PEI: Let’s start with the macroeconomic picture. How is the eurozone turmoil affecting the Nordic region?
Karlsson: Luckily we’re free from some of the constraints that are affecting other regions. Collectively the Nordic countries are running a government budget surplus. They have a positive net debt balance – quite the opposite of what’s going on in Southern Europe. And their current account balance is also positive, so we don’t have the borrowing problem you see in some other countries. Consequently people are expecting GDP to grow 1.5 percent faster in the Nordic region than in the rest of Europe.
[So] it’s a pretty good macro backdrop, but you still have the same concerns that are affecting people across the globe: retail is uncertain, people are questioning what will happen with export businesses, and so on.
Munthe: I would second that. The macro picture is promising. Norway is to an extent its own special case given the country has won the lottery with its oil reserves – meaning that public finances are extraordinarily strong. That said, the government has been very skilled at keeping the surplus cash out of the economy; we have a very balanced inflation level [compared to] the other Nordic countries and the cost levels aren’t higher than the rest of the region.
Likewise, the Swedish government has done a fantastic job of guiding the country through this turbulent period. Finland and Denmark are also sound. The public sectors in the Nordic regions are characterised by sound finances, GDP is stronger than the rest of Europe, and politically there is no instability – these are very well-functioning democracies, and whoever’s in power has enough authority to run the country.
You do see the European uncertainty start to creep into the big ticket items in retail, for example – we have a bedding company that is somewhat affected. But overall, we’re in an excellent position. The region has been very strong at educating first class engineers and companies have invested in technology, so there’s a very strong technology base.
Fallenius: The Nordic economies are undoubtedly more stable [relative] to the rest of the world. Of course if the problem increases in the banking sector, it will have an impact on financing. But [for now] there’s still the possibility of obtaining debt for deals.
PEI: The Nordic banks seemed to have fared better than their peers elsewhere in Europe. Why is that? And can it continue?
Munthe: Nordic banks have stuck to the basic idea behind them: to lend money. They haven’t got inflated balance sheets with all sorts of exotic securities that could lead them into trouble – no junk bonds or sub-prime loans, and very little or no exposure to southern European sovereign debt bonds. They’ve been lending into the local economies and they’ve been doing so at a professional rate, which means they won’t have major setbacks as a result of having to write down securities on their balance sheets. If the interbank market dries up, that will affect everyone. But for now it’s open, which means the banks are very much open for business.
Karlsson: [The Nordic banks] have done a very good job of managing their lending and the assets side of the balance sheet. [But they’re] still part of the overall international banking system – and if that is going into anaphylactic shock once more, that will have an effect. Interbank and funding markets are still important to the Nordic banks, [so] one cannot rule out them being drawn into a larger European banking mess if another economic crisis were to occur.
PEI: A severe downturn in the eurozone will also damage the region’s export prospects. How badly would that affect your portfolio companies?
Karlsson: The Swedish, Finnish, Norwegian and Danish economies are small, open economies, based to a large extent on export business. Sweden and Finland in particular have very large capital goods sectors – so we are quite dependent on the outside world and thus the Euro area. More than half [our] sales are in German-speaking countries. [But] the funds’ exposure to the PIIGS [Portugal, Italy, Ireland, Greece and Spain] is less than 5 percent of sales, compared to about 12 percent for emerging markets. It’s a reasonable mix – but it would be foolish to say that what happens in the rest of Europe isn’t a problem.
Munthe: We have a lot of exposure to the oil and the offshore sector, which is very strong and developing very nicely. We have more of a regional focus than Nordic as we’re smaller. Those [portfolio companies] that do export into Europe have of course noted a softening of demand.
PEI: What about regulatory threats?
Fallenius: There is an ongoing debate [about] private equity’s involvement in tax-financed sectors like healthcare and education – and [about] the way it is taxed. The Swedish finance minister has criticised the fact that private equity-owned companies in these sectors reduce the Swedish tax basis through interest deductions, [and has] promised to take swift action to address that. A committee was recently appointed to review the corporate tax system in Sweden, with one aim being to try to neutralise the tax treatment of equity and debt investments. In future it is likely that we’ll see changes regarding the deductibility of interest in the Swedish market.
Karlsson: That’s not surprising, though – Sweden’s one of the few jurisdictions that doesn’t have limits on interest deductions. If the finance ministry decides to introduce that sort of legislation, it won’t be unexpected – and as a Swedish citizen, I think it makes sense. What is unfortunate is that we have a tax authority that is trying to legislate through the back door; it’s trying to aggressively reinterpret quite established rules of conduct from the past. I have no problem with Parliament enacting sensible tax laws, but it’s much more difficult to conduct any type of business or investment activity when you’re not really sure what laws are in effect.
Munthe: As with any new, fast-growing industry, there will be tax-related discussions. But we don’t have any political issues on the horizon. There haven’t been any big political scandals here to do with private equity nor have any senior politicians been talking about locusts and so on. It’s considered positive.
Karlsson: Private equity is part of the business community and ownership fabric now. It’s an established fact that it contributes positively to economic development and helps with structural transformation of businesses.
PEI: So is the healthy macro environment translating into healthy dealflow?
Karlsson: For the buyout market to function, a couple of ingredients are required. First, you need a functioning financing market. Second, you need a degree of macro stability. Those are both present and dealflow has held up relatively well.
Fallenius: From an advisory perspective we’re seeing fewer deals, and the deals that are being accomplished are taking longer. Firms are taking a lot longer to do due diligence. It’s also clear that the focus is less on financial engineering and more about actual value creation within the portfolio company. That’s the reason why firms have lots of people with operational backgrounds and contacts in the relevant sectors.
PEI: Are there any sectors that you’re steering well clear of at the moment?
Karlsson: We don’t typically advise the funds to invest in businesses where you don’t have the majority of important aspects in your own hands – for example, if a company is completely reliant on commodity prices, political decisions or technological development, that can make life difficult. That puts a lot of the basic material sectors off limits: oil companies and businesses that are heavily affected by the oil price are something that we would advise the funds to stay away from.
PEI: What sort of valuation multiples are you seeing?
Karlsson: The Nordic Capital funds don’t actually focus that much on acquisition multiples. The funds have paid very, very high multiples for certain businesses that have turned out to be their best investments. They have also paid very low multiples for some investments that have been not so successful. So when looking at track record we find zero correlation between entry multiples and value creation.
Munthe: At the end of the day, it is a question of: “Do you understand what you get into and do you have a clear plan of how you are going to add value?” I remember one company with a notable multiple: Pronova, a pharmaceutical group. That is by far our most successful investment. We will hopefully generate a return of between 10x and 15x on that investment and we paid 14x EBITDA when we bought it; we got so much heat for that at the time. I am convinced that private equity in the long run is not about financial engineering. It is about investing in companies that you truly understand and where you truly can add value. You really have to build expertise in those industries on which you are focused, like we have been doing in healthcare and oil, offshore, and energy in general.
PEI: Investor appetite for the region seems to be very strong at the moment.
Munthe: It is interesting; when you poll LPs regarding their appetite, right now the top regions investors want exposure to are China, India and the Nordic countries. We are not usually compared to those fast-growing markets. But I think it is quite clear that investor appetite when it comes to the Nordic region, at least on a relative scale, is probably at an all-time high at the moment.
Fallenius: Do you think it is because the companies in the Nordic region are in general well-managed, and there are good management teams here?
Munthe: LPs are results-focused. Regardless if it’s via Nordic private equity houses or pan-European ones, I believe they have figured out they can get very good results out of Nordic deals, time and time again. I think that is because of the local champions that are here. When you pair that with good macro development [and] a seemingly positive regulatory backdrop, it makes sense.
On the flip-side, it is obvious that if too much capital rushes into this region, it will cause upward pressure on prices, and downward pressure on returns. However at this point in time we have not seen any newcomers willing to invest the time, effort and resources necessary to become part of the business community.
Karlsson: We are not used to being compared to India and China – but somewhat to our surprise, we find that the Nordic region ranks just after these two in many LPs’ minds. Probably, investors go to India and China for the positive macro picture – and the Nordic macro picture is also relatively positive, [but] with much better transparency and track record.
That said, you can’t just fly in from London and say ‘I want to do a deal here’. You need to invest in local presence; you need to do the groundwork. There are bigger firms that are going to fly in from London or New York but that is not going to work because you need to put down roots and interlink yourself [with] the business community. I have seen a couple of bigger firms like Apax and Doughty Hanson leaving Stockholm or downsizing their activities. Those fly-by-night guys that come in once in a while to look at discrete structured auctions – [they] will be able to do the odd one-off investment, but they won’t really get access to the interesting deals nor understand the “inside truth” of many stories.
PEI: So your main competition comes from other Nordic firms?
Karlsson: The majority of our competitors are people who fly in from London or elsewhere, which I think we would prefer over local competition, to be honest. Nordic Capital funds’ strategy is to be local, as it gives you a lot of advantages in terms of understanding. We’ve been around a lot of companies that have been our potential targets for decades. We know them inside out, and we’ve followed them through good times and bad. We know most of the management teams – and if we don’t, we’ll know someone who knows someone who does understand what is going on. The Nordic business communities are quite small and concentrated, so everybody keeps tabs on everybody. If you fly in from London, maybe you’ve been able to tap into those networks some other way; but if you don’t, I have a hard time seeing how you will be able to do due diligence and understand what you are buying in the same way a local would do. So if I had to choose to compete with a Herkules or a big US outfit, I know exactly which one I would prefer.
PEI: Nordic firms can point to a strong track record of performance (see p. 24). Presumably that’s critical?
Munthe: We are the only asset class globally where you find a very strong correlation between previous performance and subsequent performance. Successful firms will continue to thrive, and not-so-successful businesses will, over time, leave the market or receive smaller capital commitments. You need to nurture the confidence the investors have given you, and not go ballistic – not make too-large funds, or create lots of different alternative investment buckets, or raise a department store of different funds to go after every opportunity in the world. You need to focus on what you know, and develop your business from that basis. I think then you have a reasonable chance of being successful.
Fallenius: It’s interesting, though: we have had a lot of requests for reviewing and establishing new funds – generally spin-outs from existing groups. It will be interesting to see what happens with them. The key there will be linking track records at the previous firm to the executives who are starting a new fund.
PEI: So can private equity keep generating strong returns in the Nordic region in the medium to long term, given the likely macroeconomic climate?
Karlsson: I think private equity as an ownership model is going to continue to increase in importance. The Western European economies are going through what is likely to be a period of slower growth. We need to manage our ageing populations, our extensive welfare systems, improve productivity and we still have a huge environmental debt to sort out. I think private equity is part of the solution though. I think the business model is very conducive to creating economic value. I think that it will continue to grow, and the Nordic region is probably suited to benefit from that because we are open economies accustomed to embracing change.
Munthe: The macro picture is strong, both short and long-term. Private equity owners who provide expertise and a proven track record are very much sought after by owners of businesses. As we continue to recruit and train top-level people I believe the prospects continue to be positive indeed.
Gert Munthe is the founder and managing partner of Norwegian private equity group Herkules Capital. He launched the firm in 2002, and has more than 20 years of senior executive and chief-executive-level experience.
Odile Fallenius is a partner at law firm Vinge, based in Stockholm. She specialises in tax, particularly with regard to private equity transactions. Prior to joining Vinge she worked for Linklaters.
Joakim Karlsson is managing partner at private equity firm Nordic Capital. He joined Nordic in 1998, having previously worked in the advisory group at JPMorgan in London from 1997 to 1998.