How popular are large cap buyout funds amongst investors at the moment? Many practitioners would say far less than they used to be ? both in Europe and the United States. The key question the markets are asking is, will they be able to deliver the returns that investors expect? Limited partners are also a much more fractious bunch today. They fret about greater competition among financial sponsors making transaction processes more efficient, which means higher purchase prices and less opportunity for multiple arbitrage, which means the need to work harder for longer to transform an asset. To many this spells downward pressure on investment returns going forward. Investors also worry about the flurry of secondary and even tertiary buyouts. They have concerns about the trend towards equity syndication (club deals). And they are more resistant to the terms and conditions they are asked to accept when investing in new funds.
All this makes the job of heading a major league pan-European buyout firm that bit more challenging. There's more scrutiny, more questions, more expectations. Especially if you are wanting to raise a new fund at the moment, as is Industri Kapital (IK), the buyout firm co-founded by Björn Savén in 1988. In this current environment a private equity firm's CEO needs patience, focus, commitment ? and a bit of humility.
Björn Savén graduated from Stockholm School of Economics, worked for three years for Gulf Oil in Stockholm, went to Harvard for two years, working in the summer for a US industrial business, then went back to Sweden to join an acquisitive printing business called Esselte. During a 14-year tenure, he was exposed to significant M&A activity in Scandinavia, Europe and the US. By 1988, at 37 years old, it was clear to Savén that there was a new opportunity though.
He had just sold a division of Esselte to a Finnish forestry company. ?I knew enough about the cashflows of the buyouts that had been done that I figured out they didn't pay more than somebody could have paid with a little help from a friendly private equity operator. In a way that was the beginning of IK.?
There were not many buyout practitioners covering the Nordic markets then. More people with more capital were needed to take care of the opportunities. Savén wanted to be part of this.
He had already lived in London and soon realised that the city provided an ideal base to start a buyout business: Swedish regulations at the time were not conducive to establishing a buyout firm. He joined forces with Enskilda Securities, then one of the larger broker dealers in the European public equity markets, got a UK merchant banking licence and began to assemble a team of various Scandinavian nationalities under one roof. The first fund closed in 1989 at €108m. It was captive, although less than 50 per cent was committed from the bank. By the time of the second fund, which raised €250m in 1994, Savén and two colleagues had bought out the bank (which continued to invest in subsequent funds as well as provide banking services).
The third fund in 1997 reached €750m. IK had grown into one of the leading buyout firms in Europe. By the time the 2000 fund was raised, which closed at €2.1bn, the firm counted some of the largest private equity investors in the Nordic region (39 per cent of commitments), Europe (31 per cent) and the US (30 per cent) among its LPs.
A new mood
Like fellow large-cap buyout operators Charterhouse Development Capital, Doughty Hanson and Terra Firma Capital Partners, the group's latest fundraising has been subject to much media and market speculation. A year in to the process, and investors and sources close to the firm say that in addition to the general market malaise, at a time when the buyside feels distinctly risk-averse when evaluating new propositions, IK has had to respond to a number of other issues.
For example, the partial flotation of Swedish engineering company Alfa Laval, the firm's most successful disposal in 2002, is thought to have cost IK some credit among Scandinavian investors after the post-IPO revelation that Alfa was potentially liable for asbestos-related problems in the United States. This had not been disclosed in the company's IPO prospectus, and the news caused the share price to drop sharply. No wrongdoing of IK was even alleged (Alfa Laval said at the time that the asbestos issue was not disclosed ahead of the IPO because it had been regarded as ?immaterial?), but the incident nonetheless left a bad taste in the mouth of some who had received stock distributions.
A more current issue that some investors are dwelling on is that out of IK's €2.1bn 2000 fund, some €600m is invested in two Nordic chemicals companies, Dynea and Sydsvenska Kemi. (Another €100m were committed from the €750m fund raised in 1997.) Dynea is a global provider of adhesive systems to the woodworking industry, while Sydsvenska Kemi specialises in coating intermediates and formaldehyde technology. Although operating in different chemical industries, both businesses have been hit hard by the global economic downturn. People familiar with the investments say they have turned a corner and are back on course. However, the fact that Harald Mix, another IK co-founder and the widely acknowledged architect of the company's chemicals investments, left two years ago, had some wondering whether these assets were still well looked after.
Turnover at the senior executive level of a private equity partnership tends to set off alarm bells on the buyside generally. ?One of the first questions they'll ask you is, ?when did you last lose a partner??, comments another GP presently raising a venture fund. When Mix's new company, Altor Equity Partners, earlier this year had no trouble reaching an oversubscribed €650m close on its debut Scandinavian midmarket buyout fund, some took this as a signal that the smart money was following Mix. Others dismissed the point, pointing out that Altor's mid-market strategy is fundamentally different from IK's.
The broader issue is more telling. ?The supply of capital has been weak but it seems to be turning right now?, Savén says. ?You could look at the capital markets and say they're binary: they either want to invest, or they want their money back. Until recently they wanted their money back.?
One way of dealing with the new mood amongst the buyside is to feed them facts, and IK's track record proves a powerful tool in this regards. Since inception, the firm has completed 24 exits from 46 investments. Last year it demonstrated a knack for pulling off exits even in a difficult environment, when it achieved three IPOs (including the Alfa Laval deal), one trade sale and four recapitalisations. Of the €3.1bn in original capital commitments to the four funds raised since its inception, IK says it has so far returned over half to its limited partners. ?I think that is a very good result, given that the two largest funds were raised relatively recently, and that many of the assets currently in the portfolio are still young,? says Savén.
There have been a number of write-downs, but according to Savén, the firm was able to either restructure or ?recover on the way up?. And despite the 2001 bankruptcy of I-Center Elektrogrosshandel, a German electronic equipment wholesaler, which forced IK to write off over €100m of equity it had invested from the 1997 fund, none of the firm's limited partners interviewed for this article disputed that the team were anything but good investors. Says one investor in the 2000 fund: ?We remain supportive: the performance has been good, there has been no style drift and no major problems in the portfolio.? Another LP who went to a recent investor gathering in New York describes the mood among those IK had invited to attend as ?pretty bullish?.
IK, its professionals say, is committed to exercising active ownership of the companies it buys. Says Savén: ?We make most of the money by increasing earnings. Our yardstick is to double operating profit over the holding period of an investment.? To illustrate that this is indeed working, Savén points out that over the past two years, combined operating profits of IK's holdings have increased by about 25 per cent.
According to Michael Rosenlew, another senior partner at IK, plenty of work has been carried out to ensure that both Dynea and Sydsvenska Kemi, the firm's two most high-profile holdings, perform as planned despite the market downturn. Non-core assets have been sold off, cost reduction and synergy savings programmes have been carried out. ?There is still a lot to do, and you can't get away from the macro cycle, but I think from an efficiency point of view, we've done the right things.? Working capital and business process improvements are still ongoing, but earnings and balance sheets are already improving, says Rosenlew.
After Mix's departure in 2001, Rosenlew took over managing IK's investment activities in Sweden, Finland and German-speaking Europe, which currently account for some 65 per cent of the portfolio. (Gustav Öhman, based in the firm's London headquarters, oversees investment in Denmark, Norway, France and Benelux.) Rosenlew stresses that when Mix left, there was still a team in place, led by himself and Stefan Linder, another Stockholm-based executive, to manage the assets Mix had helped assemble. ?The original strategy for these investments has not changed. If anything, we're now more structured and more involved in implementing the strategy set by the board, not least because the market environment turned out worse than we anticipated when we made the investments.?
This emphasis on management continuity is understandable, given that the market's current preoccupation with personnel-related questions about IK has clouded some of the performancerelated aspects the firm is keen to underline.
The exit of Rosenlew's predecessor two years ago also left the market wondering whether Savén, who is both chairman and chief executive, played too dominant a role in the firm. Now Stockholmbased, Savén rejects on a number of counts the notion that he may have too much influence over how the firm is run. He says IK has long been focused on growing and preserving a cohesive investment culture based on clearly defined systems. Investment processes for instance can take three to six months to complete. ?All investment professionals are involved during the early stages of the process. We hold area level, directors and executive committee meetings where the investment professionals and senior partners meet, before finally holding the full board of directors meeting to approve transactions.?
This, he says, is a process that doesn't suit every dealmaker's personal style: ?People with a more individualistic approach to investing might have found the guardianship of the investment process and the wide ability to discuss and think about various transactions to be hardnosed. But that's how it should be. I really believe we have the procedures in place to make sure that people look at all the aspects of a transaction that gets questioned.? Between 300 and 400 investment proposals per year are subjected to this treatment.
Savén also explains that the ownership structure of the firm has been widened significantly. ?Recently Michael Rosenlew and Gustav Öhman became senior partners in the firm, alongside myself and Kim Wahl?. This quartet has worked together for a decade. There is also a process under way to extend formal co-ownership of the firm to all the directors, scheduled for implementation ?in the near future?, he adds.
Sources close to IK say efforts to spread the firm's income more widely among staff are in part designed to give comfort to new investors. There is also said to be an ongoing effort to improve transparency and investor communications, moves prompted by complaints last year that the firm had gone about the launch of its new fundraising somewhat highhandedly. According to some familiar with the firm, too little time and effort was devoted to attracting existing limited partners to the new fund first before marketing it to new investors. Savén insists that the firm is committed to providing investors with the information and communication they require. ?We've improved a lot and are trying to exceed investor expectations. Our recent investor meetings in the spring have been well received, and I think people are positively surprised by our emphasis on this area.? Investors say the intensified IR effort is noticeable and is paying dividends already.
Europe's buyout opportunity
The measures currently being taken are ultimately intended to prepare the firm for the next investment cycle. IK, established at a time when the buyout market in the Nordic region was still in its infancy, has been successful as one of its most influential pioneers. Now market conditions have changed, but while there are practitioners in the business doubting European buyout GPs' ability to continue to deliver from here on, Savén is certainly not amongst them.
Yes, there is now greater competition among financial sponsors than there used to be, but to Savén, what matters more is that buyout operators are getting better at formulating and fine-tuning investment strategies that are genuinely differentiated. ?Beauty is in the eye of the beholder. Different buyout firms understand different things. We're likely to win deals where we think we have a better understanding of what the strategic development of a company will be.?
IK's approach is anchored on what the firm calls its ?multidomestic European approach? in Scandinavia, Benelux, France and Germany, overlaid with a focus on certain key industries. The strategy is based on the belief that European markets are currently at an early stage of a process of ?continentalisation?. Savén likens it to the arrival of nationwide television in the US, which helped to unify the country's entire consumer market in the 1950s. Savén sees the emergence of a pan-European market place as a very powerful ?mega-trend? that is set to transform the way European businesses operate. It also clearly informs the strategic direction of IK.
He says: ?The implications of this development are still underestimated. People's perception of how things are and how things are managed lags reality. You can already say that in economic terms the nation states in Scandinavia don't exist anymore. Today you can drive a truck of oranges non-stop from Spain to Northern Sweden. There are TV channels where you can buy European-wide advertising. The use of IT and the English language are increasing all the time. All of this is going on at a scale that will drive businesses to an increasingly Continental European approach.?
The team who are tasked with executing on IK's strategy consist of seven directors who work with the aforementioned four senior partners: Christian Salamon and Stefan Linder run a team focusing on the Swedish market; Detlef Dinsel runs the Hamburg-based German operation; Gustav Öhman, in addition to his regional responsibilities, co-ordinates coverage in Benelux; Mads Ryum Larsen heads up the effort in Denmark, Norway and the UK; Christopher Masek runs France; and Thomas Ramsay is about to take on the Finnish mandate. Each unit comprises between four and six investment professionals. A limited partner in the 2000 fund says the line-up is impressive: ?They have a very deep team to do what they're trying to do.?
Savén himself is still excited by the prospect of investing in industrial assets. IK has made a habit of acquiring neglected divisions of large corporations to trim them first before looking to make addon acquisitions. And there's plenty more of this to do. ?If you can develop a business and bring the power back to its own board room, help it make add-on acquisitions, grow earnings and then return it to the stock market as an independent company ? that's a very satisfying experience.? Has he ever thought of doing something different? ?We've only just started. I want to develop this firm as best as I can.?
Meanwhile there is the new fund to raise. A first closing is scheduled for the summer, en route to a final close in a year's time. Observers expect IK to round up commitments of at least €500m by the time of the first close, after which, as one LP puts it, ?the landscape is likely to change significantly, as other investors will start making up their minds.? As part of its strategy for this fund, IK hopes it can bring in new investors from North America. Given the firepower of the large US institutions, it will take only a handful of positive decisions to get the fund much closer to its target. Fundraising in this kind of market is unpredictable business. But few people doubt that IK will fail to raise sufficient new capital to play a significant role in the next stage of European corporate restructuring.