In July 2008, with oil reaching a record high of nearly $150 per barrel and fastgrowing economies showing no signs of slowing down, investors in the North Africa and Middle East seemed more positive than ever about prospects for private equity in their region.
Fast forward six months. With oil down more than $90 from its mid-July peak, annual GDP growth forecasts for the region cut by theWorld Bank to just north of 5 percent by 2010 and massive sell-offs on most of the region's major stock exchanges during the third quarter, itmight seemthat the optimism was misplaced.
Not so, claim those on the ground. Private equity practitioners and related professionals remain optimistic about the asset class's future in the region. They point to strong fundamental drivers and robust deal pipelines as feelgood factors – although they are not without some degree of caution as a result of recent market developments.
Public markets around the MENA region have certainly not been immune from the contagion spreading from the West. As Vincent Le Guennou, executive vice president at private equity firm Emerging Capital Partners in Tunis explains, the region's larger and more liquid capital markets tend to attract more international investors and have therefore taken a severe beating. At the time of writing, the Cairo Stock Exchange was down nearly 60 percent since the beginning of the year and the Casablanca Exchange was down 10 percent. Meanwhile, the MSCI Gulf Cooperation Council ex-Saudi Arabia index shed nearly 22 percent in the third quarter.
This is certainly unsettling for private equity investors looking to exit investments via IPOs. But beyond that, the region's investors aren't reading too much into the fall.
“The decoupling myth's been exposed as regards the capital markets but not as regards the underlying fundamentals in the region. The real economies remain strong and there's a positive outlook for the region,” claims Tom Speechley, executive director of private equity firm Abraaj Capital in Dubai.
Robert Wages, executive director of private equity at the Abu Dhabi Investment Company (ADIC) sovereign wealth fund, agrees. “In the Middle East, there's maybe a decline in the rate of growth but the economies all still look like they're growing more than 5 to 6 percent a year for the foreseeable future,” he says.
One key driver underpinning that growth will continue to be the region's projected infrastructure spending need, which is likely to stay on course despite the recent market turmoil as most oilproducing states budgeted their infrastructure outlays on oil prices below even the current range of $55 to $60 per barrel.
“The Middle East countries, especially Saudi Arabia and the UAE, have made a commitment that they're not slowing down because they see investment in infrastructure as the engine for growth in the future”, says Abraham Akkawi, Ernst&Young's head of infrastructure advisory practice for the Middle East based in Riyadh, Saudi Arabia.
Nor is infrastructure spending limited solely to governments. Akkawi recently co-authored a report in which he estimated the need for $100 billion of private-public partnership investments in the MENA region over the next five years.
Family-owned enterprises, which represent around 70 percent of the workforce in the GCC, are likewise opening up more and more to private equity investors. Family succession planning, the sale of non-core assets and the need to raise capital to scale business plans are among the drivers.
“We have a large deal flow of companies, virtually all owned by family groups, where they are looking to shed some businesses to support the growth of other businesses. And with the financial crisis worldwide, we are not really seeing any diminishment of that trend,” Wages says, adding that he expects to be doing deals at a rate of about three to four per year.
ADIC's strategy is to take majority stakes in family group divestitures, as it did most recently when it bought an 80 percent stake in a speciality beverage distributor from the Al Zarooni family in UAE, a leveraged buyout for which the private equity firm borrowed half the purchase price.
Faisal Belhoul, founder and managing partner of private equity firm Ithmar Capital in Dubai, also sees robust deal flow from family-owned enterprises, but views sales of non-core assets as a secondary opportunity.
“The more attractive opportunity is partnering with family groups in their core businesses to participate as a minority shareholder in those prime businesses,” he says.
In Israel, investors also see a buyers' market. “We've been investing in Israel since 1993 and we have never seen so many opportunities for an attractive price as we see today,” says Edouard Cukierman, chairman of investment firm Cukierman Investment House in Tel Aviv.
But unlike the GCC countries, some of Israel's pipeline of deals stems from forced selling by venture capital and private equity firms winding down operations. Cukierman estimates that there were 100 funds operating in Israel in 2000, one of which was his Catalyst Fund I. Today, he estimates that only 15 of them remain.
The private equity community in MENA recognises that it's operating in a much different world than it did just a few months ago. This means that private equity firms are more careful in deploying their capital. ECP's Le Guennou observes that tourism, manufacturing and real estate “trigger a more cautious approach from private equity players” in North Africa.
In the Middle East, Ithmar's Belhoul is adopting a “back to basics” strategy of focusing on noncyclical and recession-proof businesses like healthcare and education. Chances are he's not the only one.
This caution means buyers have an upper hand in the market, passing up more opportunities in search of quality assets and bidding more conservatively.
“Before the summer, multiples were great. Business appeared to be booming, and it was a sellers' market. Now it is the opposite,” says Amjad Ali Khan, a partner in the private equity practice of Middle East law firm Afridi & Angell in Dubai.
“Investors are shell-shocked. Whichever asset class they have other than cash, they've been hit,” he adds.
Bashir Ahmed, Khan's fellow private equity partner at Afridi & Angell adds that this has dramatically slowed fundraising in the region as limited partners adopt a “wait and see” attitude.
One type of fund that is not waiting, however, is the vulture fund. Khan sees these popping up in the region more and more to take advantage of distressed asset valuations, especially in real estate. One more sign that the private equity industry is alive in MENA – as well as an unwelcome indication that even in this fastgrowing region the global financial crisis is having an effect.
THOUGHTS ON MENA
“We believe in the current marketplace there is a ‘going back to basics’ strategy in noncyclical and recession-proof sectors such as healthcare services and education. These sectors will continue to grow with the population and be profitable.”
Faisal Belhoul, founder and managing partner, Ithmar Capital
“The Middle East is really where the US was in the 1980s when it was practicing private equity. So I would expect the trajectory of the private equity industry in the Middle East to track how private equity developed in the US, Europe and other places, them having been involved in private equity longer.”
Robert Wages, executive director, private equity, Abu Dhabi Investment Company
“There's such pent up structural demand in the market, especially in soft sectors such as education and healthcare, where we focus, that even though you're taking market risk, it is relatively low risk.”
Tom Speechley, executive director, Abraaj Capital
Overall, banks in North Africa are more isolated from the rest of the world and have not been exposed to the subprime crisis. Companies in the region generally have access to the banking sector in order to finance their operations.”
Vincent Le Guennou, executive vice president, Emerging Capital Partners
“There were 100 funds in 2000 and only 15 survived, which means that 85 have no new funds to support their portfolio companies. They have to sell the assets. That's why there's a lot of actors [in the market] that need to sell at any price. They are at the end of their and they have no interest in supporting their portfolio companies.”
“There were 100 funds in 2000 and only 15 survived, which means that 85 have no new funds to support their portfolio companies. They have to sell the assets. That's why there's a lot of actors [in the market] that need to sell at any price. They are at the end of their fund life and they have no interest in supporting their portfolio companies.”
Edouard Cukierman, chairman, Cukierman&Co. Investment House
THOUGHTS ON MENA
“Even now, with the oil price going down to less than $60 [per barrel], there is commitment to continue with the same pace of development in infrastructure investment. Oil went up so quickly that the plans they drew, the five-year plans mainly, did not catch up with it quickly enough. It's more about timing a cycle; it wasn't deliberate. What does it mean to investors? I don't think it has much bearing. There is a huge [infrastructure investment] need in theMiddle East.”
AbrahamAkkawi, head ofMiddle East infrastructure advisory practice, Ernst &Young,
“The crisis hit the Middle East later than other parts of the world. I think people are in shock. There was a belief that somehow it couldn't happen here, that it wouldn't happen here, but we're seeing prices coming crashing down.”
BashirAhmed, partner, private equity practice, Afridi&Angell
“Investors … are shell shocked and they're not coming up with the money. They are still cash-rich. They're sitting on piles and piles of cash but where they have invested, whichever asset class they have other than cash, they've been hit. So even though they're sitting on lots of cash, they're just sort of licking their wounds at themoment, thinking ‘where is this headed? Do I want to put in more money?’”
Amjad Ali Khan, partner, private equity practice, Afridi&Angell