The Million Euro Challenge

28 July 2011

This year the remit for this series of articles is 'Investment in Krakow'. With that in mind we thought we would speak to Krakow residents who have experienced firsthand the opportunities and pitfalls of investing and working in the city. We gave each one a million Euros (our budget allowed for Monopoly money only) and asked them how they would invest it in Krakow. We were interested in not only the idea but also the thought process behind it. Some gave us pages, some a paragraph, however all ideas were eye opening and offered a fresh perspective on the city.

Marek Godawski is an entrepreneur who has worked in high tech startup firms in Krakow.

'In my opinion one million Euros is too much money for an initial internet startup idea and also too little to scale up such a company once it gets going. I would therefore focus on long-term safer investments. I'd approach small business owners whose businesses have been on the market long enough to have proved indispensible to their customers. Reasons for this customer loyalty could include:

  • Lack of competition due to a limited supply of professionals providing the service or good
  • Scarce resources whether it is location, tangible assets or anything else needed to run a similar business.
  • The innate nature of products that are very well perceived by the customers even when the owner can't clearly describe the phenomenon.

I would then make a list of privately held companies that meet these criteria.

  • Dental services in nice neat neighborhoods where young families live.
  • Restaurants that target middle class and lower income customers. They may have a few stores already and are well known for good food and service. Good examples are Polakowski, Pierozki u Vincenta and Fabryka Pizza.
  • Small travel agencies, which own a few rooms near their offices, which they rent out.
  • Grocery shops in locations where there is little risk of the customer moving to hypermarkets.
  • Drugstores

It would be best if these are small family run businesses, where the hierarchy is set by seniority and where financial results are positive despite possibly old-fashioned management styles. Due to lack of financial experience the owners may not be aware of the value of their firms.

Once the list is prepared I would start a due diligence process. I'd personally approach the owners offering them investment in their businesses with me as a silent partner. I'd only pick companies with a net income higher than 150,000 zloty and steady income over the past 5 years. My initial investment goal would be 10% return a year, which translates to a P/E (Price earnings ratio) of 10. This is how much I'd be willing to pay for a part of their business. My offer would be limited only to 10% of their company, which at one million Euros investment and 150,000 zloty net income results in a need to find 27 companies meeting the above criteria.

I would not care how they invest the funds, only that I get paid a dividend on a regular yearly basis (debatable if not more often). Overtime these businesses' income should rise if good businesses are picked, so the initial 10% a year will rise as well.'

In my own office Maciej Piotrowski, Sales Manager at our development firm, Nordic House Group, took a look at the current market and identified a plot of land that would meet our criteria for an apartment development project.

  • We tend to look for land with outlying planning permission or zoning as this allows us to calculate the potential of the plot and timeframes with more certainty.
  • We focused our search on the Krowodrza area of Krakow. This is a popular district that while close to the city centre has good schools, university areas and small parks.

The plot we identified is at a crossroads on Wroclawska street, 1.4 kilometres from Krakow's main market square. It is in Krowodrza but located at a potentially busy crossroads. We would therefore expect to price apartments at around 9,000 PLN/ square meter (sqm), which is at the lower end of the range for the area (8,500 – 12,300 PLN/sqm). The lower price offers the advantage of a good flow of customers, who are looking to affordably enter the area. For a developer predictable cashflows can be almost as important as profit margin.

Importantly the cost of the plot includes an existing architect project (A significant cost). Under this plan you can construct a building of 1,310 sqm with 18 parking spaces. We estimate the cost of construction of 1sqm will be around 950 Euros/sqm.

So here's how we would use the money:

  • We would buy the plot for around 900,000 Euros
  • We would apply for the final building permission using the existing architect project.
  • Assuming there are no delays and no one objects to the project we receive the permit after around 3 months.
  • During this time we finance team costs and initial marketing work with around 20,000 Euros.
  • After receiving the permit we will pre-sell around 20% of the building 'off-plan' as this will be a pre-condition of any bank loan.
  • With the cost of the plot and building permit financed by ourselves and with 20% pre-sales we will then apply for a bank loan for the construction phase of the project.
  • Over the next 2 years we will simultaneously build and sell the apartment units, repaying the scheduled bank loan tranches and interest with funds from sales and then accumulating our profit.

On a project like this we estimate that we could make around 1.6 times our original investment, so 1 million Euros becomes 1.6 million Euros after two and a half years. For us the consistent demand from suburban first time buyers in Krakow makes this a relatively predictable and profitable use of the money.

More speculative real estate investments typically include buying agricultural land around Krakow, which has no zoning plan, but has the potential to convert into building land. Some people buy up in bulk apartments from troubled developers, however there is a risk that there may be a hidden structural issue, mortgage or building law problem.

Mariola Piotrowska is head of ikropka publishing and our fearless leader here at Airgate. Mariola sent me an entire business plan for an adventure travel company, based in Krakow. The service would take advantage of Krakow's location in southern Poland with easy access by land and air to 'virgin parts of Europe'.

'All trips would have an explorative character and would above all respect local societies. We would work with local hotels, local guides and contribute a portion of our fee to local charities such as 'Kosovo refugees'. Possible trips include mountain trekking in Albania, train trip to Siberia and off-roading at the eastern border of Poland's 2nd republic

The one million Euros would be used to purchase used off-road cars, tents and trekking equipment, creating a chain of accommodation bases (Moscow, Tirana, Sarajevo, Prisztina, Irkuck) and most importantly hiring the team. The team would be composed of multilingual staff with backgrounds in photojournalism and reporting. They would travel with groups and at the same time create a constant stream of marketing materials such as photo reportages.

Our core target market would be individuals based in southern Poland, of above average income, who are no longer satisfied with the standard travelling experience. Some of the target market will be attracted to these destinations through historical and family links.'

Joss Wilbraham, an English investor with experience in and around Krakow, suggested creating a supermarket chain following the model of 'Tesco Metro' in the UK. Several years ago some of the large supermarket chains identified a gap in the market in the centre of large and medium towns and villages and opened smaller local stores with ranges of products that would suit shoppers there. These stores, which include Tesco Metro, Tesco Express and Sainsbury's Local, are much more than a corner/convenience store and have been successful in offering those just finishing work premium products (Ready meals, wines, desserts, fresh baked goods) at a convenient local level. 'There is often nothing decent in central areas of towns in Poland, just corner shops and starting with Krakow I would create that'

Undoubtedly my favorite idea came from Trevor Coyne, a businessman from Ireland. Ann Summers is a company in the UK that have been highly successful selling a range of lingerie and adult toys to woman by employing a 'Party' strategy. 7,500 party organizers hold over 4,000 parties a week in the UK. They are exclusively women only, held usually in the home of one of the attendees and allow presentation of all the items in a fun friendly atmosphere. 'I think Polish women would find that type of event fun and I'd use the money to set up a firm using that strategy here in Krakow.'

To round off I thought I'd give you a short excerpt from a conversation at the last Airgate editorial meeting, between myself and Rita Beldis our theatre and culture expert:

Tej: "This month I'd like to set a one million Euro investment challenge"

Rita: "Give me the one million, I'll have no problem investing it for you"

Tej: "Errrr ummm, I'm not sure buying a truck full of Jimmy Choo shoes is what I had in mind"

Thanks to all those who contributed ideas to this article, apologies that I didn't have room for all of them.