Private equity may still be very much an alternative asset management class in south-east Europe, but there are increasing signs that it will come of age in the next few years.
Although the region accounted for less than 1% of the $33.2 billion raised by emerging market private equity funds in 2006, there are a growing number of practitioners looking to enter the largely untapped markets in the region. And even frontier markets such as Albania are now beginning to appear on the radar screens of private equity fund managers, as they seek to take advantage of the strong regional macroeconomic fundamentals to tap into companies with high-growth potential.
Much remains to be done, however. “Private equity is still very much in its infancy in the region,” says Zoran Mitic, director of South East Europe Capital Partners (Seecap), a Belgrade-based corporate finance advisory firm, whose activities include identifying suitable targets for private equity investment in Serbia.
Signs of interest
But he says that the country is increasingly attracting attention from funds looking to diversify their exposure away from the more established and more competitive markets of central Europe. “We’re starting to receive expressions of interest not just from small regional funds, but also major US and European private equity funds,” he says.
At present, though, Mitic says that Serbia is likely to remain the preserve of regional specialists, given the relatively small scale of the companies in the country. “In Serbia there are lots of companies that could cope with a E1-5 million investment, far fewer with E5-10 million-type requirements, and still fewer with E10 million-plus funding needs,” he says.
Serbia is just one of the countries in the region being targeted by KD Private Equity, which is looking to raise E70 million by this summer to provide expansion capital to mid-market companies in Albania, Bosnia, Bulgaria, Croatia, Macedonia, Moldova, Montenegro, Romania, Serbia and Slovenia. Seed investors in the fund include parent company KD Group, a leading Slovenian asset management group with over E850 million under management. Co-investors include major Slovenian banks and the Swiss government development fund Seco.
Matjaz Peterman, managing partner of KD Private Equity, says that the lack of major investment targets in the region – he estimates that there are probably no more than 50 or so companies big enough to attract investments in the E100-150 million range – means that small regional specialists like KD Private Equity should be able to establish a track record of successful investments and exits, without having to compete against the financial might of the big global private equity houses.
Challenge
Having met with over 100 potential investors in the course of fundraising for the new fund, however, Peterman says that selling the concept of private equity investment in a largely untested environment remains a challenge.
One of the difficulties facing private equity start-ups in south-east Europe is that the pension fund and life insurance industries – the principal source of private equity backing in western Europe – are still relatively underdeveloped. For their part, western European insurers and pension funds typically look to put large amounts of money to work, so many of the investments targeted by KD Private Equity fall below their minimum investment threshold.
Another hurdle is that the public equity markets in the region remain rather shallow and illiquid, such that the primary exit will have to be via the strategic investor rather than the initial public offering route.
On a more positive note, Peterman says that one very significant advantage the south-east Europe region possesses compared to other emerging markets, such as the Bric countries – Brazil, Russia, India and China – is the fact that the countries in the region are all hoping to join the European Union, which is helping to create an increasingly positive investment climate, characterized by high economic growth, higher asset valuations and a stable, predictable political and legal environment – all strongly supportive for private equity investors.
KD Private Equity is looking to acquire major or controlling stakes in basic industries such as construction, engineering, financial services, food processing, healthcare, distribution and logistics, and telecommunications and media. “These are all sectors which have high growth potential and are attractive to trade buyers,” says Peterman. “Given the relatively small size of companies in the region, you have to adopt a generalist rather than a sector-specific approach.”
Exit strategy
Investments will typically range from E3-15 million, big enough to be exitable, while small enough to form part of a proprietary pipeline, although Peterman says the fund will also look at non-proprietary deals on an opportunistic basis, either leading or joining a consortium on E15 million-plus transactions. Ideally, the firm will target companies with an established track record and brand name in their particular market niche, with a view to exiting them after three or four years. “We’re not looking to be long-term investors, so we won’t be looking at infrastructure or real estate development projects,” says Peterman.
He emphasizes that, given the frontier market nature of much of south-east Europe, it’s imperative to have a combination of a local presence and local knowledge, which enables a hands-on, active management approach. “All the members of the KD Private Equity team have a background in running companies in the region – you must be able to replace key personnel if something goes wrong,” he says. “We intend to do more than just reconstruct balance sheets – anyone can do that.”