Publication: Budapest Business Journal
Provider: New World Publishing
Date: October 10, 2005

Capital injections, buyouts offer hope for tech firms

Successes in the Hungarian tech sector are surprisingly few and far between, despite the optimism witnessed during the heady days that preceded the burst of the dot-com bubble in 2001. There are, however, enough success stories, and several recent venture capital deals and buyouts, to suggest that there are genuine opportunities for the future of technology-related Hungarian firms after all.

"With the unrealistic valuations of the technology boom now firmly behind us, there are tech firms which, even though in the early stages, are serious about old-fashioned things like profit and cash flow, and which represent good investment opportunities," said Tom Howells, partner of Euroventures Capital Advisory Kft.

According to Howells, venture capital in the tech sector can certainly play a role.

"The real issue is in earlier-stage deals; IT deals still get looked at, but everybody is looking at bigger deals, such as mergers and acquisitions, because investors have become rather wary of risk in the last few years," said Steve Carlson, chairman of IT forum First Tuesday Budapest.

First Tuesday's Budapest meeting was once a swarming hive of activity during the internet heyday – an event that drew investors interested in meeting start-ups. Carlson is now planning to relaunch First Tuesday in conjunction with the CEU Business School in mid-November.

"People still view Hungary as an emerging market, though my gut feeling is that there is a change going on in investor perception toward Hungarian investments, which bodes well for the future," said Carlson.

While larger buyouts are appearing to be more attractive for financial investors (from the investors' point of view), smaller early-stage investments can often be less risk-ridden, Howells noted.

"In a funny sort of way, I think that early-stage technology and other venture capital investment might, at this point in the cycle, represent a safer investment – relative to the potential returns – than the big buy-outs," he said.

Howells explained that larger firms throughout Europe are often riddled with ever-increasing amounts of equity and debt, and are priced in West European terms – which, since Hungary's EU accession, also includes Hungarian companies – at historic highs, at an average of 8.4 times EBITDA.

"Really high prices accompanied by lots of debt are, of course, risky propositions, and investors can't rely on 'secondaries' [a sale by one private equity investor to another, currently the most common route for exiting private equity], or refinancing [adding to debt to take out more equity] to bail them out indefinitely," said Howells. "I predict increased interest in and improving returns from tech investments and venture capital, if only because no one is really doing it at the moment."

Strategic partners

Overall activity and interest is picking up. Last week, the U.K.'s Aegis Group Plc, a media communications and market research group, announced that it had acquired Kirowski Rt, Hungary's leading full-service digital agency. Kirowski will become part of Isobar, Aegis' fast growing digital network, employing nearly 1,200 specialist staff.

"This is the best way to secure market position for the next five to 10 years – their strategy for the region met our strategy 100%," said Péter Novák, head of digital marketing and media at Kirowski.

Novák also mentioned that nowadays it is better to have a strategic partner than take on a venture capital investment, which contrasts with the situation five years ago.

"Then it was all about growth, as the market was very small," he said. "We believe over the next few years the market will be much more integrated to the overall advertising market – therefore we have to be part of a bigger network."

Novák added that the Hungarian interactive advertising market is already quite big, though a gap of one or two years still exists when it is compared to Western countries.

One year ago, Kirowski made the decision to commit to realizing regional growth through spreading its knowledge and services. Novák said its cooperation with Isobar will help both companies' ambitions in the CEE.

"This action won't mean any new strategy focus for us or for Isobar," he said.

The purchase price will comprise a total cash consideration of up to $10 million, payable over four years and subject to rigorous performance criteria, revealed Aegis.

Founded in 1996, Kirowski's clients include many well-known local and international advertisers, including Magyar Telekom Rt and its various subsidiaries, as well as Mol Rt, Nestlé and Renault. Kirowski provides clients with a wide range of digital marketing services, including interactive marketing, digital media planning and buying, e-business solutions and business applications.

"The acquisition of Kirowski is consistent with Aegis' strategy of building Isobar into the leading international digital network," said Robert Lerwill, CEO of Aegis. "With Kirowski's strong market position and comprehensive set of skills, we shall be able to provide clients with exceptional service capability on the fast-growing Hungarian market."

As well as being the largest digital marketing agency in Hungary, with a 25% market share of online advertising, Kirowski has also won a number of prestigious digital technology and creative awards for its work, noted Lerwill.

The broader Europe

As reported in the BBJ last week, U.S. telecom giant Motorola Inc. made a strategic minority investment earlier this year in IP communication solutions firm Asylum Telecom LLC, which has key operations in Budapest, and plans to use this as a springboard to further investments, according to John O'Donohue, managing director of Motorola Ventures in Europe, the Middle East and Africa (EMEA).

Asylum is Motorola's first venture capital investment in a company that has a significant R&D and support facility in Hungary.

"What we call 'broader Europe' is a key region for Motorola and for the quality of technology that's here," said O'Donohue. "We hope our investment in Asylum will be a gateway to looking at other companies in the region."

O'Donohue told the BBJ his company is continuing to monitor the Hungarian market for new opportunities.

Up until now, Motorola has been investing $75 million–$100 million annually in new ventures, primarily in the United States. O'Donohue kicked off investments in Europe 18 months ago, completing six European investments last year. The goal is to grow investments in Europe to 25% of the company's U.S. budget, investing in four or five companies annually. Within this, the CEE region is an important area of focus, O'Donohue explained.

O'Donohue noted that Motorola will obtain customary minority investor rights in Asylum through its investment, but emphasized that it will not seek to change the path of the firm's development. Motorola Ventures typically takes between a 10% and 15% stake in the companies it invests in, he added.

Meanwhile, Primus Capital Partners LLC, the U.S.-based venture capital fund with a focus on Central Europe, announced in September that it is investing in leading Hungarian enterprise portal software (EPS) maker Sense/Net Kft. As its fourth investment in Hungary, Primus acquired a minority stake in Sense/Net, a company with revenues last year close to $1 million.

The software developer will use the funding to develop and expand its integrated internet, intranet and extranet portal software solutions, as well as to assist with corporate expansion.

"Sense/Net is a fast-growing company, profitable for eight years, with a successful product and a significant client base in both the public and private sectors here in Hungary. It also places competitive technology on the international market," Zoltán Bruckner, managing director of Primus Capital Partners, told the BBJ on announcing the deal.

"After the dot-com era, during which 'solutions' appeared one after the other without proper strategic or technological planning and market rationale, the IT market has stabilized," observed Sándor Kiss, CEO of Sense/Net.

Fathoming success

As for Euroventures, one of its Hungarian technology investments, Fathom Technology Kft, grew first through Euroventures' own venture capital investment, and later after being acquired by an American firm, EPAM Systems.

"Fathom is a largely unsung Hungarian tech success story," said Euroventures' Howells. "Its relative local anonymity is due to the fact that it has no Hungarian clients, but it writes software for such big names as Reuters, British Telecom and the London Stock Exchange."

Despite its excellent technical skills, Howells said Fathom lacked scale, and the 2004 merger with EPAM Systems has greatly improved its size and position.

"It is now the European headquarters of EPAM, and serves as the front office for software delivery to European corporations," he said.

Howells added that EPAM has now developed beyond being a mere "body shop" that sells cheap programming hours to the West.

"Such a model is not sustainable in any case, but the company is increasingly moving up the value chain by interfacing with clients and delivering solutions that work, not just billable hours," he explained.

He added that EPAM's approach is characterized by the "near sourcing" model, as opposed to outsourcing.

"Outsourcing is generally carried out in India, where faceless programmers in a different time zone generate reams of code," said Howells.

Euroventures was the largest investor in Fathom, and retains a stake in EPAM.

As First Tuesday's Carlson pointed out, not all start-ups are eager to attract investors, and are often reluctant to do so because of the strict terms attached, as well has having to forego control over the company's eventual destiny.

"Taking on an investor isn't just about bringing in bundles of cash. It often signals the beginning of your eventual exit from the company," he said.

Carlson also noted that there have been cases where investors have had to give up on their substantial investments and walk away in order to cut losses.

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