The first half of 2008 was a non-event for private equity with very little to cheer about, except for those skillful exits that everyone seems to have mustered. No great fund announcements to be heard of — the largest new fund announced was Gulf Capital Fund II at $500 million, and the largest fund closing was NBD Sana Capital, also valued at the $500 million mark.
And there were no billion dollar deals: the largest deal closed was Intaj Capital’s purchase of a majority stake at an announced $188 million transaction size. As a matter of fact, only 12 investments were made across MENA in first half of 2008, down from 33 during the same period in 2007.
But there are many happy investors reaping the fruit of their patience: 12 announced exits in the first half, including the maestro exit of Egyptian Fertilizers Company at $2.5 billion in one year and the $432 million IPO of Depa.
In a low after a long high
There need not be any worries however, private equity is not going into mass liquidation stage. It is merely a pause after a three year sprint.
Since 2005, the private equity industry was doubling in size every year. Based on the Gulf Venture Capital Association’s report, the annual growth in funds under management has been increasing by 70% annually, and investments have been increasing by 129%.
The beginning of 2008 was a pause for reflection amidst gigantic events, in the GCC and beyond. Very close to home, the political tension around the Gulf reminded everyone how exposed the GCC economies are to political risk as one missile crossing the Gulf may turn the prospects of the GCC upside down. Witness the performance of the stock markets in the first half of this year, which declined by 11%, as a barometer for investors’ sentiment.
Inflation is another worry. At a macroeconomic level it is a threat to growth, as governments are challenged to balance growth and fiscal expansion with spiraling inflation. At the micro level, mounting inflation is putting pressure on companies’ earnings as salaries, raw material, and services are rising unchecked. For example, the air transport sector was particularly hit, and budget airlines (many are backed by private equity funds) are scaling back their operations. As a consequence of an anti-inflationary policy, revaluation of GCC currencies may further negatively impact companies that earn revenue in foreign currencies like tourism, transportation, exports, and oil services.
Farther afield, but with gigantic rippling effect, the credit crunch is casting an ever growing darker shadow on global economic prospects. The crisis within the US and European banking system has now shifted slowly but surely into the real economy. Higher interest rates to leverage deals coupled with dimmer economic prospects have ground the private equity deal making machine to a halt. Mega deals, an almost a daily event in 2006 and 2007, are a rare and shy species nowadays. The attractiveness of private equity as a viable investment class (at a global level) has been put in doubt.
Foundation still standing strong
Yet the fundamentals that led to the rapid rise of private equity back in 2005 are even stronger. Economic prospects have actually improved as oil prices doubled since last year. The impact of the dramatic rise in oil revenue will be felt in the real economy in one or two years as governments start spending the additional oil windfall and national oil companies’ budgets balloon even further. (For example, Aramco is the second biggest spender in Saudi Arabia after the government with a budget exceeding $35 billion). All this will translate into liquidity ready to be employed in newly established PE funds and brisk earning growth.
Inflation is not expected to run out of control because governments have moved it to the top of their agenda given its social and political implications. However, global and local factors will keep inflation at high levels in the short term. With the economic system back to relative stability under new inflation parameters, earnings are expected to rise faster than inflation. Recent research from UBS analyzing the inflationary period after 1973 confirms this conclusion.
The recent exits reassure investors that private equity is not a one-way street, and that hefty returns await them. With most exits achieving spectacular returns exceeding 30%, private equity is earning its designation as an alternative investment class. The MSCI Arabian market index, on the other hand, has only increased by 11% over the last 18 months!
The music will go on… except if someone decides to wage another holy war.
Imad Ghandour is the Chairman of Information & Statistics Committee —Gulf Venture Capital Association