Private equity funds in Central and Eastern Europe are struggling to keep the attention of emerging market investors dazzled by the returns made in the likes of Asia and Latin America. However, with CEE continuing to converge with Western Europe, the comparison with other emerging markets is starting to look incongruous.
Either way, fund managers in CEE insist (predictably perhaps) that although they expect to see some consolidation of the private equity (PE) industry in their part of the world, there's plenty of opportunity left, with the larger funds facing little problems raising new capital. It's simply a matter of weighing risk and return as CEE assets are re-rated as simply "European". "There is an increasing move in CEE's asset class towards core Europe," points out Przemek Szczepanski of Syntaxis Capital, "and that should continue."
Reflecting the views of investors and fund managers across the region, Alpha Associates partner Richard Seewald says that several of the CEE houses are due to go out to raise new funds, but it will take longer than in previous years. "Those with performing track records should prevail," says Seewald. "Although CEE doesn't present the same high growth opportunity as some of the BRICS, it does present the opportunity for attractive risk-adjusted returns and outperformance of Western Europe."
That last point is the answer of the local industry to recent reports that CEE is sliding alarmingly in terms of its attractiveness for emerging market investors. A survey by the Emerging Markets Private Equity Association (Empea) in April suggests CEE is now viewed as the least attractive of nine emerging market regions; Latin America and Southeast Asia took the top spots, with three-quarters of investors or more expecting them to produce returns of 16% or higher.
To a degree, suggests Szczepanski, it's a question of fashion. "Fundraising is tougher globally now. CEE has been hit more than most, but that's partly because the hot money is looking elsewhere." That view appears to be supported by Empea's survey, which says that whilst just 15% of all investors expect CEE to offer returns of 16% or more, amongst those that already have capital deployed in the region the figure jumps to over half of respondents. "We can clearly see that the overall pool of capital for CEE has significantly shrunk compared with the boom years of 2006-2007, when €6bn-7bn was targeting the region," Szczepanski says. "That won't come back, but it will be good if it stabilizes around €3bn-4bn."
That change in fortune for the region suggests that some of the myriad of fund managers tempted into CEE during the boom will indeed struggle. "The returns in CEE have been excellent over the last decade, but not as high in the last four years or so," points out Brian Wardrop of Arx Equity Partners, which raised its last fund in 2009 and has around 50% of it invested. "We do hear that appetite for CEE is not especially high right now. There will be fund managers that will not be able to raise follow-on funds."
That promises a rosy future for those who pull through however, with all commentators insisting that there's plenty to do in "core CEE" - meaning the EU members of the region. At the same time, Szczepanski suggests, "some more risk adverse investors, such as the large pension funds, are likely to head deeper into core CEE as convergence continues."
"For the survivors," Wardrop continues, "there will be less money chasing more deals. The shakeout will probably take a couple of years, after which we should see an attractive investment market in CEE for the next decade or more."
That predicted opportunity - which Wardrop suggests is particular to CEE as the masses of companies founded in the wake of communism in the early 1990s ripen for PE investment - means established fund managers plan little fundamental change in strategy. Instead, they view the investor pullback as temporary, driven by the crisis in Europe. "We won't dramatically extend our geographic base," the Arx man says. "There's lots to do in core CEE. What we aim to do is develop a deeper and increasingly systematic PE model in our core region."
Szczepanski concurs that core CEE has plenty to offer, but also suggests that interest in less explored markets in the region is also set to rise in some quarters. "There's likely to be some movement towards the more 'frontier' markets in [Southeast Europe]. When the hot money that is now going to Asia etc. returns after the European crisis, it will head to those markets."
Emerging and emerged
Szczepanski says that with core CEE in the midst of re-rating, it could be that the next round of fund raising will see some lines being drawn within the region. For instance, Roland Berger's "European Private Equity Outlook 2012" classifies Poland as a separate market within CEE, with the study showing the country attracted a full 7% of total European PE investment in 2011; the remainder of the region had to make do with sharing just 6%. "It would probably be easier right now to sell a Poland-only fund," he smiles, although adds that, "Romania and Bulgaria should present attractive opportunities in a couple of years."
CEE is, of course, not a homogenous market, given the different stages of development, but Seewald points out that one constant across the region is the catch-up process going on with core Europe, meaning "it makes sense for us to cover CEE and Russia comprehensively, giving our investors exposure across the cycle."
Wardrop, who picks out the Romanian retail sector as one to watch for PE deals in the medium term, says Arx also has no plans to restrict the remit of any future fund, although he acknowledges that through the crisis, that has been the de facto situation. "Since 2008, we've only made investments in Poland and the Czech Republic," he says, putting the blame firmly on the macroeconomic and banking environments in the rest of the region. "In those countries we can still leverage investments systemically, whereas finding the capital can be difficult somewhere like Hungary or Romania."
"Exits are much easier as well," he adds.