LeadersOpinion

A strategy, please

by Nabila Rahhal
written by Nabila Rahhal

Lebanon’s tourism stakeholders have learned the hard way that an over-reliance on one type or one nationality of tourists is akin to shooting yourself in the foot. One need only take a look at cities such as Bhamdoun or Aley – and even Beirut, to some extent, which saw a drastic drop in footfall once tourists from the Arab Gulf decreased their visits to Lebanon – to see the dangers of putting all our touristic eggs into one basket.

As such, private sector investors and civil society groups began developing elements of tourism that would rely more on local demand: one can see signs of these elements through the positive initiatives currently spearheaded by local municipalities across the country. From restaurants and guesthouses opening in rural areas, to wellness retreats and environmental activities, locals and expats have a lot to discover right in their own country.

But despite the flurry of activity, these diversifications are still very much at a grassroots level. If we, as a country, want tourism to truly prosper and be more than a mere internal redistribution of cash, then the government has to devise a national plan which would include the development of infrastructure that would make sure it does.

The Ministry of Tourism has supported rural tourism with a five year strategy and is currently supporting religious tourism initiatives – such as the placement of our Lady of Mantara on the World Religious Map – and cultural initiatives such as developing, alongside the UN World Trade Organisation, touristic experiences shared with neighbouring Mediterranean countries through the Phoenician Route.

[pullquote]Tourism was once the second largest contributor to the country’s GDP and it’s about time more structure and weight is given to it[/pullquote]

Municipalities, in collaboration with international NGOs, are looking at their individual towns’ territorial assets and exploring how they can develop them touristically to attract visitors and improve the local economy. While real potential exists in all those initiatives, they will remain little more than scattered efforts with minimal impact at the country level if there is no solid long term national plan guiding their development.

Tourism was once the second biggest contributor to the country’s GDP and it’s about time more structure and weight is given to it instead of letting it develop haphazardly. The government, along with relevant stakeholders from the private sector, civil society and NGOs, needs to develop a strategy that would incorporate all elements of tourism in Lebanon – from rural to environmental, from religious to wine – under one framework, complete with realistic deliverables, milestones and a clear delineation of responsibility.

Part of this national strategy must be the development of infrastructure to support tourism. Towns like Broumana, Ehmej or Hammana all cited ease of access through the wide highways connecting them to Beirut as one of the main drivers behind their increased footfall. Meanwhile, other towns may have beautiful forests or a significant cultural landmark, but without being fortunate enough to be next to a major highway – municipalities don’t have the authority to develop their own highways – most tourists find it too much of a hassle to get there. Infrastructure is a major consideration in developing tourism, and all areas of Lebanon should be able to benefit from this ease of access to the city.

Despite the security issues in Lebanon, which have unfortunately become almost a fact of life, the country has many beautiful elements to offer. We owe it to Lebanon to diversify our tourism and highlight these elements in a sustainable and organized manner.

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BrexitEconomics & Policy

A post-Brexit world

by Thomas Schellen
written by Thomas Schellen

After 43 years of – often rocky – togetherness, the United Kingdom is leaving the European Union. What sounds like a run-of-the-mill divorce is much more. It is an economic step that will have ramifications for many countries, including Lebanon, at least as far as tourists and traders, importers, investors, migrants and financial workers are concerned. It is a step of segregation that has implications for politics and decision making. It was a step that caused markets to stumble and politicians from the two largest political parties, Labour and Conservatives, to step down or, if they were exit proponents, ramble triumphantly.   

Many of the economic consequences are unclear. Key central banks’ first reactions were tellingly subdued. The Federal Reserve of the United States said in an initial statement on Friday, June 24, the day after the referendum, that it was “carefully monitoring developments in global financial markets” and prepared “to provide dollar liquidity through its existing swap lines with central banks, as necessary, to address pressures in global funding markets, which could have adverse implications for the US economy.”

The European Central Bank (ECB) commented on the same day and in the same worryingly reassuring tenor (the kind of speak a school principal uses when announcing that your child is unlikely to reach the next level). “The ECB is loosely monitoring financial markets and is in close contact with other central banks,” it said.

The ECB comforted that it would continue to fulfill its responsibilities of ensuring price and financial stability in the euro zone (as if we had suspected that they all had decided to escape to some tropical island) and declared that it has prepared for this contingency. It “stands ready to provide additional liquidity, if needed, in euro and foreign currencies,” it added.

The most elaborate first response was up to the Bank of England (BoE), whose Governor Mark Carney acknowledged in a video statement that “a period of uncertainty and adjustment” would follow the vote to terminate membership in the European Union and that “some market and economic volatility” was to be expected.

The BoE and the Treasury were engaged in extensive contingency planning, including on the night of the vote, Carney said. “The [BoE] will not hesitate to take additional measures as required as those markets adjust and the UK economy moves forward,” he stated, adding that the bank had done its homework in ensuring that the core of the financial system is “well capitalized, liquid and strong”. UK banks have more than GBP 600 billion of high quality liquid assets and the BoE “stands ready to provide more than GBP 250 billion of additional funds through its normal facilities,” he assured. The Bank of International Settlements (BIS) followed suit the next day, on June 25, and said that central bank governors at its Global Economic Meeting on that day “endorsed the contingency measures put in place by the Bank of England and emphasized the preparedness of central banks to support the proper functioning of financial markets.” 

Contingency planning, liquidity assurances and notions of collaboration. Central banks are mightily coordinating their responses, clearly reminiscent of the lessons of recessions past when liquidity posed a big problem. Of course it is nice that they are assuring us of liquidity. But honestly, one is used to the ECB and Fed as moving in discord. The fact that they stand ready to pull with all their power on the same rope, sounds disconcertingly alert of what?

Sudden shock

Earlier in June, the situation looked like it would be all cheers for the status quo. The Swiss had voted no in a referendum that would have mandated a universal basic income. The Fed’s open market committee – in what might prove to be its best move in the sense of stability and confidence support in quite a while – decided on June 15 to keep the prime rate unchanged, i.e. as low as in the past six months. But now this exit vote. Analysts were united in saying that nothing will ever be as before and agreed that Tory leader David Cameron pissed EU membership off by calling for a referendum and Labour leader Jeremy Corbyn delivered a perfect assist by scoring an own goal.

Most of the EU denizens, including the majority of voters in the UK where the average age is around 40, can have no personal history dating back to the days of the UK joining the European Union in 1973. Beginning with the premierships of Edward Heath and Harold Wilson, and lasting through the New Right era of Margaret Thatcher and John Major, and the pro-capitalist New Labour government of Tony Blair and Gordon Brown, it was the one-nation Conservatives Cameron and Boris Johnson who, for whatever reasons, unintentionally facilitated (the former) and championed (the latter) the change that will realign Europe at least in articulating its national identities and/or shared identity.        

The initial signs from the UK were concomitant with what one would expect in any market response to a bad surprise: a double-digit drop in the exchange rate for the pound Sterling from around $1.50 to the pound on June 23 to less than $1.35 on Friday and on Monday and a loss in the shares on the London Stock Exchange. British banks – like Royal Bank of Scotland and Barclays (30 and 33 percent down by Monday, June 27) – suffered harsh share price drops, as did airline stock like easyjet, which lost 500 pence or 33 percent of its share price between the referendum day June 23 and market close two sessions later, on June 27. By the same date, ratings agencies moved to lower their assessment of the UK’s credit worthiness.

Global repercussions

For the citizens of other nations there will be practical – financial, monetary, and lifestyle – consequences even though they had no voice in the decision. How they will be impacted is the first question in this regard that concerns Lebanese investors and local clients of private and investment banks who have invested in the UK or elsewhere in Europe. While the impact is varied and includes a currency shock due to the losses in the value of the Pound Sterling and then in the drop of equity values, Lebanese investors with typically diversified international portfolios face limited exposure as they are commonly “tilted towards the fixed-income space,” said the chief investment officer of Bank Audi Private Bank, Youssef Nizam.

Paul Donovan, economist at UBS and responsible for formulating and presenting the UBS Investment Research global economic view, said that the Brexit’s consequence is uncertainty on multiple levels from local to global. “Middle Eastern investors are no different from any other investors in this situation. They need to adapt to the a less certain environment, and one where political risk is higher,” he told Executive.

Nizam explained that Lebanese are generally more accustomed to investing in fixed income than in equities since local equity markets are not highly developed. “Fixed income is doing well,” he said, but noted that Lebanese investors on the European equity side would be exposed to hits not only because of the currency drop but also on asset valuations because of increased uncertainties translating into higher risk premiums. Lebanese banks with European subsidiaries would on their part “not at all” be experiencing the kind of pressure on their share prices that some British banks have seen in recent days because Lebanese banks are influenced by completely different profitability factors than their European peers.    

[pullquote]The initial signs from the UK were concomitant with what one would expect in any market response to a bad surprise: a double-digit drop in the exchange rate for the pound sterling[/pullquote]

Wealth advisors and asset managers from all over the world rushed to publish statements reacting to the Brexit and generally attempted to allay investor fears. The rate of published reactions from Beirut-based financial institutions was slow by comparison and Executive could not locally reach some private bankers and wealth managers in the days after the Brexit, given the summer season, regular business travels, and the time near the end of the fasting month Ramadan.

While the Lebanon representative of Julius Bär, a Swiss bank that maintains an office in Beirut, was not reachable for comment, the same bank’s chief investment officer Yves Bonzon described the Brexit in a phone conference for investors on June 24, which was uploaded on the bank’s website, as an “exogenous event” and as such not predictable. But the bank was prepared to take advantage of it, he said, pointing to an “intriguing opportunity” in subordinated bank debt and in buying of volatility. Banks in Europe will have pressure on equity and investors would not want to be in the equity structure of banks but will find subordinated debt rewarding as price pressure will create opportunities, he elaborated, and described “selling puts and buying reverse convertibles” as another opportunity, within an overall scenario of taking advantage of investors’ overreaction to the shock. 

Union Bancaire Privee (UBP), also a Swiss Bank with an office in Lebanon, said in a brief published on its website on June 24 that near-term uncertainty after the UK referendum’s outcome led to market anxiety but went on to say that “liquidity and falling discount spreads should make Asian equities an attractive asset class to hold”, mentioning equities in India and ASEAN countries.

Regional players were also quickly seeking to evaluate the Brexit’s impact. Emirates NBD Chief Investment Officer Gary Dugan commented on June 28, saying there was “no clarity at all on the magnitude of the impact on either the Eurozone or the UK economies”. He advised investors to watch out for stress amongst European banks and, for those persons willing to get back involved in trading in the markets, to “get a sense of the trading range in the markets before diving in”.

The National Bank of Kuwait comment on the outlook for GCC markets said, “We do not expect anything particularly big or special, barring persistent volatility in international financial markets.” It expects marginally weaker world growth to be “slightly less supportive of oil prices” and assumes that the Fed will be less prone to raise rates more than once this year, similarly for GCC central banks.

All this may be comforting to investors and wealth clients of banks but of less importance for average income earners who are feeling stuck lower on the wealth ladder. At a World Economic Forum event in China, New York-based economist Nouriel Roubini commented that it seemed unlikely for the Brexit to trigger a new recession in world markets but warned of backlash against globalization spurred by the fruits of growth not trickling down to all segments of society. “What we saw in the UK referendum was a division between rich and less rich, young and old, skilled and less skilled. This kind of pressure is becoming severe,” he said according to a WEF press statement.

In which isle is the single malt on sale?

Irrespective of the prospect (assumed by the UK government and many economists already before the Brexit vote) that the British economy could be contracting in the coming years, Lebanon has, macro-economically and in terms of consumption, not much to fear in the short term. Exporters of Lebanese wines to England will negatively feel the impact of lower British purchasing power but Lebanese tourists and entrepreneurs in the overseas programs of UK-Lebanon Tech Hub will sigh in relief that underground tickets will look, in dollar comparison, less overpriced than they actually are. Fans of Tate Modern (free admission but tempting coffee shop) and the British Museum (pricy special exhibitions) can plan more repeat visits. Looking at buyer accounts, less expensive British painkillers, hard liquors and marmalades will increase the margins of some local pharma importers and supermarkets (price drops are likely not going to be passed on in full). Cars made in UK will be more affordable.

[pullquote]Rejection of joining the EU by electorates is nothing new, starting with Norwegians and Swiss in the 1970s and 1990s[/pullquote]

The euro, which is of greater importance for Lebanese trade than the pound Sterling, will by all signs not be losing as much of its value. Importers will react in ways that reflect their business models: some will take advantage to gain market share from competitors which are importing dollar-based goods, some will import more from euroland than they could already in recent times because the euro to dollar rate of summer 2008 (1:1.50) or spring 2012 (1:1.30) will not make a reappearance anytime soon, if ever. If the current range of 1.06 to 1.15 dollar per euro will weaken further (early last year it had been predicted to happen by the fourth quarter of 2015 but didn’t) and move to parity, that we shall see but it will probably not change our consumption habits.

Birth defects of institutions?

Finally there is the question of what this means for the concepts of trade blocks and even for the concept of democracy. In the days of the 1960s and early 70s when the block was still understood as the European Economic Community and moved from a puny six member countries to nine (1973) and 12 European Community members (1986) before the fall of the Iron Curtain in 1989, the program behind the European pact was “no more war”. The EEC was rooted in a European idea that previously gained political weight after World War I thanks to a few thinkers such as the people behind the Pan-European Union (PEU) in the 1920s. The PEU was headed by two aristocrats for most of the 20th century, its founder Count Richard von Coudenhove-Kalergi and then Otto von Habsburg. While Coudenhove-Kalergi liked to speak of nobility of the mind and not of the blood (he believed, in line with his own Japanese-European DNA, that the future European would be of mixed ancestry), his movement was not one of the masses.

The European idea was driven further onward in the middle of the century by the experience of two devastating European wars that turned into world wars. Its drivers were a few visionaries and politicians – usually cited are Robert Schuman of France, Konrad Adenauer of Germany and Alcide de Gasperi of Italy, plus personalities such as Winston Churchill, Paul-Henri Spaak, Sicco Mansholt, and Joseph Bech – meaning one or two visionaries per country. 

Rejection of joining the EU by electorates is nothing new, starting with Norwegians and Swiss in the 1970s and 1990s. From the treaties of Paris and Rome to the treaties of Maastricht and Lisbon, the EU was described by its critics as an elite creation. It was supported by many, myself included, but the treaties were not expressions of popular will. Yours truly covered the first European Parliament direct elections in 1979 from Germany and was enthusiastic about the prospect of growing citizens’ participation. The election turnout at the time was 62 percent even as the European Parliament was notoriously described as empowered to do nothing but vote on its own budget.

However, since 1979 in every successive election for the Strasburg Parliament’s five-year terms, the election participation dropped and eroded to 42 percent by 2014 (of course the total voting populations of the nine countries voting in 1979 are numerically different from the 28 countries that were eligible to vote in 2014). But also when the project of a European constitution was on the table in 2004, the project proved less inspirational than administrational and was rejected in referenda before it resurfaced in the Lisbon treaty. Last month’s referendum in the UK brought over 72 percent of eligible voters to the polling stations (despite flooding in some towns) and more than 17 million people voted for an exit from the union.

Masses of people, entire countries, followed their political leaders and thinkers into the union but there were always many who demonstrated indifference and others who remained active Eurosceptics. The skeptics, of which there were many in Europe at all times over the past century, even included people who signed (albeit with procrastination) the treaty of Lisbon, like then Czech President Vaclav Klaus, who described the often cited European democratic deficit “as a chronic disease” and the European institutions’ inability to convince the people as incorrigible “birth defects”. He argued in a speech in 2010 that it would be impossible to create a continent-wide European citizenship. The system-related question posited with renewed intensity by Brexit is if the skeptics are right. This issue is worth considering in Lebanon as a society with a high share of expatriates living abroad, such as Lebanese living in Europe. 

In economic terms, the UK exit creates the question of whether or not trade blocks are as good for the people in them as globalists thought. The European Union was studied by the GCC when they researched the road map for their own monetary and political union, which never happened. Turkey, which was the scape goat of populist anti-EU opinionators in the UK for allegedly being on the brink of accession, according to The Guardian, had its deputy prime minister Nurettin Canikli tweet “The European Union’s disintegration has started”, and say that his country was now less likely than ever to pursue the EU membership route.

It will be several years at least, in which article 50 of the Lisbon treaty (which regulates withdrawals from the EU) will be applied to the UK and this period will show what direction Europe will take. Economically, there (most probably) will be much time for Lebanon to ponder its options.

[pullquote]What does it mean for democracies when diffuse fears and anti-foreigner campaigns trump economic predictions and statements by top professionals?[/pullquote]

Does Lebanon, which has been perched on the edge of its chair regarding WTO membership, want to draw conclusions as to if it wants to join any block (like last year’s talk about Jordan and Morocco to accede to the GCC)? Is there merit to the European neighborhood project or any sort of Mediterranean partnership? Or will Lebanon be faced with economic surroundings of rising national interests, in which discussions over a French exit, Dutch exit, Greek exit, or the separation from the EU by other states only grow in the post-Brexit world?   

The continent’s final countdown

Europe has, in the views of union advocates, a chance to pull together after the UK vote and prove the benefits it brings. Or, as others argue, there will be more referendums about this unloved central bureaucracy that the EU has become. For a country like Lebanon that is a historic stakeholder in trade, the question over the viability of trade blocks is worth taking an interest in, not only in Europe but in three continents. 

The second question that seems worth looking into is the role of democracy in interstate blocks. According to different media reports, the UK voters were divided, as the opinion editor of The Telegraph newspaper put it, into tribes within camps. The amazing thing is that, according to the newspapers, two thirds of people who left school at age 16 voted for the exit and two thirds of people with a university education voted to stay. What does it mean for democracies when diffuse fears and anti-foreigner campaigns trump economic predictions and statements by top professionals? It is hardly filling one with confidence in the wisdom of the crowds when premier Cameron steps down with a statement on the need for fresh leadership after admitting failure to convince of his best assessment that, “I was absolutely clear about my belief that Britain is stronger, safer and better off inside the EU.”

The EU was built by visionaries but its appeal is not democratic. In a world where changes of power have limited consequence because the choices are so similar, it has worked to proclaim democracy as the worst form of state management except for all others. Europe may be in the paradox that it only can remain viable when it can mobilize mass support for what has historically been nursed as an elite project. But the Brexit ultimately raises this question: when it comes to matters that are of such economic consequence, do we want to entrust decisions over supranational developments to popular votes?

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EditorialOpinion

Banking on our self-reliance

by Yasser Akkaoui
written by Yasser Akkaoui

The first rule of business ethics is: if you’re not proud enough of your work to talk publicly about it, something must be wrong. That the government once again cancelled a waste management contract without even naming the winner proves something dirty is going on. Worse than the implementation, of course, is the actual plan. We’re going to landfill our garbage in the sea. Waste is poisoning and disfiguring this country, whose natural beauty and rich history should instead be drawing tourists from around the world.

Of course, foreign tourists are no longer coming in large numbers for more reasons than just uncontrolled garbage dumps. Our tourism industry is now relying on the increasing number of locals who choose to leave the beach to discover the wide variety of picturesque landscapes and new hospitality venues this country has to offer. The private sector is fighting tooth and nail to spur growth in this country. And more and more municipalities are waking up to the fact that they too have a role to play in developing their local economies. This self-reliance is empowering and should be encouraged. Yet with summer set to kick off in earnest after the end of Ramadan, another reminder of the cyclical risks facing this country awaits.

Back in the 1970s and 80s, my father loved weekend road trips, no matter the security situation at the time. I can still hear him telling anyone willing to listen how we watched the news in the morning, knew bombs were falling and bullets flying, but hit the road anyway. He would end every tale with a smile from another fond memory: “We took the risk and had a great weekend. It was worth it.”

This is how the Lebanese think. We always aim to defy the odds.

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Hospitality & TourismSports

Your dream of the stadium, Fly-Foot assists you there

by Lynn Soubra
written by Lynn Soubra

It was over their mutual love of football that Rayan Ismail, Georges Batrouni and Firas Arab hatched their plan to create Fly-Foot, the first football game travel company in the region.

Football (or soccer) is the world’s most popular sport with an estimated fan-following of 3.5 billion people. The 2014 FIFA World Cup held in Brazil reached a total of 3.2 billion viewers, with 1 billion fans tuning in for the final between Argentina and Germany. Football is also tightly interwoven with the lives of people from the Middle East, being the region’s most popular sport. However, the Middle Eastern football fan community remains underserved. While Lebanon is host to numerous football fan clubs such as the Manchester United Supporters’ Club and Chelsea FC Lebanon, not many people get the opportunity to travel abroad to watch their favorite players in action. With the upcoming UEFA European Championship in France, Fly-Foot, a local startup, is geared up to get their own piece of the action.

Self-funded, self-taught

In 2011, Ismail, Batrouni and Arab, who are based in Lebanon, London and Barcelona respectively, all pitched in from their personal savings to fund their project. “We had no salaries and we used to only get paid from sales commission,” remembers Ismail. The business partners saved all their earnings in the first two years in order to fund growth. “The team stood together from the very beginning until today and managed to run a company out of nothing,” he adds. 

While most start-ups research their market in order to gain perspective on their clients before launching, the team at Fly-Foot found no competitors in the region to compare their business to and instead opted for the trial-and-error strategy in the first two years of operation. “We felt that we were not only promoting our product but also creating the market for it, and that was our main challenge,” explains Ismail.

It was with that leap of faith and a strong will to share the live football experience with fellow fans that the partners embarked on their venture, selling their first package to their friends for less than $1000. “There was no business or marketing rationale behind [the pricing of the tickets] but we considered it as a first challenge,” says Ismail. Five years later, Fly-Foot has a more structured pricing system.

The company offers two types of products: the semi-packages that include accommodation, stadium seats and Fly-Foot on-spot services, starting at $300 and the full packages that include round-trip flights, accommodation, stadium seats, airport pick-ups and Fly-Foot on-spot services, starting at $700. The majority of package sales are in the $1000 – $1500 category.

Fly-Foot started by serving Lebanese fans and later expanded its services to cater to fans in Dubai, Amman and Jeddah, among other cities. Today, the company flies more than 2000 clients a season (including the World Cup and the European Championship) from the Middle East to stadiums in eight cities across Europe.

Business model and new teammates

The Fly-Foot squad, consisting of 12 fixed full-timers in the starting lineup and various reserves (such as drivers), expanded their initial model of football travel to sell clients more than just a match when visiting new cities. The team builds on-the-ground relationships with football clubs, local boutique hotels, nightclubs and other attractions in Europe to give clients who want to make an entire vacation out of their trips a variety of options. “We have an on-spot service if [the customers] need anything, if they want to ask where they can go shopping, book a restaurant or get on our guest list for certain clubs,” says Ismail.

Fly-Foot is also incorporating business-to-business sales into their model by working with travel agencies to maximize profit and efficiency for both players of the game. “We provide the service to the agents but leave it up to them to set the final price to their customers,” explains Ismail. Travel agents can buy semi-packages from Fly-Foot at discounted partner rates, add them to flight tickets and sell them to their customers. “We position ourselves as providers or suppliers to these agencies,” explains Ismail. The company gives its partners special rates on each game and trusted partners get priority on ticket availability and prices.

The business trio does not depend on advertising to generate new business leads but instead relies on social media and word-of-mouth. “Fly-Foot has been growing organically since we began,” explains Ismail. They plan to develop an app. While Ismail prefers not to talk exact revenue figures, he tips that Fly-Foot is expecting to grow its turnover to $1 million this year.

Looking to grow

The company is also expanding into the region. “We are attracted by cities with low setup costs since we’re still a self-funded company. We opened an office in Amman in January 2016 and are trying to serve the region out of there in order to mitigate the risks present in Lebanon,” he explains. Next on the list is growth into the Gulf Cooperation Council (GCC) market by opening offices in the United Arab Emirates and Saudi Arabia. The expansion comes with added payroll and operations expenses to the tune of $500,000, and the business partners are cautious about raising capital. “We are being careful with the equity financing as we believe that an investor willing to finance the growth in the GCC should also be able to provide a business added value, or else we can go for debt financing especially since the needed amount is below $1 million,” he says.

Exits?

And while they may be looking to expand beyond Lebanon, the business partners are not yet ready to part ways with the company they created. Asked if they are seeking a potential buyout or looking to go public any time soon, Ismail explains that Fly-Foot is currently not for sale. “We are registered in Lebanon, and going public in such an immature financial market is not an option,” he says, adding that the team is “adding value to our brand by the minute.”

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Banking 2016Special Report

Investment decisions

by Matt Nash
written by Matt Nash

Investing in a venture capital (VC) fund is a bit like betting on a horse. The gambler can choose a horse carefully, looking at the animal’s past performance and even evaluating the jockey, but once the race starts and the money’s laid down, all the gambler can do is sit back, watch the race and hope for a big payday. Risk is high, but promise of a windfall is higher. Georges Hajj does not look like a gambler. Nor does he talk like one.

Hajj is the head of the CEO’s office at Banque Libano-Française (BLF) and speaks to Executive about the bank’s VC bets under central bank circular 331. He says BLF invested $8 million each into Berytech’s Fund II, Middle East Venture Partners’ Impact Fund, and Leap Ventures’ first fund, commonly referred to as the “Leap fund” (although the company doesn’t mention a name for the fund on its website). He says the bank also put a total of $4 million into the Cedar Mundi fund (a joint-venture between Kuwait’s International Financial Advisors KPSC and Spain’s Mundi Ventures SL) the Division I fund managed by B and Y Venture Partners and the Azure fund, the latter two of which do not seem to have yet publically launched. In industry parlance, BLF is a limited partner (LP) in each fund in which they’ve invested. The managers of each fund are its general partners (GPs). Outside of Lebanon, the horse betting analogy is apt. Limited partners have no influence on how general partners make investments. They put up the vast majority of a fund’s capital and then sit back to watch the race (which can last 10 years or more), hoping their investments come back in multiples. In Lebanon though, that’s not exactly the case.

[pullquote]Unlike most other markets, bank representatives sit on the boards of the funds into which they’ve invested[/pullquote]

A dozen or so commercial banks are taking advantage of circular 331 (which guarantees 75 percent of their investments into VC funds and startup companies) and are currently LPs in one or more of the local VCs. (As no database tracking 331 money exists, specificity is difficult.) Unlike in most other markets, bank representatives sit on the boards of the funds into which they’ve invested. Hajj explains that, because some funds have many banks as LPs (Berytech boasted 19 when it launched Fund II), not every LP has a seat, but all of the funds managing 331 money have bankers on their boards. He doesn’t specify how many boards BLF sits on, but does note it offers the bank at least a voice in decision making (a no-no in other markets, see PE law article). “We, as BLF, believe that being part of the board of directors is good for us to follow [up] on all these investments,” he says, noting that while a fund’s investment committee takes final, independent investment decisions, the board approves and can influence a fund’s general investment strategy. Not exactly as passive as our gambler. Nor, Hajj says, does the bank hope for a big profit. Asked what return BLF is anticipating, Hajj explains that a return of the initial investment makes it a successful venture for the bank. Though he points out that should the investment prove profitable, gains are split 50-50 with the central bank, not 25-75 the way the risk is divided. 

Off to the races

IN THE PIPELINE

Of the handful of projects in Lebanon’s startup ecosystem that have received a 100 percent guarantee from Banque du Liban (BDL), Lebanon’s central bank, only the UK-Lebanon Tech Hub (UKLTH) lacks a revenue model (i.e., they are not taking equity in the startups they assist nor charging any fees). That, however, should soon change, according to Marwan Kheireddine, chairman of Al-Mawarid Bank, which is invested in the UKLTH. Asked if taxpayers will end up paying for the UKLTH, Kheireddine says: “We’re changing the model exactly for that. The original intent of the UKLTH [when it opened in June 2015] was to serve the space for two years.” The new plan is to ditch the two-year timeframe. “Our decision is for it to continue,” he explains. “We are re-visiting the model and saying, ‘Ok, now, if we’re going to continue that effort and make sure UKLTH has enough funds to go forward, we cannot rely 100 percent on the funding from the central bank.’ Obviously, we can expect that the central bank will continue to support UKLTH somehow, but UKLTH needs to look at other sources of funding, and we are. We’re looking at funding from the European Union, from interested entities, be it NGOs or companies that have a budget within their CSR to contribute to UKLTH, and, obviously, we have to turn to the companies that we are accelerating and say, hey guys, we can really be of service to you, we have been of service to you, we can’t do it for free. You have to give us something in return somehow. And this whole re-visiting is being done as we speak, so I cannot confirm now exactly how and what we’ll be doing, but I can confirm we’re looking.”

While Executive did not interview every bank making use of 331, BLF’s approach seems to be industry standard. Indeed, only three of the country’s banks are either known in the market to be direct investors or have publicly announced such equity participations. (Again, the lack of a database means these figures are based on Executive’s open source research and interviews, meaning there may be a direct bank investment or two we missed). Of those three, Executive was only able to arrange an interview with Al-Mawarid Bank, which got the 331 party started back in June 2014 by making the first compliant investment into Presella, an “online e-ticketing platform,” according to its website. Since then, Mawarid has made eight more direct investments (the value of which the bank did not disclose). Seven of them basically fell into the bank’s lap, explains Marwan Kheireddine, the bank’s chairman. In addition to being active in directly deploying 331 money, Mawarid has its fingers in a few more pies. Banque du Liban (BDL), Lebanon’s central bank, is giving 100 percent guarantees to Mawarid investments into the UK-Lebanon Tech Hub (UKLTH) – the result of a partnership between the central bank and the UK Government – as well as Bootcamp (which describes itself as the place “where ideas become startups”). Kheireddine explains that seven of the young ventures Bootcamp has worked with could not find the small ticket investments they were seeking, so Mawarid stepped in. (The bank provided a list of the companies it invested in but not the exact ticket sizes.)

These Bootcamp opportunities, however, may not be around for very long. Two new funds – Division I from B and Y Ventures, which Executive covered in April – and the Phoenician Fund I, managed by Phoenician Funds, will be focusing on seed investments. Phoenicia, however, will generally only invest in companies dealing with financial technology (FinTech), health care and e-government, explains Jad Salame, one of the fund’s five GPs. He notes the managers are open to opportunistic investments larger than seed and in other sectors. In addition to the two soon-to-launch funds, Kafalat is running an equity investment program (iSME) that is funded via a World Bank loan to the Lebanese government. Part of the program includes giving $15,000 grants (with no equity participation) to entrepreneurs directly as well as startups, explains Bassel Aoun, the project manager. Aoun says that since iSME began disbursing grants in Q3 2015, 46 were given as of May 24. While iSME’s website is not up to date (less than 30 grantees are listed), many grant recipients have also passed through Bootcamp, the UKLTH or Speed@BDD, an accelerator run out of the Beirut Digital District.

Outside looking in

[pullquote]Three of the country’s banks are either known in the market to be direct investors or have publicly announced such equity participations[/pullquote]

Raed Khoury, chairman and general manager of Cedrus Invest Bank, is taking a conservative approach to making use of 331 money. He says the bank generally would prefer doing a direct investment as opposed to investing in a fund, but notes he has not had the time to find the right opportunity. Khoury admits that lack of centralized data on new companies being created and deals being signed makes the task of finding a good investment more difficult, but he has no fear of missing out. Instead of rushing to enter promising companies as soon as possible (with the associated risk), he says he’d rather let the ecosystem develop more before jumping in. “I’d rather go at a later stage with a higher valuation and more visibility,” he explains. 

This article was amended on October 27, 2016. Executive misspelled the name of Phoenician Fund I and manager Phoenician Funds. We regret the error. 

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Banking 2016Special Report

A law for building wealth

by Thomas Schellen
written by Thomas Schellen

Lebanon is being blessed with another proposed law, and several serious voices are intonating praise of the type of a minor doxology to the deities of capital. The new private equity draft law is designed to boost the – currently lacking – ability of fund operators to incorporate commercial entities that are best suited as establishments offering private equity and venture capital avenues. These establishments have hitherto been forced to function with difficulty because they had to rely on holding companies or other conventional formats instead of incorporation as firms with a general partner/limited partner structure.

Mohamed Alem, managing partner of the law firm Alem & Associates in Beirut, explains to Executive how and why his firm has approached the project of drafting the law. “Lebanon is not known to have an infrastructure on the legal level that encourages the creation of Lebanon-based private equity funds,” he says. “The purpose [of introducing the law] is to allow room in Lebanese legislation to permit the structuring of private equity funds, which are typically funds structures, obviously companies, in which you have a general partner and limited partners.”

According to Alem, Lebanon’s dated Code of Commerce, or legal framework for corporations and businesses offering the well-known société anonyme Libanais (sal) or société à responsabilité limitée (sarl) company forms, is not optimally suited to the tasks of giving investors enough minority shareholder protection, the fund managers the flexibility to make decisions, and provide the whole corporate structure with what he describes as “tax transparency”. This is an extremely important issue to address, he says, as for companies using the private equity funds structure “there should be no penalization from a tax point of view.”   

Whereas the common formats of incorporation such as sal and sarl according to the central bank  both limit shareholder liability to their capital contribution, they also give shareholders duties and rights that allow them to influence corporate decisions on the board level. Converse to that, the European continental format of the société en commandite simple (known as SECS or SCS in francophone countries and as KG in German speaking ones) distinguishes two classes of participants in the company, which according to Alem corresponds to the general partner/limited partner structure commonly used by private equity companies.

In private equity (PE) parlance, the general partner (GP) of a fund is the decision maker regarding the investments and manager of day-to-day operations. The limited partners (LPs), on the other hand, supply the fund with its ammunition – the cash needed for investments – and have certain expectations, namely to make a healthy return on their money.

The law is being commissioned by the Office of the President of the Council of Ministers – the prime minister’s bureau. The main driver behind the initiative is Lebanon for Entrepreneurs (LFE), a nonprofit organization that was established in 2013 and that, in the words of its managing director Abdallah Jabbour, supports legal reform and other measures that would be beneficial to the business community, with special emphasis on entrepreneurs and members of the Lebanese diaspora. “We started with 16 laws on our list in 2014, three of which we were able to pass successfully. We have been drafting several laws in conjunction with the prime minister’s office and advocating for adoption of some laws that have been sitting in various drawers,” Jabbour says.

The Lebanese private equity draft law will benefit the country’s economic community and more specifically, the group of financial actors that spend their time with the structuring and operations of private equity and venture capital funds. This funds industry is a highly skilled and specialized profession, with a handful of practitioners who contribute to wealth creation – firstly their own.

Confidence in confidence

What makes this a macro-economically interesting discussion is the disproportionately large growth of entrepreneurial companies that are taken forward by PE and VC funds. This is also the argument of Firas Safieddine, executive board member of the Capital Markets Authority. “As regulator we believe that the private equity law is a requirement to complete the ecosystem as regards to equity and capital markets,” he tells Executive.

Under this mandate, the CMA became a stakeholder in reviewing and assessing the draft law, which according to Safieddine was “beautifully written” but would need a further round of drafting and review. He expects that the law, once it is passed, would deliver a component to make the Lebanese scene more inviting for investors.

[pullquote]Firas Safeddine, executive board member of the Capital Markets Authority, expects that the law, once it is passed, would deliver a component to make the Lebanese scene more inviting for investors.[/pullquote]

He also admits that it is an “ambitious undertaking” to attract investment funds to base their operation in Lebanon, but chooses to see the cup as having room. “Optimistically, the private equity law is a major step forward in terms of creating more confidence in the market,” he says.

Building the ecosystem from a legal point of view will not only require the PE law but “many laws that need to be addressed and attended to,” he says, naming the bankruptcy law as an example for other needed legislations.

Since Lebanon does not have a setup where such funds could be incorporated, the law would close this gap, and the CMA would further contribute to building trust and developing capital markets. “We will be proving very soon that the CMA is a major source of confidence,” he states.

Safieddine’s belief extends beyond the PE law into a trust of being able to remedy a more fundamental disequilibrium: as general agreement goes, banking dwarves the financial markets, and he emphasizes that capital markets are so tiny in Lebanon that they are “negligible”. That needs to change and he points to the case of the United States’ post-recession recovery after 2008/9 as an indicator that equity-based economies recover more quickly from economic weaknesses. “We are heading towards shifting our economy from a debt-based banking reliant economy towards capital markets, an equity-based economy.”

Whereas Safieddine claims to have read studies that show how equity markets and growth of GDP are correlated one-to-one, the story according to other studies is more complicated and it is an open question if debt or equity are suitable as magic keys for economic growth. Post the Great Recession, academic opinions and empirical indications are against one-key solutions and more tending towards combinations, meaning that the financial secrets to best-possible growth scenarios will likely be different for different countries and economies.

The Bank for International Settlements (BIS) indicated as much in a research paper two years ago, finding wide diversity. “First, financial structure differs considerably between countries. The relative importance of banking ranges from less than 20% in the United States to over 60% in Austria, Hungary and New Zealand. Second, financial structure is not static. Market-based intermediation has gained ground over the past two decades,” it said in a paper published in March 2014.

Noting that market-based financial intermediation tends to increase as per-capita GDP rises, the BIS paper found that some industries in emerging markets tend to benefit from capital markets while others – like small firms and sectors with tangible and transferable capital (such as agriculture), as well as those where output is easier to pledge as collateral (such as construction), are more amenable to bank debt finance.

[pullquote]Recessions in countries with bank-oriented systems are three times more severe than in those with a market-oriented financial structure[/pullquote]

“The results of this paper confirm the widely accepted view that both banks and markets are very important for economic growth,” it said. “We also find that banks provide services which differ from those offered by financial markets and that such services prove to be particularly beneficial for less developed countries […] Finally, our evidence suggests that banks and markets differ considerably in their moderating effects on business cycle fluctuations. Banks are more likely to supply loans during a ‘normal’ downturn, thus smoothing the impact of the recession. But their shock-absorbing capacity is impaired when the downturn is associated with a financial crisis. In this case, recessions in countries with bank-oriented systems are three times more severe than in those with a market-oriented financial structure.”

A few hurdles yet to clear

Given the near two decade-long dormancy of the Beirut Stock Exchange in combination with the dominant role of bank debt in the domestic market, plus the inertia in the political and legislative class, it seems moot to debate whether the Lebanese migration toward capital markets will be a “shift” with rapidity, as the CMA’s Safieddine contends, or slow and gradual, or even more hesitant and not actually tangible, as some economists suspect. But the drafting of the PE law has already been remarkable, says Alem. Besides helping local companies, which previously had no choice but to take on debt, to tap into capital markets, the law in future “can attract foreign private equity managers to base themselves in Lebanon because of the modern legal framework,” he says.

The draft law for private equity was accomplished by a team at Alem & Associates that comprised two partners and two associates. By researching existing laws in Luxembourg and France and by adapting the draft from suitable European codes – a job that required about 240 hours of legal research and writing and was supported by three PE companies as sponsors which LFE could mobilize – the team developed a draft law that is at the forefront of such legislation for the entire Middle East and writs forth the pioneering business legislation in the same tradition by which Lebanon introduced the offshore corporate structure in 1983, Alem says.

LFE’s Jabbour agrees, emphasizing there is “no modern law for private equity funds in any country of the Middle East. If our law passes, it will be the most modern one in the region.” According to him, adopting such a law comes with positive implications not only for tech-oriented funds and investors in the knowledge economy but also for real estate funds and any area where separation of investors and managers of funds is desirable.

He acknowledges the pitfalls of acceptance by Parliament, such as the fact that no law of any sort is passed when the assembly does not gather. But once that barrier is removed, the private equity draft law stands a good chance of being adopted, he says. “Usually, passing a law faces little opposition when it does not affect the vested interests of politicians or groups,” he reasons. A combination of proper advocacy (he doesn’t like to use the word ‘lobbying’) and the absence of vested interests will help the draft pass into law at one (not yet determined) point, he hopes.

“We need a law that is flexible, that follows global standards and makes any investor feel comfortable,” he emphasizes.

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Lebanese film industry 2016Special Report

Streaming hits big in the Middle East

by Natascha Schellen
written by Natascha Schellen

It’s a sunny afternoon in Beirut and you’re sitting in a café, waiting for a friend who is running fashionably late as usual, but it doesn’t bother you because now you have time to catch the latest episode of The Big Bang Theory on your smartphone. This is the attraction of video on demand (VOD): the convenience of watching whatever you want, at any time and on any device. Provided there is internet, of course.

In the Middle East, millennials are increasingly turning to online for entertainment and internet usage has been exploding in recent years. Saudi Arabia and the United Arab Emirates rank among the top countries for YouTube views per capita in the world. With the introduction of American VOD provider Netflix to 130 countries, including inside the Middle East, at the beginning of this year as well as regional and local players that already exist in the market, online streaming has nowhere to look but up. And although it’s taking them a while, advertisers are slowly catching on to this. Members of the advertising industry in Lebanon agree that spending on digital advertising is rising, albeit from a low base, with estimates for 2015 ranging between 8 and 10 percent of total advertising spent in the country.

The challenges of VOD in the Middle East

There are other advantages to advertising online. “The targeting is so efficient that you can really target who you want. It’s much cheaper [than TV] and it’s more efficient, especially when you’re targeting millennials,” says Daniel Habib, co-founder of Iron Heyoka, an online production house that creates corporate videos for clients in addition to original web series. “I don’t know any millennials who still watch TV,” he adds.

On the consumer side, it also makes sense to pay for this content, according to Nasri Atallah, managing director of media and publishing at Keeward, a digital production company that partners with a number of brands including Iron Heyoka. “I think what’s shifted over the last few years is people just aren’t willing to pay stupid amounts of money to see a film or to download a piece of music, but Spotify and Netflix [work] because it seems like the right amount to pay to do something legally and have a nice experience,” Atallah says. A Netflix subscription can set you back as little as $7.99 a month for the basic package, which is less than the average price of a cinema ticket in Lebanon today.

Regional VOD platform Cinemoz, however, argues that online payment is still a challenge as many Arab users don’t own credit cards, which is why the company has chosen to rely on advertising for revenue. Cinemoz founder and Chief Executive Officer Karim Safieddine explains that “advertisers are addressing the millennials by a landslide. The only reason why we’re generating very sexy revenues is because we cater to that demographic; they are the new consumers.” The company, which started in 2011, is hoping to close the year with more than $1 million in revenues.

Another challenge has been the notoriously unstable internet connection in Lebanon and other countries in the region, but tech-savvy VOD service providers take this into account when they develop their software. Eli Khoury, the chairman of Lebanon-based content provider M Media, addresses this issue: “We have spent a lot of time on the back engine. Today you could watch it even on the weakest internet [connection] without cuts.” The M Media website is currently in beta mode – with all videos available for free – and plans to launch fully once they have reached their targeted amount of content.

The potential of the internet

VOD requires considerable financial investment as well, particularly when it comes to purchasing rights from major Hollywood studios. Starz Play Arabia Chief Commercial Officer Danny Bates says that the Middle East and North Africa (MENA) service, which was launched in 2015, has invested a significant amount so far, though he is unable to reveal the exact figures at this time. Starz Play Arabia announced on May 23 at a press conference in Dubai their partnership with Samsung TV, banking on the popularity of their smart TV range in the region, particularly in the Gulf. The majority of their 720 hours of Arabic content was in fact produced in the Gulf,  but they are looking to expand with Syrian and other Levantine content in the near future.

This has implications for the Lebanese film industry. As the road to distribution remains unclear (see story page 68), the fast-rising VOD segment is one that Lebanon has the opportunity to exploit. Most film producers and distributors that Executive talked to agreed that there are fewer barriers to bringing a film to an online platform when compared to the struggles of securing a theatrical release. Although the latter currently offers much greater financial gains, online prospects are looking good, with new platforms springing up annually that are thirsty for Arabic-language productions to feed the demand.

The Middle East market is avid for content, attests Cinemoz’s Safieddine, whose site currently boasts an average of 2 million views per month. Finding enough Arabic content is proving to be a main challenge for Cinemoz. “It’s improving, but today the volume of Arab films released yearly is not enough to sustain the viewership that we are reaching today,” says Safieddine.

Following in the footsteps of global VOD giants, Cinemoz is co-producing several original series to be released in early 2017 on their new brand TVmoz. “With the help of our analytics, we have a much better idea of what our audience wants,” says Safieddine, adding that the web series line up includes a zombie show and a sci-fi comedy, among others.

Internet speed notwithstanding, Lebanon has achieved some success online. Shankaboot, which according to As-Safir aired as the world’s first Arabic web-based series, ran from 2010 to 2012 and won a Digital Emmy Award. In recent years a number of players have ventured onto the field, among them Iron Heyoka. The progress has been slow, but the future looks bright. Referring to their rapidly increasing business in producing corporate videos, Iron Heyoka’s Habib enthuses, “It’s like Lebanon woke up two days ago and figured out there’s internet; it’s crazy.”

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Hospitality & Tourism

Hotels bridge troubled financial waters

by Nabila Rahhal
written by Nabila Rahhal

From the fifteen year long Civil War which began in 1975, to the assassination of Prime Minister Rafik Hariri in 2005, to the sit-ins in downtown Beirut in 2007 and numerous other disruptions, it seems that Lebanon is always either in crisis or recovering from one.

This roller coaster of stability has had a negative impact on tourism, with the number of tourist arrivals dropping almost every time Lebanon makes the news for a security incident, only to rise again as soon as the situation stabilizes. Khalil Arab, co-owner of Warwick Palm Beach Hotel in Minet el-Hosn, gives the example of how their low room occupancy rates shot up considerably the day after President Michel Sleiman got elected in 2008 and the sit-in in Riad el-Solh Square was dismantled.

[pullquote]Many hotels have outstanding loans which hotel owners took out for the purpose of renovation or improvement to property[/pullquote]

Survival yet again?

It is no wonder then that hotel owners have become almost accustomed to riding out and managing the latest crisis while waiting for the good times – which previously were typically not too far off.

However, the length of the current instability in Lebanon and the region – which began with the conflict in Syria in 2011 and has stretched on with various security incidents extending into Lebanon – has gotten Lebanese hotel owners wondering if they will be able to weather the storm this time.

“Hotels in Lebanon have become seasoned in dealing with crises since we have passed through so much. But this time it has lasted for a very long time and this is causing some establishments who were doing well at the onset of the instabilities, almost five years ago, to reach a critical financial situation today,” says Pierre Achkar, President of the Association of Hotel Owners in Lebanon.

The new tourists

Achkar does admit that the past five years have not been all bad. Summer 2015, for example, got off to a good start tourism-wise until the waste management crisis late August, which drove sightseers away due to the garbage on the streets. He says that the type of tourism to Lebanon has changed, with the average length of visit shorter and the spending power less than it used to be.

“What has changed is the nature and style of tourism with citizens from the Gulf no longer being the main tourists of Lebanon. These tourists had the most capacity to spend and usually stayed for a month in Lebanon, whether in their properties here or in hotels, but either way they spent in the country and revitalized the economy to some extent,” says Achkar, explaining that these days tourists to Lebanon stay for an average of a week.

The need to look good

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Many Lebanese hotels are finding themselves with few guests and are struggling to meet their operational costs. What compounds this dire financial situation is that many hotels have outstanding loans which hotel owners took for the purpose of renovation or improvement to property – bank loans are only given to cover these expenses and not for operational costs. Achkar explains that these loans are subsidized by the central bank which finances a percentage of the interest that hotel owners owe the bank, and were meant to support new major investments in Lebanon.

Hotel owners with properties that are several years old must renovate and update them, no matter what the situation in the country is, explains Arab, who took a loan of $1.6 million two years ago with his partners to finance the renovations of Palm Beach Hotel’s three restaurants and a later loan of $700,000 to upgrade some of the rooms. “We had to renovate because if we didn’t do so, people would stop coming, thinking the hotel is old and rundown; for them to come they have to see some change,” says Arab, adding that they had chosen to renovate in this period of low activity for hotels in Lebanon so that they would be prepared to welcome guests when the situation improved.

The cost of renovation loans

Getting loans for renovation is easy, explains Arab, as the cost of renovation is very low when compared to the value of the hotel property which the bank uses as collateral. “It was easy to get the loans because we are taking a loan of $2.5 million against a property that is worth $40 to 50 million plus. In our case, the loan was personally guaranteed by the owners so the bank has zero risk,” he explains.

When taking loans for renovations, hotel owners bet on the increased room occupancy and business generated by these improvements to cover the loan payments. But with the situation being what it is in Lebanon, tourists have not been flocking to the country and renovated hotels have not seen the increase in customers they expected. Instead, many hotels have had to manage the payment of their bank loans as well as the operational losses.

[pullquote]Closing down means sending home about a hundred employees[/pullquote]

If hotel owners default on their loans, explains Arab, they lose the subsidy of the central bank in financing a percentage of the interest and they will therefore have to pay the full interest themselves. “So it is better for us as hotels to keep paying the loan rather than losing the support of the central bank and paying the high interest,” explains Arab.

Achkar explains that when banks see that a hotel owner has reached a point where, no matter what they do, they cannot pay back their loans, the first thing they do is stop the increase in credits given to that hotel. “This paralyzes the hotel and if the situation in the country continues as is, it can lead to the bankruptcy of some hotels,” says Achkar, while adding that bankruptcy for major hotels with property values in the tens of millions of dollars and upward is still unlikely at this point.

Financing losses

To cover their operational losses, and pay back their debts, hotels have had to tailor a financial plan based on their own unique situation. “There are many hotels in critical financial situations but how they handle it depends on each hotel. There are some who might increase the capital, or who might sell land to cover their debts,” explains Achkar, using his hotel, Printania Palace, in Broumana – where he leased its garden to food and beverage outlets for the summer and as such covered a percentage of his operational costs – as an example of what hotel owners could do to hang on during this rough period.

Achkar urges the Ministry of Finance to support debt restructuring, which he explains as deferring payment of the loans for a longer period, as a way to help hotels manage their losses. “The loan which is supported by the central bank was developed to encourage new investors but today they don’t exist so why don’t you support the existing ones through this debt restructuring?” asks Achkar, explaining that while the decision lies with the minister of finance, there seems to be a sense of apathy in the government towards the risk of big names in the hospitality industry going bankrupt.

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Closure Versus Survival

[pullquote]Khalil Arab took a loan of $1.6 million two years ago with his partners to finance the renovations of Palm Beach Hotel’s three restaurants[/pullquote]

When hotels are unable to meet their operational costs or pay back their debts, closure might be the only option for them. However, Arab, who along with his two partners is dipping into his personal funds to finance the operational losses and renovation loans, explains that closure does not come without its own price. “Every time I tell people we are losing, they ask until when and I have no answer for that because the alternative is to close down and closing down means sending home about a hundred employees. Apart from the inhumane aspect, this is also costly for the hotel because we would have to pay compensation for these employees and when things finally get better, you will never be able to find the same quality of staff who have been working at the hotel for about fifteen to twenty years. It is also bad for the reputation of the hotel if it closes down. So you see the alternative is also costly and we are stuck hoping things will get better,” says Arab.

No one knows when or if the situation will improve and the outlook for summer 2016, which will only truly commence in July following Ramadan in June, is still unpredictable as most bookings are made only a few days in advance, explain both Achkar and Arab.

Until then hotel owners have no choice but to hang in there and manage as best as they can for as long as they can.

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Banking 2016Special Report

In conversation with Freddie Baz of Bank Audi

by Thomas Schellen
written by Thomas Schellen

In May 2016, rumors circulated that the largest banking group in Lebanon, Audi, had engaged in an exercise of tinkering with the possibility of relocating its corporate holding to a foreign jurisdiction. More tangibly, the bank released its results for the first quarter in 2016, showing lower assets and deposits when compared with the end of 2015 but a 10 percent year-on-year gain in profits. Executive sat down with Freddie Baz, the group’s chief strategist, to inquire about the group’s numbers, strategies and exercises in planning.

E  One reason why we felt the necessity to sit down with you at this time was to seek ultimate clarification of the rumors that Audi Group was considering a move of its holding.

I am not going to expand on this point. Everything needed as clarification was stated in our press release [see page 64]. It was very clear.

E   Looking at the results, there was a noticeable downturn in numbers at the end of the first quarter in 2016 when compared with the end of 2015. Can you explain?

A big chunk, albeit not all of [this drop] was due to currency movements, because we have a material presence in Turkey and Egypt. Sometimes there is some [foreign exchange] impact when we translate [all figures] into the national currency, which is the Lebanese pound, because the parent [company] is in Lebanon, but we express it in US dollar because of the currency peg.

E   But the Turkish lira did not drop much in the first quarter, or are we mistaken?

No, it was almost stagnant. What shows is that we have adopted a wait-and-see attitude in Turkey not only in Q1 but even in Q4 of 2015. We decelerated a bit. The prospects are still good. Turkey is an atypical case whereby the fundamentals are good, as seen by the improvement of the real sectors last year. They achieved 4 percent real growth, which is a very good performance as it represents more than two times the average GDP growth of emerging markets last year, excluding India and China. The very good performance does not only relate to growth. If you look at the debt profile, the fiscal balance to GDP is at a mere 1.5 or 2 percent – and the total debt to GDP [ratio] is within the Maastricht criteria (for EU economies). The concerns are only about the current account – which have also improved significantly, going down by almost 50 percent. So when you look at fundamentals, the country is doing well, but Turkey has a paradox. Its major weakness is [that they possess] zero oil and gas, so they have to import all their energy needs and [at the same time} it is an exports-driven economy. Thus they need to import the major inputs in exports, which is the most important driver of GDP growth. So there is some kind of dependence on the oil bill. This is a weakness which makes Turkey vulnerable from time to time, especially when the international environment is not supportive, such as the current one, which has been pervading for the last two years.

E   What pressures or non-supportive elements are you referring to?

The tapering and the Fed[eral Reserve’s] policy towards emerging markets which have led to many investments to exit emerging markets and return mainly to US markets. Turkey is very vulnerable. This, as I often say, is a weakness that is coming from a strength. Because it is an industrial country and Turkey’s exports are a major GDP growth driver, they need to import energy and are suffering from a structural current account deficit, which needs to be covered by short-term portfolio investments or longer-term foreign direct investments. If the international markets are not supportive, [Turkish economic players] can suffer some pressures on the real exchange rate, which happens from time to time – but they are wise enough to have implemented all kinds of hedge accounting.

[pullquote]The economic performance wasn’t achieved randomly. The GDP growth of 4 percent [in 2015] was supportedby more accommodating Fed policies.[/pullquote]

E   Does the Turkish scenario contain other specific challenges?

There are many pluses and minuses which are translating into a real sector which is performing well within the context of a currency which is drifting, in my opinion, with no fundamental reasons. I have to mention also the second vulnerability besides the capital account in an efficient market which translates into capital inflows and outflows and ultimately the exchange rate. But Turkey is also a very politicized country that is undergoing major structural political changes under [President Recep Tayyip] Erdogan as he wants to change from a parliamentary system to a presidential one. This is generating some domestic political tensions which are impacting the psychological dimension of the exchange rate. It is true that the exchange rate was at 1.70 (Turkish lira per USD) when we did our investment but the fair value at that time was [better than] the market rate. After the change in the international environment and the slight deterioration in the domestic political environment, the market rate closed the gap to the fair value and went beyond that. Today most knowledgeable market analysts put the fair value of the Turkish lira at 2.4 while the [exchange rate] is at 2.9. This means there is a markup of close to 20 percent because of the political volatility and that is too much.

E   How much of the political volatility and markup of the exchange rate vis-à-vis the fair value is in your opinion domestic and how much is related to international issues?

In my opinion it is today almost 100 percent domestic. The economic performance wasn’t achieved randomly. The GDP growth of 4 percent [in 2015] was supported by more accommodating Fed policies and the oil prices were at a level which was supportive for Turkey to significantly reduce its current account deficit, and, more importantly, the improvement in the eurozone, which remains one of the most important trade partners for Turkey, has all together supported the economic performances. What remains is the domestic political scene where there were two very sensitive points at the beginning of the year that were creating [political] volatility. One of [the challenges] was mostly solved through the nomination of the [relatively independent, experienced and well-liked] central bank governor. Also the renewal of positions of all the members of the monetary policy committee was carried out with people [who were accepted by the markets] and provided comfort and confidence to the market. What remains now is the regime change [and the questions related to the ambition of Mr. Erdogan].

E   Aren’t there also international issues, such as the row with Germany over a satirist’s words?

That is all part of the game. But in my opinion, 20 percent markup is excessive. One has to go to Istanbul and see the situation on the ground. People love to talk politics but at the end of the day there is a socioeconomic issue which is so large and so dense that there is some power of inertia in Turkey. I am telling you this because in the full year 2015, the [banking] sector achieved growth rates of major aggregates in two-digit territory, on US dollar adjusted basis.

E   So how did Odeabank perform in this context?

We have outperformed the industry by adding four to five bips market share in assets, loans and deposits. That means that our growth rate was higher than the average. These are five basis points, but it is a $700 million market. But in Q4 [of 2015] we said [to go slower] and we kept [that approach] in Q1 [2016].

[pullquote]You shouldn’t relate deposits to profits. You should relate deposits to spreads, which is the top line, not the bottom line.[/pullquote]

E   But as you said, the currency fluctuations cannot explain all the drops in your aggregates of Audi Group.

This brings us back to the first argument that we have been in consolidation mode in Turkey versus our traditional growth mode. In Egypt, we did grow but this was impacted by the heavy depreciation of the currency, and Lebanon did not achieve any significant performance. The end result was those slightly decreasing figures but it is not meaningful [to review performances] on a quarter to quarter basis. We have a budget to add $3 to 4 billion in the full year 2016 and we are confident that we will achieve it. Having said that, however, we have been able to increase our profits by ten percent.

E   Is it then naïve to think that growth in profits is correlated to growth in deposits?

You shouldn’t relate deposits to profits. You should relate deposits to spreads, which is the top line, not the bottom line. If you want to buy market share, it is at the detriment of your spread. It will ultimately impact your bottom line but it starts by looking at the top line. Our spreads have been improving and we haven’t been competing to get deposits. This explains to a certain extent this consolidation mode versus the growth mode, but is as strategic as growing your deposits base. We are very happy about our overall performance; it is true that we haven’t shown in Q1 important increases on the major aggregates on the group level, but when you look at the key performance metrics of the group, they all improved in terms of spreads, non-interest income generation and decreasing cost to income; and also you need to know that the 10 percent increase in consolidated profits do translate into similar trends in the positions of individual entities. The breakdown of consolidated profits over major development pillars – Lebanon, Turkey, Egypt, and private banking and other entities – shows a balanced contribution to the increase from all those pillars.

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Banking 2016Special Report

Dissecting the numbers

by Thomas Schellen & Dany Baz
written by Thomas Schellen & Dany Baz

Although 2015 was a trying year for the Lebanese economy and tested many economic players beyond what they experienced in the already challenging year of 2014, the results of Lebanese banks were remarkably stable. It is notable that the consolidated market shares of alpha and beta banks maintained high concentration on the domestic side. Their domestic assets increased by 13.2 trillion Lebanese lira, accounting for over 95 percent of the growth in total assets.

The same is true for domestic deposits, which edged up 5.1 percent to over $151 billion, with the highest growth in percentage terms in lira-denominated deposits at 7.1 percent, down only 30 basis points when compared with 2014. Growth rates in foreign deposits, due to foreign currency developments, were down a multiple versus 2014, namely at 1.7 percent from 22.8 percent in 2014. This was reflected in the aggregate figures where the share of domestic deposits of overall alpha and beta deposits moved up by 50 basis points, in opposition of trends seen in previous years.

Lebanese banks in the two main size segments by deposits, the alpha banks with more than $2 billion and the beta banks with $500 million to $2 billion, account for over 95 percent of the sector. Bankdata, the consulting and analysis company covering the Lebanese financial sector, has consolidated the results of alpha and beta banks (14 alpha and 12 beta) for the past two years, illuminating their performance in a new and sharper light.

Overseas operations of alpha banks were stronger than those of beta banks as only two beta banks are active in markets outside of Lebanon. But the consolidated results reveal that alpha and beta groups together reached stable portions of approximately 82 percent of assets and deposits, 72 percent of loans and 82 percent of their profits in the domestic Lebanese market.

The profit growth rate of alpha and beta banks in 2015 was 7.5 percent, down 2.4 percentage points from the 9.9 percent growth achieved the year before. However, the growth rates of profits remained strong when compared with all other aggregates; growth in assets, deposits and loans were halved from the growth rates seen in 2014.

Beta banks, whose overall contribution to the consolidated aggregates revolves around 8 percent, saw an increase in their operating expenses that amounted to twice the increase in their operating income.

Of the total workforce of alpha and beta banks, 24,000 or about 70 percent, are active in the domestic market, compared with 10,000 employed overseas. Domestic recruitment was increased versus 2014. The concentration of bank branches is still in a wide range of less than 20 branches per 100,000 residents in outlying provinces to more than 80 branches per 100,000 persons in the Greater Beirut conurbation.

The overall bankerization rate of the Lebanese population is estimated by Bankdata to have reached above 70 percent. In terms of the outlook for network developments, we believe that there are still unused potentials for domestic rollouts, especially using advanced, diversified and innovative methods.

In review of the ratios reported by alpha and beta banks, liquidity is maintained at a high level in both the Lebanese currency and foreign currencies, mainly US dollar. Total net primary liquidity over deposits stood at 31.03 percent at end 2015, compared with 32.38 percent at end 2014. Portfolio securities over deposits increased to 40.97 percent. Collective provisions over net loans and operating expenses over average assets remained in the same ranges as 2014, registering 1.11 percent and 1.41 percent respectively.

Yield ratios on earning assets increased 7 basis points from 5.68 percent in 2014 to 5.75 percent in 2015, reflecting in stable interest margins of 1.97 percent and spreads of 1.89 percent. Asset utilization rates and net operating margins moved in narrow ranges, registering 2.83 percent and 35.08 percent respectively. The closely observed ratio for return on average assets (ROAA) remained unchanged at 0.99 percent while the return on average equity saw a marginal weakening from 11.35 percent in 2014 to 11.19 percent in 2015.

Bankdata notes that the stability of performance ratios and asset quality ratios is remarkable, given the overall market conditions and disruptive developments seen in 2015, and provide proof that Lebanese banks are resilient, run by bankers who are experts at what they do.

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