Flight to quality could be driver for Nordic price hike

It was an expensive year for Nordic private equity in 2015. Full-year figures from unquote" data, published and analysed in the unquote" Annual Buyout Review 2015, reveal GPs in the region spent as much money last year as they did in 2014, despite completing 20% fewer buyouts.

The data is broadly representative of predictions made by industry practitioners as early as the beginning of 2015, suggesting investors would be more cautious when choosing assets due to concerns over increasing prices, and commit capital to fewer deals as a result.

The Nordic countries saw 79 buyouts in 2015 – down from 97 the year before – worth a total of €15.5bn. From 2014 to 2015, there was a drop in volume across all deal-size brackets, except for the €50-250m slice, which saw a small uptick and provided nearly half of all dealflow in the region.

The shift into the upper mid-cap space, which has been Nordic GPs' bread and butter for an eternity, could be a sign that funds are simply paying more for the same assets in an increasingly competitive market. An ongoing influx of capital into Nordic-focused private equity funds might conceivably tempt investors into overspending on sub-par assets in a rush to deploy their bloated commitments.

However, sentiment in the region's private equity industry suggests the reason behind the increase in total deal value is a flight to quality by local investors, as GPs have become more wary of committing capital to assets with potentially excessive valuations brought on by a bull market, negatively impacting the funds' ideal risk/return profile.

There will be a general downward drift out of necessity, unless long-term interest rates and bond yields go up. Mainstream private equity will have to settle in at lower numbers" – Harald Mix, Altor

High price, low risk
In the Buyout Review, partners at two Nordic private equity firms argue that investors have become increasingly picky and have drifted towards larger, higher-quality assets as a result.

It is noted that Nordic GPs in the upper-mid and large-cap brackets are seemingly becoming more attracted to safer deals, preferring a secure 2.5x and unlikely 4x transaction to the possible 5x deal that could end up as 0.5x.

Though the strategy is not guaranteed to result in lower returns for the current vintage of Nordic funds, lower overall returns would reflect what several industry players were saying last year that LPs invested in Nordic funds should expect.

At the unquote" Nordic Private Equity Forum in May 2015, Altor's founder and managing partner Harald Mix said: "Looking at return requirements in the future, there will be a general downward drift out of necessity, unless long-term interest rates and bond yields go up. Mainstream private equity will have to settle in at lower numbers, but will still be attractive to investors."

The trend of investors' increased focus on asset quality and maturity may also benefit GPs operating downmarket. The general view of investing in the lower end of the market seems to be that there can be a larger disjoint between price and quality downmarket compared to the core mid-cap.

Because the ability to mark to market decreases in the lower end of the market, small-cap-focused funds may look at riskier plays to achieve target returns, rather than exceed their equity ticket mandate in order to invest in "safer" (or pricier) assets.

If GPs in the space are taking on more risk and valuations remain a mixed bag, it could end up having the effect of separating the wheat from the chaff. Underperforming funds will be purged from the market, while those who garner good returns will continue to attract investment and improve the average fund quality of the industry overall.

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