Private Equity in Turkey By : Hany Hussein, CFAJanuary 2012

How should we see PE in Turkey ?

Private Equity in Turkey

Robust macro picture & political

stability

Booming economic sectors especially Consumers

&Healthcare

Promising deal flow within SMEs in Black sea, Anatolian,

and AEGON region

Favorable investment environment & strong FDIs

Why Turkey ?

•Turkish economy is one of the fastest growing and was tripled over the past decade reaching US 772 billion in 2011. IMF expects real GDP growth of 4% until 2016. • Liberal and secure investment environment: Post Arab Spring, Turkey emerges as a stable and peaceful Oasis within the regional turbulence •Big population of 75 million people with over 26 million are young, well educated and motivated professionals• Large and Growing Domestic Market equipped with modern market tools: 50 mln internet users, 65 mln phone subscribers, 51 million credit card users, 31.5 mln international tourist arrivals, and 18 mln airline passengers (2011 figures)• Developed infrastructure: New and highly developed technological infrastructure in transportation, telecommunications and energy•Competitive tax system: Tax was reformed and corporate tax was reduced from 35% to 20%. •Turkey has customs union with EU countries & mature and dynamic private sector

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012e 2013e

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

GDP Real Growth Rate

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

0

100

200

300

400

500

600

700

800

Nominal GDP in $bln

PE Dynamics

• Over the past 20 years, almost US$ 7 billion was invested in the Turkish private equity market. • Until 2005, the market was in its infancy stage with few small transactions every year in the range of US$ 2-3 million focusing mainly on small – mid cap consumer sector• 2006 – 2008 saw the big bang of the market as regional fund managers and global buyout funds showed interest in big tickets in the range of US$ 100 million – US$500 mln across all sectors of the economy•2009 did not see strong activity as economy contracted by c 4 percent. Only 9 transactions worth of US$ 244 mln were executed.• In 2010, private equity performance was quite strong with 11 deals worth US$ 411 mln took place. Investments were not limited to a single sector but target the companies that underpinned Turkey’s rapid growth. Buyout groups were especially keen to invest in companies that operate in or cater to the country’s booming consumer market.•Valuation climate, overall investor sentiment, exit activity which literally froze from Q4 2008 to Q1 2010 were revived in Q2 2010.

23%

18%

18%

11%

9%

7%

14%Healthcare & life Sciences

Consumer

Industrials and Manufacturing

Infrastrcuture

Service

Media and Telecom

Others

Private Equity Investments by Sector 2010-2011

Before 1999

99-00 2001-5 2006-7 2008 2009 2010

0500

10001500200025003000350040004500

Investments in Private Equity in US$mln

2002 2003 2004 2005 2006 2007 2008 2009 2010

0

5

10

15

20

25

FDI in US$ billion

Strong FDI

2002 2003 2004 2005 2006 2007 2008 2009 2010

0

5

10

15

20

25

FDI in US$ billion

Series1

Ranking in A.T. Kearney FDI Confidence Index's top 25 

2001 2003 2005 2007 2010 2012

2324

13

2023

13

FDI Distribution among major Industries 2006-2009

Financial Service

Manufacturing

Transport

Whole sale & Retail

Electricity, water, gas

Real estate

others

• FDI in Turkey has shown a steady increase since 2002 due to improving key macroeconomic indicators in addition to enjoying political stability. The value has decreased starting 2008 due to credit crisis and has started the increasing trend in 2010

• With the surge of FDI in 2007, FDI to GDP ratio has stayed above those of developing countries, however the decrease thereafter has put Turkey below

• Share of energy sector as a percentage of FDI is expected to increase in the near future. Insurance has been one of the active segments within financial services as it is underpenetrated while manufacturing is attractive due to cheap labor for European companies

In addition to the robust FDI from international investors, availability of local finance is one of the key drivers of Private Equity / buyouts. Private equity funds are able to find local leverage especially to finance large transactions such as Migros

Fund Raising

Development Finance

InstitutionsDFIs

Limited PartnersLPs

Local Investors- Family Offices &

Pension Funds

-In general, all fund raising activity happens outside of Turkey as local investors haven’t participated in local private equity market yet. This does not encourage international investors either -Usually General Partners (GPs) refuse money from local family offices to avoid conflict of interest with rest of Turkish business community. In the near future, family offices should stop considering their investments in PE funds affiliate businesses- On the other hand, family conglomerates predominate privatized assets. In 2010, conglomerate MMEKA Makine bought privatized assets for more than US$ 5.0 billion. There is a room for private equity to grow once local investors are seriously invited to participate.

- Historically

- Historically Development Finance Institutions were the only investors in the Turkish Private Equity Funds. The first independent local fund manager Turkven received commitments from a number of DFIs including IFC, DEG, FMO,..etc for its first fund back in 2002. - DFIs play an important role as they continue seeding first time fund managers such as Mediterra Capital which is targeted more than US$ 300 mln for its vantage fund in 2011

-Today foreign pension funds and commercials LPs are playing greater role in the GPs fundraising efforts. -Recently Actera Partners have raised funds from Canada Pension Plans and Ontario Teachers Pension Plan for its first fund

PE Segments

Regional Fund Managers

Global Fund Managers

Local Fund Managers

Local Fund Managers have strong and wide network and act on the ground, usually present across all market segments – from growth capital to buyouts- and typically write equity tickets ranging from US$ 10 million to US$100 million such as Turkven and Acter

Regional Managers access Turkey through a CEE fund (Advent International and Bridgepoint) or a MENA fund (Abraaj Capital and Swicorp). These managers tend to target deals averaging US$ 100 million. They always use local corporate finance companies for local expertise

Global Managers are the large buyout firms. They seek out largest deals which require US$ 400-US$500 million of equity. They are considered as a second alternative of finance within the lack of bridge finance and buyout debt. Very common in the transportation and infrastructure projects

Deal Flow

Deal Flow: Too much money chasing too few deals

•There is a clear mismatch between money raised/committed over the past 5 years and investments really deployed , as not too many families want to sell their own business.

• Capital is overhang in the range of US$100 million. Too many fund managers are competing for deals in this range

• On the other hand, there are plenty of deal flow in the small to medium size segment as some 60% of Turkish companies have fewer than 250 employees where capital is much needed

• Also, the European debt crisis will eventually make banks requesting higher equity structure to lend money to Turkish companies. This would represent an opportunity for PE Fund managers to create value by rationalizing firms’ capital structure and improve cash flow management

•Alternatively, large PE Investors monitor Turkey’s active privatization program which aims to scale back government involvement in backbone sectors including Energy and Infrastructure. Turkey privatized domestic assets of US$11bn in 2006 to US$14bn in 2010 through an aggressive auction process.

• Privatizations will continue to be a key driver of bringing new assets to investors going forward, with prospective state divestments including additional power generation assets, Istanbul Ferries, the Turkish lottery, and the government’s stake in Turkish Airlines.

Exit Strategy

Exit Strategy • We noticed that many Fund Managers had a successful full cycle of PE Investments . They Invested, managed, exited , made profit, and repatriated principals and profits out.

• PE Fund Managers can exit through: • Strategic Sale to International PE Investors: Where GPs play a critical role in professionalizing the

Turkish companies and bring them up to international scale and standards and by doing this they create investment opportunities for International investors.

• Or through an IPO: • If it is US$ 200mln and above - through listing on Istanbul Stock Exchange • If it is less than US$ 200 million – could be through listing on London AIM or NASDAQ• Should the government allow local pension funds to invest in public equities, existing through

IPOs would be a very feasible option especially for the lower end segment

•In 2008, Abraaj Capital invested US$585 million in Acibadem Healthcare and managed to exit in Jan 2012 through a strategic sale.

In 2006, TPG Capital invested US$ 810 million in Mey Lcki – a Turkish Spirits company. In August 2011, it sold its stake in the company to UK Premium drinks company Diageo for US$ 2.1 billion

Improving exit is a key driver for private equity. Increasing FDI has demonstrated trade buyer interest while increasing number of active private equity funds are positive for the secondary market.

Challenges

•The Current Account Deficit: Turkish economy is structured in a manner that limits the government control over its current account which expose it to deficit due to a) union customs with EU and b) Turkey’s imports of raw materials including oil and metals. Recently the current account deficit soared to above the 10% of GDP. This could lead to higher interest rate and dampen domestic demand

• Moving towards centralized regulatory framework: Turkey has recently brought banks and capital markets under the direct control of their pertaining ministers. Concerns are now increasing if similar steps could be taken towards Turkish GPs which would affect the existing Private Equity Funds

•Legal environment: Enforceability of contracts, protection of shareholder rights and legal concepts familiar to private equity are not fully covered by the Turkish legal system. Slow moving legal environment is another disadvantage

•Outdated commercial law: There are gray areas in terms of taxation and deal structuring. Also, bureaucracy and personal liabilities at the broad level are barriers to invest in

•Minority rights issue: Legal framework is not protective of minority shareholders . Private equity funds willing to invest in minority deals need to carefully draft legal documents and perform personal due diligence for company owners carefully

• Lack of transparency: Cash transactions that stay out of the books are widespread in Turkey, this creates discomfort for foreign investors

• Lack of human resources: There is scarcity of individuals that have experienced the various stages of the equity transactions. This is especially important for top management positions.

Opportunities

Opportunities

• Focus on small–mid Caps: So far, most of the PE transactions focused mainly on Istanbul. Private Equity investors will likely find better valuations and achieve better return in the lower market segment in small-mid size transactions in the range of US10-20 million in Anatolian, Black sea and AEGON regions.

• Economic & Political Stability: Turkey is standing up to its reputation as an island of stability amidst regional economic and political volatility.

• Strong Consumers / Healthcare sectors

Retail 32%

Transportation23%

Manufacturing 17%

Healthcare3%

TMT3%

Others22%

Turkey Private Equity Investments by Sector 2006-2009

Retail 9%

Trans-portation

4%

Manufacturing 15%

TMT20%

Others52%

Asia Private Equity Investments by sector 2006-2009

Tips to consider…

Pre-Investin

g

• Even though third parties conducting financial and legal due diligence is widely available, parties conducting insightful commercial due diligence, especially for mid-market are scarce

• Sector data including market size, market share is hard to find making the due diligence effort more cumbersome

• Increasing multiple expectations by target companies due to a variety reasons including emotional attachment is an obstacle

Management

• High level of entrepreneurship in the country is resulting in poor strategic focus and unawareness of global trends

• Company owners generally have top- line focus rather than EBITDA focus

• Implementing change requires higher level of effort due to resistance from owners and company employees

• As some business has been conducted off the record reacquisition, transparency in finance and accounting are key issues

Exiting

• Emerging market appetite worldwide needs to be maintained in order for favorable private equity exits to increase

• In order to demonstrate company's true value, it is important to increase transparency, implement management dashboard and perform KPI benchmarking

Thank you