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Friday, 15 December 2017

New players drive M&A bonanza

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Despite over a decade of strong M&A activity in the Central East European region, there’s still more to come. New players are moving in and new frontiers are opening up, as Justin Pugsley reports.

There has already been tremendous consolidation in Central and Eastern Europe but experts are predicting there is a lot more to come. Yet at the same time M&A activity is evolving.

Future deals will be heavily influenced by the emergence of regional champions, interest from private equity groups and Western corporates seeking growth. The fact that Western Europe is experiencing slower economic growth only serves to make the east look that much more attractive. Even the credit crunch has not inhibited M&A activity much, although it is making financing terms more demanding.

Traditionally M&A has been dominated by Western corporations buying privatised entities, and this is set to continue. Large swathes of the automotive and financial services sectors are now foreign owned, representing what is likely to be the apex of this trend.

Further consolidation is needed among local companies to bring greater efficiency to the market, noted Mark Mobius, executive chairman of Templeton Asset Management. He cited manufacturing as a pressing example of this.

Business is also being driven by the development of regional champions – many of which were state-owned. "Many regional firms have outgrown their domestic markets and are expanding into neighbouring countries so they can continue growing," said Miklos Kormos, managing director and head of global banking for Central and Eastern Europe with Deutsche Bank.

Examples include Czech utility, CEZ, Hungarian bank, OTP, Croatian conglomerate, Agrekos, the Warsaw Stock Exchange (WSE), Polish oil and gas group PKN Orlen and Hungarian peer, MOL.

CEZ has developed a large footprint in Poland; in Bulgaria it recently consolidated three electricity distribution companies into one unit; its presence in Romania dates to late 2005, when it gained control of the formerly state-owned distributor, Electrica Muntenia Sud; and it has other subsidiaries in Slovakia, Hungary, Kosovo, Serbia, Bosnia and Herzegovina, as well as Ukraine and Russia, where it is particularly keen to strengthen its presence.

Meanwhile, PKN Orlen is often mooted to be a bid candidate for Polish peers Lotos and PGNiG. It has majority control of Lithuanian refiner Mazeikiy Nafta and has subsidiaries across the CEE. The great fear among these oil groups is competition from Russian and Western super-majors, which possess greater economies of scale.

“Not all regional champions are local,” noted a banker familiar with the region. “There are several Austrian, Greek and Italian groups, which have the CEE region as a major focus.” These include Austrian bank, Raffeisen, Italian peers Entesa Sanpaolo and Unicredit and Greek private equity fund, Marfin Investment Group (MIG).

Meanwhile, Austrian oil & gas group, OMV, also has regional ambitions and is currently engaged in a €10bn-€11bn hostile take-over bid to buy Hungarian peer, MOL “I think these two companies getting together would be a good consolidation play,” said Mobius, whose fund holds shares in MOL. They should also invite Russian companies like Lukoil or Gazprom into the deal, he suggested, given their heavy dependence on Russian energy.

However, MOL is refusing to play ball and has deployed a formidable array of defences to fend off OMV, limiting shareholder voting rights, acquiring its own shares and parking others with friendly shareholders. OMV is challenging some of these tactics at the European Court of Justice.

“I think this will be a long fight,” said one observer. “Hostile take-overs are a new phenomenon in the region. But, it is a sign of growing maturity.”

While OMV has managed to accumulate nearly a fifth of MOL’s shares, its chances of bagging its prey look challenging – though not impossible.

“If the take-over succeeds, it could encourage other companies in the region to try hostile take-overs,” said Jason Mogg, managing partner CEE with Linklaters. “East Europeans are much more into pushing the envelope and hostile take-overs are unlikely to carry the same stigma as do say in Germany.”

Private equity looks East

Another strand of M&A activity is the arrival of private equity, with the likes of Carlyle, Advent and Permira actively searching for opportunities. Others, such as Mid-Europa and MIG, have dedicated funds active in the region.

In the more developed CEE markets the focus is on acquiring privately held firms, especially those run by entrepreneurs. Many entrepreneur-run companies are selling up due to succession issues. Others are turning to private equity to give their firms a more institutional feel with the view to later floating on the stock market.

Private equity currently looks a relatively attractive alternative in light of stock market weakness, considering the other options is an IPO. This is especially true of Poland where share prices were artificially inflated due to restrictions on local pension funds investing outside the country. This made raising equity cheap.

The very large private equity houses, which seek multi-billion euro deals, will find it harder to locate targets due to the relatively small size of companies in the CEE. For those targeting mid-market or small companies there’s plenty of

choice. There is a plethora of entrepreneur-led companies operating in construction, food processing, engineering and IT. “Private equity groups will certainly be part of the next wave of M&A,” predicted Mogg.

More of the same

The third major driver of consolidation is a continuation of an older and well documented trend: Western corporations seeking a footprint in faster growing markets. A classic case is that of Heineken acquiring Czech beer group, Drinks Union. It increases the Dutch brewer’s market share there to 12% from 3%. UK retailer Tesco has also built up impressive operations in Czech, Hungary and Poland through acquisitions, and is on the look out for more deals.

The large number of foreign owned CEE banks does not preclude further changes in ownership. For example, troubled French bank, Societe Generale has a large CEE footprint and may decide to sell those branches to help shore up its balance sheet. Italian rival, Intesa Sanpaolo is thought to be interested in buying them.

Another possibility is a break-up bid for another Italian bank, Unicredit, one of the largest players in the CEE banking market. “This is an even more attractive target than ABN AMRO was. It’s a real candidate for being broken-up,” said Kenneth Murray, chief executive officer of Blue Planet Investment Management, which focuses on investing in financial services companies.

However, orchestrating such a take-over would be fraught with difficulties, with protectionism and defensive cross share-holdings among the hurdles. A potential local take-over candidate is Vienna-based Erste Bank, which has an attractive CEE banking portfolio.

New frontiers

The big regional theme is still about convergence with wealthier Western Europe. But countries are at different stages, presenting some tantalising opportunities for investors.

Poland, Czech, Hungary and Slovenia are at the vanguard of convergence. The Balkan countries, along with Romania and Bulgaria, are in catch-up phase with the last two in the EU.

Many of these states are pursuing privatisation programmes. Former state-owned enterprises often hold the best prospects for very rapid improvements in efficiency in the early years of private ownership, said Mobius.

According to Matteo Stefanel, head of investment banking at MIG, one of the most interesting countries in SEE is Serbia. “It’s basically a catch-up story,” he said, with a €30bn privatisation programme to liberalise and modernise its economy.

The ex-Yugoslav countries have been inspired by the example of Slovenia and want to try and emulate its economic success. However, Serbia like the rest of the Balkans is tainted by politics and is deeply divided over jumping on the EU accession bandwagon – or cementing ties with Russia. It’s a situation which will take years to resolve.

In Bosnia there’s the upcoming €2bn privatisation of Bosnia Telecom. Macedonia, which has seen several privatisations, is selling concessions for two airports. Albania’s state-owned oil refiner, Armo, is up for sale with over 15 companies expressing an interest in buying a 85% of it. Slovenia, one of the richest CEE countries per capita, has been trying to sell nearly half of Slovenia Telekom. Bidders have apparently balked at the high price.

The CEE region remains a cornucopia of opportunity catering for a wide range of risk appetites and expectations. The newly emerging states offer a raft of privatisation opportunities, while at the other end of the scale the more developed countries offer similar consolidation plays to more mature markets.

However, one thing all these countries hold in common is the prospect for sustained rapid economic growth. That is occurring either within an EU legal framework or one aspiring to European norms. This makes the CEE almost unique among emerging markets and offers investors a certain level of comfort when committing to the region.

All this should spur M&A activity for years to come as various players position themselves to benefit from convergence-driven growth.

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