This October, emerging market equities sank to an all time low. Dominated by few firms and largely composed of infrastructure-related companies, capital markets in the Middle East and elsewhere could not provide the liquidity needed to boost stocks. While similar effects will continue across regional bourses and affect the short-term valuation of firms, the region’s private equity industry will remain shielded because of the inherent nature of the asset class and the deal types most popular in the Middle East: buyouts and growth capital.
At the fundraising stage, private equity fund managers will continue to enjoy high liquidity for another quarter, until prospected declines in oil revenues are realized and futures contracts expire. Sovereign Wealth Funds (SWF) still have capital to deploy and will continue to partner with private equity firms for attractive buyouts in the region and abroad as company valuations sink and smart investors can invest in firms with untapped value. SWFs and private equity are best positioned to do this as they enjoy longer-term outlooks — typically five to seven years — until they exit investments. These investment horizons — coupled with the fact that most funds have recently completed fund raising and are now looking to deploy capital — make private equity a source of much needed liquidity in both the Middle East, as oil prices drop, and elsewhere, as financial intermediaries are squeezing credit flows to businesses.
Owing to the large size of most family-owned firms in the Middle East and North Africa (MENA), private equity houses have structured their funds to invest in buyout deals and offer companies growth capital. According to Amr Al Dabbagh, governor of the Saudi Arabian General Investment Authority (SAGIA), private equity investment opportunities in the region are on a scale “never seen before.”
Buy and build
Private equity buyout funds follow the traditional deal and exit structure of a private equity firm. A fund manager will scout out an attractive company, buy out the firm, build its business by adding assets or cutting costs, and exit investments to strategic investors or competitors, a secondary sale to another private equity investor, or via an initial public offering (IPO) on capital markets.
Several buyout funds are targeting MENA-wide deals and three of the most notable funds recently completed investments. Abraaj Capital’s Buyout Fund II (ABOF II) along with Waha Capital acquired a 49% stake in
GMMOS group, helping Waha Capital build a regional maritime business through its Al-Waha Maritime Group. Both maritime businesses plan to use the deal to further expansion agendas. Abraaj set itself up for a strategic deal after purchasing 100% of GMMOS Group in 2007. In this deal, Abraaj Capital partnered with the strategic buyer at the investment stage and will doubtlessly exit its remainder in the deal to Waha Capital after strengthening GMMOS Group’s corporate governance.
In another series of deals, Ithmar Capital has targeted construction and infrastructure-related buyouts. The private equity player made a recent investment in the UAE- based Dewan Architects and Engineers, a mid-market architecture, engineering, and consulting firm. Ithmar Capital’s buyout investment came amidst falling equity values and, consequently, a time when undervalued firms are attractive to long-term investors like private equity houses and SWFs.
Global Investment House (Global) has also fostered a burgeoning buyout business in the Middle East. It has recently closed its Global Buyout Fund with limited partner capital commitments, as well as additional financing by Dubai Islamic Bank and Millennium Capital, to the tune of $615 million. Additionally, Global closed another tranche of its buyout business for its $500 million Islamic Buyout Fund targeting sharia-compliant investments across the Middle East, North Africa, South Asia, and Turkey (MENASAT).
Global recently made a buyout deal through its standard buyout fund, by taking a stake in Al Sawani Food and Industry Supply Company, a food and beverage franchising operation based in Saudi Arabia with locations across twelve countries.
Abraaj Capital also made a recent buyout purchase in Nas Air with the aim of expanding the firm’s fleet of five aircraft to 18 by 2010 and eventually 167 by 2012. This buyout deal would make Nas Air the fastest growing private aviation fleet in the Middle East.
Not all MENA capital will be spent in the region. Much of it will be used for global buyouts in undervalued firms in the Asia, Europe, and the US. Credit-sapped firms in the US and elsewhere looking for long-term finance can find it in Middle East private equity shops. One deal in which this dynamic was apparent is Istithmar World Capital’s buyout of US-based Gulf Stream Asset Management, a financial services provider with $3.8 billion in assets.
GrowthGate recently achieved a final close for its $100 million buyout fund focusing on buy and build deals. With the plethora of spare capital committed lying dormant in these funds, they will be an important source of liquidity for the right firms looking to sell off their businesses.
While buyout funds are popular in the MENA region, growth capital continues to dominate the strategies of private equity shops. Growth capital proves the more popular of the two because it is a well-received investment style for entrepreneurs, and especially family firms. The reasons for this are clear. Instead of buying a firm, restructuring it, and exiting it via a secondary sale to another private equity shop, a strategic sale to a strategic buyer or competitor, or via an IPO, growth capital investments provide liquidity to firms with an established track record, possible areas for growth to different sectors or country, and a fairly sound corporate governance structure.
Entrepreneurs looking to private equity are essentially asking for investors to partner with them over several years to help grow the business and receive a substantial rate of return for helping develop the growth. Family firms are particularly worried about the potential for private equity to erode businesses, so growth capital remains an avenue through which families can find an investor but retain the business after a period of growth.
A recent investment has illustrated the process of growth capital private equity. Ithmar Capital purchased Panceltica, a Qatar-based, regional housing firm. Although the terms of the financing were not disclosed, the private equity shop provided capital for Panceltica’s growth and expansion strategy out of Ithmar Capital’s Fund II. Ithmar Capital’s Faisal Belhoul noted at a press conference that his fund is “uniquely placed to provide Panceltica with innovative investment and business development strategies to tap into the phenomenal growth potential of the region.” With most major cities sharing a high demand for the cranes to create buildings and the workers needed to operate them — from Doha to Dubai — Ithmar Capital’s investment and expertise enables Panceltica to grow its business across the region to build onsite steel structure for housing and other projects, which is eight times as fast to construct.
In search of growth opportunities
Additionally, private equity firms are looking to provide growth capital to firms which complement portfolios. In several instances, private equity managers are looking to create an integrated portfolio where the common tie to the private equity house can foster relationships between firms looking for business. Ithmar Capital, having recently acquired Panceltica and looking to help grow its business, might look in another high- growth economy in the region, perhaps in Saudi Arabia, Egypt, or the UAE, where another firms are looking to expand into equally high-growth economies. Ideally, Ithmar Capital can line up a firm that complements Panceltica and build some synergy between business and package its portfolio with perhaps a steel smelter, which could provide Panceltica with the downstream supply needed or with a property developer that could offer Panceltica an upstream market to supply temporary housing and storage solutions for large-scale developing businesses. Ithmar Capital’s holding of Gulf & World Construction might provide the sort of portfolio synergy necessary to build the relationships on a vertical level.
Buyout funds, growth capital funds and private equity in general offer large-scale companies a stable source of finance over the course of several years. For instance, a fund launched in 2005 did, on average, achieve a series of closes over 2005 and 2006 before achieving a possible end- of-year close in 2006. Once the fund achieves its first close it can start investing and will usually have deals in the pipeline. The holding period can also last several years for each investment and the fund itself will invest deliberately over a three to four year period, so a fund launched in 2005 with a first close in the same year can still invest in 2009, provided they have some capital left over. If a fund makes its last investment in 2009, then it has a few more years until closing, perhaps to 2012 or 2013, giving the fund a life of eight years. For funds with recent closes like Abraaj and GrowthGate, investments can continue over the next three to five years, enough of a gap to weather the currently credit-sapped business cycle.