Sweden's smaller deal market is hoping to stay immune from the contagion sweeping the LBO market. Andy Thomson reports.

For New York, London and Tokyo, read Stockholm too: the credit crunch has, after all, spread its influence around the globe. As a result, also ubiquitous is what's now commonly referred to as a “pause for breath” at the larger end of the private equity market as participants take stock of developments.

Summarising the current difficulties of executing large deals, one professional at a Stockholm-based GP says: “Credit committees [at banks] don't want to approve something and then regret it a week later. Appetite was very strong a few months ago, now you're nursing the banks along. If we want something in the financing of a deal that demands a little extra risk, we have to take on that risk ourselves.”

Graham Oldroyd, a partner at pan-European GP Bridgepoint with responsibility for the Nordic countries, offers a sober assessment of the financing limitations in today's market: “I would say completing deals where the enterprise value of the target company is between €750 million to €1 billion would be very difficult at the moment – and I would not expect to see a €1 billion-plus deal succeed until the debt market has recovered.”

Others prefer to delay offering verdicts until the fog has cleared a little. Says Gustav Ohman, a Stockholm-based partner at Industri Kapital: “A few test balloons will go up and people will watch them carefully to see how much has changed. One thing you can predict is that people will try to remove as much of the uncertainty from deals as possible. Ready-made debt packages such as staple loans will make a comeback, for example.”

But whatever the conclusions being drawn regarding the plight of the credit markets, many GPs in Sweden can afford to do so with a degree of detachment. This is because the bulk of private equity activity in the country takes place at the medium-and smaller-sized end of the market. Here, says Niklas Sloutski, a senior partner at Stockholm mid-market GP Accent Equity Partners, “relationships really matter. It's all about working with the banks you know and which are familiar with your processes. From our experience, they are still very keen to do deals, especially in exclusive situations.”

Some observers say that current market conditions have swung back in favour of the local, Nordic banks at the expense of their bigger, international competitors. Says Oldroyd: “The Nordic banks' balance sheets won't take large risk exposures so they are suited to the mid-market. They can do upper mid-market deals on a club basis or smaller mid-market deals on their own, and they want to make money from holding assets rather than arranging debt and then selling it down.”

For mid-market investors, this continuing supply of debt finance is, unsurprisingly, welcomed. One GP strikes a discordant note however, by arguing that the terms demanded by lenders will likely become less favourable should a small group of local banks end up with the market largely to themselves. Equally, some say they are worried that the banks' loss of risk appetite may become so profound that it afflicts the entire deal size spectrum. “If banks close their balance sheets to all private equity exposure, then you're looking at a totally different scenario,” points out Sloutski.

In the absence of this bleakest of scenarios, though, what matters most to Sweden's mid-market GPs is that the country's economy continues to demonstrate benign characteristics. Over the last few years, GDP has remained above the Western European average and looks set to do so again in 2007. The job market is strong, and consumer spending has been bolstered by the removal earlier this year of annual residential property taxes.

Despite these positive indicators, however, there is a feeling in certain quarters that the good times may not last for too much longer. While private equity professionals frequently express a reluctance to peer into crystal balls, some in Stockholm appear to have been doing just that – and with unsettling consequences. There is a widely held view, for example, that the US economy may be on the verge of tipping into recession. Should this happen, even currently buoyant economies like Sweden's would surely get caught in the downdraft to some degree.

Concerns such as these can have a material effect on deal-making decisions. Oldroyd says Bridgepoint takes into account whether target companies have “a high level of resilience” to economic volatility. As an example he cites Lund-based Gambro Healthcare, Europe's second-largest dialysis care service group, which Bridgepoint acquired for an undisclosed sum from EQT and Investor in May this year. Oldroyd says that, because patients suffering severe renal disease must undergo dialysis treatment on a regular basis, you have “extreme customer loyalty and very predictable utilisation of company resources, which allows you to invest with a high degree of confidence”. Such safety-first investments should be expected to become more commonplace in the event that today's calm waters become a little choppier.

Choppy waters are not something that firms targeting the Swedish lower mid-market have had to acquaint themselves with in recent years. Ask GPs operating in this space for a précis of their strategic approach and the answers tend to be rather uniform. Broadly speaking, it typically revolves around identifying family businesses operating in strong niches that can be taken to the next stage of development assisted by the rigorous disciplines of a private equity firm and its supporting network of industrial advisers (the latter being a traditional strength of Nordic private equity given the region's strong industrial backbone).

Uniform the approach may be, but it also appears highly credible given the strong returns and successful fundraisings that a number of operators in the space have posted. For example, Litorina Kapital, which closed its Fund II on around €50 million in 2002, is said by sources to be nearing a final close of its Fund III on approximately €150 million. The firm was buoyed by a return of more than nine times cash invested from its joint investment with 3i in Q-Matic, a queue management systems manufacturer which was sold to Nordic buyout firm Altor Equity Partners in June this year.

Harold Kaiser, managing partner at Litorina, says the possibility of selling assets to a firm like Altor is significant. “The secondary buyout market has become an interesting exit route for us and one that simply wasn't there five years ago. It has provided us with a whole new market place,” he says.

Litorina is one of a clutch of firms exploiting the lower mid-market opportunity in Sweden. Segulah, whose €250 million 2002-vintage fund was reportedly four times oversubscribed, is expected to come back to market soon and has been conspicuously beefing up its team with recent hires such as veteran industrialist Lennart Kalen as a partner. “We are building out at all levels of the organisation,” says Segulah managing partner Christian Sievert.

Also putting more people on the ground in Stockholm is The Riverside Company, the Cleveland, Ohio-based lower mid-market investor that closed its third European fund on €315 million in July this year. The following month, the firm launched a new Stockholm office headed by Lars Eriksson, formerly of Swedish mid-market corporate finance boutique Avantus.

Says Tony Cabral, head of Riverside's European operation: “We see a very good opportunity for us in the SME space in that geography. We've been active there for around three or four years and have done some very successful deals.”

As the LBO market takes its pause for breath, the Swedish mid-market is showing sufficient stamina to claim that ‘business as usual’ prevails. Professionals in the space will be hoping their luck holds.