Go East young man?

A question is vexing the minds of institutional investors: how much – if any - of my European portfolio should be in the East? Andy Thomson reports.

Amongst many other subjects under discussion at the recent European Private Equity and Venture Capital Association (EVCA) Symposium at London’s Hilton Metropole hotel, was the rate of progress made by the private equity markets of Eastern Europe. One theme upon which all delegates could agree on was that maturity and intense competition increasingly characterised many Western European markets. Could the relatively immature East, they pondered, deliver racier returns?

Certainly, there was a strong feeling that now is crunch time for many institutional investors. In recent years, some have been bold enough to add Eastern European allocations to their overall European mandate – a development that has unsurprisingly gathered pace since the accession of ten countries in the region to the European Union early last year. Nonetheless, many said from the outset they would only back successor rather than debut funds – leaving the GP trailblazers to raise their first capital pools mainly from organisations such as the European Bank for Reconstruction and Development (EBRD) and the European Investment Fund (EIF). But many of these first funds have now been fully or almost fully invested, and as the GPs in question come back to market, so they will be testing whether the attitude of international blue-chip LPs has shifted.

There is some evidence of positive change already. When Warsaw-based Enterprise Investors closed its second €300 million fund in June last year, it managed to lure in heavyweights such as AlpInvest Partners, CalPERS and Partners Group. Mind you, Enterprise Investors is acknowledged to be one of the leading – if not the leading – GP group in the region. As such, one should not necessarily extrapolate too much from this isolated example. 

In reality, there are still a number of questions in investors’ minds. While countries such as Poland and Hungary have demonstrated a strong entrepreneurial culture since wresting themselves from the yoke of Communism, other nations – the Czech Republic was, perhaps surprisingly, cited in this context – have flattered to deceive, showing themselves to be more economically conservative than many observers had envisaged. In addition, many of the most successful deals thus far have taken place in the telecom sector. What happens, ask LPs, when the flow of such deals begins to dry up – as, in all likelihood, it will. What is more, investors demand not just equal returns to what they would get in Western Europe, but some kind of premium in light of the added risk.

Nonetheless, there are encouraging signs. Enterprise Investors in particular has demonstrated through a number of successful exits that the Warsaw Stock Exchange is becoming an increasingly attractive exit option for private equity firms. And realisations are being boosted in other ways: international trade buyers are being reported in increasing numbers, whilst the secondary buyout is also appearing on radar screens: witness the sale of cable firm Aster City by Argus Capital Partners to Hicks, Muse earlier this year.

Viewed in tandem with the appearance of more debt finance teams such as Erste Bank and Bank PeKao, as well as mezzanine funds run by the likes of Darby Investments and Mezzanine Management, one gets a sense of a region maturing fast. Whether fast enough to generate sufficient interest from international LPs to make fundraising a breeze for a majority of Eastern European private equity funds next time round remains to be seen. But the question of whether to go East is certainly becoming a talking point.