Private equity in Central and

Eastern Europe: a widely

misunderstood market
by Petra Salesny, Alpha Associates AG

There was almost unanimous consensus in the press a year and a half ago
that Central and Eastern Europe (CEE) was facing economic disaster and
would probably go under. Well, it did not. And the private equity market in
particular, given its characteristics, has withstood the crisis well.

39 First of all, CEE is not a homogeneous block, but made up

of a number of countries with very different
macroeconomic fundamentals and prospects. The global
financial crisis has further highlighted the differences.
While countries with weak fundamentals like the Baltic
States and Ukraine suffered severely, countries which
exaggerated – is still delivering good results on average.
All the top seven players by assets, controlling around
one-third of total assets in CEE, were profitable in Q1 2010
and improved upon the performance of the previous
months; in fact, all with one exception were profitable in
2009 as well. The CEE banking sector will not be an

previously did not overheat, have relatively healthy local impediment for the development in the region in the

banking sectors and the flexibility to aggressively loosen coming years, but rather be able to provide some stimulus
for the countries with a more solid industrial sector.
monetary conditions are doing well, some of them in fact
strikingly well. Poland was the only country in all of Europe
boasting GDP growth in 2009 and is expected to grow 2.6%
in 2010 and 2.8% in 2011 according to UniCredit.
UniCredit’s GDP growth forecast for the entire CEE region is
3.1% in 2010 and 4.3% in 2011, while the Eurozone will
probably stagnate and at best grow by 1% this year. With
the exception of 2009, where net exports were the largest
contributor to the Polish GDP growth, private consumption
and secondly investments have been the largest
contributors over the past five years, and private
Dr. Petra Salesny, Managing Partner
consumption is forecast to continue to remain the most
Alpha Associates AG
important driver of GDP growth in 2010 and 2011.
tel: +41 (43) 244 31 03
The CEE banking sector, considered the Achilles’ heel of
e-mail: petra.salesny@alpha-associates.ch
the region – one year later it is clear the concerns were

CHAPTER 7 I EUROMONEY HANDBOOKS

 GDP growth in CEE countries Exhibit 1

2
% y-o-y change

–2

–4

–6

–8

–10
Bulgaria Czech Hungary Poland Romania Russia Slovakia Slovenia Eurozone
Republic
j 2008 j 2009 j 2010 j 2011

Source: UniCredit 40

GDP growth contributors in Poland Exhibit 2

8.0
6.8
6.2
6.0
6.8

4.0
3.7
3.6
2.5
2.0
%

1.8

0.0

–2.0

–4.0
2005 2006 2007 2008 2009 2010 2011
j Private consumption j Public consumption j Investments
j Change in inventories j Net exports — GDP growth
Source: CASE

CHAPTER 7 I EUROMONEY HANDBOOKS

 Russia is expected to nearly return to its growth level in
2008 by 2011, with GDP forecast at 5% by UniCredit. Troika
forecasts GDP growth of 5.2% for Russia in 2010 already.
The countries with the strongest economic fundamentals
and prospects in the region are Poland, the Czech
Republic, Slovakia, as well as Russia and Turkey. Recovery
in Bulgaria and Romania will take longer and is not
expected to occur before 2011. However, Romania is
expected to show year-on-year GDP growth of more than
3% in 2011. Notably, contrary to widespread perception,
government and household debt figures, with the
exception of Hungary, are more solid in all the CEE
countries than the average in the Eurozone. Public debt as
a percentage of 2009 GDP in Poland, the Czech Republic,
Romania and Russia, the largest economies in the region,
is well below the levels in each of Germany and the UK and
dramatically below the levels in Italy and France.
41
Statements in early June about Hungary defaulting and
being in a similar position as Greece have been widely
dismissed as exaggeration, and the Hungarian government
has announced a renewed fiscal squeeze. In Greece, public
debt as a percentage of GDP is expected to reach 150%
over the coming months. We do not expect any contagion
risk from Greece on most countries in the CEE region. The
only two countries that may be affected are Bulgaria and
Romania. Trade ties are small; according to Capital
Economics, Greece accounts only for 10% of Bulgarian
exports and less than 2% of Romanian exports. However,
there are financial linkages; it is estimated that Greek
banks account for around 20% of total banking assets in
Bulgaria and 15% in Romania, which will likely cause a
tightening of credit conditions.
Over the past 12 months, the major local currencies have
stabilised and strengthened against the euro, and the
stock exchanges have shown a strong recovery from their
lows at the beginning of 2009, with the Polish WIG, the
Czech PX index and the Russian RTS almost back to their
mid-2008 levels.
CHAPTER 7 I EUROMONEY HANDBOOKS
Pre-crisis private equity
investments have held up well
Private equity investments made in CEE pre-crisis have
generally withstood the crisis well and overall fared better
than those in the developed markets. There are two main
reasons for this: one factor that has always distinguished
the private equity market in CEE from Western Europe and
the US, and recently also emerging Asia, is that it has
never faced a capital overhang. Deal competition has
therefore been lower and entry valuations generally more
attractive. Fundraising volume has grown steadily until
2008; nevertheless, total fundraising volume for private
equity investment in CEE and Russia/CIS combined
reached only US$5.5bn at its peak in 2008, representing
only a fraction of the size of some single buyout funds
raised in Western Europe or the US. The volume raised in
2009 dropped to US$1.2bn. Total fundraising volume for
private equity investment in western Europe was €79bn in
2007, according to the EVCA, €80bn in 2008 and €16bn in
2009. For private equity investment in emerging Asia,
according to EMPEA, US$29bn were raised in 2007,
US$40bn in 2008, and US$16bn in 2009.
The other distinguishing factor is that the level of leverage
deployed in private equity transactions in CEE has always
been conservative, typically not exceeding 3-4x EBITDA
even in buyout transactions on the large end of the
Eastern European scale. As competition and pricing were
less fierce than in the western markets, fund managers
were not under pressure to deploy aggressive amounts of
leverage into buyout transactions to achieve their return
targets. In addition, revenue and EBITDA growth of target
companies were stronger. As an example, in 2007, the
median EBITDA growth rate in the portfolio companies of
our current CEE fund-of-funds was 30%. Financial
engineering and ‘covenants light’ were not an important
topic in Eastern Europe. In South Eastern Europe and
Russia private equity deal flow continues to be dominated
by growth capital investments, where little or no leverage
is deployed. Therefore, debt service or refinancing issues
have been the exception rather than the rule in the
portfolios in the region.
CEE and Russia/CIS are two distinct look it becomes evident that CEE does not quite fit the

private equity markets
When talking about private equity in Eastern Europe it is
important to note that the private equity market of CEE is
distinct from the private equity market of Russia/CIS in a
number of ways. The types of investment opportunities
available, the managers that operate in each of the
markets and the risk/return profile of private equity
investments differ substantially. CEE private equity funds
are country funds, multi-country funds or regional funds
and typically have a focus on the member countries of the
European Union (EU) and no allocation for investment in
Russia or other countries of the former CIS.
Russia-focused private equity funds typically have
allocations to invest in other former CIS countries, but do
not invest in the countries of CEE. When taking a closer
emerging markets category any longer, but given the stage
of the development of the private equity market and its
characteristics, should rather be considered an emerged
market, while Russia clearly remains an emerging market
like China or India. All the countries of CEE have
democratic governments, most of them are EU members
today and have adapted their legal and regulatory
frameworks to EU standards, ownership and intellectual
property are fully protected, strong corporate and
bankruptcy laws have been introduced, and law
enforcement and judicial process are continuously
improving. International accounting standards and
corporate governance standards are widely accepted, and
western professional service providers operate throughout
the region. In addition, the private equity industry in CEE is
today 20 years old meaning there is a number of

Alpha Associates, based in

42
Zurich, Switzerland, is an inde-

The best way to pendent private equity fund-

of-funds manager and advisor.
We build and manage globally

Central and Eastern diversified private equity fund

portfolios for institutional and
private clients.

Europe leads Alpha Associates is the lea-

ding private equity fund-of-
funds manager for Central and
through Zurich. Eastern Europe. We have in-
vested and managed over 400
million Euro in more than 60
fund and direct investments
in Central and Eastern Europe
since 1998. Take advantage of
our experience.

Alpha Associates AG
Talstrasse 80
P.O. Box 2038, CH-8022 Zurich
phone: +41 43 244 31 00
info@alpha-associates.ch
www.alpha-associates.ch

CHAPTER 7 I EUROMONEY HANDBOOKS

 Performance comparison of private equity markets Exhibit 3

50
45
40
35
30
25
%

20
15
10
5
0
3 yr 5 yr 10 yr
–5
j EBRD Russia/CIS j EBRD CEE j CA Asia (ex-Japan)
j CA Latin America j CA US

43 Note: The European Bank for Reconstruction and Development (EBRD), London, is the largest private equity investor in CEE and
Russia /CIS, with aggregate commitments as of over €2bn. EBRD data is the most representative sample of private equity
returns in the region.

Sources: End-to-end returns in %, net of fees and expenses, as of December 31, 2008; Cambridge Associates,
EBRD Fund Performance Report 2008 (in US$).

experienced private equity fund managers operating in the
region today who can demonstrate the necessary skills and
experience and, most importantly, realised track records.
The industry has undergone a wave of consolidation since
its beginning in the early nineties, there is a survivor bias
among the fund managers operating in the region today,
and investors do not have to pay the cost of a first time
fund manager’s learning curve any longer. This is why,
based on data of the European Bank for Reconstruction
and Development (EBRD) and Cambridge Associates,
eastern Europe, aside from Russia, is the only emerging
market where the sought-after risk premium has indeed
been earned by investors.
In terms of the investment opportunities, CEE is a
developed market today, where leverage and mezzanine
capital are available. Target companies are profitable,
cash-flow positive businesses, and the investment focus is
on buyouts and late stage expansion financing. Russia, on
the other hand, is still a typical growth capital market, like
China or India. Although the universe of fund managers in
Russia is substantially smaller than that in emerging Asia,
it has the advantage of being relatively mature, with some
fund managers having already been active since before the
1998 Russian crisis, having successfully managed their
portfolios through the Russian crisis, and a number having
emerged after the Russian crisis and gone through at least
one full investment cycle already. Competition from
pan-European funds is very low in both the CEE and
Russian markets as the private equity opportunity is
dominated by small and mid-market buyouts, which
happen below the radar screen of the very large
pan-European buyout groups. And when it comes to
mid-market buyouts in the region, local groups with a local
presence and local knowhow have a clear competitive
advantage in accessing and executing transactions.

CHAPTER 7 I EUROMONEY HANDBOOKS

 Private equity performance pre- and post-1998 Russian crisis Exhibit 4

180

160

140

120

100
US$m

80

60

40

20

0
Agriculture Construction Consumer Manufacturing Pharm Primary Services TIM Wholesale
& forestry & medical & energy & retail
j Cost 1996-1998 j Total value 1996-1998 j Cost 1999-2002 j Total value 1999-2002

Source: EBRD, in US$m

44

Russian private equity has strategic buyer looking for a foothold in Europe’s largest

outperformed and most promising consumer market.

Russia probably suffers from the worst international

Clearly the legal, regulatory and political risks in Russia are
investor perception of all countries in the world, excluding
substantially higher than in CEE, however, the risk/reward
those not deemed investable at all. Only the investor who
profile appears to be intact, as proven by data of the EBRD
is willing to take a closer look at the fundamentals and
and Cambridge Associates: over the three, five and 10-year
characteristics of the private equity opportunity and who
horizon, Russia/CIS has been the best performing private
can get over and beyond the perceptional and sentimental
equity market globally, generating higher net returns in
hurdle will be able to appreciate the opportunity. Russia is
US$ than all other emerging markets and the US, and,
one of the most overlooked private equity markets as the
based on data of the EVCA, higher returns than Western
discrepancy between perceived risk and actual risk is
Europe measured in euros.
significant. Investors can therefore benefit from a number
Successful managers in Russia are those who have trodden of inefficiencies.
carefully in choosing their investment targets; who have
avoided strategic and politically sensitive sectors – and
strategic economic sectors are politically sensitive not only
The post-crisis investment
in Russia, but practically any country in the world; and who
environment is very attractive
have worked hand in hand with local entrepreneurs to grow So what are the opportunities post-crisis? The convergence
their businesses and prepare them for an exit to a Western story remains intact in CEE, the Central European countries

CHAPTER 7 I EUROMONEY HANDBOOKS

 are already back on their growth path and so is Russia, and
over the mid and long term the region will grow
significantly faster than western Europe or the US. The gap
between capital supply and demand has widened further,
resulting in a decline in entry valuations, which sets the
region aside not only from the western private equity
markets, but also emerging Asia, where huge amounts of
capital have been raised and are waiting to be deployed
over the next years. In the portfolio of our current CEE
fund-of-funds, the average entry valuation in 2009 was
only 5.6x EBITDA.
This is not the first crisis CEE and Russia have seen, and
valuable lessons can be learnt from prior crises: portfolio
data of the EBRD, the largest private equity investor in the
region with commitments of more than €2bn, shows that
investments made in CEE in the vintages pre-2001 crisis
have generated good returns; but the post-crisis vintages
have generated even higher returns. Further, investments
45 in the years preceding the 1998 financial crisis in
Russia/CIS have performed well, but investments
post-1998 crisis have performed exceptionally, as shown in
Exhibit 4: it compares the cost of investments made in the
years 1996-1998 by the EBRD in Russia/CIS versus the
value realised from these investments and the cost of
investments made in the years 1999-2002 and the value
realised from these investments. What could be observed
CHAPTER 7 I EUROMONEY HANDBOOKS
in CEE after 2001 was that investment in cyclical sectors
declined, while investment in consumer products and
services and the retail and distribution sectors continued
or grew. In Russia, currency devaluation spurred
investment in the local consumer-oriented sectors
post-1998 as imports became expensive, equally creating
positive impulses for local consumer-oriented industries.
We are in the post-2008 crisis window today, and we
believe history does repeat itself. The private equity
opportunity in the region is comparable to the post-2001
and post-1998 crises opportunities in terms of the
attractiveness of entry valuations, however, the economies
in the region are incomparably stronger today and
investors can back fund managers with track records
exceeding 15 years.
Contact us:
Alpha Associates AG
Talstrasse 80, PO Box 2038
CH-8022, Zürich, Switzerland
tel: +41 (43) 24 31 00
fax: +41 (43) 24 31 01
web: www.alpha-associates.ch
e-mail: info@alpha-associates.ch