More foreign players flocking to region as private equity industry witnesses growth

More foreign players flocking to region as private equity industry witnesses growth

The private equity (PE) industry in the Middle East and North Africa (Mena) region has been under the spotlight over the last few years with more and more foreign players flocking to the region, said Professor Dr Rasim Kaan Aytogu, Executive Director of Tanmiyat Group.

He said the PE industry in the GCC in particular and the Mena region in general ended 2005 with a record number of funds launched and announcements made.

More than 12 funds with a total of around $3 billion (Dh11bn) of commitments started their operations in that year. International PE funds, including The Carlyle Group, 3i, and CVC, for the first time started to look for deal flow from the Middle East after having considered the region solely as a source of limited partners in the past.

Since then, the industry never looked backed. By the end of 2007, funds under management in Mena increased to 76 funds under managing $13bn. This sudden take-off can be attributed to many factors within the context of the global prominence of PE as an investment class. Economic growth, high oil prices, increasing economic liberalisation, reduced restrictions on foreign investment, privatisation of state-owned assets, and greater liquidity of regional stock markets have all been put forward as stimuli for the impressive growth of PE in the GCC.

Starting from 2002, oil prices began their continuous climb from $20/barrel, rising around 30-40 per cent annually. Liquidity from petrodollars was compounded by the repatriation of capital from the West following the 9/11 events. The excess capital was first directed towards the capital markets, which appreciated 100 per cent annually between 2003 and 2005. Liquidity then filtered into real estate, which in the past few years witnessed a flood of announced mega real-estate projects (for example, the Palm, DubaiLand and Kind Abdullah Economic City). In 2005 some of the excess liquidity moved into private equity, jump starting the industry.

Fuelled by the increasing oil prices and production, GCC economics have witnessed stellar growth in the past three years. Future economic growth is expected to be maintained in the short and medium terms and to surpass global economic growth of five per cent. Aggressive financial policies and economic restructuring by the GCC governments will ensure that growth in the non-oil sector will be over five per cent and relatively isolated from the volatility of oil prices.

Despite the windfall from higher oil revenues, the GCC governments have started selling state-owned assets at an increasing rate. This is in light of the increasing economic benefits from private sector management which have led the governments to restructure their economies during a period in which a favorable environment exists.

Airlines, power stations, desalination plants, industrial assets, postal services, banks, stock exchanges, telecom operators, and ports are some of the assets that have been or will be sold to the private sector either partially or fully. The value of the assets in all GCC privatisation programmes is estimated at as high as $1 trillion.

Within this positive environment, the PE industry has risen quickly in the GCC. Not only it is viewed as an out-performing investment class, but also more importantly, governments and economist are preaching its positive role in developing the private sector and creating strong, globally competitive local corporations. Whenever an investment in PE fund is announced, the local media has consistently praised the announcement.

Industry experts keep on reiterating whether the industry has grown too fast on the back of the excess liquidity. Although the value of investments has increased considerably in 2007, the number of transactions has staggered to an extent. Moreover, the largest three transactions have been all in Egypt, whilst the GCC has only witnessed transactions mostly smaller that $100 million, as the flow of privatisation transactions in the GCC has not yet materialised.

Aytogu believes that the quality of deal flow continues to improve, influenced by favourable macroeconomic factors. Corporate Arabia profitability is increasing steadily, and this will create bigger companies that will sooner or later need serious capital injection to maintain their growth trajectory. Banks reluctance to extend additional lending against a backdrop of a global credit crunch will also increase the chances of opening capital to private equity funds.

Egypt has emerged as the leading destination for private equity money in 2006-07. The size of the Egyptian economy, its need for capital, and the government's liberal policies have all contributed to Egypt's attractiveness. The UAE, traditionally the leading destination, remained at No2. Saudi Arabia is rapidly increasing its share, albeit from a lower base. Jordan has also maintained its attractiveness at the fourth position, despite the small size of its economy.

It is interesting to note how sensitive private equity money is to macroeconomic policies. Countries like Kuwait – third largest economy in the GCC – attracted less investment than Jordan – fifth the size of Kuwait's economy. Saudi Arabia's share of private equity investments increased only after government policies became more investment-friendly. The PE industry quickly completed the investment cycle, and the number of exits soared in value in 2007 to more that $1.5bn. The internal rate of returns (IRRs) achieved by these exits have ranged between 31 per cent and 348 per cent, very healthy returns for a nascent industry.

Exits were split between IPOs, trade sale, and financial sales. Despite the robust activity in the IPO market, IPOs as an exit route are decreasing in importance as trade and financial buyers are becoming more active. Naturally, private equity players find trade and financial sales less complicated, and hence, are exploring such exit routes more aggressively than before.

With new plans sprouting up to develop Saudi Arabia's infrastructure, particularly in the transport and communication sectors, as well as down-market industries in the supply chain of goods and services, Saudi Arabia is a slow giant ripe for the introduction of management efficiency.

A slow relaxation of regulations on private equity firms is just one of the series of measures – along building the social infrastructure of education and healthcare – where the kingdom is thoughtfully giving a thumbs-up to private equity groups looking to enter the market. This is done through obvious contacts with regulatory and other government authorities, but also with the country's major family firms.

The noticeable difference between the Saudi market and those of its neighbouring economies are the following:

• Both the UAE and Bahrain have been leaders in creating regulatory and economic environments that have been inviting and welcoming to foreign investment, particularly the development of the banking and financial sector.

• Because Saudi Arabia is the biggest market in the Gulf Co-operation Council (GCC) and its economic powerhouse, the economy is slower, more deliberate and has a regulatory scheme that is changing on a more deliberate basis.

• But the kingdom has already made significant changes, for instance the Saudi government shifted from its traditional policy to spend 60-70 per cent of GDP on defence and infrastructure to the new plan whereby more than 50 per cent of the GDP is being spent on housing, education and healthcare. To prepare the country for an era of declining demand for oil and the possible price drops associated with it.

In addition, the Saudi regulators are in need of having to set criteria, they have to be careful, then they have to make a move attributing the caution to the relative size of the country and the potential for grave errors from a regulatory or economic missteps.

Culturally, however, entry into the Saudi market is a new frontier for private equity firms. They must understand how to navigate policies by deciphering them.

There is a need for liquidity and a formal capital structure in an increasingly competitive free-market economic environment, which will result in significant merger, acquisition and divestiture activity. Many companies have capitalised on these opportunities.

The numbers

$13bn: worth of funds, which increased to 76, were under management in Mena by 2007-end

$1trn: is the estimated value of total assets involved in all GCC privatisation programmes


Challenges and trends

Robustness of economic growth: As the subprime crisis snowballs in 2008 into a global economic slowdown, the impact of such a negative turn-around in the world's economy on growth in the GCC cannot be clearly assessed. However, it is expected that the GCC will be one of the least affected regions.

Entry of international players: The previously timid interest of international players in the region was suddenly emboldened when The Carlyle Group announced its plans to raise a MENA fund for up to $750 million by 2008. The Carlyle Group is following the footsteps of many international players like 3i, TPG, Duetsche Bank, Credit Suisse, CVC, Ripplewood, HSBC, and EMP. The entry of The Carlyle Group will definitely entice many other global heavy-weights to establish funds for the region.

Larger funds: The PE industry surpassed the $100m per fund milestone in 2003, the $500m in 2005, and the $1 billion in 2006.

Track record: As regional fund managers start exhibiting their investments, their track record is being established – in most cases showing 30 per cent plus net returns. The window of opportunity for new fund managers is starting to close, and 2007 has seen some fund managers is starting to close, and 2007 has seen some fund raising efforts being aborted.

Deal flow: Business and social habits, limited opportunities in the private sector, and delayed privatisation programmes have made good deals hard to come by. Proprietary access and extensive deep business networks are essential for succeeding in the region. Regional dynamics have not allowed intermediaries to play a significant role in maturing deal flow, and hence made deal sourcing process a competitive edge for some and frustrating issue for others.