2. ANALYSIS
2.2. C ENTRAL E UROPEAN MARKET
In this part of the thesis we will try to analyze trends which are undertaken by private equity firm focusing on Central European region in LBO transactions. As most of the trends were extensively described in previous subchapter here we will try use examples upon which we will prove their presence or absence in Central Europe. While considering trends we should be able to find answers to questions raised in introduction.
In order of clarity, under term Central Europe we understand 15 countries spanning from Baltic to Adriatic Sea and from eastern borders of Germany to Black sea coast in the east46. Data for these markets are gathered together as separately these economies are not interesting even negligible from private equity point of view. Even overall Central European data are nowhere near numbers regarding European or US M&A markets.
For our analysis we will use mostly data from Mergermarket as this is local variance to Dealogic and Thomsons Financial for Europe and US markets respectively. In most of the trends we will use simple examples as deals are still scarce and won’t suffice for any statistical analysis.
Overall emerging markets accounted for USD 619bn of deal value in 2006 of which only fraction was contributed by Central Europe. Graph 18 shows that number of deals in Central Europe develops slightly differently than global market. First of all there is no cyclical development which corresponds with ever-faster growing economies of involved countries. Their GDP growth rates exceed those of EU and USA usually by 100 percent. As prospects are getting only brighter (e.g. Slovakia expects 10 percent GDP growth in 2007) we should see further expansion of M&A activity.
46 Precisely we mean economies of Czech Republic, Poland, Slovakia, Hungary, Estonia, Latvia, Lithuania, Slovenia, Bulgaria, Romania, Croatia, Bosnia-Herzegovina, Macedonia, Serbia and Montenegro and Yugoslavia.
Graph 18: Number of deals in Central Europe.
Leveraged transactions are fairly recent development in Central Europe as there were plenty of other distractions which private equity funds embraced47. First, during early 1990s and continuing (although in smaller scale) even today, there was a privatization.
Era can be described as learning by doing time. Western government sponsored maturing of the market) started only in 2003. This is the era of leverage (as shown on Graph 18) with doubling the number of leveraged transactions in 2003 and 2004.
Maturation of M&A market with introduction of true leveraged financing will continue for several years from now on.
47 As mentioned in EMPEA (2006). Described development can be also viewed as stages of maturing of the market, from rough 1990s to standard private equity / M&A.
As seen on Graph 18, 2006 was not the record breaking in terms of deals numbers, but it was similarly to global buyouts market records setting pace in regards of deal size48. Dip in number of transactions is partly caused by fund raising focus of private equity managers but most importantly and especially in 2006 it is due to realizations of funds’
investments. Exiting from first wave investments will be succeeded by buying focus in 2007 and probably 2008. Statement is supported by findings of Deloitte Central European Private Equity Confidence Survey (see chart below).
Although, not substantially Central European private equity industry is exceptional in terms of targets pursued. Besides general characteristic of going after market leaders, Central European funds tend to look more on middle size and family or management held companies which are acquired through management out or management buy-in.
Graph 19: Investors’ activities.
-20 40 60 80 100
Mar'03 Sept'03 Mar'04 Sept'04 Mar'05 Sept'05 Mar'06 Oct'06 period
%
Buy more Buy and sell equally Sell more
Source: Deloitte (2006c).
Multiple analyses in case of Central Europe should be taken with pinch of salt. Due to low deal numbers average is strongly affected by the biggest or the smallest transactions. Overall development since 2000 is erratic with frequency of ups and downs at two years period. We should expect smoother development in 2007 as deals and multiples should continue to rise. In 2006 for example, revenue multiple is strongly affected by purchase of Radiokomunikace, a.s. and increased by more than one
48 Purchase of Radiokomunikace by consortium of private equity investors which will be detailed further below.
turn. On the other hand it only strengthens the overall effect as multiples rise in recent years49. Therefore we would rather focus on average deal values of the acquired companies. As shown on Graph 20, size of company subject to LBO increased significantly in 2006. This trend should continue in 2007 as funds will try to utilize their resources and go after bigger companies, a trend started by the end of 2006 with purchases of Aero, Radiokomunikace and BorsodChem (EUR 465.6m, EUR 1,190m and EUR 674.3m respectively).
Hand in hand with increased size and primarily due to discovering of LBO possibilities in Central Europe, increases in Debt to EBITDA and Enterprise value to EBITDA should be expected.
Graph 20: Average deal value of company acquired in LBO.
Besides above mentioned trends we would like to point out several other (as mentioned already in previous part). Club deals are appearing fairly regularly over last couple of years and clubbing should continue as a main facilitator of bigger LBOs in 2007 and 2008. The best example of it is acquisition of Radiokomunikace, a.s. in December 2006 by consortium of investors consisting of Mid Europa Partners LLP (one of the largest private equity investors in Central Europe), Lehman Brothers Private Equity (US based arm of investment bank) and Al Bateen Investment Company (an United Arab Emirates based investment company).
49 Excluding this deal, revenue multiple would rise up to 1.4 (40 percent increase year on year).
In the acquisition consortium successfully purchased not only Radiokomunikace but also 39.23 percent stake in T-mobile (a top 2 mobile phone services operator).
Bivideon BV, a Dutch investment holding company created by Deutsche Bank and TDC – a Denmark telecommunications firm, received consideration of EUR 1,190m which gives approximately 3.7 multiple on its total investment. Rare height of entry multiples (14.4 revenue multiple) should be attributed to the T-mobile stake.
EUR 750m of the acquisition price is financed via mezzanine and senior debt provided by ING Group NV50, which gives us little higher than average equity participation by investors (37 percent). Thus transaction can suit as an example of not only club deals but also as an example of introduction of leveraged finance into Central Europe region.
Also, as we can learn from press51 investors brought in experienced manager with deep understanding of related market in person of Terrence Valeski. This is in accordance with practice of private equity firms hiring highly paid professionals in order to increase and / or improve performance of portfolio company.
Similar to previous example of club deal can be second largest deal in 2006 – taking private of publicly traded BorsodChem Rt. BorsdoChem is a Hungarian chemical group involved in production and processing of plastics and other chemical materials.
Through it’s bid-company First Chemical Holding, Permira (one of the largest private equity funds in Europe) and Vienna Capital Partners agreed to acquire entire issue of shares and subsequently take it out of the trading floor at Hungarian stock exchange.
Offer price of EUR 11.6 per share valued entire share capital at EUR 846m (deal value was lower by EUR 172.4m in net debt position) giving premium of 2.92 percent on closing price of November 6, 2006 (last trading day before announcement of the deal) and premium of 11.48 percent as of July 6, 2006 (last trading day before announcement of intended deal). Although premium intended is more than 10 percent it is nowhere near the heights of late 1990s before the burst of dotcom bubble.
Another taking private transaction happened in Poland, one of the busiest capital markets. Polmos Lublin SA (Polish distillery company) was acquired by Oaktre Capital Management (private equity house offering various types of investment from HY bonds investments to private equity transactions) in November 2006. Although by
50 According to information from Mergermarket
51 iDnes.cz (4 December 2006)
far not as big deal as the previous one (deal value was around EUR 47m) it approximates better Central European potentialities. Central European market is still small enough that private equity firms find opportunities they are able to undertake by themselves and with minimum or no debt required. In US taking private transactions would require pooling of resources of several private equity investors and using of HY issue as well as mezzanine loans in attempted taking private transaction. Size of the market (even though Warsaw is the busiest market in region) enables fund to pick the berries out of the cake and go after them by themselves.
Offer price of EUR 13.3 is approximately at 2.7 percent premium above closing price prior to announcement (EUR 12.95), 11 percent over Polmos average three months price and approximately 15 percent over six months average price. As seen 10 to 15 percent premium is sufficient in satisfying share owners and thus it encourages private equity investors in pursuing deals of such kind.
Taking private transactions are becoming fashionable in Central Europe as well as globally. Mega deals when brand with worldwide recognition is taking private by funds were very common in US in 2006 and even bigger buyouts are expected in 2007.
It appears from development in 2006 that even though capital markets in Central Europe lack liquidity and only limited number of companies are actually traded on daily basis, we can see similar trend. Attempting to interpret occurrence of take private transactions we should point out that it is mainly due to miss-valuation of companies by stock markets. As trading lacks continuity, private equity is confident that in acquisition of companies it can extract significant value upon exit and meet its IRR goals.
If taking look at the fundraising activities in the region we notice difference in approach when compared to global trends. Due to the size of the markets, funds are being raised through private commitments from traditional sources. Involvement of public and capital markets should not be expected in coming years as funds does not aim for sufficient size to justify broad investors’ participation (the biggest funds are being raised in EUR 600m to EUR 700m range and we are still waiting for first Central European fund cracking EUR 1bn barrier). Diverging from global trend further more is involvement of institutional investors into funds specific for emerging markets.
World Bank and EBRD are participating in funds in order to promote and support
creation of market environment as well as pressure for creation of legal framework (on note that governments would protect such investments in order to avoid international scandals and draw complaints).
Different to global is also make up of competitors of private equity houses.
Individuals who became rich during 1990s are either leaving Central Europe for Bahamas or attempting to continue their business operations by establishing investment companies. Via these companies they invest and manage their money and eventually compete with private equity firms52.
Most striking difference is although on finance side of the transactions. In Central Europe financing of the deals is done mostly through syndicated secured loans provided by banks. With HY markets virtually nonexistent due to inability of placing of bonds, private equity funds started to introduce mezzanine financing as alternative to secured bank loans or as complementary source of finance. As shown on Radiokomunikace example mezzanine debt can have strong position in deal financing.
In doing so, region just jumped over the period of its evolution when (as in Europe) HY were prime source of finance for LBOs. Another way to finance the acquisition is full equity portion. Such arrangements are possible due to low deal values and relative abundance of capital. We should not forget that boom of buyout type of deals happened only in 2003 and continued in 2004.
Secondary and tertiary buyouts are becoming more and more frequent as more and more private equity funds are entering the area. As new countries joined European Union and rest of the countries about to join it, risk of conducting business in region became lower and thus new funds are prepared to enter the playground. Former players have not only new competitors but also new potential investors.
In order to use newly discovered willingness of bank in Central European region to lend capital, portfolio firms undertake recapitalizations and investors extract further proceeds from them. Most recent examples of such recapitalizations are Severomoravske Vodovody a Kanalizace Ostrava, a.s. and OKD, a.s. Severomoravske Vodovody owned formerly by Penta Investments underwent restructuring of its balance sheet in order to payout dividends of about EUR 50m before its subsequent sale to strategic investor. OKD, a.s. underwent such balance sheet restructuring in amount of
52 Penta Investments, PPF Group, J&T Group to name the few.
EUR 720m. Amount was used to decrease equity of the company and paid out balance to the shareholders. Such restructuring was able due to previously low debt portion on total assets and no covenants in place. More of such actions should be seen in following years as private equity firms become more aggressive in pursuing higher returns to theirs partners and competition increases.
Conclusion
On the pages above we tried to provide as much information about leveraged buyout transactions as possible. We described their structure, participants in it, their roles and obligations through debt issued and finally benefits they can reap upon successful completion.
During our examination of trends in global buyout industry and later through searching for similar trends in buyout industry of Central Europe region we attempted to predict behavior of the markets in next two to three years. Major findings revealed significant increase in deal values in both Central Europe and global markets as well. With increasing deal values significant increases in entry multiples were overviewed. Such development is due to the abundance of liquidity in hands of banks and other institutions, which do not there to finance more leveraged and daring deals. With general decrease in risk perception among investors and finance providers trend of increasing entry multiples and deal values should continue in 2007 and might survive into 2008.
As M&A sector develops according to development of overall economic activity, with downturn will come implosion of all markets as it will have to sober up after heavy partying. To the contrary of some analysts we expect further continuation of present trends and further pushing of deal value records not only in Central Europe but also across the globe. Such statement is based on evidence of the capital in hands of private equity as well as expectation (at least for Central Europe) of further strongly expansionary years to come. In Central Europe particularly, entrance multiples are slightly lower than in Europe. This enables for higher returns on capital or IRRs.
From the point of view of other issues raised we can summarized that club deals and taking private acquisitions had found their way into private equity in Central Europe.
Even though still substantial part of the deals are performed on a “sole ranger” basis when private equity funds are carefully guarding their golden eggs, which are capable of grooming on their own.
Another general trend is entrance of new competition in form of new and bigger funds being raised and new private equity houses declaring their interest in Central European investments. This is due to improving quality of institutional environment, decreasing
country risk as it enters European Union and need for new territories as old markets are becoming overcrowded. With applications for member ship still pending, similar pattern can be envisioned easily for non-member Balkan countries.
In recent years European financing of the buyouts saw major structural changes with even more to be hoped for in 2007 and 2008. Mezzanine loans saw increased of their volume and share of High Yield issuance from mere 17 percent up to third in 2006. As battle appears to be lost for High Yield bonds issues (at least in regards of dynamics of the respective segment), HY now have to regroup and concentrate on bigger deals where mezzanine is not able to raise sufficient funds. Small and middle transactions saw equaling of both products (HY and mezzanine) with HY offering lesser interest rates but less flexibility due to call protection and more standardized approach and mezzanine winning over private equity firms with flexible terms of refinancing and tailoring to specific characteristics of transactions.
It will be much more difficult to maintain HY position in Europe as there mushroom more and more new products offering to provide risky transaction capital. Again this corresponds with overall liquidity abundance of financial markets. In US on the other hand due to its institutional set up HY are still very much in demand even at smaller deals (although competition is increasing as well).
Second lien loans are one of such arrangements. Financial backers became more open to offering so called second rank mortgages on assets of business and thus cloud more seniority scale of capital from Graph 1. New products were not described in our thesis due to lack of space.
In Central Europe majority of deals is still completed with financing via syndicated secured loans from banks or by all financing provided by acquirer. Although deals are nowhere near New York or London averages, banks rather enter into syndicates in order to diminish their risks and diversify their exposure. To further prove our case of distinguishing Central Europe from both major markets, we should point out that size of deals often allows private equity house to finance deal by its own capital. Such deals are in amount of EUR 50m and are most common in Central Europe. Also note that leveraged transactions and buyout boom is very rare development tracked backed to only 2003. Although deals of buyout character can be find in earlier period these are overshadowed by other developments (e.g. privatization etc).
No need of additional (besides its own and secured bank loans) finance makes Central European markets still junior and somehow lesser. Position might be reversed by continuing consolidation and mergers between Central European firms and further development of capital markets but process is very slow and will take years. While recently Czech Republic experienced two IPOs (both in towards the end of 2006) which is more than past years total, HY market is still virtually nonexistent.
As for other trends we can say that Central Europe is fairly mature region. It copied global trend of taking public companies private (with at least two explained examples), it jumped over the HY chapter of its development and immediately introduced mezzanine financing as preferred finance raising channel53, and last but not least companies are today undertaking recapitalizations in order to optimize their financing and / or equity and liability part of balance sheet.
In general we can say that Central Europe is mature market for LBO transactions but with significantly great asterisk. Asterisk representing insufficient capital markets and other institutional framework, which has long way to go to be comparable with centers of today’s financial world. Of course this is partially brought about by size of the market of 15 countries re presenting the region. Hopefully we would be able to say
In general we can say that Central Europe is mature market for LBO transactions but with significantly great asterisk. Asterisk representing insufficient capital markets and other institutional framework, which has long way to go to be comparable with centers of today’s financial world. Of course this is partially brought about by size of the market of 15 countries re presenting the region. Hopefully we would be able to say