Private equity’s rise in the Middle East and North Africa (MENA) region has ballooned through large institutions as well as smaller, boutique organizations. In addition to the two types of regional private equity houses, there are firms from abroad trying to tap into the local markets, including The Carlyle Group, Goldman Sachs, Credit Suisse, and others. 

Shailesh Dash, senior vice president of alternative investments at Global Investment House, said, “the various data you read through will show you that until 2004 investment in the organized private equity market in the MENA region was about $1 billion.” 

Today, Dash and his firm are “looking at a fundraising of approximately $24 billion in the last three years.” Suddenly, the market dynamics have changed and many new players have entered private equity. “In terms of the investment issues,” according to Dash, “most of these investments have been in the relative open economies. I believe, in 2006 the total private equity done in the region was about $2 billion and if you look at most of these investments, they have been done in the UAE, Oman, Egypt, Jordan, a little bit in Syria and North Africa.”

Every private equity firm is looking for an edge and wants to spot the best deals available. However, as the industry matures in the coming five years, firms are looking to establish their niche markets in the region, including focusing on certain industries and countries.

Romen Mathieu, managing director of Capital Trust Group, believes the Gulf is a crowded place in which to operate a private equity business. Giving consideration to his institutional investors in the Gulf as well the European Investment Bank, Mathieu stated that he would “not take money from the Gulf to invest in the Gulf, whereas you have today more than 20 funds that are multi-billion dollar funds fighting amongst each other to source the funds. This is not my playing ground over there.”

Spreading a firm’s reach can have its advantages especially if, as with Mathieu’s firm, it liaises with “local funds in Morocco where you have

5-8 funds locally and in Jordan and Egypt. But we do not see these local funds as competitors but as partners because whenever they have an operation to do, they always look to co-invest with someone.”

Flowing finance from abroad

The MENA region is one of the fastest growing developing markets, often listed just behind those of China and India, the region is attractive for foreign investors, especially Western capital, to reach the region through investments in private equity operations.

Yahya Jalil, senior vice president of private equity at The National Investor (TNI), separated foreign capital inflows to MENA into real estate-related capital flows and non real estate-related capital inflows: “For real estate-related capital flows, if you are the fund manager of a global or emerging market real-estate fund and you don’t have any exposure to Dubai, I think you will be underweight in the sector. In other words, the scale of real estate development in the GCC region is such a meaningful proportion of global real estate development that the asset allocation models of the big global asset management firms would require them to invest in this region to have proper emerging market exposure. So frankly, part of the foreign direct investment into the region is structural.”

However, for non-real estate-related foreign capital inflows to the GCC, there are three factors Jalil lists, including “the market meltdown in developed markets, which is sending asset managers looking for other geographies to deploy their capital, the phenomenal growth rate of the economies of the region, and the opportunity to be an early mover into the market. Of course, none of this might have happened without the macro and regulatory changes happening here.”

Wadah Al-Taha, head of strategies at Emaar Financial Services, believes that infrastructure is driving foreign capital opportunities in the Gulf, which demands experience from abroad. He explained that “to a certain limit, foreign investment is welcome, but to have hard liquidity moving fast, the market and the

level of education doesn’t match this movement.” He believes that entry requirement regulations will have to be tight enough “but not too tight as to show some type of rejection. The regulators will have to maintain a level of attraction with a certain level of control”.

Richard Dallas, managing partner of private equity at Gulf Capital, believes that capital will not only move eastward, but industry watchers will “see an active movement both ways” as sovereign wealth funds and private funds find “incredible bargains in the West that could be bought.” However, the private equity industry will remain strong since “you want to put your money to work where you are comfortable, where it’s your backyard, and you can see the returns, so I think you are getting not only inflows from Western institutional investors, you are getting money from guys here who would have otherwise invested their exportable cash now redirecting it into the region.”

He thinks that “we are going to see more institutional money look for opportunities to diversify in the West, because that gives them income streams which are not so linearly correlated to oil money coming in and filling the government coffers.”

For Dallas’ firm to involve themselves with a handful of companies, Gulf Capital looks at 200-300 opportunities, which represent around 15-20% of what his private equity group has been shown. Thus, in terms of deals the market is good, but finding the best among them is proving a challenge to firms focusing on increasing returns and driving restructuring efforts.

Dallas explained that private equity firms have to “figure out how to marry investment rigor, basically going through, doing your due diligence Six Sigma-style, making sure you know what the liabilities of the company are and structuring a set of documents that educate one another about the risks involved and the allocation of risk.”

The toughest challenge, according to Dallas, is overcoming due diligence and achieved outcomes because “a legal document in this part of the world or anywhere is not something where you are allocating legal rights, waiting to sue each other.” In the local context, “it is really all about negotiating back and forth and in that process you have to understand what sort of knowledge and information they have and their strengths and weaknesses, they understand your expectations, and so that document is just a framework of a dance of how to allocate risk for the transaction between yourselves. It creates an educational process.”

A look back: MENA private equity snapsh

Fund raising in MENA during 2007

Sailing to success

Junaid Jafar, general partner of EMP, thinks that “over the last 18-24 months, we have seen a number of new private equity players coming into the market, which has resulted in a shortage of talent. You need a combination of both private equity experience as well as the ability to work in the regional context, especially if you are dealing with family groups.” 

He is certain that firms will not get very far “not having the right skills and knowing the cultural sensitivities. Some firms have hired people who know how to do deals, but maybe not regional deals. It’s not really rocket science, but having someone who has been here and knows who to call and who to meet with cannot be underestimated.”

Nearly all private equity players admit their business isn’t rocket science, but the scientists whose discipline is needed are in short supply.  Another industry leader, Jamil Brair of SHUAA Partners, explained that “getting the talent with the number of players in the region is difficult, as there is already a shortage of talent at the experienced level.” For Brair, the lower-level players with one to four years of experience are commodities and can be acquired, but the challenge is finding a senior-level executive with knowledge of the market, good Arabic, and an understanding of the local business environment.

PE Transactions by Industry 2007

Working through choppy waters

Private equity firms are troubleshooting the obstacles ahead for the industry’s next decade. According to TNI’s Jalil, the obstacles at the fundraising level include increased competition for returns “from non-private equity asset classes,” particularly real estate, which is returning over 30% annually, making the “case for investing in private equity not so compelling.”

For private equity investments, MENA investors have also shown a strong preference for government-owned infrastructure businesses, “which use up a lot of available liquidity.” In addition, the nascent nature of private equity in the region means that only a few “private equity funds in the region have fully exited a complete fund, so there is no track record. GCC investors are choosing from among a number of first time managers.”

At the investing level, Jalil believes the biggest challenge is deal flow, because deals generated through intermediates “such as investment banks and brokers tend to have very rich valuations.” This is because “family businesses in the region haven’t really grown up in an equity culture.” Generating deal flow through direct family contact will be much more difficult and is proving the biggest hurdle for new market entrants. In the region, family businesses are usually financed through debt, so “the concept of taking in a new equity partner is one that requires some convincing, and it’s not an easy sell. If you are looking to buy a controlling stake in the business, then the challenge becomes that much harder.”

Dallas noticed the opportunities in the region and “the natural entropy for people who have high net worth want to put that to work directly, they are businessmen, that is how they generated the money. So the idea of putting it into a fund, which is by nature a blind pool, you are giving money to someone for five to eight years or ten years and you don’t know exactly what they are going to invest in, is basically trusting a management team or trusting an institution.”

One challenge private equity firms continue to face is the lack of a “little entropy to put money to work saying ‘I can build a project.’ So there is a little bit of reluctance for firms engaged in commercial activities to put that money into funds.”

The private equity idea was initially foreign as the big money institutions sought out other asset classes, but the need to create returns to defray expenses has made Gulf institutions think again and look to new ideas of asset management. Dallas thinks “it is really difficult to get people to understand the concept of leveraging that wealth and multiplying it as opposed to putting it to work for them.”

SHUAA’s Brair explained the Arab mentality toward business, saying “they are very attached to it and are not willing to give up control. We would be OK with only coming in with a significant, protected minority interest, not to be in the driver’s seat, but certainly in the passenger’s seat if you will.”

Setting sail beyond the GCC

Robert Wages, executive director of the Abu Dhabi Investment Company, believes the UAE is “quite serious about privatization” although industry experts also see Egypt and Jordan as also being ‘quite serious’.  For MENA governments heading in the right direction, they “do not necessarily know how to optimize the processes as best they could.” Regional governments would do well to learn of the Gulf economies’ experiences that “companies owned by private equity firms perform better than others because owners in the business are highly motivated to build and grow the companies, and to create equity values when you have incentives offered that are different from structures in other companies.” The result is that “companies that grow faster, tend to be more aggressive and provide better services and products to their customers, and they tend to have satisfying work environments for the people involved. The discipline and focus on building business value that private equity firms have generated elsewhere in the world can be very valuable in the MENA region to help countries fully optimize what they are doing.”

Wages indicated that government motives “range from raising cash for themselves to using privatization as a way of making the economy more efficient. All of the governments have mixed motives. I think when they focus on country efficiency; it tends to make transaction work well because commercial considerations are very important.”

Romen Mathieu of Capital Trust Group splits regional private equity outlook into North Africa and the Middle East. He believes North Africa “will continue its growth. Algeria is opening, although there are some issues from time to time, but privatizations are going ahead. Morocco is already a mature market in terms of private equity and there are lots of private equity firms, lots of deals over there and a good stock market. Tunisia is small but has a very good stock market. Egypt is a very mature market, 80 million consumers and a lot of interest for private equity. We could invest hundreds of millions just in Egypt and it has a very good stock market as well.”

“Jordan, Palestine, Syria and Lebanon are the question mark, unfortunately,” said Mathieu. He thinks that “there are not many regional private equity funds in Lebanon, we are one of the only ones. We are still here because there is the sea, the sky, the mountain, and our families. We still find an advantage in being here in Lebanon, which is very important although you see in our portfolio we only have two Lebanese companies out of seven and even these are regional.”

Infrastructure private equity deals in MENA during 2007

Coordinating expeditions

Gulf Capital’s Dallas believes that it is not so much a consolidation that industry watchers should expect, but instead a change in their environment, one which brings a competitive spirit for firms to create value. He explained that “now this region is flush with liquidity. Raising money is not the issue, but you are going to have inter-linked economies over time. We may not be subject to global competition today, but my view is that in the next five to seven years, you better be ready for global competition.”

Dallas does not think the firms established in the region are insulated just because the Gulf is booming.  Like many others, he believes “there are going to be other people who try to come here. So businesses have to become world-class, ready to deal with world competition. And so I think it is incumbent upon the investment community to be involved in this area, but it is going to take a while and you will have private equity firms that emerge to give them a meaningful opportunity into the ability to do business here.”

A. Shabu Qureshi, director of EMP Global, also agrees that private equity will face competition “as the more aggressive firms go outside of the region from GCC to MENA, and then to Asia, those numbers of businesses are going to shrink. If your market is Saudi Arabia, you grow the number of businesses you have, but once you go outside of your country you grow by picking your best business and really try to focus on them and expand them as much as possible. Over time this will lead to a consolidation in the number of businesses that large family groups are involved with.”

Wages was much more sanguine about the outlook for the regional private equity business. He explained that industry consolidation is “a long way off. In the US, there are nearly 2,000 PE firms. In the MENA region, there are probably less than 100 in total with different specialties, so we are currently not worried about competition. The economies are growing, there are plenty of companies, and a lot of ways people can participate in private equity here.”

Looking forward, Abe Saad, partner at Rasmala, believes the region will see more international firms. According to Saad, “there are a lot of international firms coming to the market, but you see a lot of small, regional firms popping up. I think the challenge is to be able to raise a second fund. Raising the first fund, because of high liquidity, was easy. It’s a must to get the partners from the core fund to have those same partners invest with you in the second fund.”

For him, what will separate the men from the boys is “a shakeout or a consolidation in the area. Right now we see new funds popping up everyday. It’s good to have some Western funds coming into the region that will raise the bar for everybody. You will see a few regional players whose profiles and balance sheets could compare with the international players. You have some Western educated personnel in small mom and pop shops, but that is really about it.” 

Some firms can avoid consolidation by maintaining a non-traditional focus for the region. Junaid Jafar does not foresee his firm juggling consolidation worries, as their investments expand into developing markets in Africa and Asia. The institutional money from the Gulf, to which they are entrusted, keeps them confident that “what we are trying to do here is to build our own platform and cross-utilize the existing EMP franchise to provide investors with a number of regional funds, an option nobody can provide at the moment.”

Status of PE transactions 2007

Size of PE transactions 2007

Looking to the next phase of development in the MENA region and the private equity firms which will accommodate it, TNI’s Yahya Jalil would “like to see where some of the 50-plus entities who claim they are doing private equity in the region are in five to ten years down the road. In other words, what I hope to see is variation in performance. I hope to see the best firms migrate to the upper quartile of fund performance, with audited fund track records, not just claims. That will pave the way really for the private equity industry in the GCC to enter its next phase of development.” Injazat Capital’s principal of private equity, Rami Bazzi, explained that the industry “evolved from being a collection of random investments to more structured types of funds with a well-defined investment policy and a well articulated investment strategy. I believe this trend will be reinforced going forward.”

Bazzi foresees a shift “from opportunistic or generalist funds to industry-specific funds. While opportunistic funds offer an enticing business proposition, I believe we will be seeing more industry-focused private equity funds. These funds will add value to their portfolio companies as well as the industry in which they operate.”

However, not every industry executive agrees that consolidation is already in the works in the medium term. Khaled Al-Muhairy, CEO of Evolvence Capital, believes that consolidation will not yet occur and thinks “everybody wants to be king of his empire.”

According to him, “we are going three steps ahead. In every society you have the banking sector, the insurance sector, and investment banks and large investment companies. But if you look down across the Gulf, only Kuwait has that. There are not that many investment companies in Dubai. They are just starting the DIFC. There is nothing in Abu Dhabi, there is nothing in Qatar, in Bahrain there are few. In Saudi there is absolutely nothing, except now they are setting up. You need this layer before you move to private equity. That is what usually produces the managers who are in private equity. If you look at it like a pyramid, the first one is the banking sector, then on top of it, is the insurance sector, then the investment banks/investment companies and on top of that you put the asset-management business, which includes everything that’s to be managed.” 

However, what happens when you take one block out and move to the other block on top? For Al-Muhairy, “every segment feeds off the whole. That is how capital markets are in terms of resources. People from investment banking, after being successful, are moving into private equity. You do not see a credit officer or the head of a retail bank moving to become a private equity player.”

Disregarding the jump as nonsense, al-Muhairy said that firms follow the logical ladder of the private equity business, but “unfortunately, that number three isn’t there, or tiny if it is there. So all across the Gulf you need to create 200-300 investment companies. Those companies, if they can produce five people a year, then you are talking about a thousand knowledgeable people coming in terms of private equity, managing assets, managing people, managing deals, getting transactions.”

In the end, Al-Muhairy thinks that “it’s very simple. The way I look at private equity here is that it’s phase one out of seven to eight phases. It is fashionable. Today I told a very experienced placement agency that private equity is like a dance; sometimes you make a mistake, but you have to if you want to dance. And it’s a 10-year commitment and it’s a top-down approach in terms of people. You manage people on partner levels and you manage portfolio companies that have people who make them. So you have to be really good in communication.”

In the short-term and medium-term, private equity is likely to remain strong in the MENA region, buoyed by high oil prices and the abundant liquidity for investments and deal flows from increasingly regional entrepreneurship. According to Ziad Maalouf, senior vice president of MENA Capital, “the only thing that remains a challenge is the exit. We need more efficient capital markets to be able to accommodate the increasing number the private equity deals that would be looking for viable exit strategies in the coming few years.” SHUAA Partner’s Brair thinks that the benefits of private equity firms are yet to be seen, and believes that “you will be able to realize the benefits of private equity if you fast forward five years.”