India, China, Brazil? Iain Morse finds that investors are apt to look at the Nordic countries when considering the most attractive places to commit private equity money

Nordic private equity is hot. In 2010, half of buy-out giant KKR's European Fund's investments, measured by value, were in the region. Prospective investors, including foreign pension funds, insurance companies, and other institutions, are queuing to become limited partners (LPs). "We raised €360m for mid-market fund Polaris without difficulty,' notes Dermot Crean of private equity fundraising boutique Acanthus.

Polaris I and II were both funded exclusively by Danish instsitutional investors, while Polaris III attracted money from institutions across Europe. Why do foreign investors love the region so much? No government here is going cap-in-hand to the European Commission or suffering downgrades by the rating agencies. "The Nordics are wealthy, well run, with high levels of GDP, high levels of education, sound infrastructure and good companies," observes Henrik Kraft, director at KKR with responsibility for the Nordic region. Corporate governance is also of high quality, with much emphasis on transparency and socially responsible investing. For battered, risk-averse investors, this combination is hard to resist.

In fact, Nordic private equity has shunted into an unexpected position. "New investors are most interested in China, India - and the Nordics," says Joakim Karlsson, managing partner at Nordic Capital. Of its four constituent countries only Finland uses the euro and the region seems to have its own centre of gravity, a long way from Brussels. "Take Polaris as an example," adds Crean. "It started in Copenhagen but quickly branched into Sweden; there is a strong affinity between the Nordic states." Despite their wealth, these economies are not very large, and successful companies, therefore, tend to go cross-border early in their development. "This creates an enterprising corporate culture," notes Karlsson.

There are virtuous circles wherever you look. Nordic wealth and relatively high savings rates have created some substantial long-term investors, notably Denmark's ATP and the Swedish AP funds. Many are actively engaged in investing into Nordic private equity across a range of deal sizes and themes and have been doing so for a decade or more. Some invest directly, all go via partnerships. Some have followed the example set by big Dutch pension funds, establishing their own private equity funds.

Founded in 2001, ATP Private Equity Partners, for example, has just raised €1bn from its parent, the €70bn ATP fund. This is ATP PEP's fourth fund of funds, with plans to make 20-25 commitments, typically around €50m, to buy-out and growth funds. ATP already has a long history of joint ventures with other Nordic funds, such as Sweden's EQT Partners, founded in 1994. Its joint ownership of KMD Group, Denmark's largest IT services provider, says much about the way Nordic private equity functions.

KMD's core business remains the provision of these services to well-financed Danish municipalities, a franchise now being rolled out across the Nordic region. EQT and ATP purchased the firm in 2008 for DKK2bn (€270m) on a debt-free basis, with EQT taking 85% and ATP the remaining 15%, funded with 50% equity and 50% debt. Finance for the deal came from Danske Bank, Nordea Bank, Danish bank Nykcredit, Danish private investment bank FIH, and ATP. You will find the same banks involved in deal after deal in Denmark and Sweden. Look out also for the advisory roles played by Nordea Corporate Finance and Danish law firm Gorrissen Federspiel.

These are all local players with a granular knowledge of their market. Nordea Bank and Danske Bank are visible throughout the Nordic private equity scene. Sweden has a strong financial services industry, as does Norway. This is less the case in Finland, but there is an abundance of local know-how to support deal flow. The board members and executives doing deals tend to be under 50 years old and of Scandinavian origin. Many attended the same universities and have, at one time or another, worked with or for each other. For example, Torben Vangstrup, managing partner at ATP Private Equity, has previously worked at Danske Bank as head of equity research, while his colleague, Klaus Ruhne, was previously head of M&A at the bank.

KMD, meanwhile, is slated for an IPO, but the exact date is unknown. Indeed, a sense of caution pervades the market at all deal levels. Last year and this, some regionally significant IPOs, notably for Falck and ISS, were abandoned, the companies in question tarrying on the balance sheets of private equity partnerships and banks. It's not that a wave of IPOs is necessarily required for a healthy private equity market, but they do provide an exit at the top end of the market. As Soren Norbjerg, partner at Advizer, a Danish private equity fund raising boutique, puts it: "It's the end of the conveyor belt."
Hearsay is that deal flows and prospective IPOs are building up and need release, but continuing global instability, political and economic, is inhibiting the Nordic IPO market. "IPOs need support from institutions such as pension funds and insurance companies but these are inhibited for many reasons, including changes to capital adequacy requirements," says Dan Kjerulf, in-house private equity legal adviser to Danske Bank. "This needs to change." One good IPO might carry market sentiment with it. "But we don't expect a lot of near-term IPO activity," adds Norbjerg.

Deal multiples, meanwhile, have only partly recovered their pre-crunch levels. "Deal structure is pretty much the same as elsewhere in Europe," Kjerulf argues, "with financing available on similar terms." This means that ‘covenant-lite' loans are more and more widely available - albeit at a price. "Post-2008 there were no easy covenants and the banks wanted high premiums," he says. Bank risk margins are still high measured on a historical basis but are now more scaleable. "This is a gradual recovery and a recovery in IPOs would certainly help this process," says Petter Killfors, private equity practice leader at Arthur Little.

The metrics and rationale of deals has also shifted significantly. Pre-crunch, the emphasis was on financial engineering, stretching multiples with ever more complex debt structures. Banks and hedge funds competed with private equity partnerships to get access to these structures. Securitisation provided a ready means to sell-on layers of debt which might otherwise have found few buyers. "The way deals are done has changed," confirms Lars Ericksson, partner at Riverside, the LBO specialist, which has a significant Nordic operation. The emphasis now is not on financial engineering but on the operational side. "If you place the emphasis on the operational, and if you are focused on adding value to a business by making it work better, then you can avoid paying to much for it," he adds.

This change of emphasis, greater caution and sense that the market is waiting for a clear signal to proceed are reflected in the fundraising and the substantial amounts of uninvested capital held by Nordic private equity partnerships. Between 2006 and 2009, mid-market funds raised over €8bn. Much of this is still held in cash. Last year, three funds raised €900m from third-party investors - much less than in the UK (€2.7bn), with its very mature private equity industry, but considerably more than in Germany (€400m).
Cash overhangs looking for deals to finance will have plenty of choice, according to analysts. "There are a lot of privately owned companies in the Nordic region," notes Killfors, "particularly in the mid range with values of €200-300m." This small to mid-sized sector of the market might be the sweet spot for investors. Deals are being done on multiples of three to four times EBITDA and rarely exceed multiples of seven. "But some are going ahead of this," warns Ericksson, "depending on growth prospects."

The overall sense is of a private equity market waiting for a return of investor confidence and improved liquidity. This will permit the deal floodgates to open - or so the argument goes. "Private equity returns are sometimes measured in vintages and we are laying down some vintage returns right now," thinks Kraft. Only time will tell. But prospective investors better start queuing if they want to grab any bargains.