LPs are 'part of the problem': Nordic roundtable

Escalating fund sizes are concerning to Scandinavian investors, who admit they have helped drive this momentum.

In this second part of PEI's Nordic roundtable, market participants discuss how a flood of returns to existing LPs and increasing appetite for the asset class have led to private equity funds becoming too large.  

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Erik Wall PwC

ERIK WALL
Partner, strategy&
PwC
Stockholm-based Wall has worked on numerous deals, due diligences and M&A projects with private equity firms. He previously worked for information technology company Ericsson and has 14 years of experience in the TMT industry.

Daniel Winther Skandia

DANIEL WINTHER
Investment director, private equity
Skandia Asset Management
Winther invests in international mid- and large-cap private equity funds and co-investments, focusing on Europe and North America, and has invested, on aggregate, approximately $1.5bn since 2012.

Ola Nordquist Permira

OLA NORDQUIST
Partner, head of Nordic office
Permira
Nordquist has worked on a number of transactions for the firm, including aquaculture company Pharmaq and communications group TDC. Prior to joining Permira, Ola worked in London at Apax Partners on a number of buyouts, specifically covering the Nordic region, and in M&A at Lehman Brothers. He was a manager in the strategy division at Andersen Consulting in Washington DC.

Per Olofsson AP7

PER OLOFSSON

Head of alternative investments
AP Fonden 7
The seventh Swedish National Pension Fund has SKr344 billion ($41.2 billion; €36.1 billion) of assets, of which 3 percent is invested in private equity. Olofsson has been with AP7 since 2002.

GETTING TECHNICAL

Although they share similar business norms and processes, each local market has different economic drivers “and the investments you make can be quite different”, says Nordquist.

Sweden enjoys a diversified industrial base; Norway is rich in raw materials, energy and fishing; Denmark offers a lot of opportunities in healthcare, logistics and shipping; Finland is resource-driven with strong tech and start-up industries; and Iceland has specialised in data centres and resource-intensive industries such as aluminium.

However, investment in technology is a theme across the region. Of its sub-sectors, software as a service (SaaS) is particularly “hot”, says Wall. “The underlying growth [in the SaaS market] is still 10-plus percent and the market is still fragmented,” he says.

The level of interest is exemplified by the sale in late June by KKR of its remaining stake in Norwegian software company Visma to a consortium led by HgCapital, an existing investor, and including Singapore’s GIC, Montagu and Intermediate Capital Group. The deal valued the company at $5.3 billion making it the biggest European software buyout to date, according to KKR.

Wall points to the 3.3x return HgCapital made when it exited Danish hosting and cloud business Zitcom Group in June after only 18 months as an example of the scope of the opportunity. This encompasses not only tech companies, but the potential impact of new technology on how companies operate internally and engage with customers, Wall says. “Digitisation is something that has become very important in the operational improvement of a company,” he says, noting it applies to GPs too, where it is transforming operations and deal sourcing.

Permira, which invests in consumer, financial services, healthcare, industrial and technology sectors, has deployed a “significant portion” of its recent funds into technology deals, says Nordquist. “We talk about it across sectors all the time – consumer tech, fintech, industrial tech, health tech. Here in the Nordics you see a lot of start-ups maturing, a lot of success stories. To find the dealflow you have to be specific and proactive and have a clear point of view about the latest trends.”

VENTURING OUT

The venture capital segment of the Nordic market is particularly vibrant, says Winther. “There are a number of new managers popping up and a lot of new capital flowing in and a lot of activity in the venture growth space, which is very encouraging for the future. Skandia has one of the biggest VC portfolios in Europe, which has been quite a contrarian view, but it has paid us well. Our exposure is 80 percent US, 20 percent in Europe.”

Getting to know companies very early in their lifespan pays off for advisors and managers alike, says Wall. “Start-ups are growing so fast, adopting new things. I know a lot of GPs are, if not investing in them, closely monitoring what is happening to keep track of sub-sector trends.”

In line with this theme, in the year ahead, Nordquist expects to see a greater emphasis on growth investments. To that end, both he and Winther note that deal structures are changing, with managers more willing to take minority stakes.

“We’ve been looking at opportunities and realised that you can exert real control and influence without our funds owning 100 percent of a business,” says Nordquist. “We are more flexible in terms of sizes and can take slightly smaller tickets in very fast-growing companies in fast-growing industries where we also see the opportunity to pursue a buy-and-build strategy. This kind of flexibility is going to be more and more important for us.”

GPs are also spending more time developing relationships with management teams than they did, says Wall. “If the company has been owned by PE before, then the management are also willing to invest that time.”

Here Sweden stands apart from the other Nordic markets where there has been less private equity penetration. “When investing in Sweden and talking to management teams there is always one or two that have been in a private equity situation before. It’s a more mature market. In other countries private equity might be totally new for the management team,” Wall says.

Fundraising by Nordic-based managers has remained relatively steady over the past few years, with around $8 billion raised in 2014 and 2015 and $8.3 billion in 2016. However, in the first half of this year alone, funds have collected almost $9 billion, according to PEI data.

“We’re at the point in the cycle where fundraising is very quick and a few funds tend to close in the first round having reached their target or hard-cap,” says Olofsson. “Funds have gone from €350 million to €600 million and now €1 billion-plus. In this segment there’s a clear advantage to being local, but moving up to the larger end, for funds around €2.5 billion or so, competition is much tougher. There’s no real advantage in being local.”

At the same time, he adds, “There are a number of GPs that used to be able to raise funds at around €500 million but in their last fundraising they reached around €200 million and they will probably not be able to raise funds again.”

Winther notes that the past few years have also seen a number of spin-outs and GPs launching different types of vehicles. “It’s astonishing. It’s been a very creative period. It also creates a shift in the industry, with LPs having to think more than once about which horse to back.”

TIME TO TRIM THE SAILS?

Escalating fund sizes are a concern, however. “I would love GPs to come down a bit in size,” says Winther, conceding, “LPs are part of the problem”. The flood of returns to existing LPs and increasing numbers of LPs investing in alternative assets has driven some of this momentum, he says.

Olofsson agrees. “At AP7 we’ve had large inflows and good returns. We’ve been growing in size. Then you have the denominator effect, which means that we have to put more money to work, and to commit more capital. We would need to put quite a lot of money to work to reach our target of 4 percent invested and 8 percent committed capital [exposure to private equity]. We’re a bit further than halfway.”

But AP7 is remaining disciplined. “We’d rather stick to a diversified portfolio. As LPs we want to see regular cashflows, though not too regular – having calls and distributions all the time is tough for us to handle – but every quarter or so, a couple of times during a quarter would be sufficient.”

Local managers have played a role in this virtuous circle. They have been “one of the best performers in our portfolio for a very long time”, says Winther. “We try to look for the best opportunities whether in Europe or America, but taking a step back, Nordic GPs have done really well in comparison.”

By Adam Le and Victoria Robinson