Industry players need to reset their expectations in new business environment
- By Babu Das Augustine, Deputy Business Editor
- Published: 00:00 September 13, 2010
- In the first half of this year, the value of private equity investment in the Middle East plunged to a low not seen since before the financial slowdown. But the region has a young and promising population that with increasing wealth and increased political stability could constitute a major driver for economic growth and increased demand for products and services.
- Image Credit: MEGAN HIRONS MAHON/Gulf News
Dubai: The Middle East private equity (PE) industry that went through a phase of breakneck growth between 2004-08 and a drastic slowdown during the last two years is facing shakeout and needs to reset its expectations in the new economic environment, said analysts and industry players.
From 2004 to 2008 alone, global PE growth in the Middle East reached 70 per cent. Yet despite its rapid ascent, it is an industry that is still trying to find its footing.
Many PE firms operating in the region were founded at the height of the industry's boom in 2007 and early 2008 as investors pumped money into the PE bandwagon.
But few knew where to invest. Some invested in real estate and listed equities, and some didn't invest at all. The investors will start to lose patience over the next few years as funds reach the end of their terms and exits remain elusive.
"In fact, only three per cent of the aggregate capital across all funds raised from 2000 to 2010 is under liquidation, representing only 15 funds, or about 11 per cent of the total number of funds", said Peter Vayanos, partner, Booz & Company.
Private equity investments globally as well as regionally were affected by the continued recession in 2009. PE industry in the Middle East and North Africa witnessed a decline in 2009, with fund managers raising only $1.06 billion compared to a near-record $5.4 billion in 2008. Investments also declined from $2.72 billion in 2008 to $561 million in 2009, according to the latest statistics from the Gulf Venture Capital Association (GVCA).
According to Zephyr M&A Report for the first half of this year, the value of private equity investment in the Middle East plunged to a low not seen since before the financial crisis.
Just $135 (Dh495.45) million of private equity transactions was recorded in the first half of this year — a decline of 78 per cent from $617 million in the second half of 2009 and 62 per cent from $355 million in the first half of 2009. There were just ten private equity deals targeting the Middle East and only three of these have known values. The UAE was targeted by private equity three times, while Saudi Arabia and Bahrain had two leveraged deals apiece.
Industry observers expect a turnaround in the near future. The region has a young and promising population that with increasing wealth and increased political stability could constitute a major driver for economic growth and increased demand for products and services.
Increasing appetite
"A survey of 46 PE professionals conducted by Booz & Company and Insead in April 2010 confirmed that 73 per cent of industry leaders will be looking to tap this demand over the next five years through direct investments in companies from the region," said Vayanos.
Recent figures on fund raising points to a steady revival in the industry. Private equity firms in the Mena region raised $1.25 billion in the first quarter of 2010, an 18 per cent per cent increase over 2009, as regional economies recovered and investor appetite returned.
"Overall there is a revival in the fund raising activity in the region, the size of regional private deals has clearly come down," said Vikas Papriwal, KPMG's UAE Country Head of Private Equity and Sovereign Wealth Funds, said at a recent presentation on trends in regional PE industry at the Dubai International Financial Centre (DIFC).
Leading regional players say there is an increasing appetite for both private equity venture capital (VCs) investing in the region. "There is a growing interest from regional investors in funding start-ups through VCs and angel funding," said Frederic Sicre, Executive Director of Abraaj Capital. Venture capital received significant attention in 2009 with 7 transactions estimated at $25 million was closed, a substantial increase over previous years.
"The outlook for private equity in 2010 and beyond remains positive. The story in the region continues to remain one of growth and economic stability, and private equity funds will have ample opportunities to invest profitably in the coming few years," said Emad Ghandour, executive director of Gulf Capital who also chairs GVCA's Information Committee.
Experts say investors looking to participate in the Middle East's next stage of growth will still need to be cautious. The region's heady growth over the last decade worked to cover up some critical weaknesses in the PE industry. As these weaknesses come into full view, investors will need to trust that they will be addressed.
For starters, significant gaps remain in the region's legal and regulatory frameworks. Bankruptcy laws, for instance, are still not in place in many countries in the region, leading to confusion when portfolio companies fail. Methods for dealing with closure are not explicitly detailed, and in most cases it is left to the parties to reach agreement with each other.
The enforcement of contracts is not always swiftly implemented; the procedural phases of filing, trial, judgment, and enforcement typically take an average of 635 days.
"Saudi Arabia ranks 140th out of 183 countries for enforcing contracts, according to the World Bank's International Finance Corporation. Syria is even more challenged, ranking 176th," said Ahmad Yousuf, principal, Booz & Company
Corporate governance is another area that requires development. The influence of family-owned businesses may hinder corporate disclosure and limits transparency.
"Corporate governance plays a crucial role in the PE industry not only because good governance has a positive effect on company valuation, but also because in most cases, PE funds have limited ability to sell their ownership stakes, and are therefore committed to staying with the company for the medium term. This increases their dependence on good governance, transparency and disclosure in invested companies," said Dr Nasser Saidi, Chief Economist of DIFC.
Hawkamah, the Institute for Corporate Governance has set up a Task Force on Corporate Governance in Private Equity with regional PE firms and international to assist regional PE firms and PE-backed companies with their corporate governance frameworks. The Task Force will issue its first set of guidelines on October this year.
As limited partners prepare to make the leap of faith into a market poised for growth, the PE firms that judiciously apply their knowledge and talent stand to capture the benefits. However, general partners will need to adapt their practices to local and changing circumstances.
Family businesses
Family-owned businesses, which play an extremely important role in the Middle East's economies, offer sizable opportunity for PE firms. The restless entrepreneurs who have run many of these family-owned businesses for the past few decades are giving way to a rising second or third generation of family members who see the need to develop more focused strategies and more professional management approaches.
In the years ahead, these businesses are expected to divest some of their scattered holdings, scale up the businesses they retain, and seek to improve their overall performance. To do so, they need to acquire good management capabilities with a breadth of strategic, financial, and operational knowledge, a scarce resource in the region.
"The size of the opportunity is evident from the role that these companies play in GCC economies: They account for roughly 40 per cent of the region's non-oil GDP and 50 per cent of private sector employment," said Ahmad Yousuf, principal, Booz & Company.
