The luxurious Dorchester Hotel in London was the setting for an uncomfortable meeting between the world’s private equity (PE) chiefs, where there was no doubt nervous exchanges as to how the global financial crisis has impacted their companies and what the future is for private equity. Some analysts are claiming that PE is at death’s door due to the huge amounts of leverage that PE firms took on. This led PE firms, it is argued, to get caught up in the asset bubble and to pay grossly over-inflated prices for companies landing them now in serious financial trouble. The value of companies owned by PE firms, according to The Economist, fell by 50 percent and, according to Deloitte, they expect the same percentage of PE houses to close or to return whole funds next year. However, others are not so pessimistic as to global prospects for PE in 2009 and the affect of the global financial crisis. Coller Capital, in their ‘Global PE Barometer’ report, stated that although large buy-out funds — in excess of $3 billion — will find it difficult in 2009, smaller PE firms will still be able to find good value on the market. Further to this, as companies forcibly deleverage, some PE firms will be able to step into the breach.
Good news in bad times
If the global financial crisis was inevitable, then for PE firms in the Middle East the timing was fortuitous. The sector has managed to side step the worst of the crisis primarily due to the fact that regional PE firms were not highly leveraged. “The crisis has had an affect but only limited. We are still raising funds, investing and divesting, this is the core of our business,” said Gilles de Clerck, a senior manager at Capital Trust. However, the drop in Initial Public Offerings (IPOs) has hit PE firms as it has cut the possibilities that they have to exit their investment. PE firms in the region are taking a serious look at their portfolios, reassessing their business plans, delaying exits and fund raising. So there is a general expectation among analysts that PE will see a lot more portfolio management and a lot less buyouts in the Gulf.
PE chiefs in the Middle East are all congratulating each other on the limited amount of leverage they took on. “In Europe or the US you could see deals with 80 percent leverage, but here leverage was only used for the large deals and even then it was 40-50 percent,” explained de Clerck. This low level of leverage is seen by many as the central reason that PE in the region has escaped the worst affects of the crisis. However, with leverage now severely restricted and becoming much more expensive, there will be significant constraints on PE operations in 2009. The key to the regional PE market is that the economies of the Middle East continue their robust growth, as this is how they have been able to escape the use of significant amounts of leverage previously. “We [Capital Trust] are currently raising a fund so we know there is still cash out there. In terms of investments, the companies in the region still need to grow. There is less growth but they are still going to grow at 20-30 percent so they need more funds to invest in machinery and so on, with banks becoming more cautious and the stock market being a no go PE has an important role to play,” said de Clerck of Capital Trust. “If you have the right companies which are ones that are regional and have the right management and team you will always have a market [in this region].” PE houses in the region may be breathing a sigh of relief, but they also know 2009 will be a difficult year — only the fittest will survive.
The immaturity of PE in the region has been a highly beneficial attribute with regard to the global financial crisis and its affects on the industry, but the learning curve ahead will be steep. Ziad Maalouf, vice president of MENA Capital explained that, “[PE] is so new to the region, it only started in the last three or four years. Not a lot of companies have been taken public so many PE investments have yet to be realized.” Thus, many of the PE firms in the region — especially the micro PE houses — feel they can take the hit delivered by the financial crisis and wait it out. As Gilles de Clerck of Capital Trust stated, “PE is a five to seven year investment so a loss of a year is not a big deal. Our firm continues to invest because we want to be there when growth picks up again because some of the players will not be here when things pick up.” When the economy of the region does ‘pick up’ again, it is clear that PE will have to be a leaner and more astute industry than before the financial crisis. Sitting back and letting the exponential growth of the region and the hype of Initial Public Offerings (IPOs) do the work for PE firms will no longer be an option. “In the past people were bullish and PE firms were investing in a wide array of companies in the hope of taking them public, when the stock market was booming and investors would buy in to that story. But with capital markets affected as they are, with less liquidity, PE firms have to be more selective,” said Maalouf. He also stated that those PE firms that survive will be those that are, “more careful and selective in the type of industry invested in, the quality of management, the structure of financing, the structure transaction and the legal structure.”
P.E. houses in the region know 2009 will be a difficult year — only the fittest will survive
Buying at the right price
However, for those PE players that bought at a high valuation, there will be a tougher lesson to learn and they may have a long wait before they get a return on their investment, if ever. “The key in the PE game is buying at the right price… Probably some of the other players, due to the excess liquidity of that time, might have paid higher prices and some places where we were competing with these players we pulled back,” said de Clerck of Capital Trust. For those PE firms that bought at highly inflated prices and conducted badly constructed deals, the future is going to be a lot less forgiving. The Middle East is getting what is probably a well-needed purge of the PE industry. For 2009 and beyond, the industry will have to be much better managed and the result should be more sustainable and productive deals. PE firms in the region may have escaped the crisis in part because of their immaturity, but now it will be those which show their maturity that will survive.
