Using the world’s de-facto barometer of investment danger, credit default swaps (CDS), many fast growing Middle Eastern and North African economies including Saudi Arabia, Egypt, Abu Dhabi, Bahrain and Qatar are perceived as less risky investment destinations than heavily indebted, slower growing European states.
For much of the month of May — even after the announcement of a 750 billion euro debt stabilization package for the European Union — the cost of a five-year Saudi CDS was lower than a French or British CDS of similar maturity, while Egyptian CDS prices remained below those of Greece, Portugal, Spain and Italy. Even the Middle East’s most indebted state, Dubai, was cheaper to insure against non-payment than Europe’s most indebted state, Greece. If May’s CDS prices are a guide, it’s better to be locked into a currency union with Abu Dhabi than with Germany, the traditional model of financial probity, transparency and geo-political safety.
It goes against stereotypes, but the MENA region’s relatively low and improving risk profile is real, and its appeal as an underpenetrated market for private equity is immense. Regional opportunity is largely the product of more than a decade of legal and financial reform, particularly in the Gulf States. Since 1998 all six members of the Gulf Cooperation Council have passed capital markets laws, deregulated and privatized industry and opened up domestic investment to foreigners.
Today, the GCC economic engine is transforming both the Gulf and its MENA neighbors through rising levels of private equity investment. Private equity has accelerated regional consolidation in fertilizers, logistics, banks, travel, the internet and high-end retail. As MENA private equity expands, it is improving balance sheet discipline and corporate governance, strengthening financial markets, sowing seeds for new industries and diversifying economies that remain overly dependent on hydrocarbons.
A youthful market
Less than a decade old, with years of expansion ahead of it, the local private equity industry has no reliable performance indexes. But the returns of the region’s best private equity teams have been stellar — with internal rates of return of 30 percent or more, frequently achieved after only two or three years of investment and largely unleveraged by debt. Unlike Asia, a region that cannot accommodate the huge numbers of private equity investors looking to invest there, access to top teams — once identified — remains relatively easy in MENA markets.
Growth, at least at the moment, also comes cheaper in the MENA region. The MSCI Arabian Markets Index, for example, has a price-earnings to growth (PEG) ratio of 0.9. That is lower than the PEG ratio for China’s CSI 300 Index and India’s BSE Sensex 30 Index by 18 percent and 44 percent respectively. GCC corporate earnings growth is better than in Latin America, another emerging market where increased popularity has made access to top teams difficult.
This is a particularly propitious time for regional private equity investors for other reasons. The financial crisis of 2008-2009, and the spectacular regional failures and scandals it provoked at MENA’s most overleveraged and least transparent companies, has led to a transformation of attitudes at the family groups that dominate MENA’s still fragmented and overwhelmingly local businesses. Traditionally reluctant to sell equity to outsiders, many owners now welcome deals when they are packaged with private equity expertise that can focus and streamline diverse local business lines into disciplined platforms for regional expansion.
A safe bet
Stagnant regional bank loan growth after the collapse of Lehman Brothers has also increased the appeal of private equity financing, while decreasing its competition. Long-term private equity financing for expansion is all the more coveted, given that the overwhelming majority of regional bank loans mature in three years or less, meeting working capital needs but little else.
Although this stands in contrast to more developed economies, the most successful investments in the MENA region tend to be minority investments. With significant amounts of debt leverage largely absent from Middle East private equity deals, taking a large minority stake often allows entry at a bargain price, since it shifts the incumbent owner’s focus from current valuation to future value creation. The best local private equity teams have often paid less than 10 times historic earnings, versus listed rivals selling for twice that. In this way, well-negotiated minority stakes provide effective leverage when the investment is finally exited.
United by common language and tradition, the MENA region is a young and increasingly dynamic block with a population of more than 210 million, an economy that is already worth $1.6 trillion, and an annual growth rate that should clock in at 5 percent this year and continue for the foreseeable future. Buoyed by the budget and trade surpluses of conservatively managed Gulf States, this is one emerging market that smart money should not ignore.