Private equity’s ESG expertise equips CEE business with more than just finance

Private equity in CEE enjoyed a bumper year in 2021 as deal numbers rose from 319 to a record 399. Values rose from EUR 20.14bn to EUR 23.6bn, second only to 2018 in the past decade, illustrating how private equity has become part of the financial and corporate landscape of the region and accounting for around 20% of M&A activity.

Deals involving financial investors included nine with a value of EUR 600m or more. The year got off to a vigorous start as the pent-up demand that had built up towards the end of 2020 manifested itself in a commitment to pushing deals over the completion line.

CEE business owners are showing a greater awareness of and willingness to interact with private equity. Meanwhile, private equity firms based in the region are growing more ambitious, while those from outside and showing a greater understanding of the opportunities in CEE and a greater willingness than ever to engage with the region’s sellers.

Beyond P&L benefits

One of the key functions of private equity is to grow businesses and take them on to the next level, whether the owner is looking to retire or to bring in additional shareholders to help grow the business. But the focus is not just on profit and loss accounts or balance sheets. In a world where there is growing public concern about the environmental and social impact that businesses have, there is also more awareness among business owners and potential investors of the need for high standards of governance to make sure they are run in the best interests of the wider stakeholder community.

This puts ever closer focus on environmental, social and governance (ESG) issues which has created an additional motivation for sellers to seek out private equity expertise. In the wake of the COP26 summit, the spotlight has been on the environment and ESG provides the tools to comply with or stay ahead of regulations and guidance on topics such as sustainability, energy use, resources, emissions reduction and climate change.

Graham Conlon, CMS partner focusing on private equity in CEE/CIS, said: “Private equity has the skills to grow a business and develop efficiencies. There’s growing pressure to be mindful of the obligations in relation to ESG and especially E-for-environment.”

ESG is at the core of the work done by the European Bank for Reconstruction and Development (EBRD) which celebrated its 30th anniversary during 2021. Tamas Nagy, director and co-head of private equity at EBRD said: “We were set up in 1991 to make companies understand ESG and now ESG has really gained traction and public support. It’s not a fringe theory, it’s more widely understood. We work closely with private equity partners so that ESG is an important part of the whole investment thesis.

“When we work with private equity, they are very much in the financial driving seat, but we are pleased to see more funds reaching out to us with an ESG mandate looking for opportunities where they can co-invest with us.”

As a neighbour to emerging European countries Austria provides an important gateway to the region, particularly from DACH-focused investors. Alex Rakosi, CMS partner in Vienna, said: “Private equity players bring a high level of sophistication, optimise operational performance and development core business ideas. It goes far beyond just providing funds for growth, they bring expertise in business efficiency and in ESG.”

Among the large private equity partnerships based outside the region, but with a keen interest in CEE, is Advent International. Since it was founded in 1984, it has invested USD 58bn in more than 380 businesses across 42 countries, including CEE.

Milan Kulich, Advent director in Frankfurt, said: “ESG is a top priority agenda for us, and we are focused on achieving ESG objectives globally as well as in CEE. Our global investment philosophy is centred around the sustainable growth of the businesses in which we invest. We believe the management of ESG risks and opportunities at all stages in our investment process helps to protect and enhance reputation and financial performance and create stronger, more valuable companies in the region.”

Global capital eyes big ticket deals

The impact of private equity on deal-making could be seen in activity across the region. After Poland, which was the largest private equity market despite a drop from 99 to 74 deals, Russia became close second as it saw the number of private equity deals surge from 47 to 73. Turkey saw deal numbers rise to 45, while Romania saw an increase to 32 and Bulgaria saw deal numbers almost treble to 29. Hungary, Croatia and Serbia saw more deals than in 2020, while Czech Republic’s volume remained stable at 43.

Graham Conlon said: “It used to be rare to find a deal of a few hundred million euros or more, but there are increasing numbers of big ticket deals and we are seeing more in the EUR 1billion-plus range. Private equity is no longer just about local players because bigger players in London or elsewhere are starting to take the region much more seriously.”

Tamas Nagy at EBRD said: “These markets are developing and growing so that companies are becoming larger and that means they invite more interested investors. A few years ago if you wanted to deploy EUR 100m there were only a handful of companies you could buy, but fast forward to today and those opportunities are coming up much more frequently.”

The scope and ambition of dealmakers is illustrated by the fact that the entry point into the top 10 largest private equity related deals in 2021 was EUR 464m, following a pattern that has become firmly established in recent years. There were increased deal numbers across the three busiest sectors as Telecoms and IT, with 101 deals, overtook real estate and construction, with 83, as the hottest sector, followed by manufacturing with 56.

The region is becoming a prolific location for technology start-ups which play into its strengths in turning out well educated people capable of quickly building businesses that can compete on a global scale, as illustrated by the number of unicorns emanating from CEE.

Milan Kulich at Advent said: “We have witnessed an accelerated shift towards e-commerce exposed business models including customer facing platforms as well as fulfilment providers. In addition, digitalisation has become a must across sectors. At Advent, we invested significantly into internal and external resources to drive this development in our portfolio companies as well as recognising these value creation opportunities when reviewing new deals.”

Deal drivers

In the early days of private equity in CEE, returns on investment were driven by turnarounds and modernising businesses, but there are now broader motivations behind deals as emerging Europe has become increasingly attractive to the private equity sector and attention that might previously been directed towards Asia is now being turned on the region.

Funds can still find companies that have a lower cost of doing business than further west and because they produce goods and services sold into the west they provided an opportunity to benefit from stable and healthy countries in the EU.

The long-awaited flood of succession-driven deals is finally starting to arrive, as founders from the first wave of private companies look at their next steps three decades on when they may find their children do not want to take over the business. However, other deal drivers are coming into play. According to Milan Kulich at Advent, turnarounds still have role, along with corporate carve outs and value creation opportunities and – more recently – opportunities to take minority stakes in high growth assets.

Success breeds success

Emerging Europe is increasingly offering private equity interesting targets thanks to the innovation of its entrepreneurs who have created a host of new businesses that are growing to a size where they are attractive to buyers and can contribute to deal flow.

The creation of unicorns and a pipeline of multi-million euro deals has helped focus attention on the region and means more global private equity funds are screening emerging Europe for opportunities, though those already operating on the ground are by no means a pushover. Healthy competition means private equity looks well placed to account for even more than the 20% of M&A deals it already underpins.

Tamas Nagy at EBRD, said private equity activity was nowhere near reaching a ceiling and added: “To my mind the opportunities for private equity are ever increasing. I believe that entrepreneurship is coming into its own. There are some great stories coming out and success breeds success.”

Further reading

17/06/2021

Sum­mary of study find­ings

The study fo­cuses on over 300 private, in­sti­tu­tion­al, al­tern­at­ive, il­li­quid funds (the “Sample Funds”) on which CMS ad­vised between 2017 – 2020 (the “Re­view Peri­od”). The Sample Funds cov­er a range of geo­graph­ies and as­set classes, over 2/3 are fo­cused on European strategies, ap­prox­im­ately 1/3 are real es­tate, 1/3 are private equity (“PE”) and 1/3 are in­fra­struc­ture, debt and oth­er strategies. Our study has been in­formed by in­ter­views with lead­ing in­dustry par­ti­cipants and over 100 sur­vey re­sponses (both un­der­taken at the end of 2020). As Sir Ron­ald Co­hen, the in­ter­na­tion­al ven­ture cap­it­al­ist and PE in­vestor, said “The first bounce of the ball every­one can see. To an­ti­cip­ate the second, you need a really deep un­der­stand­ing of the mar­ket.” A lot has happened in the re­cent past, very little of which was pre­dict­able, and what hap­pens next may be even more sur­pris­ing. We now won­der where the un­cer­tain second bounce of the mar­ket will be. We set out be­low some key find­ings of the study. Key find­ings Over­all fund rais­ing volume re­duced in 2020 off the high­wa­ter mark years of 2017 and 2018;Al­though 2020 saw few­er funds es­tab­lished, there was a lot of trans­ac­tion activ­ity as in­sti­tu­tion­al in­vestors con­tin­ued their pro­grammes and made new al­loc­a­tions in light of the risks, op­por­tun­it­ies and chal­lenges that arose out of Cov­id;In private equity a strong sec­ond­ar­ies mar­ket con­tin­ued to de­vel­op as in­sti­tu­tion­al in­vestors looked to stream­line their hold­ings and take an act­ive ap­proach to port­fo­lio man­age­ment;When ma­ter­i­al un­cer­tainty over com­mer­cial real es­tate val­ues made it ne­ces­sary to sus­pend daily deal­ing in some open-ended prop­erty funds, fund man­agers worked with the reg­u­lat­ors to make this hap­pen quickly and safely; we ex­pect fur­ther reg­u­la­tion in this area;2020 saw in­vestors sell off what they per­ceived to be high­er-risk in­vest­ments and pur­chase safer in­vest­ments in per­ceived Cov­id win­ners (prin­cip­ally tech­no­logy and dis­tri­bu­tion re­lated as­sets);Lux­em­bourg con­tin­ues to be the most pop­u­lar fund jur­is­dic­tion for European fund launches, par­tic­u­larly in light of Brexit, with Dub­lin also start­ing to garner ad­di­tion­al pop­ular­ity in re­la­tion to funds mar­keted through­out the EEA;Funds with no com­mit­ment from man­agers are be­com­ing less com­mon with in­creas­ing man­ager com­mit­ments in closed-ended funds;A hurdle rate of 8% re­mains stand­ard for closed ended funds across real es­tate and private equity;Man­agers in the up­per quart­ile (in terms of per­form­ance) kept their man­age­ment fees steady but there is some evid­ence that new man­agers are of­fer­ing fee re­duc­tions or oth­er in­cent­ives in or­der to raise cap­it­al; an­dThe de­mand for ESG products grows with in­dic­a­tions that in­vestors see ESG as a value driver as well as a risk mit­ig­at­or.

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