The days of personal relationships are over as the reality sets in after the global crisis and the region’s private equity firms adopt sustainable and realistic models.
In the GCC, where the big players in the economy are either government-run entities or family-owned businesses, the private equity firms operating in the oil-rich Arab countries have been following a unique model based on personal relationships – very different from the structure in Europe or North America.
While finer details of only a few transactions become public knowledge, most of the deals depend on personal and even family ties.
The personal network is key to conducting business successfully. Generally, deals are finalized following a close examination of the account books in the developed markets. However, sources in the industry said several investment deals in the region used to be verbally finalized by seniors in the company, and then executives at the PE firms chalked out a plan to execute those deals and make them profitable for their limited partnership investors (“LPs”) and, ultimately for the Private Equity managers themselves (the “GP” or general partnership).
In the current economic climate, however, the role of private equity firms has become more important and the regional firms are graduating to the more sustainable and realistic model followed in the developed economies.
Matteo Stefanel, senior partner at Abraaj Capital, which is an investor in Mediaquest, parent company of TRENDS, said, “The role [of private equity firms] is becoming more pivotal in this tough economic climate, as traditional forms of financing continue to shy away from the market, making private equity the source of capital of choice for companies looking to raise funds to fund and pursue their growth plans.”
However, the old business model followed by some private equity firms in this region worked out fine during the boom years until the ripple effects of global crisis hit Arab economies. It’s getting extremely difficult for PE firms to exit their investments in companies in which they invested in 2002 to 2007, because the prices paid at that time were quite steep, while the recession combined with the Arab Spring has severely impacted businesses in the Middle East and North Africa region, making profitable exits that much harder to achieve in the context of today’s low market valuations. An executive associated with the Dubai-based private equity firm said, “We have no option but to wait and restructure ourinvestee companies.”
Stefanel said, “The continued turbulence in global markets limits the prospects of IPO exits for PE firms, however, we believe that equally attractive and popular exit routes remain wide open. These include divestments to trade buyers, who tend to have relatively superior access to third-party financing, and potentially secondary sales to other PE firms, who are equipped with adequate amounts of fresh capital raised pre-crisis and ready to be deployed in new investments.
“Exits in the region have been historically limited, partly because the majority of completed deals are relatively young.
“As investments mature over the next two to three years, we expect to see an increase in PE exits. The exit strategy is generally a function of the size of the business and its target sector, the requirements of its future growth plans and the quality and aspirations of its management. These factors help determine whether a business is best suited to be taken public, or be sold to a larger strategic or a financial buyer,” he said.
Currently, the dry powder in the GCC market is available, but it’s unable to find instruments where the capital can be employed, said an industry source, adding that the companies that need capital are holding back as they watch the unfolding of developments in the MENA region, the looming crisis in Europe and abysmal financial figures in the United States. On record, about eight private equity and venture capital deals were closed in the Middle East during the first seven months in 2011. A report by the MENA Private Equity Association said that 24 deals were finalized in 2010, while 46 were signed in 2009. According to industry insiders, that wished to remain anonymous, the size of the industry used to be close to the $6bn in 2008, before dropping significantly and would not get back to this level before 2013. They also said 2011 is one of the worst years for the region’s PE firms. Speaking to Dow Jones, CEO of Qatar’s First Investment Bank, Emad Mansour, said PE firms would like to forget about 2011 and pretend it never existed.
Nowadays PE firms are focusing more on existing portfolio companies rather than closing new deals in a bid to save the available dry powder and protect balance sheets amid ongoing market volatility. Investors are also becoming very selective and only firms with solid returns, clear exit strategies and track records are attracting attention, said sources.
According to the executive director of Dubai-based Abraaj Capital, Mustafa Abdel-Wadood, while getting buyers and sellers to agree on how to value a business and then obtaining financing for deals were the biggest challenges in 2009 and 2010, 2011 has seen significant deal flow as expectations of both sides have re-aligned.
Managing director of The Carlyle Group, Firas Nasir, adds, “I’ve seen a lot of press about deal flow being the biggest challenge for PE firms in the region. I disagree.
“Deal flow is plentiful, especially if the investor’s value-add is apparent. I believe the exit is the biggest challenge, which is why it’s a central part of our investment thesis. We focus on the IPO as the primary exit and M&A opportunistically. We prefer to invest in enterprises with attractive business models and the scale to be come publicly-traded companies; ones that are domiciled in countries with liquid public markets – such as Saudi Arabia. Relying on M&A as the sole path to exit can be precarious.”
Summing up the PE sector, CEO of Abu Dhabi-based Gulf Capital, Dr Karim El Solh, said, “I think its early days for the region, but we will start to see a level of maturity. In 2005 and 2006 everyone rushed to launch private equity firms, so there were at one point almost 100 different players in the Middle East, which is a staggering number for this region. A large number of players entered the market and that is not healthy. What you are seeing now is a consolidation. A number of players raised funds, which they were not able to deploy or generate attractive returns [for their investors],” he said.
Stefanel added: “We believe the current conditions strongly favor the market leaders who can bank on their superior record of deploying capital, creating value and generating returns to steer through these difficult times. The gap in the PE market between the leaders and weak performers is becoming more pronounced. This is evident by the fact that about 75 percent of the value of completed transactions in 2010 was related to one transaction, Abraaj’s acquisition of a 49 percent stake in Network International. In addition, we see a polarization of raising capital between SME funds on one side, and multi-billion funds on the other, a trend already apparent in 2010, with 25 percent of total funds raised relating to venture/SME capital.
Among the most significant deals in the region in 2011 was Standard Chartered’s acquisition in August of a minority stake in Saudi Arabia’s Construction Products Holding, a subsidiary of Bin Laden Group, worth $75m. This was the bank’s first private equity deal in Saudi Arabia and its second in the GCC since the beginning of the Arab Spring.
Some of the few home-grown private equity funds have concluded deals outside the region this year, such as Investcorp’s acquisition in June of the Residence Inn Manhattan Beach hotel in Los Angeles, and the purchase in May by Bahrain’s Arcapita of a majority stake in J. Jill, a multi-channel specialty retailer of women’s apparel based in the United States.
The biggest deal of the year came when Abraaj Capital acquired a 49 percent stake of Network international. The transaction amount was $545m, according to Bloomberg. The sources said that the regional firms are increasingly looking abroad for investment deals because the GCC market is still quite small compared with opportunities available in the developed and emerging markets, including Turkey. Also, the region’s SME sector has failed to gain momentum.
The weaker state of the industry in the past few years has also triggered the start of the consolidation, with the few at the top starting to buy the smaller firms.
One of the first consolidation deals has been the acquisition of North African private equity platform of Amundi, the French asset manager jointly owned by Société Générale and Crédit Agricole. Abraaj took over management of the $161m SGAM Al Kantara Fund, as well as absorbing the 11-member Amundi investment team. The transaction size was not announced and Abraaj refused to comment on it.
However, life has returned to the market with a recent exit from an investment.
Abu Dhabi-based Gulf Capital made a successful exit and sold Maritime Industrial Services to London-listed Lamprell in July. Talking to TRENDS, Dr Solh said that his firm is planning to exit two more investments in the next five months.
Gulf Capital and another regional private equity firm, Amwal Al Khaleej, sold their stakes in Maritime Industrial Services in a $336m deal to Lamprell in one of the rare private equity exits from the region. Rumors are that Abraaj would also be exiting a hospital deal in Turkey’s Acibadem, which they entered in 2008. Transaction size is rumored to be north of $1.5 billion. The company did not comment when asked.
In the past few years private equity investments have seen a sharp drop, with investors backing out of capital calls, sellers demanding higher prices than buyers were willing to pay, and increasing competition from family groups hampering growth.
Simultaneously, the multiplier paid by PE firms has dropped from the 20s, which was the norm before the crisis, to a six to eight in line with other markets.
Meanwhile, industry insiders have also raised ethical issues regarding some of the investors who make cash available to the PE firms. A source, who wished not to be identified, said that some ‘cowboy investors’ have entered the market with grey money and as transparency, accountability and regulations are still at the nascent stage in the yet-to-mature sector, questions of morality are being raised by executives who have worked in developed markets and are now trying to build their professional portfolios in the Middle East and North Africa region.
However, the Gulf Capital CEO said that in his firm there is due diligence before any investment is approved and the firm uses services of globally recognized auditors to get realistic valuations. “We also implement know-your-investors program, before raising capital,” he said.
About grey money, the industry insider said the global crisis came at the right time and it is good for the PE firms. Responsible companies use money of responsible investors responsibly, he said, adding that the rogue firms that used grey money will disappear once the dust of the global economic recession settles down.
Further, an insider said the capital raising had become much more difficult, as investors and families have become savvier and have hired advisors to help them evaluate each potential investment. The consequence of PE not being able to engineer many exits in the past two years has also delayed capital raising, as investors want to see reasonable returns on IRR, which firms have not been able to provide.
The crisis has also had consequences for some LPs in search of liquidity. According to industry insiders, some LPs have been trying to sell their stake in some of the funds they are invested, at a hefty mark down of 60 cents to the dollar. TRENDS contacted some companies that trade on the secondary market for private equity to assess the price paid for funds in the region. All declined to comment.
As with all sectors in an economy, the private equity has it own challenges and the jury is still out on the short-term outlook of the industry, but major players moving toward professionalism is certainly a good news for the sector.
Debt as investment
Credit investment is rarely seen in the GCC. Managing director of Gulf Capital’s Gulf Credit Partners, Christopher Baines, said that asset-based lending is much more common, but it is the conventional way of lending. The region is gradually maturing to handle sophisticated investment vehicles as there is a huge gap in the market for MENA financing.
The SMEs and family businesses in the region have only two options – either seek a collateralized loan from a bank or take the private equity road. In the first option, assets are tied up with the loan and in the second control of the company is at stake. Baines said Gulf Capital’s $300m credit fund is perfect for family-owned businesses that do not want to dilute control of their companies.
“The main area of focus would be healthcare, infrastructure, manufacturing and logistics,” Baines said, adding that the fund would be targeting the UAE and Turkey. It will also look at opportunities in other GCC countries, with strong macroeconomic fundamentals such as Qatar and Kuwait.