As Central and Eastern Europe comes of age as a private equity destination, Mid Europa Partners looks set to be an influential force in its continuing evolution. Andy Thomson met London-based managing partner Thierry Baudon shortly after the firm had raised a new €1.5 billion fund dedicated to the region.

In at least two senses, Mid Europa Partners managing partner Thierry Baudon has a different view to that of most London-based private equity professionals targeting the larger end of the buyout market. For one thing, he remarks that the view from the balcony which adjoins his firm's boardroom is one of the finest in the city. Situated between South Kensington and Knightsbridge and flanked by Harrods department store and the imposing Holy Trinity Brompton church, it would be hard to find a more impressive location than that enjoyed by Baudon and his colleagues.

Also at variance to many of his peers is Baudon's view of current market conditions. LBO investors focused on Western markets continue to fret over the credit crunch. But in the countries of Central and Eastern Europe, where Mid Europa Partners plies its trade, private equity business seems to continue not far short of normal.

He explains: “Leverage ratios have always been lower in Central and Eastern Europe than in the West, which has to do with the higher growth/ higher capex environment and with the banks' risk management policies. On average, leverage ratios tend to be one to one-and-a-half turns lower; during the recent credit crunch, we faced some tightening in terms and a repricing of mezzanine and sub-debt tranches on the larger deals, but overall the impact has been very manageable. Another factor is that Central and Eastern Europe continues to be more dependent on banks than on institutional lenders. The banks have always dominated, and their appetite remains strong.”

Baudon, who was born and grew up in Frnace, has evidence to back up his observations. He points out that, since the turmoil in financial markets first erupted towards the end of June, Mid Europa Partners has completed the €415 million ($601 million) refinancing of cable broadband operator Aster (which was the largest-ever private equity refinancing in Poland and involved no less than ten banks) and the €1.4 billion leveraged buyout of Austrian mobile telephony firm One. While he admits that these deals would struggle to be classified as “mega” within the Western definition, they are substantial in a regional context and clearly imply a strong degree of confidence in prospects going forward.

Baudon, it should be noted, has more reason than most for hoping that benign conditions prevail. In October, Mid Europa Partners closed its third fund on €1.5 billion, making it the largest vehicle dedicated to private equity investments in the region. The successor to the firm's €655 million second fund, which closed in December 2005, was raised in just five months and was significantly oversubscribed. The level of demand resulted in a hard cap being imposed at a level €250 million above the €1.25 billion initial target.

It is clear that Baudon was in something of a quandary when deciding what an appropriate fund size should be. On the one hand: “You need to avoid raising an excessively large fund and being slow to invest it, because it kills your performance-based economics. That makes your investors unhappy and your colleagues unhappy.” On the other: “The problem with our second fund was that we were too conservative in capping it at €655 million. As a result, it was almost fully invested in 18 months – despite offering a large amount of co-investment to our LPs.”

One of the reasons why the second fund was allocated so quickly, and why Mid Europa has seen its assets under management escalate, is that deal flow is burgeoning as a greater volume and variety of businesses appear on the private equity radar. Baudon explains why, in the past, the investment landscape was narrow: “Fifteen years ago, after 50 years of Soviet domination, the information-related industries – telecom, media, broadcasting, advertising etc – were all extremely undeveloped. For the first ten to fifteen years after the collapse of the Berlin Wall, it was natural that most investment would go into those areas.”

“Central and Eastern Europe continues to be more dependent on banks than on institutional lenders. The banks have always dominated, and their appetite remains strong.”

It led to a period where TMT investment and private equity investment were virtually synonymous in Central and Eastern Europe. Mid Europa Partners demonstrated a strong bias toward the sector in its first two funds. But now, says Baudon, such deals are “tapering off” and “the game is changing”. He identifies two key deal drivers today as cross-border industrial consolidation and the relocation of manufacturing to the region from the US and Western Europe.

In addition, the makings of a consumer boom are underway. “We just became the number one private healthcare provider in Poland,” Baudon enthuses, in a somewhat wide-eyed manner which suggests he still hasn't quite grown accustomed to the fact. The feat was achieved in October when the firm acquired Lux-Med and Medycyna Rodzinna, the second- and sixth-largest operators in the country respectively.

He adds: “There is pent-up demand from a growing and affluent middle class. There will be many more deals to be done in areas such as consumer finance, mortgages and leisure, as well as healthcare.” Because of this wellspring of new deal opportunities, Baudon says the third fund is likely to have a more balanced portfolio than its two predecessors.

Although its ability to invest widely may have been restricted in the past, Mid Europa Partners has always been an innovator and a pioneer. Its website directs you to a series of “landmark transactions” including: the largest private equity investments in Slovenia (Telemach) and Slovakia (Orange); the first dividend recap in the region (Hungary's Invitel); and the largest buyout in Serbia (SBB).

Another particularly striking example of boundary pushing came in January this year with the acquisition of Bité, a mobile operator in Lithuania and Latvia. The deal was not only the largest buyout ever seen in the Baltics, but also featured the first all-bond LBO financing in Central and Eastern Europe and the first floating rate note (FRN) issuance in the region.

It's tempting to attribute this succession of firsts to the region's immaturity as an investment destination. While there is some truth in that, Baudon was busy putting his money to work as far back as the early 1980s in countries such as the former Yugoslavia and Hungary. At that time, he was a senior executive at the International Finance Corporation, the emerging markets investment arm of the World Bank. Two years after the fall of the Berlin Wall in 1989, he was headhunted by the European Bank for Reconstruction and Development (EBRD).

“The problem with our second fund was that we were too conservative in capping it at e655 million. As a result, it was almost fully invested in 18 months – despite offering a large amount of co-investment to our LPs.”

Baudon reflects: “I was part of the initial core team that launched the EBRD in 1991 and it was a fascinating place to be at the time. The people who joined in those early days did so out of a sense of mission. There was an incredible variety of backgrounds and talents. It was quite intense.” It was also a good training ground. “A significant proportion of the successful private equity managers in Central and Eastern Europe have come out of the EBRD stable,” Baudon points out.

In 1995, Baudon moved into the corporate world to head up the international finance division of French company Suez. Nowadays its activities are mainly focused on energy, but, during his spell there, Suez was indisputably a conglomerate. Its activities included areas as diverse as cable TV, waste, nursing homes and – perhaps most surprisingly – the long-term management of cultural heritage sites.

The stint at Suez not only gave Baudon exposure to a broad range of industries but also deepened his relationships with the corporate world. It's no coincidence, therefore, that one of his proudest achievements at Mid Europa has been partnering with large corporate entities on a number of deals. Until recently, this was always as a minority investor – for example, supporting UK glass company Pilkington's launch of a state-of-the-art factory in Moscow in 2003 and investing alongside Canadian mobile operator TIW in Czech GSM firm Oskar Mobil from March 2004 until its sale to Vodafone a year later.

But it was the deal to buy Austrian mobile firm One in October which provided perhaps the clearest evidence of Mid Europa's credibility in corporate eyes. In this instance, France Telecom accepted a 35 percent minority position to Mid Europa's controlling 65 percent majority.

Particularly where companies require turning around, or at least strong operational input, Baudon believes it makes sense for private equity firms to lead the dance. “It can be hard for corporates to transplant their own people to a new company in a new market and make a success of it. Will career people be prepared to kill themselves for three or four years? That would be tough for them, but that's what we do. At the end of the turnaround period, they can take us out if we've done well or choose not to if we haven't.”

The One deal is part of the latest chapter in an increasingly impressive story since Baudon took the seminal decision to move into private equity in 1998 by agreeing to join emerging markets manager EMP Global. The firm, established four years prior, had already raised Asian and Latin American funds and was also making plans to launch operations in the Middle East and Africa. Baudon was to spearhead the firm's push into Europe's former Eastern Bloc.

He reflects: “At the time, the first big transitional phase in Central and Eastern Europe was coming to an end. It had been a period of heavy structural adjustment, but now the growth phase was starting and it was clear that EU accession was becoming a reality for many countries in the region.”

The story was persuasive enough for investors to commit $550 million to EMP Europe's debut fund, which closed in September 1999. This is not to say there was an absence of scepticism. Baudon relates that some would-be backers did not believe his assertion that EU accession would take place by 2005. In the event, eight of ten new joiners in 2004 were former Communist nations.

“In some emerging markets, you can create value over five or six years and then have it destroyed in 24 hours by a political decision or a macroeconomic shock. In most of Central and Eastern Europe, that kind of thing doesn't happen.”

From the outset, Baudon believed it was important to operate out of London in order to stay close to the banking community and also to run the rule over potential recruits, including CEE nationals working within investment banks. Equally: “We knew it was important to be in the region because it's so fragmented. There are 100 million people in 14 or 15 countries with many different languages.” Hence, the firm also launched offices in Warsaw and Budapest, the capitals of Poland and Hungary, which between them account for around two-thirds of Central and Eastern Europe's population and GDP.

Baudon says that, while he wanted a regional presence, it had to be on the basis of regional hubs with a “critical mass of people”. “We need people to bounce ideas off each other, and you can't do that if you're isolated. From the start, we wanted to treat the region as a kind of ‘global market’. We didn't want to create little kingdoms where people would just be looking for deals in their territory without proper checks and balances.”

Perhaps most importantly, Baudon wanted to create an organisation that could boast a collegiate spirit. More than once, he mentions the importance of “alignment within the team”. And this, it is clear, was one of the key motivations that lay behind EMP Europe spinning out from its parent and becoming the newly independent Mid Europa Partners in 2005 (prior to the second fund being raised).

Says Baudon: “It is my view that strong alignment of interest can only really be achieved in small, independent organisations. It was difficult to achieve as part of a group [EMP] that was itself part-owned by AIG. The sharing of economics at EMP was not quite what I wanted to see. Since independence, the proportion of carry that goes to non-partners here is well above the industry average.”

There was another reason why charting a new course for the firm made sense, and it was one based on culture rather than economics. Says Baudon: “By 2004, it had become clear that most of Central and Eastern Europe would not remain a true emerging market area for much longer. By then it had gained macro-economic stability and predictability through the shared objective of joining the eurozone and also had acquired an institutional anchoring in the European Union. But our colleagues within EMP were emerging markets people, and it meant the shared culture was disappearing. Our investment strategy, origination techniques, processes, instruments, and access to debt markets were all getting radically different.”


Founded: 1999 as EMP Europe (became Mid Europa Partners in 2005) Most recent fund: €1.5bn Mid Europa Fund III (MEF III), closed October 2007
Offices: London, Budapest, Warsaw Realised investments include: Oskar Mobil (GSM operator, Czech Republic); Karneval (cable TV operator, Czech Republic); MobiFon (mobile communications provider, Romania); Melrose Petrol (gas field owner and operator, Bulgaria); Estonian Railways (railway infrastructure services and rail cargo transport provider, Estonia)
Typical deal: Investments in the €25 million to €200 million range in companies with an enterprise value between €100 million and €1.5 billion
Sector interests: Telecom and media; utilities; transport and logistics; natural resources; basic industries
Key personnel: Thierry Baudon (managing partner); Craig Butcher (senior partner); William Morrow (managing director and COO); Robert Knorr (director); Zbigniew Rekusz (director); Matthew Strassberg (director) Current portfolio includes: Pilkington Russia (float glass factory, Russia); Aster (cable TV provider, Poland); LUX-MED (outpatient healthcare provider, Poland); One (mobile communications services, Austria); Falcon Group (digital broadcasting, Czech Republic)