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PE eyes growth opportunities in South East Europe

With private equity in Western markets increasingly reliant on financial engineering and high levels of leverage, investors are starting to look to South East Europe for investment opportu

With private equity in Western markets increasingly reliant on financial engineering and high levels of leverage, investors are starting to look to South East Europe for investment opportunities, with sectors that have matured in the West, still in their infancy in the region.

The Romanian economy has been growing steadily since 2000, with the country enjoying greater political stability in recent years. Given the country’s accession into the EU – which is expected to further enhance growth in Romanian GDP, consumer and industrial demand – and the EUR10bn of EU funds earmarked for Romania, the region now presents a ‘compelling investment prospect’.

Ion Florescu has built an enviable track record investing in the country. His latest fund, Reconstruction Capital II, which is listed on AIM, and which invests primarily in Romania, was launched in December 2005, when a total of EUR23.4 million was raised, net of expenses. In May 2006 a further EUR40.5 million, net of expenses, was raised from investors. Since inception the fund has made a 43.39% return and year to date has delivered 27.49% (as at 31 May 2007).

The fund operates two investment programmes, a Private Equity Programme, which is focused on acquiring and disposing of significant or controlling stakes in companies, and a Trading Programme, which focuses on portfolio investments in listed equities and fixed income securities. Florescu’s main strategy under the Private Equity programme is to work closely with the management of the companies RC II invests in, and by taking a hands-on approach, develop those companies to sector leading positions, ultimately listing them on a local exchange or exiting by means of a trade sale to a strategic investor.

The potential for investment in the region is clear; the Balkan countries are making significant progress in key consumer and industrial services, and infrastructure remains under-developed and requires significant investment, from both the public and private sectors. ‘Investing in Romania at this time presents a growth opportunity that is simply no longer available in the more mature Central and East European markets,’ says Florescu.

In identifying Investee Companies for its Private Equity Programme, the fund intends to add value by implementing operational and/or financial restructuring over a three to five year horizon. RC II’s plan is to construct a concentrated portfolio and to obtain a minimum 20% equity stake in each Investee Company, but also to establish a clear exit strategy – a trade sale, break up and subsequent disposal of different divisions or assets, or a flotation.

‘Romania is in a period of great change and development," adds Florescu. "Consumer confidence is on the rise, with people looking to spend a greater proportion of their wages, both on their physical wellbeing and in their daily lifestyle. Sectors that matured many years ago in the West are only now starting to find their feet in South East Europe. Because we believe RC II invests in relatively safe, low-tech companies with strong asset bases and good growth prospects, we believe we can offer investors considerable downside protection, at the same time benefiting from the substantial growth story.’

The Investments

RC II’s first private equity investment was finalised in November 2006 when the fund increased its shareholding in Albalact SA to 16.4%. Although it is a quoted company, the shareholding in Albalact has been included in the Private Equity Programme due to the size of the investment, RC II’s presence on the Company’s Board of Directors, and the likely mid-term horizon for this investment. Albalact is Romania’s leading independent fresh dairy products company. With strong brands on the local market, a powerful milk collection system – which covers one of the best dairy regions of the country – and a new production facility under construction, Albalact has proven to be one of the most dynamic players in its sector. Annual sales growth has averaged 65.7% over the past 3 years and the 2006 net profit is 98.0% above the previous year.

"In Western countries, the dairy industry is considered to be very mature and of limited growth prospects," Florescu. "By contrast, because during communist times poor distribution meant that the ordinary man on the street did not have access to industrially processed fresh milk, this is a relatively new industry for Romania with huge growth prospects. The new EU hygiene compliance requirements are putting pressure on the small producers and favours the industrial players like Albalact. Albalact has had extremely innovative packaging and a very dynamic approach to the sales and marketing function, making it one of the fastest growing companies in this sector in Romania’.

Another area that is undergoing tremendous change in Romania is that of private medical and occupational health services. RC II has acquired a minority shareholding in Romar Medical, a group of five companies operating in the area of private medical services in Romania and the country’s leading provider of occupational health services by number of patients.

Established seven years ago, Romar has evolved from a medical services company into a high-growth group of companies, with a turnover over EUR 9 million in 2006. The group conducts operations in nine Romanian cities, operates 15 policlinics, four diagnostic centres and five laboratories.

By leveraging its expertise in occupational heath services and using the EUR3 million in development capital provided by the Fund, Romar aims to deliver investors a significant return on capital. Investors should see the Group grow organically through the acquisition of new portfolios of customers, as well as raising brand awareness and enhancing relationships with family doctors and driving the usage of fee-based services for new and existing customers. The Group also has plans to enter the business of private medical insurance by setting up a health insurance company.

The private health insurance industry is new to Romania, which makes it an attractive opportunity, especially for an operator with Romar’s client portfolio. Florescu is keen to stress the opportunity: ‘Private medical services are only just starting to take off in Romania and Romar intends to leverage its existing client base to offer an increasing range of services. The reach that Romar has through its network of client portfolios means that it is very well placed to be at the forefront of this growth industry.’

RC II has also acquired a 92.3% shareholding in Top Factoring, a privately owned company and the third largest receivable collection business in Romania. Top Factoring was founded early in 2006 and has risen to become an important player on the Romanian receivables collection market in less than eighteen months. By working with leading banks, consumer finance companies, consumer product companies, GSM companies and utilities, Top Factoring looks to work out bad debts as an agent for its clients or takes on a principal role by purchasing portfolios of receivables at a sharp discount to their nominal values, seeking afterwards to recover as much debt as possible in its own name. RC II has provided EUR3 million in existing shares and development capital, primarily to grow the purchase line of business.

Debt purchases are highly profitable as the Company retains the entire value of the collected receivable. Florescu’s interest in the Romanian debt collection industry is fuelled by the growth potential for this market. Still in its infancy in Romania, very few companies have the expertise and know-how to operate effectively in this market place. Banks, non-banking financial institutions, GSM operators, direct sale companies and utility providers are expected to grow significantly and become more sophisticated in their intention of externalising the debt collection process. As a direct consequence, RC II forecasts that more and more clients will look to professional receivable collection companies, these companies offering a more professional approach and a higher success rate – at a lower cost.

Florescu says the development of the debt collection industry ‘is closely related to the general growth in consumption, as well as more specifically the growth in consumer lending. Both general consumption growth and growth in the consumer finance industry should remain strong, backed by increasing incomes and decreasing interest rates. The collection services market should follow a similar growth model. Sustained lending activity and aggressive competition for clients are expected to lead to deterioration in non-performing loan ratios, especially in relation to consumer loans. This should result in further market growth for the debt collection industry.’

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