Private equity sector faces shakeout

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.

Palestinian Venture Fund creates opportunity and optimism

An interesting take from from Jean Case on 18 Mar 2010

Following the Annapolis Israeli-Palestinian talks in 2007, Secretary of State Condoleezza Rice appointed a group of private-sector leaders to help ignite economic development in the West Bank. The idea was that the co-chairs would mobilize private sector resources and investment that could benefit the West Bank and bring new hope and prosperity to the Palestinians – all in an effort to facilitate progress toward a two-state solution to peace. The initiative was called the US-Palestinian Partnership (UPP).



Against the backdrop of recent weeks where diplomatic snafus and territorial disputes have fueled tempers and shone a spotlight on the inherent barriers towards progress, I am at an event today in New York City that signals what is working in the region, instead of what has not, and I am feeling very encouraged. Led by the private sector, UPP is announcing a new Middle East Venture Capital Fund that is in many ways the culmination of the work we began in 2007 and gives me great hope for what the future holds.



In less than three years, the U.S.-Palestinian Partnership has facilitated millions of dollars in new youth programs and initiatives from Intel, Cisco, Microsoft, USAID and others; convened hundreds of investors and corporate executives in Bethlehem and Washington through the investment conferences; and co-hosted G-Pals Days with Google for small business owners and software developers to gather in Ramallah to learn new skills and compete for development prizes. And, today I am smiling ear-to-ear because we are in New York to announce and celebrate multi-million dollar lead commitments from the Skoll Foundation and Soros Foundations Network to a new $50 million fund that will bring hope and opportunity to thousands of men and women in the West Bank. These investments follow the European Investment Bank’s (EIB) significant commitment to the fund. Read EIB's press release about the fund here.



The Middle East Venture Capital Fund will invest in entrepreneurial companies in the Internet, mobile and software sector that are growing out of the substantial community of software and telecom engineers and other entrepreneurs in Ramallah and throughout the West Bank. It will give US and global investors an opportunity to do well while doing good – making meaningful contributions towards creating a viable Palestinian state and getting a valuable financial and social return on investment in the process. And thanks to our partners at the Skoll Foundation, Soros Foundation Network and the European Investment Bank, we are within sight of meeting our investment goals in the fund.



Perhaps I’m so optimistic today because of some history. Many years ago, when I was at AOL, we acquired a young company in Israel called ICQ, which revolutionized instant messaging across the Internet. The investment was not only significant because of the value it added to AOL’s success at the time, and the value it created for the leaders of ICQ, but more importantly because that single transaction with an Israel-based company helped serve as a beacon of the burgeoning innovation and talent in Israel in the early days of that country’s efforts to grow an ICT sector. Since that early investment, a technology boom has taken place in Israel, and today the ICT sector has become a cornerstone of the Israeli economy. I can’t help but see the potential of history repeating itself as this new fund goes forward. In addition to a highly-educated workforce, low infrastructure costs and a burgeoning technology sector, the same entrepreneurial spirit and innovative thinking is alive and booming in the West Bank.



While the private sector can’t do much to address diplomacy or security, it can play an equally important role through the contribution of resources and investment to the region. It has been a complete delight to see the undaunted courage of private sector leaders who’ve stepped up and in the midst of troubles and strife, have made commitments to go forward with this important work in the West Bank. There is a passionate belief that there’s really money to be made here, but these leaders are equally excited about the potential for the prosperity and stability these investments might help enable. These good things only happen when people come together with commitment and passion – I am enormously grateful to those who have stepped up early and to those who are at the table with us now looking at future investments

Goldman sees $80 trillion emerging nation stock market by 2030

The market value of emerging market stocks may surge more than five fold to $80 trillion in two decades, overtaking developed nations, as China becomes the world’s largest stock market, Goldman Sachs Group Inc said.

Faster economic expansion and growing capital markets may lift emerging nations’ share of world equity capitalization to 55 percent by 2030 from 31 percent on Wednesday, Goldman strategists led by Timothy Moe wrote in a research report.

Institutional investors in developed nations will probably buy a net $4 trillion of emerging market equities, lifting holdings to 18 percent of their total portfolios from 6 percent now, Moe wrote.

In the report on Monday, Moe wrote: “The primary drivers are rapid economic growth and the maturing of equity markets that are at earlier stages of development."

“Developed market institutional asset management pools will need to increase their holdings of emerging market equities.”

The MSCI Emerging Markets Index has more than doubled since the beginning of 2000 even as the MSCI World Index of advanced nation shares dropped about 21 percent.

Emerging economies will expand 6.4 percent as a group next year, compared with 2.4 percent in developed nations, according to forecasts by International Monetary Fund.

Prospects for faster growth spurred investors to add money to emerging market equity funds for a 14th straight week even as they pulled $6.87 billion from global stock funds, research firm EPFR Global said on Wednesday.

The 21 country MSCI emerging gauge has gained 1.2 percent this year, while the MSCI World index declined 4.2 percent amid concern that stagnant jobs growth and spending cuts by indebted governments will hamper economic recoveries in the US and Europe.

The emerging gauge is valued at 14.2 times reported profits, compared with the MSCI World, which trades for 15.1 times earnings, according to data compiled by Bloomberg.

The MSCI China Index of Hong Kong traded shares has slipped 3.4 percent this year and the Shanghai Composite Index, comprised of stocks traded mostly by mainland Chinese investors, has dropped 18 percent.

The market value of Chinese shares may climb to $41 trillion by 2030 from $5 trillion on Wednesday, topping the $34 trillion projection for the US, Moe wrote.

Moe wrote: “Emerging equity market capitalization could increase substantially."

Moe also added: “Investors, financial intermediaries and developed-market corporates will have significant opportunities as well as challenges from these shifts in the equity landscape.”

GCC Market Analytics GCC Equity Market Analysis, Trading Strategies & Performance Metrics

Below are the year-to-date percentage returns for all GCC market sectors.  The top performers this year are the insurance sector in Qatar and (surprisingly?) the banking sector in Kuwait.

Seven of the bottom ten performing sectors are from the UAE market.  The Dubai utilities and Abu Dhabi real estate sectors have been by far the worst sectors so far this year.

Is there a tendency for the best or worst performing sectors to continue to perform well or poorly in the future?  I'll be taking a look at sector rotation strategies in an upcoming post.

Sovereign Wealth Funds and the Global Economic Crisis

Sovereign Wealth Funds and the Global Economic Crisis

The global economic crisis has left many sophisticated institutional investors reeling. Most are yet to fully recover even though markets have clawed back some of their early losses. Worst hit are the hedge funds with exposure to financials and commodities. For instance, New York based Ospraie Fund that was worth some $2.8 billion at the start of August 2008 wound up later in the year as its holdings took a massive hit due to falling commodity prices. London based RAB Capital, which invests in small cap mining stocks, had to seek protection from redemptions due to falling commodity prices and consequent poor performance. Assets under management by RAB have reportedly fallen by 74% in 2008.

It is not only regular hedge funds that have crash landed but also mighty Sovereign Wealth Funds (SWFs). The Monitor Group, a US based consulting firm, estimates SWFs to have lost $57.2 billion on the publicly disclosed investments of $125.7 billion they have made since 2006. According to a working paper on Gulf Cooperation Council (GCC) SWFs published by The Council on Foreign Relations (Brad Setser and Rachel Ziemba), SWFs in the GCC have lost as much as $350 billion in 2008. SWFs elsewhere haven’t faired any better.

SWFs are returning to the market again and are making big investments. Some of these investments are in strategically important assets to their sponsors; i.e. their respective governments. SWFs have made a wide range of investments covering a multitude of sectors such as banks, real estate, energy and technology.

With their massive wealth and sprawling investments, SWFs have marked the rise of state capitalism. Owned directly by a sovereign government and managed independently of other state financial institutions, SWFs were created to manage the country’s foreign exchange reserves. Some high profile SWF investments include $3 billion in Blackstone Private Equity Firm by the Chinese Investment Corporation (CIC), $75 billion in Citigroup by Abu Dhabi Investment Authority (ADIA) and $800 million investment by Mudabala Investment Company from Abu Dhabi (Mudabala).


The advent of SWFs was viewed by many with considerable hostility and even prompted Mr. Larry Summers, the former US Treasury Secretary, to express concerns over potential threats by SWFs. Mr Summers’ concerns stem from the differences between investments by governments through SWFs and those by other conventional institutions as the former may have different motives. Mr Henry Paulson, another former US Treasury, urged the International Monetary Fund (IMF) to develop “best practices” to govern SWFs investments to, “demonstrate to critics that SWFs can be constructive, responsible participants in the international financial system.”

Those were the heady days of 2007-2008, when markets were defying gravity and oil was reaching new highs. And most of the SWFs are actually from oil rich nations. With government coffers brimming with foreign reserves on the back of the oil windfall, SWFs such as ADIA, Kuwait Investment Authority (KIA) and Qatar Investment Authority (QIA) were making inroads into markets in the West with investments in large corporations, banks and private equity firms.

Given the influence SWFs can exert and the magnitude of funds under their management (estimated to be $3.22 trillion), an analysis of SWFs and their investment strategies would prove to be appropriate. So what are the implications of these losses to the investment world? What have been the responses by SWFs? How will they change the investment strategy of these funds? What would be their role in a post financial crisis environment?


We interviewed investment officials and policy makers from several prominent SWFs to determine the answers to the questions above. In a series of articles we will be publishing views, findings and conclusions, of course within the boundaries of confidentiality.


One notable observation was that SWFs have started reducing their investment time horizons in response to market uncertainties and declines in reserve transfers. This appears to be the case particularly for SWFs established by oil producing countries. Views on expected returns have changed, leading to the postponement of some investments. It is fair to say that SWFs will not be making aggressive investments such as those in 2007 – 2008, unless of course the assets are at fire sale prices.

SWFs are also moving towards the establishment of stabilisation funds, to insulate their respective economies from falling commodity prices and export earnings. They are also expected to provide stability in fiscal revenues and protect against Dutch disease. Russia’s Stabilisation fund is a classic example which prevented the emergence of Dutch disease in the country.

SWFs as stabilisation funds are also expected to make investments in ailing domestic companies, as indicated by Kazakhstan’s sovereign wealth fund Samruk-Kazyna. The fund is seeking to buy gold, copper and iron assets which would benefit companies such as London listed KazakhGold Group (LSE: KZG), Kazakhmys (LSE: KAZ), Eurasian Natural Resources Corporation (LSE: ENRC) and Toronto listed Alhambra Corporation (TSX: ALH). Similar investments in local companies are expected by Singapore’s Temasek, CIC and Brazil’s SWF.

According to the International Monetary Fund (IMF) some SWFs are seeking indirect hedges in response to falling commodity prices. This would change the asset allocation strategy in the SWF portfolios resulting in overweighting assets that are negatively correlated with the price of the commodity that funds them. For example, though not exactly a SWF, Gazprom’s investment in Airbus Industries provides a natural hedge against falling energy prices. This may lead to SWFs seeking investments in new sectors and new regions as well as different asset classes that they have not invested in before.

This bodes well for sectors such as natural resources, particularly mining, as they currently have a relatively low exposure amongst current SWFs. At present, SWFs have the highest exposure to banks and financials, even after the market meltdown, followed by real estate and energy. As SWFs seek to diversify into other sectors, the mining sector emerges as an attractive candidate.

While SWFs have already made investments in the mining sector, it is worthwhile highlighting the latest SWF investment in a mining company. The China Investment Corporation (CIC) invested C$1.75 billion (US$1.5 billion) in Teck Cominco's (TSX: TCK.A and TCK.B, NYSE: TCK) outstanding Class B subordinate voting shares. This acquisition represents approximately 17.2 per cent equity and 6.7 per cent voting interests in the company. Other SWFs may also make similar investments in mining companies with Chinese SWFs however securing the lion share.


SWF investments in the energy sector is expect to be relatively low however, as most of the large SWF sponsoring governments already have an exposure to the sector either through investments already made or naturally through their own economies. SWF investments in oil are therefore expected to come from SWFs from countries that do not have oil resources (such as Korea Investment Corp, Temasek and Government of Singapore Investment Corporation) or from industrial nations such as China and Japan that are heavy energy consumers.

While the objectives of SWFs sponsoring governments cannot be fully ascertained, some display very clear-cut investment aims. For instance, Singapore’s Temasek Holdings acts like a reserve investment corporation seeking to generate returns to its sponsors through investments in diverse industries including energy and resources. Stabilisation funds such as the Kazakhstan National Fund seek to insulate the economy against the price swings of oil, gas and metals, on which the country heavily depends. The Government Pension Fund of Norway seeks to facilitate government savings necessary to meet future public pension expenditures and to support a long-term management of petroleum revenues.

However, concerns by the likes of Mr. Summers and Mr. Paulson are not ill-founded and it is imperative to determine if SWFs can be used as a government policy tool. Sponsoring countries could use the SWF muscle in a protectionist backlash. SWFs such as CIC can not only ensure base metal and energy supplies, they may also use their clout to gain access to greenfield energy and mining projects in places such as Africa.

Governments have so far not used their SWF clout as a policy tool. SWFs such as Temasek, ADIA, KIA and QIA have indeed remained passive partners. In the case of ADIA, Yousef al Otaiba, Abu Dhabi’s director of international affairs, even assured that they have no plans to use investments by ADIA as a foreign policy tool. CIC in its investment in Teck has also assured that they seek to be mere passive investors. One would fervently hope that SWFs would indeed follow similar policies and usher in a more effective system of corporate ownership.

Sources & Acknowledgements:
Sovereign Wealth Fund Institute, International Monetary Fund, International Financial Services London, Council on Foreign Relations, The Economist, Individual Sovereign Wealth Funds, The Monitor Group

Saudi grants approval for UBS securities business

* UBS Saudi Arabia to offer full range of services

* Part of expansion in Middle East

ZURICH, July 14 (Reuters) - Saudi authorities have granted approval for UBS (UBS.N: Quote, Profile, Research, Stock Buzz) (UBSN.VX: Quote, Profile, Research, Stock Buzz) to start securities business activities, which the Swiss bank said on Tuesday would help it expand in the fast-growing Middle Eastern region.

In establishing the business, UBS said it had partnerned with Mohammed Al Dhoheyan, former chief executive of the Saudi Development and Management House for Investments, and MerchantBridge, an equity house investing in the Middle East.

UBS, the world's second largest wealth manager by private client assets, is struggling to rebuild its once powerful brand after massive investments into risky U.S. assets forced it to make more writedowns than any other European bank.

Last year, UBS won won a licence to open an investment banking branch in Saudi Arabia, the world's top oil exporter and the region's largest economy, joining a growing list of western banks boosting their presence in the booming Gulf Arab region.

UAE and Saudi to lead GCC M&A activity in Second Half of 2009

Even though merger and acquisition agreements have fallen considerably across the GCC, in sync with the global slowdown, the UAE and Saudi Arabia may see most of the agreements happening in the second half of this year as far as the region is concerned.

According to Azhar Zafar, Head of Mergers and Acquisitions at Ernst & Young Middle East, the UAE and Saudi Arabia will see the most number of deals in the Middle East.

Nawal Roy, Managing Partner, Shobhit Capital Group based in the US, sees the UAE as one market where maximum number of deals are expected to happen in the latter part of the year.

"We expect to see M&A activity still subdued in the second half of the year. Early signs suggest there maybe some activity in Saudi, Egypt and the UAE," says Vikas Papriwal, a partner in KPMG's private equity and sovereign wealth funds practice. However, market stabilisation is vital if deals are to happen.

"In the beginning of the year, there was little buyer interest in transactions at any price. With stabilisation in the last couple months, groups are again considering growth investments, but buyers can afford to be selective. We should see some pickup in activity at the year-end as more bids and asks continue to converge," Steve McIntire, Managing Director, Capital Street Partners told Emirates Business.

Agrees Zafar: "M&A deals activity in the coming quarters is dependent on investor confidence – the key driver, which means for companies achieving good operating results as well as on the availability of liquidity," he said.

Experts believe this is a great opportunity to buy but if credit remains limited, most of the deals may be distressed and out of necessity. "It will be more driven either to strengthen or just out of sheer necessity for survival," said Roy.

"If liquidity remains tight, we can expect to see more mergers particularly in the real estate and financial services sectors," said Zafar.

However, deals could be more than just distress, said McIntire. "This is a great time for opportunistic buyers with valuations in many sectors failing to reflect growth inherent in the UAE market. As the market recognises that new consumers will eventually live in all these properties close to completion, there will be bids that appeal to more than forced sellers, at least in non-construction, consumer-driven sectors," he said.

"Sectors that are likely to be more favoured include healthcare, power and utilities and financial services," said Papriwal.

Experts differ on the subject of the sectors that may see the most M&A deals in the coming months.

According to E&Y, most activity is expected in the financial services, telecommunications and the real estate. Roy believes banking sector is very ripe for M&A activity.

McIntire, on the other hand, sees retail and consumer products as the best sectors ripe for deals.

"Retail and consumer products are the broadest markets with the most opportunities. Despite the recent down trend, the UAE consumer market will grow over a five-year horizon. In both consumer product and retail, there is a healthy mix of sellers and buyers along with some interest from financial buyers who recognise the longer-term growth dynamic," he added.