March 1, 2012
Interviewed by: David Snow
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Turkish Deal Flow

Turkey’s economy is growing, but what does this mean for actual private equity investment opportunities in the country? In “Turkish Deal Flow,” David Wilton, CIO of Global Private Equity for the International Finance Corporation (IFC) and Demet Ozdemir, Private Equity Leader for EY – Turkey, discuss how deals are being sourced and the challenges of pursuing traditional private equity strategies in Turkey’s unique environment.

Turkey’s economy is growing, but what does this mean for actual private equity investment opportunities in the country? In “Turkish Deal Flow,” David Wilton, CIO of Global Private Equity for the International Finance Corporation (IFC) and Demet Ozdemir, Private Equity Leader for EY – Turkey, discuss how deals are being sourced and the challenges of pursuing traditional private equity strategies in Turkey’s unique environment.

David Snow, Privcap: Thank you both for joining Privcap today. We’re going to be talking about private equity in Turkey, and certainly both of you have been involved in the Turkish private equity market from different angles for a number of years, and so we’re very happy to have you here to talk, and to share your expertise about the Turkish private equity market.

Demit, we could start with the question for you, which is all about deal flow.  Help us understand what is going on with regard to private equity deal flow in Turkey today.  Where is it coming from, and how does it differ from perhaps what we saw or unfortunately didn’t see in the years leading up to today?

Demet Ozdemir, EY: Well, private equity investors are interested in each and every deal, each and every sector, as long as it provides growth potential.  That’s what we understand, and that’s what we keep on hearing from them. But still there are certain things that they wouldn’t be very interested in Turkey. For example, privatizations, they’re not very much interested in that. Publicly courted companies, they’re not very much interested in that just because maybe also a company in Turkey cannot be delisted once it is listed on the Istanbul Stock Exchange. It is a current agenda on the capital market boards whether it will be changed, but it is the current situation.

Having said that, there has been a significant investment and successful exit of the major private equity in a Turkish hospital, which was publicly courted by the way, it was publically traded. Other than that, all the deal flows are coming from either from the advisors, which, Turkey has a significantly developed corporate finance or M&A advisors at different levels, either before companies, before accounting firms, or before, like ourselves, or boutique M&A houses, or investment banks who have international experience, do have offices in Turkey as well. Certainly regional M&A.

Other than that, other than the advisors themselves, private equity firms are very active in deal flow to generate the flow of down sells. So they do have a significant local market penetration themselves.  They do, and keep on the visits to local companies themselves.  So deal flow is basically from everywhere.

Snow: Well, if you mentioned that a lot of the publically traded companies are largely off-limits, there are family groups, right, that are possibly looking for investments, and there are perhaps divisions of larger corporations.  What are the dynamics of – let’s start with family groups – right now?  What is causing families to seek out a private equity investor?

Ozdemir: First of all, the interest they receive from the private equity themselves, which in some senses it is coming on a proactive way from the private equity investors is very much attractive for them, because they feel like, “Oh, my company is really attractive and I can earn that amount of money when I sell the shares.”  But then the question remains, “What shall I do with the money if I sell off all the business? Do I have any other expertise in any other sector?” No is generally the answer, so what shall I do after the divestiture?

Those are the things that are the questions in mind, and if they sell right now, the sellers may feel like they will leave the value of the company to the private equity firm which they feel like maybe the company is not there yet, and they feel they will have a better business plan, so it is not the right timing yet. The growth can be realized within the future, and then the sale can be realized is what they’re thinking.

Snow: David, your firm, the IFC, has a presence in Istanbul, a large team, and actually you have been backing local Turkish managers since 2003. What is your understanding of the deal flow dynamics in Turkey today that perhaps is distinct from all the dynamics leading up to today?

David Wilton, Global Private Equity International Finance Corporation: The first one we backed there was Turk-Ven One in 2003, and I a lot of the deal flow at that time was either entrepreneurs growing their company who needed growth capital, or families who wanted to improve and corporatize and grow their existing companies. Both of those tend to throw off minority positions. It’s not outright control. Since then, at the large end of the market, there have been a few of the big family groups starting to sell the odd and encore business, not in a big way, but I think it’s starting. Then at the smaller end of the market, some entrepreneurial opportunities, small startups getting into scale.

One thing in the Turkish market – and correct me if I’m wrong – but there haven’t been that many exits to get the sort of proof of concept that gets families comfortable with the idea that you can work with private equity. I think there have been a couple of interesting ones lately that we’re going to talk about. In other markets what we’ve seen is once you get those exits, and the families say, “Ah, this family worked.  They made a lot of money, they haven’t lost status, and by the way, portfolio wealth works just as well as wealth in a company.” Then people get more willing to start to work with private equity. So I think that’s a thing that may start to happen fairly soon in Turkey.

Snow: Well, certainly the ability to make cash, to make money is attractive in a family that’s had its wealth locked up in a company for many years. One could certainly see the value of perhaps doing a deal with a private equity firm, even on a minority basis.  But private equity firms like to say that they bring more than just money to the table; they bring expertise, they bring contacts and the ability to help grow companies from perhaps regional players, and into national or even multi-national players. Demit, do you think the entrepreneurs and the business owners that you work with understand or buy in to the idea that private equity firms can help them do more with their businesses?

Ozdemir: I fully agree with you that private equity firms can bring not only financial benefits, but also non-financial benefits. Especially for Turkish firms, corporate governance, improved management reporting and financial systems can be included in those benefits.  Depending on where you’re looking at bringing more corporate governance, increased reporting systems may even be considered as additional burden for the already operational Turkish people. So in that respect, due to Turkish families or businessmen understanding or really putting the value of the private equity investment, maybe it’s not a question mark, but maybe rather a two-folded manner.

Snow: So they say, “Sounds like, as my private equity investor, you’re going to bring a lot of new procedures and standards to my company. No thanks, that sounds like a real pain.”  Right?

Wilton: Could I just add, the Turkish tax system, how transparent and neutral is that?  As a company, I make myself a lot more transparent. Do I end up paying a lot more tax than my competitors, or does transparency become a competitive disadvantage?

Ozdemir: That’s a fair question because if you decide to make an investment in Turkey, there may be certain local companies who may have certain unrecorded transactions. Depending on which company you’re looking at. So looking from that perspective, and if you put all of the transactions within the financial system, then it may provide certain disadvantages. But still, our tax system is, yes, transparent in that manner, but there are certain tax risks and consequences, or exposures that definitely need to be considered, not only at the due diligence stage, but also at the operational stage as well.

Also from the private equity investment side, as far as the tax concern, the structure of the transaction is significantly important to consider. The structure of the transaction, not only at the investment level, like considering the tax treaties of Turkey have with other countries, and also sometimes, a set deal or a shared deal is one thing that needs to be considered. So there are ways to mitigate the potential risks as well.

Wilton: I think I was just wondering, there was one, it’s a bit old now, about 2004 or so, talking to the Turk-Ven guys, there was one industry that I thought there was a nice consolidation opportunity, it was all fragmented, mom-pop businesses. So big economies of scale, except the mom-pop businesses probably didn’t pay tax.  You get the economies of scale, but there’d be tax disadvantage, so the whole thing probably didn’t work.

Ozdemir: Because there’s no consolidation in tax corporate taxes in Turkey.  So there maybe, in that respect, there may be certain tax advantages in each and every company. But then, if you consolidate that, you may be in a position to give away the potential tax advantage. So there’s no consolidation in taxes, calculation in Turkey. That is the reason.

Snow: A classic private equity strategy, the roll-out, the gathering of similar companies, in some circumstances might not be as attractive in Turkey, and it also sounds like you’re saying in certain circumstances, family groups might not always see the benefits of greater corporate governance, of greater transparency. They’re sort of happy with where they are. But what about the big Turkish corporations and spinouts?  That’s, of course, a classic private equity deal, buying an orphaned or an under-resourced division of a larger, uh, corporation. Are you seeing any changes there as far as greater momentum towards that being a source of deal flow?

Ozdemir: There have been certain sales of non-core assets of the big Turkish conglomerates as well, so yes, in that respect, we have seen the private equity investors interested in those transactions as well. We have seen that as well.

Snow: A question for both of you, and maybe starting with David.  Obviously people are very important in growing businesses, and private equity firms are – at least they’re supposed to be very good at incentivizing people, creating alignments of interests for everyone to grow a company together.  What has changed in Turkey with regard to the quality of management for taking companies to the next level of growth?  I don’t know if, David, in your ten years investing in Turkish funds if you’ve seen any change there?

Wilton: I don’t think I’ve seen change, but I think Turkey has a good pool of senior management.  So a private equity player, as a company grows to a certain scale, can attract management – good management from another Turkish company. I think in common with many emerging markets, there then may be a slight shortage of talent at the middle-management level. That’s a common problem I think across all emerging markets. But in the Turkish context, once you’ve got a company that’s showing demonstrable growth, you can talk to the family and say, “Okay, change the incentive structure to attract new non-family talent, give somebody a bonus scheme, give them an incentive scheme, give them options.”  You can attract the talent.

Snow: Have you seen quality management available for private equity opportunities?

Ozdemir: Definitely, yes. In Turkey, there’s not the skilled high-level management or senior management is an issue at all. So we do have good management teams, but obviously if you consider the country as a whole, there are significant differences in Istanbul versus a company in, I don’t know, the Eastern part of Turkey.  But generally speaking, that company operating in the Eastern part of Turkey would not be that attractive yet for a private equity investment.  So we will be talking about the companies under that rather.

Snow: Let’s talk a bit about the competition for good deals in Turkey.  I’m going to imagine that when a good opportunity arises, there are at least several players, whether they’re local or international coming in to want to bid on it.  Can you talk a bit about the competitive dynamics for private equity deals in Turkey?

Ozdemir:  Private equity competition is significant, and if we are only talking about almost 40 different for all different locally-based companies, private equity firms who are trying to invest. I mean, the front size of each and every one is different but still they are very competitive.

In addition to these locally based companies, as we mentioned at the beginning, if the ticket size of a potential transaction is high, then we will be talking about global private equity houses, large mega funds being interested in the transaction.  Local ones can make co-investments together with them.  So in that respect, yes, the competition is significant at their level.

Wilton: To further that I’ll just say that compared to other emerging markets, the level of competition for deals in Turkey is less than, say, India or China or the BRICs.  I think at the good deal size, the deals are intermediated, there’s more competition.  You’ve got the regional funds, either middle region or European regional both playing in that.  Plus some of the global funds.

At the small and mid-market level, until recently, I don’t think there has been that much competition. Deals have been intermediated, but not sort of fiercely. There’s a few more players entering the space there. But still, I’m guessing, that maybe half the deals could be intermediated and half are still proprietary, something like that, which compared to India and China is still a relatively non-competitive market.

Snow: And your firm, the IFC, would always back the smaller, newer private equity funds, and so as you evaluate those opportunities, you’re probably looking at the competitive dynamics of the deal flow that they invest in, and it sounds like you’re saying that the smaller you get in Turkey there’s just not much, at least private equity competition.

Wilton: Yeah.  I think the small to mid-cap spaces are still, compared to other markets, and relatively less competed.

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