Karim El Solh

A lot has changed both economically and politically since the early days of the Middle East private equity industry in the mid-2000s. For Gulf markets, not least among them has been the switch from accelerated economic growth powered by oil prices of around $150 a barrel at their peak in 2008, to a sharp drop in pace as the price plummeted to lows of $35 a barrel in 2016. Today, with a barrel of oil trading at around $65, we asked Abu Dhabi-based Gulf Capital chief executive Karim El Solh for an update.

It’s been a hard few years. What’s the investment environment in the Middle East like today?

Karim El Solh: There has been a lot of change in the region. The economies in the Gulf had accumulated $1.4 trillion in fiscal surpluses and were on a good growth trajectory until the oil price crashed in 2014. The painful fiscal deficit that followed made governments realise that they had to change their spending patterns, which were not sustainable any more. All the Gulf economies went through aggressive economic restructuring programmes – it wasn’t just lip service. Governments introduced VAT as a new source of revenue, reduced subsidies, privatised assets, and partnered with the private sector. They also tapped the debt markets for funding, and they diversified their economies. In 2007, oil and gas comprised 66 percent of the Abu Dhabi economy. Today, it is 36 percent. These measures even included Saudi Arabia whose economy in 2007 was 60 percent dependent on oil and gas. Today the figure has dropped to 44 percent.

It’s been tough, but the economies here are turning the corner. Over the next two years, we expect growth of 2-4 percent across the Gulf. Oil reaching as high as $80 a barrel is a nice thing to have. That should trickle more liquidity into the system. We’ve taken our medicine, our economies have been restructured and we’re ready for growth.

What does that mean for GPs?

It’s a buying opportunity. If you’re sitting on dry powder, it’s a good time to deploy money. We’re seeing an improvement in the quantity and quality of dealflow – controlling stakes in market leaders at attractive valuations. That forms the basis for a good vintage. We raised $750 million with our last fund and, toward the end of 2019, we plan to be back in the market to raise our fourth vehicle.

But, isn’t it hard to raise capital?

This is true, and we see that raising capital has become challenging across emerging markets. Emerging markets’ returns have lagged those from the US and European managers by a good 30-50 percent, but the drivers of future growth will come from emerging markets, and Asia specifically. In the US and Europe, investors are nervous about high valuations, while in emerging markets, we are still seeing growth and valuations are very reasonable.

Currency risk is also a big worry for LPs investing in emerging markets. Private equity firms on the ground are building value and growing EBIDTA, but all of that hard work can be eaten up by currency devaluation. In the Gulf, we are sheltered from that currency risk. The GCC currencies are pegged to the dollar, so investors benefit from the regional growth without the concerns of currency risk. That’s an interesting combination and an effective diversifier.

You’ve been investing for more than a decade. What would you say are the key challenges Middle East investors face?

The biggest challenge is access to adequate bank financing for portfolio companies and exits. Given the small regional private equity industry, there are no secondary buyers and the IPO market has been slow. In the Middle East, you can count the number of large private equity firms on one hand. It’s positive in the sense that there’s not a lot of competition. However, this poses a challenge for exiting your investments because one of the main exit routes (secondary sales) is not available. When the secondary market opens, it will mainly be from global buyout firms arriving to our shores. We’ve already seen all the big US and European firms prospect for deals here.

Until then, Gulf Capital is more focused on strategic sales. In November, we sold Destinations of the World – a B2B accommodation wholesaler – to Australian listed Webjet for $173 million. That investment generated an IRR in excess of 15 percent. We also announced this week the sale of Medco Plast, a subsidiary of Middle East Glass, to Indorama Ventures out of Thailand. We have also sold in the past strategic stakes in our water company, Metito, to Mitsubishi out of Japan and in Metito China to Fosun out of China. Gulf Capital has been very successful in growing regional companies and then selling them to Asian strategic buyers. There’s not a lot of positive news recently coming from our part of the world, but we are on the other hand showing global investors that we are able to sell to global strategic buyers and generate very attractive returns in the Gulf.

How easy are those targets to find?

The majority of our deals have been control buyouts. When we started the company, securing control in this region was difficult. Nowadays, it’s easier because private equity is more accepted. Founders and entrepreneurs realise we can be a real source of liquidity and additional value. We are able to convince them that, while they have a smaller share in a business once they sell to us, in the future, they will have a share in a much bigger pie. Also, most of the entrepreneurs in the Gulf are expatriates and, at some point, they want to go back home. They are now recognising that selling to a private equity firm can ensure not only the sustainability but also the future growth of the business they have built, while at the same time providing liquidity to the founders. Private equity is also now more appreciated by family businesses looking at their succession planning.

Where is the Gulf in terms of market maturity?

Private equity in the Gulf is only about 12 years old. We’re about seven to 10 years behind Asia. It’s still a small and young industry. The top five GPs account for about 80 percent of assets under management. Market leaders have launched more and bigger funds and gained larger market share. It’s Darwinian evolution. The same thing happened in Europe and Asia. And there is a healthy consolidation in the industry. But [as a market] we need to have more exits and to build a track record of returns and distributions. When we establish that GPs can generate serious returns here, then the money will follow.

THE CONSUMER IS THE NEW OIL

How have you adapted your investment strategy to exploit the structural changes in Gulf economies?

When we started in 2006, the wealth of the region was in oil, and we were looking for opportunities there. Fast forward to today, and the consumer is the new oil. Consumption is growing at more than 10 percent per year. This is a very exciting theme. The Gulf has the wealthiest, youngest, and fastest growing population globally with high internet connectivity. These young men and women are among the most active on social media and they are high spenders online.

We are looking at how to embrace the New Economy. It’s early days here with digitisation, which contributes to about 3 percent of GDP in the Gulf, compared with 8 percent in Europe. In 2017, e-commerce across the entire Middle East was worth about $20 billion. In 2020, it is projected to explode to reach $200 billion. We are exploring how we can lead in that space and participate in the e-commerce revolution.

When we started Gulf Capital in 2006, we invested initially in the power, water and oil and gas sectors. All those investments at that time were capex and asset-heavy legacy industries. Today, we realise that you can’t scale those as much as other asset-light businesses. Now, we are focused on these asset-light companies that you can scale quickly, like business services and technology companies. That is where you can realise the 5-10x money multiples. We just acquired a strategic stake in the largest payment and merchant acquiring business in Saudi Arabia, called Geidea, and are looking at a bolt-on that would take it across the Middle East. We encourage our portfolio companies to travel from the Gulf into other emerging markets. Companies that operate in the defensive sectors are also interesting as a theme: food and food distribution, healthcare, education, and logistics are defensive sectors that we look at.