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Private Equity: A close look at a maturing asset class

aPE investment looks to reshape financial landscape

by Executive Staff

The Middle East and North Africa region has become apowerful magnet for private equity investment, as the totalnumber of capital raised reached $4.1 billion in 2006,according to insiders in this segment of the financialindustry. The experts expect private equity investments toincrease greatly in 2007, but also warn that the challengesfor the year ahead continue to be dominated by thedeployment of private equity cash into attractive companies.

By some measures, the region is poised to become the nextbig market in private equity, analysts say. "The privateequity industry globally is benefiting from enormous growthand the Middle East is no exception,” Colin Taylor, managingdirector and head of Credit Suisse’s Alternative CapitalDivision in Europe, told Executive. “There is a high levelof liquidity, enabling private equity players to raisesubstantial funds,” he added.

The region’s private equity evolution is trailing a fewyears behind the development of this industry in G7countries and is still small when compared with the region’seconomic engine and leading source of liquidity, the oilsector. OPEC is expected to generate close to half atrillion dollars this year, and the Middle East’s shareestimates are in the range of $320 billion in oil and gasexports revenues.

Despite a lot of buzz about private equity in conferencesand press statements, and despite the formation of aregional association for the industry, the real muscle ofprivate equity funding has not yet been shown to the curiouspublic. Numbers compiled by the international EmergingMarkets Private Equity Association (EMPEA), the regionalorganization Gulf Venture Capital Association andresearchers are several billion dollars apart in the amountsthey quote as results of Middle Eastern private equityfundraising for both the past decade and the past twoyears.

Moreover, if fundraising is the bulging biceps of PEmanagers, it has to work in productive interplay withinvestment activity as the triceps for distributing theaccumulated power into the corporate world. The fewavailable confirmed numbers on PE investments suggest thatit has been a challenge to turn collected funds intoprofit-making ventures.

A review of the funds that were active in 2006 or havebeen announced by the region’s PE firms shows that 20 fundswere in their fundraising phase with a cumulative targetamount of $4.15 billion. According to Zawya Private EquityMonitor, in total, 18 funds were in their investing phase.They had $5.76 billion in their war chests but did not sayhow much of that had already been invested into concreteprojects. For future funds, eight funds had been announcedwith combined target size of almost $3 billion, in additionto which market rumors knew of another seven fund projectsthat would be worth $1.54 billion.

Apart from the impact of the oil boom, analysts attributethis rapid growth in the private equity market, in both thenumber and size of funds, to reduced restrictions on foreigninvestment, the real estate boom—both in the GCC and Levant regions—substantial investmentsin infrastructure development and privatizations, familyconglomerates who are now interested in restructuring andgrowth strategies and favorable results for private equitymanagers from the recent high number of IPOs in the GCC.

“There is a fundamental reason why interest in emergingmarkets remains so strong: returns have not only beenimproving over the last three years, they are looking fairlyrobust on both an absolute basis and on a relative basiscompared to other PE markets,” said a report by EMPEA.

Big Deals

Private equity funds started to gain prominence in theregion in the mid-1990s, and by 1998, a small number offirms had over $300 million under management. Notsurprisingly, the overall industry picture has changeddramatically over the last three years. The private equityhas matured as an asset class with record fund raisings, asharp rise in average fund size and increasing acceptance ofprivate equity by leading institutional money managers.Today there are an estimated 83 firms with over 123 funds—announced, rumored, fund-raising, invested or closed—including those with multiple funds such as Abraaj Capital,Global Investment House, Swicorp Financial Advisory Servicesand EFG Hermes.

Although it’s growing fast, private equity in the MENAregion has yet to show the scale of returns and deal volumethat make PE a force in other global markets. Butnevertheless, there have been big deals in successfuloutbound investment, such as the $1.23 billion paid in 2006for UK’s Doncasters Group, an engineering firm, by DubaiInternational Capital for a majority stake, and Istithmar’sacquisition of billion-dollar stakes in Standard CharteredBank, pension insurance institutions, and properties in theUS and UK.

An example for a successful regional transaction was theDubai-based Abraaj Capital’s acquisition of a 25% stake inEFG Hermes, Egypt’s largest investment banking firm throughthe Abraaj Buyout Fund II in a deal valued at $501million.

And the big deals will continue to dominate in 2007, withDubai Islamic Bank and Dubai World’s announcement of a $5billion family of private equity funds to participate instrategic transactions on a global scale. Another rumoreddeal is from the US-based Carlyle Group MENA Fund, which isexpected to raise over $1.8 billion. Other substantial dealsinclude the $500 million Evolvence Private Equity GCC Fund,by Evolvence Capital, to invest in private companies invarious sectors in GCC.

The list also entails some international names that targetthe Middle East, with Credit Suisse and General Electriclaunching Global Infrastructure Partners, a $1 billion jointventure focused on energy, transportation and water projectsglobally. The fund is expected to take on infrastructureprojects in the GCC.

The need for regulation

The growth explosion in the industry and its economicimportance have not gone unnoticed by governments and themedia. This importance and the growing public awareness thatit brings have created a call for responsibility andaccountability to investors. Both in the United States andthe European Union, calls for increased regulation or for“tightening” the rules that govern private equity groups arenot new.

These same calls are now being echoed in the MENA region.Observers agree that the region should not fall in the sametrap as the US and EU, and should be prepared by developingmodern policies that would ensure the commercial climate isas supportive and competitive as possible, to protect bothsides on the private equity deal. “Regulatory changes willcontribute to growth by opening up investment opportunitiesfor PE, like the FDI rules for India, and by introducingplatforms like the DIFC to operate a PE business,” RodPalmer, a Dubai-based partner in international legal andmanagement firm Walkers Global told Executive.

Financial experts are suggesting a review of the industryin the region to promulgate new regulations that wouldensure market stability and create an oversight body forsupervision of registered firms. For example, the new bodywould look into the potential risk that PE activities mightpose to the broader financial system. Investigators shouldlook at the levels of debt in buyout deals and the growingprevalence of private equity backed bids for listedcompanies and the impact that this might have on the publicmarkets.

There has been another suggestion by experts in the EUthat call for moving away from a prescriptive mode ofregulation toward a more principles-based approach. Thisapproach places the burden on individual firms to spot therisks relevant to their businesses and to develop andimplement procedures to mitigate those risks. The biggestbenefit of this approach is that it provides a proportionateand flexible regulatory regime, allowing firms to have agreater hand in the way they implement policy. And finally,fund managers must provide more transparency by publishingdetails of their investments, investors, management andtrack record.

Some fund managers have suggested starting the wholeprocess by educating fund recipients and the public ingeneral in the dynamics and structures of the industry,thereby improving familiarity and clarifying the benefits ofprivate equity. “There needs to be a move towards educationon private equity, and then regulation should beconsidered,” Ashish Dave, partner and head of privateequity, Middle East and South Asia at KPMG, said. “PE willnot be hindered by appropriate regulation, but thegovernment and private equity firms should focus on adoptinga prudential approach to regulation,” he added.

What’s ahead for 2007?

Some experts argue that a historic shift from public toprivate equity is occurring and that the region has alreadywitnessed the birth of an asset class, which by all measuresseems to have a very bright future. “Clearly, private equityhas huge potential in the Middle East, and we expect stronggrowth in both the number and size of new private equityvehicles,” Rod Palmer of Walkers said.

Most fund managers agree that PE has an advantage overother alternatives (in particular, hedge funds), becauseit’s comparatively easier to launch a shariah-compliant PEfund, which will be acceptable to a wide range of investorsin the region. Other benefits include the important role ofprivate equity in financing and fostering innovative firms,and in reallocating capital to more productive sectors ofthe economy. “PE benefits from the fact that local investorsunderstand and are comfortable with the nature of PE andthat many of the PE funds in the region areshariah-compliant,” Palmer added.

Palmer said the industry will face some challenges in thenext two to three years that are unique to the region. Oneof the challenges will be managing investors’ expectationsof high returns, as more and larger PE funds are launchedthat are all chasing deals in the region.

Another challenge is the lack of solid and attractiveventures out there. “We expect that it might become a caseof too many dollars chasing too few deals, and funds whichout bid others will end up with a high cost associated totheir investment,” said Jamil Brair, vice president of PEfirm SHUAA Partners in Dubai. “Proprietary deals become keyand it is the fund with the best network that will be ableto keep its deals off the market and away from biddingprocesses,” he added.

According to Credit Suisse’s Taylor, the asset classesattractive to PE investors in the region are maturing interms of geographic and deal diversity. “In the Middle East,we see investment potential in the energy, infrastructure,financial services and real estate sectors. We also expectopportunities to emerge in healthcare, media, retail andservices,” Taylor said.

In order to take advantage of these opportunities, PEplayers will have to attract and retain qualified assetmanagement professionals, Palmer said, adding that fundsthen would also grow further outside of the region. “Iexpect that as the market continues to mature, we will seean increase in outward investment by regional managersexpanding their investment mandate. We are already seeingthat with the real estate PE market, where a number ofwell-established based investment houses with stellarperformance records in MENA real estate are now expandingthe mandate of their PE funds and operations into realestate in Europe,” Palmer said.

What does the future hold for private equity in the MENAregion? Experts predict that within three years, aconsolidation phase will have started to take shape, and2007 will be a year to write home about.

“2007 will continue to announce new records in privateequity in the region—largest fund announced or raised, newindustry-focused funds,” said Jamil Brair.

Private equity as an asset class has been so far successfulin the MENA region and is on its way to playing an evengreater role in building corporate and national wealth.Players in the industry have gained much and have addedvalue and leverage to small companies benefiting from theunexpected growth. However, it remains unclear how effectiveprivate equity funds will be at deploying capital in deals10 times larger than what’s available now. Most expertsagree that there is no question that private equity in theregion has the critical mass and the diversity to warrant alot of attention. According to Palmer, the trend ofincreasing size of the funds launched will continue,“particularly as size and experience of the asset managementteams within the PE houses grow and they can handle morecapital.”

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Executive Staff


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