Beirut Stock Exchange under pressure to meet regional standards

While neighboring stock indices modernize, Beirut

The vision line of Lebanon’s capital markets on new horizons for 2007 is about as unrestricted as a peek across a Scottish Highland moor in a foggy night. The sights are potentially spectacular, but highly elusive.

And that although things had been looking exceedingly good early on in 2006—with a Beirut Stock Exchange that finally sparkled. As Solidere stock and banking values had acquired momentum and were pulling the market forward in the second half of 2005, banks, financial firms, pro-privatization politicians and fast thinkers in the country’s family-owned companies all started looking at the great new idea of the stock market and contemplated new concepts that included listings and private placements.

Gulf investors also paid attention and in January of 2006, the BSE was raging. Share prices shot upwards to reach the $100 range (BLOM Bank) and more than $25 for Solidere. The Audi Saradar Group and BLOM undertook successful capital increases. By early March, investment advisors at a regional financial firm were talking of a lineup of 50 Lebanese companies that could be candidates for flotation on the BSE.

Corrections set in

As Arab stock markets in the first quarter of 2006 woke up to the unrealistic valuation levels that the bull market sentiments of 2004 and 2005 had pushed them to, correction mood set in with a vengeance that affected the BSE along with the GCC bourses. However, the slowing of the BSE was far less painful than that of the GCC exchanges; for example, during the March 14 crash (which was the “Black Tuesday” of regional capital markets but in hindsight proved to be only one day of pronounced losses in a long chain), the BSE lost only 2%, less than any GCC index.

In promising news on the regulatory front, BSE officials proudly announced in early March that the Lebanese cabinet had forwarded to parliament a draft law for the establishment of an independent Securities and Exchange Commission as oversight authority for the Lebanese financial markets. Law and SEC were hoped to contribute significantly to the further vitalization of the country’s stock market.

During the 2005 full-year results season a little later, Solidere surprised with a new income record and announcements of spectacular new land sales. Banking sector results and a strong outlook for summer tourism added their parts to the buoyant prospects.

Thus, while regional market sentiments impacted Lebanon and led some IPO candidates such as Lebanese Canadian Bank reconsider the timing of listing plans, the perspectives of the BSE throughout the first half of 2006 remained substantially better than in many years before.

But war ensued and then, three months after its end—although Lebanese shares recovered better and more quickly from the shock than many had feared—the vagaries of Lebanon’s situation increased rather than decreased in November.

Especially thrown into doubt by this latest crisis were all prospects for new corporate listings on the BSE concerning both private sector companies and privatization candidates.

Already at the end of October, the secretary general of Lebanon’s Higher Council for Privatization, Ziad Hayek, said that a sale of mobile network operator licenses was planned for no earlier than mid-2007 and privatization in the landline telecommunications sector was expected to come as late as end 2008.

With the country stuck in political disputes between pro-Syrian and pro-sovereignty forces, experience of the past eight years in futile privatization debates makes it doubtful that telecommunications and other privatization projects with hypothetically positive capital markets implications—such as the flotation of flag air carrier MEA—will be possible in the first half of 2007.

One also must doubt that known or rumored private sector listing candidates, such as BankMed, Credit Libanais and Lebanese-Canadian Bank in banking, the confectioner Patchi, or some of the major trading companies in the country will find an environment in the first months of next year where they can be confident that initial public offerings would fully deploy their potential.

In this scenario, what flummoxes the future of Lebanon’s capital markets is—of course—the state of affairs brought about by external military pressures, confused world policy strategists and regional power plays, with added doses of local inefficiencies and political obfuscation.

As it is by now a sad and proven local tradition, the regional security and political tensions must be counted on to depress the prices of Lebanese stocks. The BSE may be strongly positioned to enter a new bloom with the return of political stability in this part of the Middle East, but the unanswerable question is at what time this return will occur, making it a matter of extremely chancy political fortune-telling to project stock market trends for the new year.

Another point adding to the forecasting uncertainty is that the Lebanese financial markets culture has had very little interaction with a growing regional financial analytical trend of stock market research and recommendations.

More financial research, please

Over the past year or two, investment advisory firms and finance houses as well as investment banking units in major banks—mostly located in the Gulf region—have greatly increased their production of financial research on listed companies, providing their client base and the interested public with corporate and sectoral analyses ranging from one to sometimes well over 30 pages in size, mostly including fair value assessments and buy, hold, or sell recommendations for the respective stocks.

This trend, in which firms like Dubai’s Shuaa Capital and Gulf Capital, Oman’s BankMuscat and Fincorp, Bahrain’s Taib Securities, Kuwait’s Global Investment House, Jordan’s Amwal, Atlasinvest and Capital Bank, Egypt’s EFG Hermes, Prime Securities, and HC Brokerage are among established or rising stars, has not yet caught on in Lebanon either on the side of research providers or on the side of research targets.

Research departments at institutions such as Audi Saradar, Blominvest, Byblos Bank, Credit Libanais, Arab Finance Corporation and others, have—with a recently increasing tendency—been generating regular economic and stock market reviews covering Lebanon and other countries, but have not published much in terms of local company research.

Thus, Lebanese firms in recent years could only rarely expect to receive coverage from local financial firms. Research by regional companies into individual Lebanese corporations in this small market has also been scarce.

It is hard to find any research by the region’s financial advisory firms that offers fair value analyses and stock recommendations for listed banks such as Audi Saradar, Bank of Beirut, Byblos or BEMO. Even Solidere, one of the region’s most interesting ideas in urban development and real estate corporations, has received only very limited coverage from financial firms outside of Lebanon.

However, a few recent reports with stock analysis and forecasts are in circulation.

Issuing a first company report on BLOM Bank and its operating environment in April of this year—including a few quaint statements such as saying that Lebanon’s banking sector includes “126 banks recognized by the central bank”—Shuaa Capital made an important step in covering Lebanese equities from the Gulf.

The initiation of coverage report identified BLOM Bank as an entity set to grow in size and profitability, with prospects of outperforming the markets in which it operates. Using discounted equity cash flow and relative valuation methodologies, Shuaa at the time arrived at an $89.42 target price for BLOM. This report was followed by an update in mid-November, in which the analysts said that the impact of the July war on the bank “was not that severe, given the magnitude of the crisis.”

Based on the conflict’s limited financial impact on BLOM’s nine-month figures, Shuaa lowered their target price for the stock slightly, to $83.05. However, due to the drop in BLOM share prices since spring of 2006, Shuaa saw the stock as having an upside potential of 22.5% and upgraded its recommendation to “Buy” from “Hold.”

One fairly solitary and bright recent opinion on the share price potential of Solidere originated with EFG Hermes, the Egyptian financial firm that become a stakeholder in Audi Saradar in early 2006.

In what it called “a contrarian play,” EFG Hermes in September issued a valuation opinion that put the long-term fair value of Solidere stock at $22.54. “We go against the conventional wisdom that Solidere will be greatly harmed by the war,” EFG Hermes said, and projected a scenario under which the company would feel a mild war impact and achieve a continuation of land sales, although at a lag.

Based on its valuation of Solidere, EFG Hermes issued short-term “Accumulate” and long-term “Buy” recommendations for the stock.

Politics affects ratings

It has to be added here that the recently strengthened research team at Blominvest Bank, the investment banking arm of BLOM, in September produced a report on Holcim Liban, the leading industrial stock traded on the BSE.

Noting that the share was valued on the high end with a price-to-earning ratio of 25.78, the analysts reasoned that the valuation was comparable to that of cement companies in Egypt and Saudi Arabia and was moreover related to the lack of Holcim Liban shares available to the public. Blominvest issued a buy recommendation on the stock, based on its rising profitability, strong market share and substantial demand forecast for cement in Lebanon over the coming years.

While the BSE outlook for 2007 must prudently be considered uncertain in terms of political developments and the resultant prospects for private sector IPOs and public sector privatization measures, and while political uncertainties weigh on any stock market projections, the available analyst research on three Lebanese listed companies out of the country’s very small pool of traded firms thus provides a uniform view in recommendation of buying these stocks, even at price levels above those which the stocks reached at the end of November.

But the caveats remain. The banking implications of the country’s vulnerable state were expressed by downgrades of financial strength ratings for three Lebanese banks at the end of the year following the despicable assassination of Lebanese industry minister Pierre Gemayel. In its view on Solidere, EFG Hermes acknowledged that by the inclusion of divergent scenarios in their projections, the scenario analysis on the company resulted in high volatility in valuation. And Shuaa Capital said in its positive November research on BLOM, “we assume relative stability on the political front in Lebanon. Any future deterioration to Lebanon’s stability, however, may result in a downgrade to both our forecasts and our recommendation.”