Secondaries Central, Dubai

Three years ago, Dubai International Capital (DIC) began a foray into international private equity. At the time, with just a handful of buyout professionals based in Dubai, sourcing investment opportunities in the primary market was deemed too difficult. Instead, the strategy was to acquire well-run European mid-cap companies that were already in private equity ownership. Capital preservation was one of the objectives in pinpointing opportunities; appreciation through earnings growth another. The companies' previous private equity experience would make the acquisition process easier, allowing DIC to concentrate on selecting appropriate targets.

So far, the strategy has led to DIC Private Equity completing six secondary buyouts between 2005 and 2007. The resulting investment portfolio comprises controlling interests in engineering group Doncasters; hotel operator Travelodge; aluminium materials producer Almatis; packaging group Mauser; and Alliance Medical, a medical company. The group also has a 20 percent stake in Merlin Entertainments Group, owner of Madame Tussauds and the second-largest operator of tourist attractions in the world behind Disney.

The ramp-up has been rapid: $2 billion of equity has been invested in the assets on behalf of DIC's sponsor Dubai Holding, the investment vehicle controlled by Sheik Mohammed bin Rashid Al Maktoum, the ruler of Dubai.

For DIC, which is run by chairman and chief executive Sameer Al Ansari, private equity is one component of a diversified investment operation that also has teams dedicated to global public equities and emerging markets. At year-end 2007, the firm valued its assets at $13 billion including leverage.

An outside observer might be predisposed to taking a sceptical view of a bundle of companies purchased from private equity at a time when leverage was abundant and prices were full. Did DIC overpay? And how will the businesses be fairing in the global recession that is now officially underway?

RESILIENCE
The men running the firm's international private equity platform are ready for these questions. During an interview on a Monday morning in November at The Gate, which houses DIC's headquarters in the Dubai International Financial Centre, Sylvain Denis, Alan Hyslop, David Smoot and Michel Gaudreau put forward a number of arguments as to why they are cautiously optimistic about the future.

“All our portfolio companies were carefully selected and are well-established market leaders, with steady, defensible cash flows and potential for further growth,” says Denis, the private equity team's founding chief executive.

In a downturn, businesses that are dominant in their industries will benefit from a flight to quality, he argues: “In an environment such as today's, being a market-leading company actually serves a real purpose and not just someone's ego: performance is more likely to hold up. We're seeing this right now.”

Smoot, a US private equity professional who joined DIC as a managing director last July from Morgan Stanley in New York, says: “For me one of the attractions of DIC was the extremely high quality of the portfolio, which is showing its merits in the current climate. All our companies are strong, and they are servicing their debt.”

According to fellow managing director Hyslop, a Scot who prior to DIC was a dealmaker at 3i, the portfolio companies achieved underlying earnings growth of 16 percent during the 12 months to September. He says: “Of course our companies are not immune from the global downturn. There is no hiding place. The question is, how robust will your portfolio be? What we've seen so far in the portfolio is relatively strong performance given market conditions.”

For DIC's now 16 private equity professionals, the present focus is predominantly on making sure the trend continues. The group has not made any new platform investments this year. Denis says a “rigorous” year-end review of the existing assets is currently underway, and the firm is working closely with its management teams to finalise 2009 budgets and strategic plans “that incorporate our best judgments on the trading environments going forward.”

In light of falling public market comparables and declining business prospects, a downward revision of interim valuations in the portfolio will be “inevitable”, he adds.

Private equity firms can't go for two years without selling anything; they need to make distributions. This will make some good companies available

Alan Hyslop

Despite that, Denis and his colleagues consider themselves well-positioned to continue the development of their franchise. For the existing investments, they see scope for long-term growth through expansion both in their core markets as well as internationally.

Take Travelodge for example, says Gaudreau, managing director in charge of business development at portfolio level. As Britain's leading operator of budget hotels, Travelodge expects to benefit “disproportionally” from an increase in cost – consciousness among UK travellers; in addition, DIC is working with the group to implement a business plan aimed at expansion abroad into markets such as India.

GLOBAL GROWTH
“The strategy is to internationalise the business to create a growth pipeline before we think about an exit,” Gaudreau explains. “We like businesses with room for organic growth in their core markets, but when we can help with international expansion, that's when the strategy really works.”

Alliance Medical, which is providing diagnostic imaging services to clinics across Europe, is also set on expansion into new markets in the Middle East and Asia. Says Gaudreau: “India alone needs between 800 and 1,000 new hospitals, and we are already helping the company create a structure to take advantage of this opportunity.”

In addition to working with the portfolio, the DIC team is glancing ahead to what is to come – and is seeing an attractive investment opportunity approaching. To be sure, the firm has no specific plans for new deals in the coming months – not with the debt markets closed and price expectations between buyers and sellers still significantly adrift. However, DIC does expect to switch back into acquisition mode once market conditions normalise – and owners of businesses, including private equity firms, start making asset disposals in earnest.

BUYING OPPORTUNITY
The firm's traditional focus on secondary buyouts will remain – although with the larger investment team in place, Denis says primary targets such as corporate carve-outs are now also within the firm's reach. But it is in secondaries, as Hyslop puts it, that a “major buying opportunity” is now in the making

He says: “We'll be looking at buying from sponsors that need to harvest. Private equity firms can't go for two years without selling anything; they need to make distributions. This will make some good companies available.”

Smoot adds: “Private equity as an industry has a tendency to flush out the vanguard every ten years or so. The crisis will bring quite a violent shift to the asset class, with a large number of firms struggling to return capital. The next three to four years will be a great time to be an up-and-comer.”

PURE CAPTIVE
Implicit in these comments is an expectation that when the time comes to buy companies at post-crisis valuations, DIC will have the necessary capital to participate. Although the firm manages third-party money in other parts of the business, the private equity platform still acts as a pure captive, solely investing for Dubai Holding. As long as its parent is happy to take a long-term view, DIC should be well-positioned to take advantage if and when the reshaping of the private equity universe happens.

There has been speculation in the media recently about how the financial crisis and falling commodity prices may be affecting the finances of Dubai, but on this DIC's private equity professionals decline to comment.“We are focused on our business,” says Denis.

At some point in the future, DIC's aim is to open the private equity platform to external investors. Says Denis: “We obviously discuss our deployment plans with our parent, and we're under no pressure to invest right now. It's always been the intention to run third-party capital eventually and we're committed to that, though right now raising external capital would obviously not be easy.”

Widening the investor base is just one of the tasks DIC intends to tackle in the future. Extending the international reach of the business is another: last year the firm opened an office in London and installed Eric Kump, a former executive of Merrill Lynch Global Private Equity, as managing director in the UK.

Smoot, who joined the firm in July and since then has spent his time at HQ in Dubai, has plans to move back to New York to lead the firm's efforts in the North American market. “Will we ever buy US companies that operate solely in the US market? No. But buying US-based businesses that have global aspirations will make sense.”

In the meantime, however, it's all hands on deck to help steer the existing portfolio companies through the choppy waters ahead. Like any private equity owner of leveraged enterprises, DIC is facing a serious test in the coming year. Time will tell what the outcome will be, but the decisionmakers of the private equity team are confident that they can weather the coming storm. For them, the firm and also for parent Dubai Holding, patience and endurance will be virtues.