Long gone are the days when the Middle East was the hot spot to set up shop, raise funds and invest in private companies with the promise of phenomenal returns. Before the global financial crisis struck in 2008, the region’s nascent private equity (PE) industry saw a boom in the number of firms while listings on Arab stock markets were oversubscribed to near insanity. Yet today, the PE industry’s easy pickings have all but vanished with the socio-political turmoil engulfing the Middle East. But even while the amount of capital raised in the region in recent years has fallen, one PE firm is still holding on to its bets: Saudi-based Amwal AlKhaleej.
Through two funds totaling some $650 million, Amwal acquired stakes between 20 and 40 percent in Middle East companies across different sectors, with an average ticket size of $30 million. Fully deployed, its current portfolio includes stakes in 14 companies after completing 10 exits since its establishment in 2004, making it one of the oldest PE firms in the region. For the first fund, which started deploying capital in 2005 and with 85 percent of its exits completed, the rate of return on investment averages 30 percent. The second fund, which started deploying capital in 2008 — just before the global financial crisis — has completed three exits, out of a total of 11 investments, and still managed double-digit returns.
Amwal AlKhaleej’s survival during the recent turbulent years boils down to two things, according to Chief Executive Fadi Arbid: no use of leverage to fund their investments and a very aggressive pricing strategy. “We’ve got a stingy reputation which in many ways I don’t mind,” he says. “I am protecting the money given to me; today if we are making money on our exits it’s because we bought cheap,” he adds. Multiples on investments in companies in the region have been decreasing in recent years as investors have been less keen on deploying capital in a rocky Middle East, meaning fund managers who paid generous sums for their initial investments are now hard pressed to find buyers for an exit, thus squeezing them to sell at a loss.
The end of easy money
The business of Middle Eastern PE funds was booming prior to the global financial crisis. According to a report conducted by business school INSEAD and consulting firm Booz, the amount of money raised by PE funds went from $1 billion in 2004 to $10 billion in 2008, with around 100 funds ready to deploy capital in the Middle East. With fund terms averaging five years, the outlook for lucrative exit strategies at that point seemed whopping. And then the pain began. As the global financial crisis came closer to home, the completed PE transactions in the region fell from 73 in 2008 to 49 in 2009 — a year during which “committed funds in the region had declined to levels not seen since the end of the 1990s”, according to the report. Another blow came with the Arab uprisings, which left no industry unscathed. “Before [the financial crisis], when you sold to the public, [initial public offerings] used to be 20 to 30 times and sometimes even 100 times oversubscribed,” says Arbid. “Now if you get two to three times you are a champion.” A stark example of the hype for Middle Eastern IPOs prior to the financial crisis was the $435 million listing of the shares of the Dubai Financial Market, which was 300 times oversubscribed.
Of Amwal AlKhaleej’s 10 exits, only two were completed on the public market; listing on an exchange is far more challenging than selling to a strategic buyer, since it hinges on abiding by strict regulatory requirements, on being scrutinized by the public market and on being subject to the volatility of both global and regional markets, but Arbid says that his investments are groomed for a public listing. He added that his firm turns investments into IPO candidates through the implementation of solid growth strategies that adhere to international corporate governance standards.
With 30 percent of Amwal’s portfolio exposed to Egypt, if pressured to sell now, Arbid “would be uneasy and uncomfortable to find buyers at the right price for all the assets”, but with his fund spanning across 2016, he has the luxury to be able to wait. Another 40 percent of the portfolio is exposed to Saudi Arabia, 20 percent to the United Arab Emirates and the rest mostly to the Levant area. The first fund had some exposure to Lebanon through investments in Bank Audi and Lebanese Canadian Bank, exiting in 2006 and 2007, respectively. Arbid says investment in these did very well, but Lebanon was avoided by the second fund due to its political uncertainty.
Third is a charm
As the second fund starts shaping up for exits, Arbid says he is assessing his options but he is optimistic, having completed three exits from the two funds in 2012, of which one was the highly publicized IPO of Saudi-based Al Tayyar Travel Group. After a failed attempt to list in 2009, Amwal’s team was “stubborn, rolled [its] sleeves up and eventually as a key shareholder strongly got involved in the listing process with the company and its advisors,” says Arbid. Six times oversubscribed, Al Tayyar’s listing raised $2.2 billion on the Saudi Stock Exchange in June 2012. “Tayyar makes us proud, not just because it was completed at an extremely high multiple but also because it is an investment that embodies a lot of our values. We took a sizable minority stake, we were on the board of the company, it embodies the value added we bring in, we undertook a lot of corporate finance actions and we worked a lot and hard to take it public,” adds Arbid.
The form of a third fund is shaping up to look different than the previous two, and Arbid estimates that there is enough appetite to raise up to $350 million. With investors less keen on deploying capital into a blind pool of funds, whereby investors deploy capital and fund managers decide where it goes, the PE industry, as well as Arbid’s Amwal AlKhaleej, is shifting more to a deal-by-deal model, whereby investors deploy capital into a specific transaction.
Another direction the Saudi PE firm is also shifting to is raising capital from Western institutional clients, not just regional investors, with a target to have 60 percent of the third fund’s capital from these institutions that provide “sticky money that is unemotional”, says Arbid. As their business is to invest, they could eventually become long-term partners of the PE firm if the investments do well. ‘Family money’ on the other hand “could decide to stop investing if their operating businesses are not doing well”, says Arbid. He adds that the remaining 40 percent will be raised from 10 to 15 regional investors, who are capable of bringing in deals and “intelligence”.
Funds and fundamentals
Going forward, the Middle East PE industry is slowly adapting to the new socio-political and economic realities taking shape across the region. In addition to Arbid’s expectation of seeing a move to a deal-to-deal model from a blind-pooled funds model, he anticipates that the region will have fewer PE firms of smaller sizes in the next five years, but with a larger mandate moving beyond PE into alternative space such as opportunistic investments. When political stability returns to the region — and fingers are crossed that will occur in the near-term — the Middle East’s solid fundamentals should help the region’s private equity industry regain some of its pre-financial crisis momentum, according to Arbid. The strong growth potential, good demographics and upcoming structural reforms are motivation, he says, to continue on deploying capital as “private equity should mirror the fundamentals of the region”.