Q&A with Daniel Sachs
April 18, 2013
Can you describe Proventus in as much time as it takes to take the elevator to your office?
Proventus is a family controlled, privately owned investment company that has been active in Nordic and European capital markets for the last 40 years. It provides tailor made credit funding facilities to carefully selected European midsized companies. It has always been and will continue to be an independent and contrarian investor, active in parts of the capital market that are less developed. Why? Two reasons. Partly because these are the areas where you can find the most interesting investment opportunities, but also due to our deep interest in being involved in the development of capital markets so that they better serve the needs of companies.
How has Proventus evolved over the last four decades?
There have been three distinct phases. In the 1970’s, Proventus invested in the Swedish and Nordic stock market, which was then a very heavily regulated market with exchange rate controls, for example. It was also not a very transparent market, there was no group accounting and a lot of information about the companies was not in the public domain. Nevertheless, we were an active investor. As the market deregulated in the late 1970s and early 1980s, our focus shifted into taking larger ownership positions and being the controlling or driving owner in midsized companies. The fact was that even as the capital market deregulated, the structure of the companies was still in many ways very inefficient. By investing in these companies and taking a large enough position to drive change, and then being very active, Proventus was able to create significant value. During this time Proventus also listed successfully, but was taken private in 1995 and since then we have been a fully private company. The third phase is the one we have embarked on now, which is focusing on credit markets and on providing credit funding for midsized companies in Europe. We are still in the early days, but our decision to pursue this course really emerged in 2005 based on our experience of investing in companies in need of change, on the one hand, and on the other hand our experience of being active in the bond market and seeing how that market is very undeveloped in most of Europe, not least in the Nordic region.
So what is your niche?
We saw that the Nordic markets were reliant on either relationship banking or an active equity market, but that there was very little in between. There was minimal subordinated lending, or mezzanine financing, and the corporate bond market was very undeveloped. So, in line with what I said earlier about being an independent and contrarian investor, we started investing in this space with our own balance sheet. We started providing loans to midsized companies in need of funding, either for more forward looking reasons such as acquisitions, growth, working capital, or investment, or for more defensive reasons such as re-financing or restructuring. We have since developed our own investment vehicles with the backing of leading institutional investors.
Given your independence and contrarian spirit, why did you decide to establish investment vehicles with the help of other investors?
Pensions and insurance institutions are sitting on a lot of capital that is increasingly challenged to create enough return to meet their liabilities. Solvency II requirements mean they must avoid some of the riskier investment options. So a lot are looking to be active in this market, but can’t be so directly, so why they need partnership or intermediation. We decided at that point that in order to really make the kind of difference we wanted in this market, we needed a broader capital base, so we went out to a number of institutions and offered the chance to co-invest with us in what we now call Proventus Capital Partners. The first structure was launched in 2009, a E216m structure, in which Proventus AB was the biggest investor with 23 per cent of the money. That structure was fully invested within 18 months. We then raised the second structure, Proventus Capital Partners II, which was closed in June 2011, and is a E600m structure.
You just referred to the structural shift that lay behind the development of this market. What was this shift exactly?
When we look at the market for corporate funding and corporate lending in Europe, both the demand and supply side are changing dramatically. On the demand side there is no reason to believe that demand for funding from companies is going to decrease. If you go back to the reasons for raising funds I identified earlier, underlying this is a challenge in terms of refinancing loans that were put in place between 2005 and 2007. In that period the market accepted much higher levels of leverage than historically, so we have a large overhang of refinancing to do, something that has been referred to as the ‘refinancing wall’. It is this that is underlying the demand for funding, you could say. In addition, quite a bit of that funding has been based on a level of leverage which is much higher than we would accept today, so part of this cannot be replaced by bank lending, it will need to be replaced by money which is more risk bearing. But it is not all defensive. There will also be more forward looking offensive needs for capital to finance acquisitions, growth, investment and such like. On the supply side, the main theme is the issue of bank deleveraging. Obviously, if you look at banks’ balance sheets over the last 20 years in Europe, they have gone from around 120 per cent of GDP to almost 400 per cent of GDP, far outgrowing the growth of the economy. This means that even before we start talking about the impact of new regulation, there is a fundamental need to delever in the banking system. The other part is regulation. The Basel III rules are being put in place to make sure banks are much less thinly capitalized. Basel III will mean that deleveraging will happen, but how rapidly it will occur remains a big question. If it happens too rapidly it will have a huge effect on growth and employment, and if it does not happen quickly enough it will lead to existing structural problems continuing to be present. This is something that will have a huge impact on the accessibility of bank funding, and also on the pricing. If you look at the margins that banks have to pay on their funding, before 2007 banks paid 10 basis points or thereabouts, virtually zero. Today they can pay 2, 2.5, or 3 per cent. So bank funding has become much more expensive and this of course carries over to their clients.
But surely there are plenty of other sources for companies seeking to raise capital outside the banks?
Many people are talking about the potential of the equity market to fill this gap, but there are a number of challenges. One of them is demographics. The population is ageing, which implies de-saving which will be negative for equities. The other thing is the Solvency II requirements and other types of regulation on insurance companies, which means that they will need to invest in more risk free assets and not so much in equities. The funding gap can also partly be covered by bond markets, and we are seeing better liquidity in the bond markets than we have been previously. These are welcome developments. But there remains a need for a much more active market for lending outside the banking system. Let’s not forget that this is not a cyclical situation, it is a significant structural shift. It has been preceded by 20 or 30 years of enormous expansion of the banking system which now has to recede. Why hasn’t the bond market filled this gap? Fundamentally the explanation is cultural. We come from a private lending culture. But the bond markets are developing and we will see much more funding coming from them, but they still won’t be able to handle this whole deleveraging issue on their own. In addition, and fundamentally, many of the companies we deal with are midsized firms, big enough in their own right, but too small to consider the bond option.
So what sort of financing do you provide?
If a given company needs funding, then typically the bank says we’ll give you 50m but you will need to find another 50m from more risk bearing funding. We never compete with banks. But for the second 50m there are options. Either you have retained funds, so it is not a problem, or you can go to the equity market and either the public equity market or private equity, or some kind of bond funding, and that is where it comes to us. We provide debt financing to midsized companies, either in expansion or acquisition type situations, or refinancing, ownership changes or restructurings. Normally our capital ranks between banks loans and equity. Some people in our market take equity upside. We don’t. Typically we offer a fixed cost of capital, so you know when you fund through us what the cost will be over time. Typically it costs between what a company would pay a bank and what an equity investor expects.
What sort of companies do you invest in?
The kind of companies we look for are companies with an established market position, reasonably mature, either with proven cash flow generation capacity, a functioning business which is making money, and/or strong asset cover. We have funded companies that are losing money or are in a turnaround, but we were able to fund them because they had other assets we could base our funding on. We can invest between Euro10 million and 100 million.
What do the companies get apart from financial support?
We act as a financial and strategic partner, becoming part of developing companies that are in need of change. We are not passive money managers. We are people that like to live very closely to the people that we fund. We maintain a very tight dialogue with owners, managers and banks, among others. This means we can react to new situations very quickly be they opportunities such as an acquisition, which we can evaluate very quickly and participate in the funding. We almost always have board observer rights, at the least. We really try to find the right structure for every situation. Both to make sure the company has the flexibility and funding it needs to carry out its plans, but also to make sure that we have the right type of risk rewards situation. We don’t have a fixed idea of how an investment should be structured, there is no ‘Proventus way’. We try and be problem solvers and assess each situation individually. Last, but by no means least, it makes a lot of difference to the companies we fund that we are investing our own money, that we are entrepreneurs and a family owned business ourselves. We genuinely commit to our portfolio companies.
Has the presence of large institutions curtailed your freedom to act?
We have a very broad mandate from our investors. They know that a lot of our success is based on an entrepreneurial approach to investing. They feel comfortable with that because we are the biggest investor ourselves. They have seen what we have built our track record on over time.
So those are your operations. What is your vision?
The vision is to be a powerful and meaningful source of development capital for successful midsized European companies. It is tragic that we are seeing a lot of companies that have an amazing business but are struggling with over leverage or facing a difficult financial situation. In a lot of these situations, the type of capital we provide can make a huge difference. We have a really good relationship with the banks, we understand the owners, we can be a catalyst. We unlock potential. We believe helping them realize their potential will help drive economic growth, create employment opportunities, spur innovation and assist in the broader development of capital markets. We have acted on something to create a business opportunity. We have also brought major institutions with us and shown them the potential of this market. It is the companies that are benefiting. On top of that, we want to drive debate on these issues, on the need for more development of this market. Proventus is deeply engaged in society. We have always seen it as natural that as a company we are also a citizen. We are a part of this society and want to be a part of how it is built.