Nordic private equity fights to be heard

Jonas Nyquist

Head of private equity and infrastructure, Skandia

Nyquist has held various positions at the Swedish life insurance company since he joined in 2008, including as head of buyout fund investments. He was previously a manager at management consultant firm Arthur D Little where he focused on private equity and strategy.

Jan Akesson

Co-founder and partner,
Adelis Equity Partners

Akesson co-founded lower and mid-market focused Nordic private equity firm Adelis – which is derived from the Latin words for bold (audax) and faithful (fidelis) – in 2012. Prior to that he was managing director of Triton Advisers (Nordic) and has previously worked at McKinsey.

Isabella de Feudis

Chief executive,
Swedish Private Equity & Venture Capital Association

De Feudis has been with the SVCA since 2012 and has held positions there including head of public affairs and media relations. She has prior experience within the Swedish government and PwC.

Simon Bradford

Transaction partner, PwC

Bradford is primarily focused on M&A due diligence and is based in Stockholm. His experience includes transaction advice and support, including post-merger integration, corporate restructuring, SPA completion mechanisms and capital market assistance.

Sweden was on the brink of elections when our panel of Nordic private equity experts met in Stockholm. Campaigning had been divisive, the race was tight and the make up of the next government far from clear. Even private equity was drawn into the fray. The election campaign reinvigorated public debate about limiting profits from investments in welfare, a live issue across the Nordics.

“When you see the left-wing debating profit caps in the welfare sector, they use ‘risk capital’ [the Swedish term often used for private equity] as a bad word,” says Swedish Private Equity and Venture Capital Association chief executive Isabella de Feudis, who says she has worked hard to dispel myths surrounding private equity. “It’s hard for us to tackle this kind of general election [rhetoric]. But we are stubborn and continue with the facts.”

She continues: “If you talk to politicians in small meetings, they do understand that we need this kind of [private equity] active ownership, someone has to restructure companies, provide capital for growth; there is global competition and you need money and competence for [improvements such as] digitisation. Private equity is a great force in future-proofing Swedish business.” Polling also indicates that “almost everyone wants to choose schools or elderly care. If there are no private actors in the market then you have nothing to choose,” she adds.

“In the current political climate of the upcoming general elections, there is a difference between Swedish culture and values and private equity perceived by the public,” says Simon Bradford, Stockholm-based transaction partner at PwC. “Underneath is very different. What the public doesn’t see is if you can get someone else to professionalise running organisations you can make taxpayer money go even further.”

The public debate is a reaction to “the wave of privatisation and liberalisation of the welfare sector,” says Jan Akesson, co-founder of Adelis Equity Partners. In contrast, he highlights a shift in attitude among business owners and managers toward private equity. “The private equity model is more understood than ever. Yes, it’s election time, but private enterprise is a very important part of Nordic culture.”

Helping to reshape perceptions is the resolution of a decade-long battle between the Swedish Tax Agency and the industry over how carried interest should be taxed. “For us, it’s important that the general public views private equity as a legitimate asset class and there are clear rules for how to treat income,” says Skandia head of private equity and infrastructure, Jonas Nyquist. “That’s important for the industry.”

“The resolution was that carry gets treated under the closely-held companies rules, which means that part of your carried interest is taxed as income tax [at 60 percent], and part as capital gains [at 30 percent],” says Bradford, adding that the rules will be applied six years retrospectively. “Now, it’s down to individuals to determine what equates to income and what’s capital.”

Racing ahead

While Swedish politicians may publicly contest the role of private equity, investors across the Nordics are not burdened with such doubts. Fundraising soared this year. In the first three quarters of 2018, Nordic-based funds raised a combined $20.6 billion, outstripping last year’s $11.5 billion, according to PEI data. Among this total, EQT Partners Fund VIII – the firm’s biggest buyout vehicle – accounted for more than half at €10.8 billion, while Nordic Capital raised €4.3 billion for its ninth vehicle that closed in May.

“It’s a strong fundraising market,” notes Akesson, adding that Adelis closed its second vehicle on €600 million in 2017 in under three months. The fund has already completed two investments.

“I think it’s going to be a strong year in terms of deals,” says Bradford. “Dry powder in the Nordics is very high at the moment. According to my numbers there is $48 billion, including EQT and Nordic Capital [fundraises]. Beneath that, there’s a lot of money to put to work.”

While competition for assets is fierce, and “there are several players and probably more players on the margin, it’s also a big pond to fish in”, says Akesson. Last year there were 70 buyout deals with an enterprise value of €25 million-€250 million, up from 40-50 in previous years, according to data from Unquote. “Seventy deals in our segment is quite a number of deals.”

In a competitive market, the key to acquiring “is very careful, insightful sourcing and really driving your companies for value. These two aspects are increasingly becoming differentiators [between buyers],” Akesson adds.

Sourcing has become localised even within countries, he adds, while Nordic firms, including small general partners, are narrowing in on particular industries. “Competition is high. You need to have that specific competence and the network and really understand what’s going on in the industry to be able to extract those companies that you want to buy.”

“Firms are becoming more focused on which deals they want to pursue,” says Nyquist. “There is more focus on where they spend their time. Instead of doing due diligence [on a deal] that they might lose because it’s a better fit for someone else, they spend that time building a proactive pipeline.” But, “no matter how you source your deal you are going to have to pay a lot of money for it,” he adds.

Mix and match

The rise of multi-asset managers is leading to complexity

In an already heated market, Bradford says the trend for infrastructure-light funds to invest in equity-type deals is ramping up competition for private equity assets. So who is going to do the deal?

“We think a lot about this question,” says Nyquist.  “We like clean structures. If there’s a deal coming in, you don’t really know where it will end up – in the infra fund, or in the big or small buyout fund. On paper it looks pretty simple but GPs introduce a lot of complexity that they might not be aware of [when they invest across multiple funds]. Where’s the cut off and how do they make that judgement? How do they split the carry?

“When I started 10 years ago this situation didn’t exist. So far it’s been working
well. But it hasn’t really been market tested. That will happen when we hit the next downturn.”

Surprisingly pricey

GPs are paying “a lot, surprising amounts sometimes”, agrees Bradford. Businesses in healthcare, pharma and medtech can easily attract multiples of up to 15 times EBITDA, and “more if it’s something really interesting. Tech has been high as well – 12-15 times plus. Most of the deals I look at are in processes where there is a lot of competition, which applies pressure on the price”, he says.

“We’ve paid five times [EBITDA] and we’ve paid double digits sometimes,” adds Akesson. “High organic growth, recurring revenues and high cash conversion warrants a high multiple. It’s fairly sophisticated pricing.”

However, access to deals is not just about price. “There’s an interesting barrier to entry in this market, for the mid-market especially,” says Bradford. “Having a local presence in the market is a key differentiator in the mid-market deals space.”

Nyquist agrees. “Sweden is such an international country with internationally exporting companies. You would think that they wouldn’t have a problem with an international owner. But in fact it seems like they do.”

“Especially in the lower mid-market,” adds Akesson. “Three-quarters of the deals we’ve completed have been with founder owners and entrepreneurs. Of course, in the end you are checked on price. But when you buy from an entrepreneur, there are so many things that are important in addition to price. Trust is important. And we’re closer in language, culture, and geographical proximity.”

High prices mean the pressure is on to create value “in order to deliver returns that we demand as an LP”, says Nyquist. “During that one-year sourcing process firms are already thinking about what they can do with the company in terms of synergies, new markets, what kinds of [value-creation] levers there are. Some funds are trying to institutionalise this and write a cookbook, this is how we do add-ons and so on.”

“A classic way to add value as a Nordic private equity owner is to buy a small but leading platform and build it into a national champion through organic growth and add-ons,” says Akesson. “Then you create a Nordic champion. Not only do you build a much bigger company and hopefully generate synergies along the way, you can also deliver the business to a European strategic buyer that is looking for a Nordic platform.” Adelis’s Fund I invested in 14 platform deals, which it expanded with more than 40 add-ons, he says.

But GPs are being careful about which sectors they invest in. Some industries are faring better than others. “The ones that are more cyclical are starting to feel a bit of a pinch,” says Bradford. “One dark spot is retail and consumer. Bricks and mortar and big box [retail and consumer] are struggling. And construction. Our clients are not really talking about investing into those sectors right now.”

On the bright side, “one of the sectors that has been growing over the past 18 months is industrial products”, he says. “Anecdotally, we saw a lot of deals in that sector last year in the Nordics. Maybe it’s because it represents a significant part of the economy so the pool of assets is high. It accounts for more than 40 percent of deal activity by volume and about 30 percent of GDP. Technology is a big piece of the pie, and health and pharma has been growing.”

However, it seems that referring to technology as a monolith is becoming obsolete. “Viewing tech as a specific sector doesn’t work anymore,” notes de Feudis. “Within investment in tech, you can see everything from medtech to consumer apps and B2B services. It’s all transformational and encompassed under this huge ‘tech’ heading. You have some industries that are converging, like media and telecoms and IT. The sectors are changing from what they used to be.”

One result of this transition is some GPs are marketing traditionally non-tech businesses as technology-driven enterprises. “We are seeing a lot of GPs trying to rebrand their companies as tech companies. It might be something outside tech and they add a bit of a tech angle,” says Nyquist.

Past lessons

While none of our experts sees a financial downturn around the corner, they noted the multiplying fund sizes, abundant leverage and soaring asset prices that feature in today’s market were all prevalent a decade ago at the time of the global financial crisis. So, how has the industry evolved?

“I’m not sure we have learned that much,” says Nyquist. In terms of fundraising, “we haven’t learned anything. Prices are higher than last time round. Leverage is the same or even higher, but maybe that is into companies that can handle it.”

“There are clear signs of overheating in some aspects of the market,” says Akesson. “There are some IPOs that probably shouldn’t have been done. In terms of leverage and banks, I’d say we’re slipping back to what we had [before the crisis]. Today, banks are competing with the bond market, which didn’t really exist in the Nordics 10 years ago.”

Bradford agrees: “For a strong asset you get multiple banks trying to get a piece of the action.”

However, the picture is not all gloomy. “There are no real signs of [an impending crisis] today,” says Nyquist. “The buyout model is still valid in terms of having a single strong owner, especially in a downturn. The relative outperformance from the asset class should continue.”

SVCA-commissioned research from Copenhagen Economics shows that portfolio company profitability and productivity is “much, much higher compared to non-PE owned companies,” notes de Feudis. “Private equity investments in Swedish companies have contributed on average 0.4 percent to GDP every year for the past decade. That sums up to 6 percent of today’s GDP. It’s important for the economy as a whole.”

Where are the Swedish limited partners?

Swedish investors lag their Nordic peers, says Skandia

Skandia’s private equity programme now stands at about €4 billion with an additional €1 billion invested in infrastructure. The LP’s 10 percent allocation to the asset class “is the biggest contributor year-to-date to the overall performance of Skandia”, notes Nyquist. “It does make a difference having private equity in the portfolio.”

Nyquist questions the apparent reluctance of other Swedish LPs to follow his firm’s lead. “Sweden is an interesting place. I would argue Swedish LPs are behind Denmark and Finland, which are much more advanced in terms of the acceptance of PE as an asset class. Even big institutions [in Sweden] have very little private equity, which is surprising given the historical evidence that it has outperformed all other asset classes significantly over 30 years.” This might be because of perceptions of high costs associated with investing in private equity, he adds.

And while the Swedish National Pension Fund system will be more free to invest in alternatives as of next year, de Feudis says removing the 5 percent cap on unlisted investments is not expected to have too much of an impact on Nordic private equity. The new cap, a 30 percent ceiling on illiquid assets, “includes real estate in alternatives, so it’s not that much of a change but it will bring more flexibility for the AP funds in their alternative investment strategies”, she says. “The world has changed since the old rules where adopted especially concerning the need for investors to increase their exposure to alternatives.”

This article was sponsored by Adelis Capital Partners and PwC and first appeared in the October issue of Private Equity International.