Prospecting for acquisitions.

• Author: Lindquist, John
• Position: Planning investments in Eastern Europe - Chairman's Agenda: Acquiring in Eastern Europe

Look for the laws all over Eastern Europe to be modified further to make acquisition of equity stakes more attractive.

Starting up a new business through joint ventures with East Bloc partners has been the traditional entry strategy into Eastern Europe, but to date Western companies have been much more hesitant about acquiring major equity stakes in existing enterprises and assets. So far, Western investors have announced or completed just over one hundred acquisitions in Eastern Europe. In contrast, they have entered into more than 3,500 joint venture agreements in Eastern Europe, including the U.S.S.R.

Why have there been relatively few acquisitions to date?

First and foremost, the laws in most Eastern European countries have been, until recently, too restrictive to make acquisitions possible. While the legal framework for joint ventures and acquisitions has been rapidly evolving over the last year, the problem lies in the small print. For example, in Yugoslavia, the constitution was changed in 1989 to allow for acquisitions, but the implementing regulations have been slow to be issued.

In Poland, the new laws on privatization and foreign investment allow 100% ownership, subject to government authorization, but it is still not clear whether you can own the land underneath the company. The legal quandaries are compounded by a number of other problems. Most countries have been restrictive about the convertibility or repatriation of profits, making the payback on investments highly uncertain.

There are also issues about what to do with the legacies of the communist era that you inherit with acquired companies. Many Eastern European companies are saddled with a stock of "social assets," such as apartments and sporting facilities, and a bloated work force. Divesting the social assets and trimming the work force can prove to be a difficult endeavor. There is uncertainty regarding liability for past environmental damage.

Another complication is the complete upheaval of the COMECON (Council for Mutual Economic Assistance) trade structure. Leading state industrial companies used to tie up a third or more of production capacity in COMECON's five-year specialization agreements for ruble-based exports to the U.S.S.R. and other East Bloc countries. Now that the system has been dismantled, it is unclear as to where a large portion of future sales will come from.

Finally, there is the issue of valuation. Existing accounting data can be very misleading. Often, prices are regulated, and key cost inputs subsidized, and differ significantly from international prices; balance sheets often do not recognize basic conventions like bad debt, obsolete stock, or depreciation. Moreover, the absence up to now of functioning stock markets or previous equity transactions means there are no comparable market prices.

On the other side, Eastern European governments have their own reasons to be cautious about acquisitions. They, too, are concerned about...