Gulf Capital: An emerging Silk Road

Home to some of the world’s fastest-growing economies, the Gulf and Southeast Asia are building local and global economic ties as part of the development of a new Silk Road, say Gulf Capital’s Karim El Solh and Shantanu Mukerji.

This article is sponsored by Gulf Capital.

As geopolitical pressures reshape supply chains, many of the world’s emerging markets are capitalising on the opportunity to expand into local regions. The Gulf region and Southeast Asia, for example, are strengthening their trade relationship, while the World Bank-financed Southeast Asia Regional Economic Corridor and Connectivity Project will foster regional economic ties through the creation of transport networks and other infrastructure.

The emergence of a trade corridor between East and West Asia – a new Silk Road – is creating exciting investment opportunities for both regions, according to Gulf Capital co-founder and CEO Karim El Solh and managing director and head of the Singapore office Shantanu Mukerji. We caught up with them to find out how the corridor is developing and how these markets will develop over the next few years.

Where are you seeing the biggest economic opportunities today?

Karim El Solh

Karim El Solh: There is a strong case for investment in the Gulf to Southeast Asia corridor that connects East and West Asia. This is a high-growth corridor, with fundamentals that are particularly attractive in today’s more challenging environment globally. Countries in the region have relatively stable political regimes, their populations are becoming increasingly affluent and, in today’s increasingly polarised world, they are geopolitically neutral.

Shantanu Mukerji: In markets across the Gulf, you have very strong economic growth. Forecasts from the IMF estimate that the growth of Gulf Cooperation Council countries’ GDP will come in at 6.4 percent in 2022; some of this will come from high oil prices, with around $1.3 trillion of oil revenues set to flow to the region, but there is also underlying growth.

Saudi Arabia saw GDP growth of 12.2 percent in Q2 2022 – it was the fastest-growing major economy in the world. If you then connect that to Southeast Asia – a region that is well known for its fast growth, where consumption is rising and where companies have strong expansion ambitions – there are a lot of interesting investment opportunities.

How have these dynamics changed over time?

KES: The corridor is now experiencing remarkable growth – the Gulf is having a record year, for example. This is set against a backdrop of much slower growth in many other markets, such as in China, as well as the potential for downturns elsewhere, such as in Europe and the US. In our region, you are getting emerging markets growth rates, but also the regional economies are pegged to the dollar, so there is no currency risk. You’re getting high growth without the usual emerging market currency risks – a unique and appealing combination.

Shantanu Mukerji

SM: The macro picture is strong, but there are other factors at play. Companies across the corridor are maturing and the founders want to grow further.

Many businesses want to expand internationally, and they are turning to buyout partners to achieve this.

Historically, companies in India and Southeast Asia may have turned to China or to the US, but they are progressively realising the merits of expanding along the GCC to Southeast Asia corridor. Businesses benefit from a much higher interoperability across the corridor, and lower geopolitical risk.

The Gulf to Southeast Asia corridor is a large geographical region to target. How are opportunities best sourced across these markets?

KES: Private equity is very much a local business. You can’t fly in and fly out if you want to generate consistently strong returns: you need to be from the region if you are to invest in the region. That’s why we have local offices staffed with local teams in Egypt, Saudi Arabia, the UAE and Singapore. We have made 14 acquisitions across Asia in the past 16 years through our portfolio companies, and have expanded consistently across this region. To achieve this level of expansion, you have to have local teams who know which doors to knock on, who to partner with and which companies to buy.

How is the current macroeconomic environment affecting portfolio companies in the region? How can investors create value in these markets?

Karim El Solh: One of the challenges in PE in emerging markets is that many investors take minority stakes – this can cause difficulties, especially when it is time to exit these stakes. It really pays to be a control buyout investor in an environment like today’s. You also need to use leverage judiciously: if you want to grow companies, don’t use leverage on entry to acquire the stake in the business. Rather, preserve it for growth. Leverage works great on the way up, but it really doesn’t on the way down.

This is an ideal time to be focusing on EBITDA growth and saving your borrowing power for expanding the business. Around 94 percent of our returns come from this; we are very focused on turbocharging the growth in profitability of our portfolio companies.

Alongside this, focusing on operational improvements is important because you are building stronger, better businesses. If you have controlling stakes, you can ensure you have an investment partner, an operating partner and an industry chair on the board of the portfolio company.

We can support our businesses through more difficult times, too. We recently ran an off-site gathering for our CFOs and CEOs to share knowledge about how to manage a high inflation environment, how to protect margins, and how to price goods and services.

Shantanu Mukerji: It’s also worth saying that the economic environment will create opportunities. When the Federal Reserve is throwing out money, cash is certainly not scarce. That has created some very high valuations. As monetary policy shifts, the cost of equity reduces, and it makes more sense to fund growth and use leverage to create value. We have seen this in the past – it’s only been a 10-year cycle. This is what we at Gulf Capital have excelled at.

What are the key sectors within the region?

KES: In PE, you have to look at where you want to play for the next 10 or more years. That’s how we settled on thematic investing when we launched our third $750 million fund in 2016: we looked at 80 mega-trends, mapped more than 45 sectors and decided to invest only in the sectors that are growing in the double digits and do not face headwinds. Historically, that has meant investing across four sectors – technology and fintech, healthcare, business services and consumer. Since the launch of our new fund, we have added sustainability as a new investment sector.

We already have investments in water and waste management, and we are looking at renewables, energy transition and food security. We see these as sectors of the future, unlike more traditional areas of the region, such as oil and gas.

What are the most important lessons you’ve learned about investing in these markets?

KES: We have been investing in the region for 16 years, and that has allowed us to improve and evolve our approach. Experience has led us to evolve into a thematic investor and to focus on sectors for the future, which are very important for growth and, of course, exits.

“Private equity is very much a local business… To achieve [global expansion], you have to know which doors to knock on”

Karim El Solh

We have also learned the importance of control investments. We have done minority investments in the past and they have been very difficult to exit – no strategic acquirer wants to buy a 20 percent stake in a business. We are an active owner, and are very focused on acquiring controlling stakes so we can influence the growth of a business.

Another key lesson is avoiding single-country deals, because these have much higher currency and geopolitical risks. The best opportunities are companies with an international presence and/or that want to grow internationally. These global and international businesses are also attractive to financial and strategic buyers when it comes to exiting. We are very focused on internationalising all of our portfolio companies, which today operate in 57 countries around the world.

Finding the right partners to work with is also vital. We want to work with management teams with the same vision and that have the capability to manage both organic growth and M&A. Often that means bringing in new, international talent. In our fintech portfolio company Geidea, which is the leading merchant-acquiring business in our region, we hired seven of the eight C-suite members. This includes the CEO, who used to be CEO of PayPal EMEA. It’s a payments business that has expanded across the Middle East and grown into new business lines. To achieve that, we had to import talent, including world-class executives with experience at Worldpay, Revolut, Mastercard, First Data and N26.

What future developments do you see on the horizon in your region?

SM: Generating alpha is becoming more of an art. This will be set against a backdrop of a reversal of the interest rate regime we’ve seen over the past decade. This won’t happen overnight, and I think we’ll see a different long-term macro picture as a result.

“Generating alpha is becoming more of an art… We’ll see a different long-term macro picture as a result”

Shantanu Mukerji

We are already hearing talk of central banks in the region revising their inflation targets from historic norms of 2 percent to as much as 4 percent. That will have an impact across the economy.

KES: People are moving away from financial leverage and multiple arbitrages because it is just too risky in a high interest rate environment. The industry at large will need to find new ways of creating value now that central banks are no longer printing money.

We are feeling very positive about the region. The Gulf to Southeast Asia corridor is increasingly interconnecting, and we see high growth rates in our markets continuing. An investment in our region will be a great diversifier for global institutional investors, because it is almost negatively correlated with the rest of the world and its economies are accelerating at a time when others are decelerating.