“The small size of the [Bulgarian] market doesn’t reflect the level of companies’ competence and sophistication,” says Mr Elvin Guri, founder of Empower Capital, one of few Bulgarian venture capital funds. Early-stage companies in Bulgaria are struggling due to a shortage of funding, but their untapped potential may be released with effective incentivising by the Bulgarian government and the European Union.
In 2016, foreign direct investment (FDI) in Bulgaria was €701.7m, a 72% decrease from 2015, according to the Bulgarian National Bank. FDI peaked in 2007 and foreign investors have been reluctant to invest in the country in the aftermath of the financial crisis.
Corruption in the political and judicial systems has also deterred investors, and in fact, Bulgarian lawyers advise their foreign clients to include in their business contracts a clause permitting arbitration outside Bulgaria in the case of a dispute. They also recommend establishing an investment partnership abroad, so that only the operating company is based in Bulgaria.
The majority of partnerships between Bulgarian and international businesses now function more smoothly than previously, however, as international chambers of commerce, sectoral business associations, and western diplomats lobby actively on behalf of investors facing problems.
EU Promotion for Bulgarian Start-Ups
The European Union has sought to promote investment in the South East Balkan country via the Joint European Resources for Micro to Medium Enterprises (Jeremie), an initiative of the European Commission developed together with the European Investment Fund. It promotes the use of financial engineering instruments to improve access to finance for SMEs via Structural Funds interventions.
One Bulgarian official says that €120m+ has been invested since 2013 in companies backed by Jeremie, via four Bulgaria-based venture capital funds, and the market has room to grow: Empower Capital’s Mr Guri puts the potential for private equity investment across south-east Europe at €5.6bn.
Cause for Concern
Not everyone is optimistic, however, about the flood of capital brought about by Jeremie. Imre Hild, chief executive of iCatapult, a Budapest-based accelerator, says too many VC fund managers have private equity backgrounds and do not understand the mindset or needs of entrepreneurial start-ups: they acquire majority stakes and then micromanage the companies, almost certainly stripping them of their creativity and innovation.
The Bulgarian government is also working to attract foreign investors: in regions of high unemployment, investors enjoy tax breaks on reinvested profits and subsidies on social insurance payments. In addition, investors can take advantage of low wage costs (€4.40 per hour) and a flat tax rate of 10% on corporate profits and personal income, the lowest in the EU. The government is also actively reducing red tape for investments in manufacturing and services.
These incentives are key to securing funding for start-ups, as increased amounts of private financing will be critical to making small businesses sustainable in the longer term. Otherwise, they will move to the UK, Germany, or the US, where venture capital and private equity funding are readily available, warns Evgeny Angelov, chairman of the Bulgarian Private Equity and Venture Capital Association and former Economic Advisor to the President of Bulgaria.
Low Labour Costs
Low labour costs in particular set Bulgarian start-ups up well in terms of competitiveness. As an example, take the following two small high-tech companies: MClimate, based in Sofia, and tado°, based in Munich. They are both Internet of Things firms focusing on smart homes and offer similar product suites that include smart thermostats, controlled via apps, that adjust to the real-time behaviour of residents of private homes and small businesses.
The difference in funding between the two is significant: tado° just closed its Series C round, bringing its total funding to $56.29m. MClimate, on the other hand, is operating with only seed funding, which totals US$690.82k. Note that tado° is a few years older. MClimate reviews on Google Play are 3.4 stars, while tado° reviews are at 4.1.
While the difference in rating highlights a customer preference, the low costs of MClimate allow it to operate healthily in the market, and it’s possible that with more funding Bulgarian companies like MClimate would compete more aggressively against their more capitalised counterparts.
Bulgarian startups have so far proved competitive in the tech sphere: “These are companies that have developed world-beating technologies. They have tremendous possibilities,” stated Mr Mark Crandall, founder of PostScriptum Ventures, a venture capital group that specialises in start-ups and niche investments mainly in the energy sector.
This sector specialisation could prove useful for future EU funding, as the union emphasises the need, through structural and investment funds, to make the EU’s single market fit for the digital era by removing regulatory walls and merging the existing 28 national markets into one robust market place. The European Commission claims the move could add €415bn to the EU’s economy annually while creating hundreds of thousands of new jobs.
While Bulgaria hopes to position itself as an information technology leader in Southern Europe, businesses are finding it difficult to keep up with accelerating demand for skilled workers: although around 2,000 IT and computer science graduates enter the labour market every year, few of them have the specific skills that businesses need.
“The success of Bulgaria’s high-tech industry will depend on our ability to generate the necessary capacity of relevantly educated engineers,”
states Mr Roddy Dervishev, chief executive of Sibiz.
“If we are not able to build sufficient engineering capacity, this may lead to stagnation, withdrawal of investments and Bulgaria will not establish itself as a high-tech destination.”
Both the private and public sectors are attempting to change this situation with appropriate training, but the results will take time to show.
In conclusion, the economic conditions of Bulgaria are improving, but the country’s vibrant start-up environment will suffer unless capital inflows continue to grow and quality in the labour market holds up. The attempts of the government and the EU may be the key to helping SMEs prosper, and the result may be a sea of opportunity for venture capitalists and innovators.
Bayeux Tapestry on Loan
Emmanuel Macron has offered to loan the famous tapestry to the UK in an effort to improve relations.
Editor’s Remarks: The offer is expected to be announced this Thursday, when Macron will meet UK officials at the Anglo-French summit at Sandhurst. The Bayeux Tapestry was commission by William the Conquerer’s brother to celebrate his 1066 conquest of England and depicts the Norman king defeating the Anglo-Saxon ruler King Harold. Although it was made in England, the piece – which measures about 35 square metres – has remained in France for the past 940 years. At the upcoming summit, Macron is also expected to petition the UK to join his combined European military initiative – a move many expect Britain’s new defence secretary Gavin Williamson to push back on.
Read more on Europe:
Why 2018 Will Be the Year of European Stocks
2017 has been an incredible year for stock markets all over the world. 2018 will probably be the same. Last year, the MSCI Europe index rose 22%, compared to 19% for the S&P 500. In my opinion, 2018 will be an even better year for European stocks.
A Favourable Political Landscape
In the last years, European stock markets have suffered because of a very uncertain political environment. After surviving a number of difficult elections in 2017, the European political landscape now looks much more favourable. While some risks remain, with a particular focus on the Italian general elections in March, the chance of results that could rattle markets is very slim, as populist parties appear to have softened their rhetoric against the single currency or abandoned the plan to leave it altogether.
Positive Economic and Monetary Environment
The European economy is growing quite strongly. Real GDP is expected to grow by 2.1% in 2018, unemployment has reached the levels of 2009 and consumer confidence is well above pre-crisis numbers. The improving economy should boost EPS, making European stocks look relatively cheap compared to bonds.
“In Europe, the combination of easy credit conditions and falling unemployment should support confidence, earnings and equities […] An incredibly tight correlation has existed throughout history whereby rising consumer confidence in the euro zone boosts equity prices, and you get this virtuous cycle. We think that will continue.” Mike Bell, JP Morgan Asset Management
In addition to a recovering economy, the European Central Bank will keep buying bonds until at least September, continuing to support markets. Recovering European companies might use this cheap debt to complete cross-border mergers and acquisitions.
The Rising Euro
2018 is likely to be the year of the Euro as well. After an incredible 2017, where the currency strengthened considerably against the US dollar, many analysts predict that the EUR/USD exchange rate will reach 1.30 – a level not seen since 2014. Some suggest that the pair will end the year at 1.24.
Since the beginning of the year, the euro has already seen some interesting movements on the upside, thanks to Germany getting closer to a government, hawkish comments by the ECB and China suggesting that they might diversify their FX reserves. However, as a strong euro would not benefit European exporters, we can expect the ECB to act to weaken the currency, especially since inflation is expected to remain low for years.
Cyclical Sectors Look Particularly Interesting
Given the positive economic environment, cyclical stocks are attractive investments. In fact, in the first week of trading in 2018, cyclical stocks in the Stoxx 600 have performed much better than defensive ones.
“In an environment of solid growth and rising long-term yields in Europe, financials and value stocks in general are likely to outperform, as well as energy.” Valentin Bissat, Mirabaud Asset Management
However, UBS analysts warn that the European banking sector could suffer earnings downgrades due to risks generated by sluggish revenues, cost inflation and the threat of regulatory uncertainty. As a consequence, investments should be chosen very carefully, favouring cheaper banks with strong levels of free cash flow generation.
The Old-Economy Might Produce Healthy Returns As Well
After the financial crisis and the European sovereign-debt crisis, in old-economy industries, like building material manufacturers and homebuilders, firms have restructured their balance sheets and rationally changed their business models. As many weak companies have failed, there is less competition as well. With consumer and business confidence increasing quickly, demand for these businesses will increase as well. Those firms that have survived might even be able to raise prices, generating higher EPS.
European Stocks Are Just Cheaper than US Stocks
As said, fundamentals would justify a European equities rally in 2018. Although they are not cheap in absolute terms, they look particularly so when compared to US stocks, meaning that the Eurozone could be less vulnerable if a correction comes. In fact, the S&P 500’s forward P/E ratio is 18x, the highest since 2002, while the Stoxx 600 trades at 15x – below its 2015 peak. This same trend is confirmed by the price-to-book ratio: the Stoxx 600 trades at 2x, while the S&P 500 is trading at 3.4x – again, the highest level since 2002. The spread between the two has never been this high.
“There’s definitely less euphoria in European stocks at the moment […] Now the big question is: will European stocks be immune if there’s a correction on Wall Street?” Andrea Tueni, Saxo Banque France.
European Car Sales Surge as Consumer Confidence Grows
European car sales have reached a ten-year high as economic growth boosted consumer confidence.
According to the European Automobile Manufacturer’s Association (ACEA), car registrations were up 3.3% to 15.6m in 2017. The countries with the biggest increases were Italy (7.9%) and Spain (7.7%), followed by France (4.7%) and Germany (2.7%). New EU member states saw a 12.8% increase in registrations. In the UK car sales decreased by 5.7%, the first time in six years.
This is the fourth consecutive year that car sales have risen on the continent and the highest since 2007 when registrations were 16m. Analysts have suggested the car-market recovery could be attributed to the lowest unemployment rate since the financial crisis.
Car manufacturers which saw the highest increases in sales include Renault (6.7%) and Fiat Chrysler (5.2%), whose Alfa Romeo brand saw a 30% jump. The Japanese car company Toyota had a 12% caused by a 31% surge in purchases of its new hybrid SUV, the RAV4 crossover.
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