will impact its policies in the Middle East and Syria and its relations to Turkey. The uncertainty around politics impacts businesses." Nevertheless, Faralyali remains hopeful in the longer term: "The economy is growing at 3% and our portfolio companies are growing 15-20%. There will be a window of opportunity in three to five years where we will have clearer skies and international investors will look more positively at Turkey having seen that the country continues to grow."

Such is the conundrum currently faced by Turkey: while most LPs and local practitioners agree that long-term growth and business drivers remain appealing, the current turmoil faced by the country means pain will most likely come before gains in the more immediate future. The success or struggle of local GPs hitting the fundraising trail in 2017 should go some way towards hinting at whether LPs are willing to keep playing the long game.

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