Investing In Central Europe: Too Hot, Too Cold, Or Just Right?

Nov 11 2010 | 10:58am ET

By Mary Campbell, Senior Reporter

Central Europe (CE) has a problem, says Armando D’Amico of Acanthus Advisors. To potential investors, it seems less safe than Western Europe but less exciting than Brazil, Russia, India and China. It’s “between two stools,” says D’Amico, whose company has been advising clients on European investment for over 10 years.

“If I speak to investors,” says D’Amico, “Those who have a global view say, ‘Look, if I wanted to do something more adventurous, what’s on my mind is Brazil, India, China to some extent.”

At the other end of the spectrum, says D’Amico, are investors who are very conservative and who say “Why should I invest in Poland or Hungary? I’d rather stick to good German funds, or the UK, or something more solid.”

And that’s CE’s dilemma—a good prospect but “if you want a real growth story you go to Brazil and India and China, if you want a conservative story, you go to Europe, and CE falls in between.”

Joanna James, managing director for Central and Eastern Europe for the global private equity firm Advent International, agrees with this summation of the situation:

“It used to be, up until a couple of years ago, that if I saw an article in the FT or somewhere that said ‘emerging markets’ in the headline, I would read it because I knew it was going to say something about Central Europe,” she says. “These days it never includes Central Europe—it’s Brazil, India, China—the whole of the Central Europe region is out of the emerging market definition as far as investors are concerned.”

Moreover, she questions whether you can even refer to Central and Eastern Europe as a region anymore:

“At the time of the financial crisis, the end of 2008, people tended to assume that the whole of the former Communist bloc must all be the same and so their currencies were treated the same and people fled from their markets and so on. In fact, Poland had the highest growth in any European country in 2009.”

The region is one of contrasts between countries like Poland, the Czech Republic and Slovakia, which James says are “doing pretty well,” and countries having greater difficulties because of their deficits like Bulgaria, Romania and Hungary.

“Then you’ve got the Baltics, where Latvia is in particular difficulties but Estonia is doing quite well, so you can’t even says there’s Central Europe, Southeast Europe, the Baltics—they’re all different buckets [and] depending on the economic and political choices made by governments in previous years they can be performing in fundamentally different ways.”

And yet, within this mixed bag of investment opportunities, there is still money to be made. Advent is still investing in the region and so is Brian Wardrop of Prague-based ARX Equity Partners. ARX was spun out of Deutsche Beteiligungs in 2008, and manages €102 million in the ARX CEE III fund.

ARX specializes in lower mid-market buyouts, but within this the firm has a sub-specialization in a rather specific area: succession-driven buyouts.

“That’s an area that is very, very interesting in terms of the demographic drivers of deal-flows and the characteristics of the succession-driven opportunities in Central Europe [which], in our view, are unlike anywhere else in the world,” says Wardrop.

ARX focuses on the sort of company that was started in the early ‘90s, particularly in the Czech Republic, by a group of friends or a group of managers privatizing a state-owned company. These founders were generally in their 30s when they launched what Wardrop calls their “entrepreneurial partnerships.”

“Now, if we fast-forward to today,” says Wardrop, “Fifteen or 20 years later, basically there’s a massive demographic boom in terms of entrepreneurs hitting 50…and the normal things start to happen over time—relationships break down in some cases, strategic objectives differ, lifestyle ambitions might differ, sometimes you have medical issues. The core of what we’re trying to do at ARX—basically our last five or six deals—is to partner with one or two managers that are the driven members of the team, [the ones] that have a vision in terms of taking the company forward for the next 4 or 5 years with us.”

ARX organizes LBOs in which they buy out the owners, with the keener managers, whom they term “reinvesting shareholders,” rolling over their equity stakes into the new buyout.

“If we think of our target market at ARX—basically companies doing over €10 million in sales and companies with at least one owner 50 years of age or older—due to the demographic shift and first-generation entrepreneurs hitting 50, there’s tremendous growth in those types of targets.”

Advent’s James also sees potential in the region:

“We can do really well by investing in individual companies—you know, we’re not investing in GDP. We’re constantly looking for the high-growth subsectors and these change over time. In the mid ‘90s, mobile telephony was an extremely high-growth subset; today it isn’t because it’s saturated. So what are we looking at today? We’re looking at things like healthcare services which, having not really got anywhere very fast in the past, are suddenly booming on the back of the fact that the states can no longer afford to maintain public health services and so people are increasingly turning to private health services.”

Wardrop says that while he’d agree CE is “between two stools” as an investment proposition, he doesn’t think that’s necessarily a bad thing:

“I think it’s a question of risk-adjusted returns…We see the region as less risky than some other emerging markets—like China, for example, clearly less risky—and though we’re certainly not seeing Chinese or Indian-style growth rates in the region, the region will grow faster than Western Europe over the foreseeable future….It’s basically developed market risk with—maybe not emerging markets growth on par with China and India—but still growth that is higher than in Western Europe.”

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