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

Venture caps regain faith in IT sector

Katalin.Toth@bbj.hu

Venture capitalists have not made a great deal of investment in local IT companies in recent years, with perhaps one notable exception: one relatively new fund, Primus Capital Partners LLC, was established in 2003. Primus, managed locally by Hungarian firm Hotaka Consulting Kft, made three investments this year and one last year; other venture capital and private equity funds made hardly any.

Three of Primus' investments have gone into IT companies. In 2005, it has invested in VideoCast Kft, a developer of digital security camera systems, and Sense/Net Kft, a maker of enterprise portal software (EPS). Last year, it bought into interactive marketing and media firm Mirai Interactive Kft.

Primus' fourth portfolio company, Nebotrade Kft, a microbiological substrate and generic diagnostic equipment maker, belongs to the biotech sector, a similarly high-growth, innovative technology sector.

"Hungarian venture capital investors are showing greater risk aversion than those in the U.S.," claimed Zoltán Bruckner, fund manager of Primus Capital Partners and managing director of Hotaka Consulting. "The success of internet search engine provider Google has brought new life to the internet business, and U.S. venture capital firms are once again interested in firms providing internet-based products – which was unthinkable even six months ago. Broadband availability is driving internet-based technologies, and business models are beginning to look a lot more realistic."

While U.S. firms are getting more capital for product development, IT companies receiving venture capital in Hungary require consolidation capital for developing marketing, sales and management systems, Bruckner said. At the same time, he added, U.S. funds run the risk of product development, while fund managers in Hungary are investing almost exclusively in firms that already have established products and market clients, and are operating profitably. Some of these funds are channeled into the rapidly expanding market, as is the case with Sense/Net, he added.

"When investing $1 million -$2 million in start-ups or early-stage companies, investors need to take much more of a hands-on approach and bring some company-building skills," explained Bruckner. "This is different from investing in a more mature company with only a financial goal, but I think we're seeing a return to early-stage investments in Hungary."

Money to spend

There is a lot of money to spend in the CEE region. According to data from the European Venture Capital Association, some 140% more venture capital funding was raised in the region in 2003 compared to 2002, while money allocated for European investments in general grew by only 1%.

At the same time, private investors are not making many deals in Hungary, with government funds behind the majority of investments, said Bruckner. He named the private equity arm of the Hungarian Development Bank Rt (MFB), along with affiliates like the Small Enterprise Development Fund and IT Venture Capital Fund.

Balázs Bedő, investment manager of FastVentures, an early-stage venture capital fund specializing in IT, said large funds are tending to make one or two huge telecom privatization deals in either Southeast Europe or the CIS countries that provide enough return to not have to make several smaller – say, $3 million – investment deals in Hungary.

On the other hand, there are not many small Hungarian IT firms that are deemed suitable for venture capital investment, Bedő opined. One problem he cited is that it is sometimes difficult to cooperate with the management of Hungarian companies.

Local managers of companies with new inventions are often blinded by their own innovations and the amount of engineering work invested in them, concurred Bruckner, and are not ready to take into consideration whether there is a big enough market for the product they wish to sell. Other company managers, he added, fear that investors are there to steal their ideas or inventions – fears that are largely unsubstantiated, at least in Hungary.

According to Bedő, Hungarian entrepreneurs want to do everything themselves, and not to "limit" themselves to being just a subcontractor of a larger firm – which is, he noted, a good business model. He added that some also want to take every decision themselves, and are unwilling to accept advice, while it is also often difficult to convince them to give up their majority in a company.

Bedő observed that it is alien to Hungarian management culture to build up a company based on an innovative IT solution and then sell it to a big firm – possibly to a competitor. He conceded, however, that this attitude is also common in the United States.

Returning confidence

Another industry expert working in the field of more generally oriented venture capital funds, speaking on condition of anonymity, was more optimistic. This source opined that there are enough investment opportunities on the market, but that investors have to work harder to find them, and noted that things were easier in the 1990s, when money was being poured into internet firms.

Tamás Szalai, investment manager at venture capital fund Bancroft LLP, told the BBJ that it is difficult for a Hungarian startup to achieve a level of growth large enough to be of interest to venture capital investors, because individuals and their families are less able to provide seed capital. He added that, following the bursting of the internet bubble in 2001, it is still more difficult to find money for early-stage companies, though he conceded that IT investments are now on a more solid footing than during the dot-com era.

"The same thing is happening in Central Europe that happened in the U.S.," said Szalai. "Some business models failed, but others reached a scale where they started to make money, and the firms also learned not to give away services just to gain customers, but to charge appropriately for them. As a result, investor confidence in IT firms has also returned."

Szalai speaks from experience. This year, Bancroft successfully exited two Czech IT companies, in transactions partly managed from Budapest. Prague-based Vltava, an e-commerce portal selling books and electronic gadgets on a model similar to Amazon.com, was sold to Czech private equity firm Genezis. Another Czech portfolio firm, Computer Press, a publishing company selling books and magazines on IT and business subjects, was sold to international private equity investor Riverside. These examples show that a secondary market for IT investments has already developed in the region, Szalai noted.

Bruckner shared Szalai's optimism about IT investments returning to favor in the eyes of venture capitalists. In his opinion, online media is one of the most promising investment opportunities on the market. He argued that digital media agencies organizing interactive marketing campaigns, like Mirai Interactive or Kirowski Rt, will be able to grow rapidly.

Digital broadcasting, and digital transactions like shopping, ordering and voting over the net, appear to be the next big thing, and those who provide software for these services will make money, Bruckner opined. He added that digital television from cable and broadband will be made available by alternative service providers before Antenna Hungária Rt begins broadcasting digitally.

New customer relationship management (CRM) systems that track consumer behavior in new ways might also be successful, Bruckner said, as might be certain types of software that enable a central server to dispense with the need to purchase management information system software. But this type of software needs a U.S.-sized market in which to grow before coming to Europe, he added.

The security systems market, both online and "physical" (like those provided by VideoCast, or by FastVenture's portfolio company Vidux Kft), will also boom, Bruckner predicted. In addition, he said biometric access systems will likely become common in the near future, and noted that, for management, systems integration firms can enter onto a large, new market by installing large security systems.

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