Private equity, the high-return-oriented asset class channeling third party capital to companies looking to grow or streamline operations, is a burgeoning business in many emerging markets, and the Middle East and North Africa (MENA) region is no exception. It is an alternative to methods of investment and financing, generating interest among Arab investors willing to invest in their domestic or regional economies and can prove valuable in the medium term. In the past, oil booms providing excessive liquidity to Gulf financiers was spent on projects in North America, Western Europe, and industrialized Asia, fuelling political economy debates.
In a new direction for this asset class, money is flowing within the MENA region rather than leaving it. According to a speech by Gary Long, Investcorp’s President and Chief Operating Officer, in 2002 nearly 85% of the region’s wealth was sent overseas to dollar-backed investments; in 2007 this had dropped to 75%, attributed to attractive opportunities in domestic markets. Investcorp established itself as one of the premier moneymen encouraging MENA capital flows abroad, yet the firm, like other big shots such as The Carlyle Group, is no longer borrowing Gulf money for investments solely in the West, but has started investing in many of the region’s own companies, and channeling Western limited partner capital to companies in ranging in area from Morocco to South Asia, where a slew of firms are looking for development capital in diverse sectors such as telecoms and consumable goods.
From the family firm to the sovereign wealth fund, Arab investors are heavily considering their role as limited partners and banking on the economic potential of the region to return their money at rates exceeding 20% annually, although potentially reaching highs of 40% for the most undervalued investments and promising exits on regional bourses. The availability of new financing vehicles is making local investors more willing to get involved in places where governments are appearing friendlier to foreign investment and competition. In recent years, Bahrain, Kuwait, Oman, Qatar, and Saudi Arabia have amended foreign ownership laws, permitting up to 100% foreign ownership in firms after receiving approval from in-country regulators. Libya’s regulators have made similar moves with Foreign Investment Law No. 5 of 1997, changing the dynamics of Libyan bureaucracy for businesses.
Virgin networks
Outside capital is also flowing to the region, in search of new markets isolated from woes negatively affecting Western economies. New funds are springing up to match the demand. The Carlyle Group, once known only for its ability to develop MENA-based limited partners in Western markets, established a MENA-centric fund. BNP Paribas also recently announced plans to launch a private equity fund for the MENA region with a fund size of $200-400 million under management. The MENA fund will be the group’s first with a non-European scope and is likely to develop the trend of more Western private equity houses moving to the region.
The key for firms looking to grow operations in the region is networking ability. Both Carlyle and BNP Paribas will doubtlessly rely on their local contacts, managers, and synergies from pre-existing businesses to source the proper mix of limited partners — including government, private funds and families commanding significant sums of capital. New firms will face tougher entry costs in linking with the right networks and overcoming the unseen barriers of sourcing and financing in the region.
However, as institutions and individuals gain an understanding of private equity and become more interested in investing in their own MENA markets, new firms will have the chance to prove their capabilities, grow their teams, and execute transactions. But the window to enter a nearly-saturated MENA chessboard is small and firms will have to move in the next three to five years before the first round of industry consolidation hits the region, closing down many small boutique operations and leaving behemoths with the proper relationships and track records. Consolidation does not mean demise in the industry or in the region’s opportunity, but only a process of leaving the most efficient operations standing.
Courting regulators
Regulatory relationships will stay important in the medium term as the region faces several regulatory barriers affecting foreign ownership, among them restrictions limiting foreign capital to a minority stake in most deals and other measures with corollary aims of softening capital inflows and dangerous double-digit inflation levels. On paper, changes have been implemented, but the regulatory outlook will only change after further proof of willingness to stamp out capital controls on foreign money.
BNP Paribas likely cemented its fund aspirations after smart maneuvering through the relation-dominated waters of the region. Prior to announcing the fund, BNP Paribas owned 25% of SAIB Asset Management, an arm of the Saudi Investment Bank and likely leveraged relationships in the kingdom to earn an asset management license from the Saudi Arabian Capital Market Authority, as well as current expectations to acquire a 100% investment banking subsidiary license from Saudi authorities.
Turkey is undoubtedly joining the fray of new regulatory outlooks with authorities implementing a new law to make private equity acquisitions of Istanbul-listed firms easier. This boosts buyouts, like the planned $1.55 billion minority buyout of the country’s Migros supermarket chain by BC Partners, a consortium including Turkven, DeA Capital, and the De Agostini group. The news comes after Turkey hosted the largest leveraged buyout of Migros by the Koc group for a 50.8% controlling stake.
The fact that many regional businesses are family affairs might continue to hinder the purity of burgeoning investment vehicles like private equity as long as exit plans remain stalled. For example, Gulf governments, in an effort to ease the worries of family firms looking to retain ownership through the restructuring of the private equity process, decided to regulate some initial public offerings, allowing families to retain 70% of the shares once the firm is on public capital markets. News reports have explained the move was largely wasted because family firms remain recalcitrant to the new regime. According to attendees at an industry conference hosted by Private Equity International, 35% believed family-owned businesses look for value added, operation capability from a private equity firm, 23% believe the prime mover for family firms is private equity capital and 16% believe family firms look for chemistry with private equity shops.
Fund trends
A lot of funds went on market in the first half of 2008, with eight new ones announced. Although Tuninvest’s close of its Maghreb Private Equity Fund II for $121.6 million is Maghreb-specific, the seven others have made notable closes spread across the region, including: Kuwait’s Global Investment House’s $500 million buyout, a $555 million close for the Horus Private Equity Fund III LLP, managed by the Egyptian-based and focused EFG-Hermes Private Equity, Eastgate Capital’s $250 million close for its first fund, and Millennium Private Equity reporting two fund closes aggregating $350 million among its Global Energy Fund and its Telecoms, Media & Technology (TMT) Fund. Paladin Realty Partners also unveiled a $50 million close for its thus-far rather paltry MENA-focused realty fund. The Horus Private Equity Fund III LLP’s $550 million close made it the largest for an Egyptian/North Africa-targeting fund.
In a new MENA frontier, the Levant, SHUAA Partners closed its Frontier Opportunities Fund I, LP with $100 million in capital commitments for Levantine investments targeting Syria, but Jordan and Lebanon as well — three countries outside the scope of the asset class since its formal launch in the region in the late 1990s.
Levantine markets will attract more attention with decreased regulation and political stability, in addition to the large demand for firms looking to fulfill company goals. In private equity, firms once constrained can find capital to finance growth, acquire other firms, or recapitalize existing operations. The asset class will be more competitive than over-bureaucratized banking in markets dominated by large commercial players with high levels of collateral demanded and lending preferences to other behemoths.
New mixes of private equity financing include mezzanine debt, which is attractive for mid-sized companies witnessing strong growth. Service-based industries with soft assets can borrow on a cash-flow basis with mezzanine’s debt and equity structure subordinate to senior bank debt.
Respondents to Deloitte’s MENA Private Equity Confidence Survey ranked development or growth capital as the most popular transaction type in the region, dominating other bars in the chart with a whopping 64%. The figure comes as no surprise when viewed on par with statistics showing the equally popular growth in private companies and enterprises. A trend to grow existing operations rather than fund new ideas is the prime driver of Middle Eastern private equity, although the paltry level of venture capital is anticipated to grow. Growth capital works in tandem with a private equity house’s value-creation operation, whereby experts tweak business procedures by implementing a series of best practices aimed at building the attractiveness and financial book strength of the firm for its initial public offering or the secondary market, where other asset managers can continue adding value, once started by a first private equity house. Two percent of respondents to Deloitte’s survey believe secondaries are going to be the most important type of private equity.
The MENA’s private equity landscape carries with it a mood of optimism, claiming no end to investment capital and deal flow. However, performance has yet to be realized for most funds. Those with closes are still not fully invested and those with investments have been hanging on to their companies postponing exits. Investments will have to pick up as fundraising figures increase year-on-year.
