At the beginning of the year, Pemberton Asset Management advertised its “boots on the ground” philosophy by using a map on its website dotted with seven unevenly interspersed marks. These ranged from Madrid in the south to Amsterdam in the north, like arrows thrown at a board by a not particularly skilled darts player.
In May an eighth dot appeared to the north-east in Copenhagen, where Victor Kihlgren, the firm’s director for the Nordics, is now based. PDI asked the Swede, who spent eight years in London, if opportunities in the Nordic region have improved for private investors over the past few years. His answer is a resounding “yes”.
“I can tell you a funny story,” he says. “Just over two years ago I went around the Nordics with the head of origination [Thomas Duetoft]. I met lots of private equity firms. The feedback was, ‘If I borrowed money from you and not a bank I would be fired’.” The firms, he says, cited “myriad” factors, including their entrenched relationship with banks, their lack of understanding about private debt and higher rates.
Today, “the unitranche structure has become more accepted and banks have been pulling back their lending, so borrowers can’t get the full leverage they want”, says Kihlgren. As a result, “there’s really been a shift in the Nordics, especially in the private equity community, towards acceptance of direct lending as a replacement for the banks and also for high-yield bonds”.
Mikkel Sckerl, portfolio manager at Capital Four, a credit asset management boutique based in Copenhagen that lends primarily to Nordic companies, agrees: “I would say opportunities are rapidly increasing. There’s a lot more interest from private equity firms. In the past, most of them were just going to the banks for the financing. But now in most instances when they need financing they will consider direct lending as an option.” As a result, he says, “there are many more transactions for us to look at than 12 or 24 months ago”.
“Generally speaking, companies are very well managed, and operate in very attractive economies”
A crucial point, thinks Sckerl, is the twin pressures on bank lending. On the one hand, the banks have reduced their risk appetite. On the other, the rise in multiples paid for businesses – a consequence of the large amount of dry powder – is pushing private equity sponsors to opt for financing to support ambitious growth. That means avoiding the heavily amortising loans preferred by banks in favour of loans with either less amortisation of the principal or no amortisation at all.
This useful trend for direct lenders comes on top of the underlying characteristics of Nordic markets that attract private debt investors. One of these characteristics is the generally creditor-friendly regimes of most countries in the region, though observers acknowledge that they are not as friendly as the UK.
Another characteristic is the large number of good companies. “You’ll find a wide variation of industries and assets that are interesting,” says Alexandre Hökfelt, London-based director at EQT Credit, an arm of Swedish private equity group EQT Partners. “Generally speaking, companies are very well managed, and operate in very attractive economies.”
When examining the region more closely, most interviewees say Sweden and Denmark have the best opportunities. Sweden has good industrial companies. Both countries have attractive tech and healthcare businesses, and a fair number of private equity
investors. There is also a consensus that oil services and shipping should be regarded with caution because they are highly cyclical, and so there is less interest in Norway.
“We don’t like credits that are very dependent on one or two sectors, so we have not historically been involved in the Norwegian offshore energy markets,” says Sckerl. Finland also presents relatively few opportunities, say observers: its economy is the smallest of the four mainland countries, and it is less creditor-friendly.
Borrowers often want the money to realise a particular business plan that offers the prospect of strong top-line growth, which in turn helps sustain future payments to the lender: international expansion. “The borrower could be a very strong local champion looking to grow into other Nordic geographies,” says Sckerl. “Alternatively, it might be very strong in several Nordic geographies, but looking to expand into Europe.” The sponsor will often hope that a larger European private equity fund will buy the business after strong organic growth or successful bolt-on acquisitions.
However, there are plenty of challenges for borrowers. One is the currency problem. Private debt specialists with an international presence generally operate funds denominated in euros, dollars or sterling. But only one Nordic country uses any of these: Finland, the smallest of the four mainland economies and a eurozone member.
Kihlgren of Pemberton says currency is not generally a problem, as the cost of fully hedging the investment back into euros, the currency for all Pemberton strategies, is usually low. However, one current exception to this – at least to some degree – is Norway, where the benchmark interest rate is a full percentage point above the eurozone’s. This means high hedging costs, which make a direct lender less competitive relative to a local bank, because it must charge a higher rate to allow for this.
Competition from banks
Irrespective of the currency issue, the greatest challenge remains the region’s banks, which entered the credit crunch in a better state than many of their counterparts elsewhere and emerged relatively unscathed. They are still a force to be reckoned with, even if they baulk at aggressive leverage.
“If you’re a Nordic sponsor, the chances of finding attractive bank financing are higher than in other geographies such as the UK,” says Hökfelt. One interviewee mentions Nordea and SEB as investment banks active in this area. Kihlgren acknowledges that this competition is the single greatest barrier to lending in the region.
This banking strength keeps the market small: Hökfelt estimates the three deals EQT Credit has done in the region over the past year or so make its Nordic position “a little overweight” in terms of the size of the market. Sckerl of Capital Four says that in terms of market penetration by direct lenders, the Nordic region “has been catching up with other geographies in Europe, but I don’t think we’ve caught up yet”.
Ari Jauho, chairman of Certior Capital, a fund of funds manager based in Helsinki, says because the banks are so active, his private debt funds have little exposure to Nordic borrowers. The one exception is venture lending, where there is an opportunity because “it is a bit risky for the banks”. This is an increasingly promising area, he notes, not least because of the small number of competitors.
“In Sweden and other countries there is quite a lot of venture activity, in sectors such as computer games,” says Jauho. He says venture lenders tend to specialise in loans of between €5 million and €15 million to late-stage businesses, with a targeted return of 15 to 20 percent, based on a cash yield of around 10 percent plus warrants and an extra interest payment at the end of the loan.