Friday Letter: Transformational capital and the Middle East

Enthusiasm for private equity is spreading around the globe, and it has certainly reached the Middle East.  

Long an important source of capital for general partners based in Western markets, the region has recognised the relevance of private equity – both as transformational capital and as an asset class to invest in – within the economies of the Gulf Corporation Council and Northern Africa. Evidence of this enthusiasm, if more were needed, could be found in Dubai this week at the 2006 Middle East Forum organised by sister publication Private Equity International. Over 500 professionals joined top-level speakers to map the realities of the asset class in the region today.

It is of course early days, but the numbers are beginning to reflect the industry’s increasing heft and significance. According to figures compiled by the Gulf Venture Capital Association, roughly $1 billion of equity capital was invested in 2005, five times the overall total of 2004. Looking ahead, the deployment rate is predicted to accelerate further, with the Association expecting total investment to reach up to $3 billion this year.    

Some GPs speaking at the Forum warned that this forecast might be optimistic. But everyone agreed that deal flow is looking very promising right now. With family businesses (of which there are roughly 5,000 in the GCC countries alone) looking for expansion capital; expat entrepreneurs based in the region thinking about selling the businesses they built; and governments pondering the benefits of systematically selling off state-owned assets, there seems plenty to do. The fact that, in a so-called ‘reverse brain drain’, managerial and entrepreneurial talent is returning to the Middle East after years spent abroad also promises opportunity as skilled professionals look to put their know-how to work in their home markets.

It shouldn’t surprise therefore that local private equity groups have recently been able to raise sizeable pools of capital earmarked for local assets. According to figures compiled by Dubai-based Abraaj Capital, which last year closed the largest buyout fund ever organised in the Middle East at $500 million, there are currently 29 homegrown private equity firms operating in the region, which have a combined total of $6 billion under management. And approximately $2 billion worth of new funds are being marketed at present.

How effectively this capital can be put to work over the coming years depends on many things. For example, with the oil boom in full swing and crude fetching upwards of $60 a barrel, there is no shortage of capital competing for available assets. From the point of view of local business owners, private equity can still look like expensive money. That is why general partners sourcing transactions have to make a compelling case for the benefits that a private equity partner can bring to a business over and above the provision of cash.

More importantly, there are also socio-economic as well as political factors at work that have the potential to either help or hinder private equity’s developments in the Middle East.

In a keynote speech at the Forum, Bassem Awadellah, a former finance minister of Jordan and a close economic adviser to the country’s King Abdullah II, reminded delegates of some of the stupendous challenges facing the region now: a surging young population with high unemployment levels and low literacy rates; over-dependence on oil as a single commodity; closed economies, closed political systems and the rise of political Islam – a whole collection of formidable obstacles to economic development that the private sector is unlikely to overcome on its own. 

Awadellah called on the region’s governments to commit to a systematic process of wholesale modernisation in order to help the Middle East sustain its current forward momentum beyond the end of the current oil-driven boom. Liberalised market-based economies are what will define this vision of the region’s future. Their creation, regardless of how huge a task this may seem, is something that private equity can help get done. And if the project succeeds, the rewards to the industry as well as to the economies themselves should be substantial.