Interview with Magdalena Śniegocka, Investment Director at CVI.
What is private debt and why are these instruments attractive to investors?
Private debt most commonly involves non-bank institutions providing debt financing that is not regularly traded on organised markets and can be in a form of a loan or a bond. The asset class extends across the capital structure, including senior, uni-tranche, junior, mezzanine, or distressed debt, enabling companies, entrepreneurs or financial sponsors to finance a variety of business needs.
A private debt investor can expect pre-defined cash flows, such as coupon payments or a principal repayment schedule. Cash flow predictability and good visibility of returns are some of the reasons why private debt instruments are attractive to investors.
They also provide an interesting investment proposition for those that can accept a longer investment horizon and are able to give-up a possibility to actively trade the exposure. An investor can demand for this feature a higher return, so called “illiquidity premium”. On the flipside, illiquidity requires from investors high skills in due diligence and oversight in order to properly asses and manage credit risks.
Whether investing in senior or junior debt tranches, a private debt investor is also ranked higher in priority than an equity investor, which in times of market downturn offers better recovery rates than pure equity. Of course, an investor can achieve very impressive returns with investments in equity, which are challenging to reach when you invest in fixed-income instruments. However, it is a trade-off and ultimately a decision about investor-specific risk-return appetite.
We’ve seen a clear increase in the number of companies that raised capital through corporate bonds in 2019. Why do you think more and more Romanian entrepreneurs access private debt financing? What benefits does private debt offer to entrepreneurs?
Romanian bond market is still in a development phase, but 2019 has indeed been a breakthrough with 17 corporate bonds listings on the Bucharest Stock Exchange and some private debt transactions taking place off-the-market. I think the increase in corporate bond activity in Romania is closely related to a few aspects – the availability of capital, increasing awareness among the investors, and the power of example, namely more and more issuers recognize the benefits of these alternative financing methods.
There are several benefits that private debt offers to entrepreneurs – speed in which capital is provided, extended maturity, flexibility in negotiations and also the ability to retain full control of the business. Clearly, the ability to retain control of the business is the biggest advantage of debt when compared to equity. Extended maturity is another important factor as we see Romanian entrepreneurs making significant CAPEX investments and for this purpose, short-term financing is not appropriate. Flexibility plays an important role as well. We think that many entrepreneurs have limited access to bank financing due to lack of appropriate collateral or a complex financing structure. Private debt solutions can address these issues.
Why does CVI invest in bonds and not shares? What’s your investment strategy?
At CVI, we also have a dedicated equity fund, but equity investments account for a relatively small part of our 1.1 billion-euro assets under management. We are indeed primarily known in the region as a private debt investor. As already mentioned, debt instruments are more predictable in terms of their returns and are usually characterized by regular cash payments, which can be payable quarterly, half-yearly or annually, as well as have a clear repayment date.
Since 2012, we have closed over 550 private debt transactions in 9 European countries, with an aggregated estimated value of EUR 2.2 billion. Today we have over EUR 1.1 billion in assets under management out of which an estimated EUR 1 billion is invested in private debt in the CEE region. Our investment strategy is to invest in profitable SMEs from Central and Eastern Europe, which need financing between EUR 2-20 million in order to address various needs, some of them including working capital, capex, M&A activity, shareholder buyouts, or dividend recapitalisations. We can provide financing to different sectors and at different levels of capital structure – from senior to mezzanine.
Why are there investors who primarily invest in debt? What are the benefits of investing in such instruments?
Investors that choose funds managed by CVI appreciate the predictability of cash flows as well as security that we offer to them. We designed our due diligence to ensure that we invest based on solid fundamentals and strong documentation in cash generative companies with a proven business model and with good management that has a credible plan for the future. During our investment process we pay attention to ESG factors, which are Environmental, Social and Governance aspects affecting the business and its owners. Prior to investing, we always want to identify what will be the expected source of repayment. Once we provide capital, we remain close to the company. We monitor covenants and financial data, usually on a quarterly basis, discussing the results as well as potential challenges that the companies may face. In some cases, we join the Board of Directors, at the invitation of the company, which we usually appreciate especially if we strive to build a long-lasting relationship with the management. This helps us better understand the business at hand and in case of risks, manage it before it escalates.
We obviously cannot say that investing in debt carries no risk. We can be faced with possible insolvency of the companies that we finance; however, we aim to manage such risks properly through a very thorough investment process and strong documentation. All in all, I believe that we deliver attractive risk-adjusted returns to our investors.
What company profile do you search for in Romania? What criteria do you look at when assessing a company? What about other investors, would you say you have a fundamentally different strategy than other investors?
We entered Romania as it is the second-largest market in the CEE region and we believe it will follow the trajectory of Poland since it is a fast-growing economy, with a lot of potential.
We grant debt financing to local entrepreneurs or financial sponsors under diverse schemes, providing capital ranging from 2 to 20 million euros per transaction. We invest primarily in profitable businesses, with EBITDA between 2 to 10 million euros. Depending on country of our activity, we may have a preference for certain sectors. In Romania, our focus is on FMCG and real estate businesses, but we are open to investments across other industries, which are vital to the Romanian economy, and which generate good yields. So far, we have invested approximately 60 million euros in Romania, two of our investments were in real estate (Impact SA and One United Properties SA) while the third one was in the FMCG industry (Aaylex Group, the poultry producer behind the CocoRico brand).
Concluding, I wouldn’t say that our strategy is fundamentally different than that of other funds – after all, most investors look for profitable, performing businesses with good prospects, active in vital sectors of the economy. Nonetheless, our investment process is credit focused, driven by the nature of the debt product. We analyse a potential investment from a slightly different angle than for example a private equity investor. We analyse the cash flows, strength of security package, potential recovery scenarios – all that in order to secure a potential downside scenario, while equity investors would focus in their analysis on the upside potential.