As Western buyout markets continue to encounter challenges, the CEE region is attracting renewed LP interest. But the complexities of investing in the East should not be overlooked. Andy Thomson reports.

In September of last year, in the aftermath of the credit crunch, global midmarket private equity firm Advent International launched its fourth Central and Eastern European (CEE) fund with a target of €750 million ($1.2 billion). In April this year, the fund closed well ahead of that target on €1 billion. It is not surprising, therefore, to hear Advent managing director Joanna James assert that “the credit crunch did not necessarily affect investors' thinking”.

The most obvious reason for this is that in the CEE buyout market, leverage has never been available at as lofty a multiple, or as high a quantum, as in the West. Therefore, business has been able to continue if not “as normal”, then at least closer to normal than in the US, UK and elsewhere.

For limited partner groups with bulging coffers following the distribution bonanza of recent years, the CEE region represents a compelling opportunity to put money to work. This is clear from the huge jump in scale of Advent's fund compared with its predecessor, which closed on €330 million in 2005. One of the reasons, says James, was the involvement of US-based investors. She recalls: “In 2005, they said they were very interested, would love to know more and would keep the region under review. But they were not ready to commit capital.” The latest fundraising attracted around 25 percent of its capital from US sources, she adds, including an unspecified commitment from the California State Teachers' Retirement System (CalSTRS).

Thierry Baudon, managing partner at London-based CEE-focussed private equity firm Mid Europa Partners, has also seen his firm benefit from the still-benign market conditions. “In August last year, in the middle of the storm, we managed to execute the Aster refinancing,” he says, referring to the €415 million refinancing of the Polish cable operator – the largest deal of its type that Poland had ever seen.

The key to that deal and others, says Baudon, is that the CEE private equity lending market has always been dominated by the banks. This is significant for at least two reasons. Firstly, it was institutional investors that came to dominate the syndication market in the West – and those same institutions that decimated the mega-buyout market when they departed the scene following the credit crunch. Secondly, he says that European mid-sized banks are “the bedrock” of debt providers for CEE private equity – and “their balance sheets have not been unduly affected, as they were never dragged into the fancy structures game.”

That said, James is taking nothing for granted. She is of the opinion that the credit crunch may yet wreak some nasty side effects in CEE. “Many of the banks in the region have been taken over by international banks, so what's happening elsewhere is an issue. If a bank has over-extended itself in UK buyouts that could in theory affect CEE deals. Although we've not seen that happen yet, I'd be reluctant to say that everything's fine.”

Notwithstanding this, confidence is high in the region's prospects. James notes: “Ten years ago there was high growth but a lot of instability. Now there is recognition that the [ten] countries that joined the European Union in 2004 are stable. There is still high growth in these countries – and also lower risk.”

She adds that growth continues to be the major investment theme, but hot sectors change over time. At the moment, Advent is seeing ripe opportunities in residential construction – partly fuelled by CEE nationals who have found work abroad and sent remittances home. In December last year, Advent completed the acquisition of a 70 percent stake in Romania's Ceramica, a ceramic bricks and clay roof tile producer.

Meanwhile, rising consumer affluence was the driver behind Mid Europa's ambitious buy-and-build in the Polish healthcare sector. The firm's recent agreement to acquire CM LIM made it the largest operator of private Polish healthcare services, following its prior purchases of LUX MED and Medycyna Rodzinna. Reflecting on the buy-and-build, Baudon says: “We have a large pool of capital but in this particular sector we decided to acquire a fairly small platform in the belief that we could start consolidating the market from there and become the number one player within a short period of time. With buy-and-builds you end up with an advantage over other private equity firms because you have the synergies of a strategic buyer.”

Nigel Williams is chairman of Royalton Partners, a pan-regional mid-market GP which has offices in Bucharest, Prague and Warsaw. Williams says his firm looks to buy companies primarily servicing local markets and which are therefore “not exposed to global competition”. As an example he cites Certasig, a Romanian non-life insurance business, which Royalton acquired in December last year. Williams says he is currently seeing a lot of opportunities in Romania, as a result of which he is spending time in the country “every one or two weeks”. He says that around half the firm's previous fund was invested in Hungary.

An investor in CEE for the last 18 years, Williams has seen more deals than most and covered more territory. He argues that one of the challenges for pan-regional investors is making sure you are “sensitive to local character traits”, making the point that investing in Estonia and Romania, for example, demand two very different approaches.

Cultural traits are emphasised in a more dramatic way by Peter O'Driscoll, a partner in the European corporate group at law firm Orrick. O'Driscoll, who has advised on many CEE transactions, says: “You have to structure deals so that your position cannot be attacked by governments or corporate raiders. Investors are most at risk when a deal is going well and a local partner tries to use the weaknesses of the local legal system to steal the asset or force the investors to sell at a discount.We've seen many situations where private equity firms have been hurt by this kind of thing.”

Perhaps the conclusion may be drawn from O'Driscoll's words that simply shifting private equity capital from Western Europe to the East in response to more challenging market conditions in the former is no straightforward task. This may be a region where the credit crunch has yet to bite, but it is manifestly not without its complications. It's a place for clever money only.