The repercussions of the catastrophic events witnessed during the past few weeks will be felt throughout the globe and in every corner of the financial system. Private equity will be no exception. Even in the Middle East, many miles and economies away from the epicenter in New York, the first nine-month data show a dramatic drop in PE activity, and we should expect further deterioration as the aftershocks of the collapse are felt in the last quarter of 2008 and well into 2009.
Slowing to a halt?
The private equity industry elsewhere has begun feeling the slowdown as early as late 2007. Since the beginning of the year, deal activity dropped significantly, and private equity houses are barely closing deals these days as bank lending tightened to a halt. According to Dealogic, global deal volumes dropped by 74% to $180 billion, a four-year low. In the US, deals worth $62 billion were done in the first half compared to more than $400 billion in the similar period last year. Despite the fact that PE funds were flush with cash (they have more than $400 billion of unused funds), banks were simply not lending. PE has one healthy leg, but the other leg was severely impaired.
Fund raising was not initially affected, but was eventually caught in the storm as the crisis escalated. Although private equity funds raised close to $324 billion in the first half of the year, fund raising agents predict next year to be slow or dead. With investors under stress to revaluate their stock portfolios, private equity is taking a temporary backseat while investors shift their attention and money elsewhere. Furthermore, investors will be asking themselves: why invest again when PE firms still have hundreds of billions of unused cash?
In the region, and despite the global gloom, the fundamentals that supported the growth of private equity are still as valid today as they were two years ago. The leading private equity houses like Gulf Capital, Abraaj, and HSBC have enough unused cash from the recently raised funds to finance future acquisitions for years to come. It is estimated that around 40-50% of the funds under management (totaling $13 billion by end of 2007) are still unused.
The money marches on
Local PE funds have been doing deals with limited bank financing and the tightening of bank lending will not change their business model. They have relied, and will continue to do so, on bottom line growth to substitute for smart financial engineering. With the local economies and government spending still on a growth trajectory, corporate profits will continue to grow.
Deal flow is expected to continue if not improve. Access to debt and equity markets will be limited as stock markets plummet and banks tighten their lending criteria. Consequently, families will find private equity as one the few readily available sources of capital open for business in this conservative environment. Investment companies around the GCC will be re-organizing their portfolio after being hit by losses in some of their investments, and again, after tightening bank lending. Governments tendering public assets will find that competition will diminish significantly as Western firms face trouble at home and local firms hesitate in an uncertain environment.
Valuations will see a haircut from their 2007 levels as investors today seek better returns with bargain deals available everywhere. Even if the stock market recovers to ‘normal’ levels as it is driven up by retail investors, valuations of PE deals will be influenced more by the recovery of the global stock markets rather than by the local ones. Investors willing to write $50 or $500 million checks have the globe as their oyster, and will invest in the best opportunity available whether it is in a Saudi private company or a listed company in NASDAQ.
History has shown that private equity investing in times of crisis yield the best returns. PE funds that invested in the 2001-2003 period made hefty returns as they exited in the peak years of 2006 and 2007.
I have been a strong proponent of private equity growth in the region and I have echoed my opinion and optimistic projections repeatedly on the pages of Executive, throughout the media and in conference circles. My outlook has not fundamentally changed.
As Warren Buffet has professed earlier: cash and courage in the time of a crisis are priceless.
Imad Ghandour is the chairman of the Information & Statistics Committee — Gulf Venture Capital Association