Rearing to go

Funds raised for private equity investment in the Middle East and North Africa (MENA) have jumped this year. The numbers vary depending on which data provider you consult, but all relevant sources agree that the takings have increased sharply.

According to data compiled by the Emerging Markets Private Equity Association (EMPEA) in Washington, private equity groups in the region raised closed to $4 billion in the 10 months to 1 November, a 141 percent increase on the $2.7 billion raised in 2005.

Zawya, the Dubai-based research group, is even more bullish on the region's current appeal to fund investors. At year-end, Zawya predicts, Middle Eastern private equity firms will have raised a cumulative $10 billion. It also says that nearly half the total will have been collected in 2006, the second consecutive year of meaningful fundraising activity in the MENA region (see chart).

According to local fundraising professionals, the majority of the capital has been committed by investors based in the Gulf region – local investment authorities, privately owned trading companies and high-net-worth individuals. With oil still trading near the $60 mark, there is an oversupply of petrodollars looking for investment opportunities, and regional private equity funds have been among the beneficiaries.

The existence of such funds is one of the most noticeable changes in the MENA region in the past five years. Locals are fond of describing private equity as an investment technique that Middle Eastern traders and entrepreneurs have been familiar with for many generations. They also point to the fact that in the modern era, local investors have garnered a wealth of experience in international private equity by participating as limited partners. However, institutionally structured private equity focusing on making investments in the region is still a relatively new concept, and local groups have been mushrooming in the past two years.

Deal flow on the other hand has been relatively slow. Abe Saad, a senior investment professional based in Dubai who earlier this year left SHUDA Capital, a GCC-focused private equity equity firm. estimates that by June 2006, MENA sponsors had invested 8 percent of the capital raised since inception.

Family-owned local businesses have been cautions to embrace the private equity formula and apply it to their business development and expansion plans. Neither has large-scale privatisation of government assets taken off, though it is still being tipped as a potent source of deal flow to financial sponsors in the region.

In addition, private equity has had a tough time competing with the region's ultra-liquid stock markets, which have promised – and delivered – cheap funding to companies and outlandish returns to investors – until recently that is.

MARKET DOWNTURN
2006 put an end to the Middle East's stock market boom, which from a private equity perspective was a positive development. The market in Saudi Arabia has shed more than 35 percent of its capitalisation since peaking earlier this year. The Dubai market has fallen by more than 60 percent.

Owners have become more open to discussing private equity funding. There is a lot we can do here

Sameer Al Ansari

Naturally, private equity investors are hoping to capitalise on the downward trend. Their fortunes on the fundraising trail have already changed as a result. Says Izzet Güney, managing partner of Millennium Private Equity in Dubai: “It was still difficult to raise private equity capital a year ago. The stock market was simply too hot, people were making unbelievable returns without doing anything. Asked to invest in a private equity fund, they'd say: “So you're offering 20 percent on a monthly basis. No? 20 percent annually, and no capital guarantee?? Why would I do that?” Now that the market has turned, investors realise that they need new asset classes.”

Deal making is also expected to benefit from the stock market correction. With business owners forced to consider alternative sources of finance, private equity's stock is likely to rise. “The stock market correction is definitely helping,” says Sameer Al Ansari, chief executive officer of Dubai International Capital, an investment arm of the government of Dubai. “Owners have become more open to discussing private equity funding. There is a lot we can do here.”

Not only have entrepreneurs become more likely to enter talks with private equity, then may also be more willing to consider medium- to long-term relationships with financial investors. Says Saad: “The focus is shifting from pre-IPO investing, which has been lucrative but isn't really private equity, to value creation over a number of years. During this period, private equity investors can bring strategic advice and help overhaul a company's corporate governance.”

This does not mean that a sudden wave of buyouts is now likely to sweep across the region. But buyouts and growth capital deals involving the transfer of meaningful equity stakes including majority positions to private equity investors will increase, practitioners argue. Privatisations are also expected to pick up pace.

In addition to deploying capital locally, another strategy that some fund managers have been exploring recently is to invest local funds outside the region. In May, Abraaj Capital, the largest firm in the region with $4 billion under management, announced a $300 million joint venture with BMA Capital in Pakistan to invest in private companies in the country. Another Dubai-based organisation, Istithmar, which like DIC is sponsored by the Dubai government and has made most of its roughly 35 portfolio acquisitions to date outside the region, is about to open an office in China. Yet other firms are looking at deals in Turkey.

Güney at Millennium Private Equity has also set his sights on markets overseas. His firm is in the process of raising a number of large sector funds, including a $1 billion telecommunications fund. The latter should find plenty of demand for capital in Africa, Güney says: “The whole continent is ripe for growth. For the next two years, I expect us to be investing, investing, investing.”

HUMAN CAPITAL
Whether their focus is on regional or international deal flows, there is a shortage of skilled investment professionals that MENA private equity firms are having to deal with. Just as investment banks and law firms active in the region are battling hard to hire and retain qualified staff, so are private equity groups finding themselves under pressure to bring in the human resources needed to capture the investment opportunities they see before them.

In Dubai, recruitment is a major talking point. And the expected arrival of new entrants such as The Carlyle Group, which announced the establishment of a regional office network in November, is only going to increase pressure on the incumbent players to ensure their teams are adequately staffed.

Professionals of local descent who have worked in private equity in Europe or America and are moving back to the region are the most obvious candidates to help fill the gap. But not many professionals with such resumes have yet returned, and while their skill sets should fit the opportunity hand in glove, some caution that their emphasis on international business ethics may be seen as a threat by parts of the local establishment.

There is, in other words, much to consider in weighing private equity's prospects in the Middle East and North Africa. It is clear that the need for local economies to modernise and diversify, coupled with their governments' determination to help them do that, presents attractive opportunities. At the same time, there are cultural and social forces at play that may slow down the industry's development.

It is an environment that calls for a patient approach. The Middle East would not be the first region in the world where general partners had to overcome some formidable obstacles before finding their feet. For those familiar with the European experience, think Germany, think France.

At this point in time, MENA is evolving as a private equity location, and international investors are keeping a close eye on developments. Does the region constitute a risk that overseas LPs can afford to take on? Speaking at the Emerging Markets Private Equity Forum in London in November, hosted jointly by PEI and EMPEA in London, Shirish Saraf, managing director at Abraaj, had a clear answer to this question: “I see it more as an opportunity they can't afford to ignore.”