Finance

A new era of innovation starts in the Middle East

by Shaun Young
written by Shaun Young

Here’s a story you may recognize.

Ten years ago, two young Jordanian entrepreneurs founded an internet services company to foster an online community through which Arabic speakers could access and generate content. At the time, Arabic-speaking Internet users were only in the thousands and there were no regional venture capital (VC) funds. Undeterred, the entrepreneurs continued to experiment with different business models in the Web 2.0 space until they found one that worked. With some financial support from their families, the entrepreneurs were able to set up an office in Amman, launch their business and become pioneers in developing content for the world’s 320 million Arabic speakers.

If you identified the company as Maktoob, you’d be correct, and know that the story’s climax is last year’s $164 million acquisition by Yahoo!, marking the first major deal of its kind in the Middle East.

But, you’d also be right if you answered Jeeran.

Sharing an origin and path similar to Maktoob, Jeeran is an ad-funded online community that incorporates blogs, videos and photo sharing. With more than 6 million unique visitors per month, Jeeran is one of the most popular blogging services in the Arab world.

The example demonstrates that in the Web 2.0 space in Jordan alone, there are many promising tech start-ups: Arabic animated content, technology and multimedia design firm Think Arabia has created an educational animated short to introduce Google’s products to Arab-speaking Internet users. There is online recruitment company Akhtaboot and social media management and advertising firm Modern Media.

Among these tech start-ups, is there the next Maktoob? Quite possibly. Regarding Jeeran, Think Arabia and Akhtaboot, investors are likely to be thinking of them as the Facebook, Cartoon Network and Monster.com of the Middle East. These are tested business models transplanted in nascent and growing markets.

The more interesting question may be: Who will be the Yahoo! for the next Maktoob? Investors from outside the region will likely rush in, but the entrepreneurial ecosystem has evolved since Maktoob and Jeeran launched. Jordanian VC fund IV Holdings has invested in Jeeran. Dubai-based Abraaj Capital has bought the rights to a Think Arabia cartoon series on entrepreneurship. A prominent Middle Eastern entrepreneur has already invested in Modern Media and Akhtaboot.

With increasing regional investment and mentorship, the vernacular for rising stars in the Middle East is shifting from “the next Google” to “the next Maktoob.” According to Aramex chief executive officer Fadi Ghandour, “there is the potential for more ‘Maktoobs’ throughout the region right now. The challenge is supporting them, because several markets are more than emerging — they’re ready to explode. ”

Elevating entrepreneurship that generates the greatest impact

Small to medium-sized enterprises (SMEs) are prevalent throughout the Middle East. In April this year, the United Nations Economic and Social Commission for Western Asia (UN-ESCWA) Executive Secretary Bader al-Dafa reported that SMEs account for over 90 percent of businesses in the Middle East. Dafa added that SMEs build national economies through the job opportunities created for young people, the reduction of unemployment rates and increases in GDP.

If SMEs are a considerable driver of job and wealth creation in the region, it’s essential to support them. However, given that SMEs are such a large percentage of all businesses in the region, it seems only practical to identify and support the entrepreneurs who have highest potential and impact.

Endeavor is the global organization that pioneered the concept of “High-Impact Entrepreneurship" in emerging markets. The nonprofit identifies and supports entrepreneurs with the greatest potential for creating jobs, prosperity and a culture of innovation and investment. For 13 years, Endeavor has selected and supported 539 ‘high-impact’ entrepreneurs from 349 companies that have generated more than 130,000 jobs and $3.5 billion in annual revenues.

In its four years of operation in the Middle East, North Africa and South Asia (MENASA), Endeavor’s portfolio of high-impact entrepreneurs has grown rapidly (see chart). As of October, Endeavor was helping 41 companies that generate more than $163 million in annual revenues and provide 3,842 jobs across the MENASA.

“When Endeavor launched in 1997 with offices in Chile and Argentina, the landscape in Latin America looked similar in many ways to the Middle East today. I’ve been knocking down the doors of Silicon Valley VCs to let them know that the time for the region is now,” says Endeavor co-founder and CEO Linda Rottenberg.

Within the MENASA portfolio, there are companies that have grown into large enterprises and have become role models to aspiring and fellow entrepreneurs. For example, Pharmacy 1, the leading drug store chain in the Middle East, or Airties, the first company to introduce MESH networking technology suited for emerging markets.

However, as Endeavor has witnessed in Latin America, many more entrepreneurs can thrive given an integrated and international ecosystem of entrepreneurs, investors and mentors.

 Argentina to Egypt: a comparison of emerging market entrepreneurs

Egyptian entrepreneurs Ahmed Metwally and Mostafa Hafez head Nasr City-based Timeline Interactive, which develops video games that can be purchased and downloaded online. In 2009, Timeline released CellFactor, the first downloadable video game to use sophisticated 3D visuals and game play physics in five languages and for $10.

Founded in 2005, Timeline has already gained globally recognized partners and clients. The company is the first and only video game studio in the Middle East certified by Microsoft and Sony to develop games for Xbox360 and PS3. Timeline is creating a gaming ecosystem in Egypt by training engineers and cultivating demand for high-end games.

Metwally and Hafez also position themselves more broadly within the entrepreneurial ecosystem in Egypt. They understand that few investors and entrepreneurs in the Middle East take the initiative to become part of such a new movement. On another continent and in the same year Timeline launched, Mariano Suáraz Battán and Patricio Jutard founded Three Melons in Argentina’s nascent video game industry. After raising financing, the duo created their first game connected to advertisers, called an “advergame.” The launch of the company’s Indiana Jones LEGO game drew more than 10 million users worldwide, and more than 800,000 people every day play Bola, the studio’s first social game, on Facebook and Orkut.

Fellow Argentine and serial entrepreneur Wences Casares mentored Three Melons since its inception, and Battán and Jutard were able to raise $600,000 from Santander Bank. Jeff Brody of Silicon Valley-based Redpoint Ventures provided strategic advice to Three Melons during its acquisition by Silicon Valley social gaming firm Playdom. In July 2010, Disney acquired Playdom for $763 million.

Both Timeline Interactive and Three Melons started out with under a million in annual revenues, navigated the forefront of a regional market, developed a landmark product and won global recognition. The difference is that Mariano and Patricio benefited from a rapidly-developing ecosystem: the global and local network of investors, mentors and fellow entrepreneurs that catapulted Three Melons to the next level.

The catalyst of an established network composed of global and local investors, mentors and entrepreneurs, separates a country of high-impact companies and one of high-potential companies. Take Colombian based fitness center Bodytech and Turkish gym B-Fit or mobile phone software solutions providers ComperanTime of Brazil and Javna of Jordan, and the trend continues.

In these cases, the Latin American companies generate more impact — in annual revenues and jobs — than their Middle Eastern counterparts. Seasoned entrepreneurs like Fadi Ghandour and Maroun Chammas are set to change this. Charles el-Hage, former senior partner (now retired) at Booz & Company, says: “Entrepreneurs in the Middle East are not only creating innovative, high-growth, globally-competitive enterprises, they are assuring future generations of young entrepreneurs in the region that they can be next.”

“How soon?” not “What if?”

In Young World Rising, author Robert Salkowitz says the most important business story of the next decade is the convergence of three powerful trends: demographics, technology and entrepreneurship. The Economist addresses the union of these elements in a recent article on the rise of young entrepreneurs in emerging markets. In terms of trends, the much lower median age in many of these countries in 2020 is only the start (see chart above). Younger entrepreneurs are leading the internet technology revolution and have the uncanny ability to identify and shape new markets. They exchange seniority and security for risk and returns, and having succeeded with the trade-off, create a middle-class segment that has the wherewithal to also embrace risk. People in this group either have benefited from or are inspired to become entrepreneurs.

The article spotlights companies from Argentina to Ghana and concludes: “The next Facebook is increasingly likely to be founded in India or Indonesia rather than middle-aged America or doddery old Europe.” The article’s conclusion is provocative, but not as much as its omission: nowhere is a company or entrepreneur from the Middle East mentioned.

In the Middle East, technology, unemployment and innovation will start to expedite the development of the entrepreneurial ecosystem. It will happen by necessity, if not by design.

People under the age of 30 account for 70 percent of the Middle East’s population and this demographic is the primary driver of Internet penetration rates, which reached 28 percent in the region in 2009. There is urgency as this demographic faces one of the highest unemployment rates in the world. According to King Abdullah II of Jordan, the region will need to create over 200 million jobs by 2020.

Where established employers fail to provide them, many entrepreneurial young people will take matters into their own hands; in June 2009, Qatar-based nonprofit Silatech reported that 26 percent of Arab youth are planning to open a new business in the next year, in comparison to 4 percent of youth in the United States. 

With such a hunger for entrepreneurship, many aspiring and current entrepreneurs from the Middle East will participate in Global Entrepreneurship Week (GEW) in the region and the “Celebration of Entrepreneurship” conference in Dubai this month. Last year, 5.4 million participants attended GEW events in Endeavor-hosted countries. In the first quarter of 2011, Endeavor Lebanon will launch and, within the year, will support a portfolio of Middle Eastern entrepreneurs.

Who knows — one of them may be the next Maktoob.

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Economics & Policy

Chinese whispers

by Gareth Smith
written by Gareth Smith

 

With Russia, we remember centuries of territorial disputes, with the British their past control of our oil, and with the Americans we remember them supporting the Shah,” says a leading business journalist in Tehran. “There is no memory of China in our contemporary history, and therefore little emotion.”

On the other hand, Iranians are wary of cheap Chinese goods that have — as in so many countries — flooded the market, bankrupting domestic textile and shoe manufacturers. And there are rumbles too over the quality of Chinese technology in building the Tehran metro.

As a result, mixed feelings over China abound in Tehran as Iran’s relationship with Beijing becomes crucial both to its economy and its international policy. As the latest wave of United States-led sanctions squeeze Iran’s trading partners, including South Korea, many Iranian analysts are nervous about overdependence. This is political as well as economic; China now stands as Tehran’s main supporter in the United Nations Security Council, after Moscow’s decision in September not to supply the S-300 missile defense system signaled its disquiet with Iran.

In economic terms, the summer’s United States and European Union sanctions have increased China’s importance to Iran both as a supplier of gasoline and a buyer of crude. Sadegh Zibakalam, politics professor at Tehran University, warned in September of the dangers. 

“It would be most unpleasant if the Americans make trouble for the Chinese,” he wrote. “China has for some time decreased its investments in and oil purchases from, Iran… The claim that the sanctions have not worked and have forced us to blossom is all entertainment and propaganda.”

China has considerable investments in Iran’s energy reserves, including an agreement in principle to buy 10 million tons per year of liquefied natural gas (LNG) over 25 years from the largely untapped South Pars field. Sinopec, the Chinese oil group, has agreed rights to exploit the Yadavaran oil field in the southwestern Provence of Khuzestan, with reserves reported at 15 billion barrels.

But much Chinese investment is far from nailed down. Work at Yadavaran is overdue.

 There have also been reports in Iran that China National Petroleum Corporation (CNPC) has slowed down work on a master plan for the South Azadegan oilfield, despite Iran pressing it for a final agreement on a 70 percent stake. Under US pressure, Japan’s Inpex announced last month it would be relinquishing its 10 percent share in Azadegan.

CNPC has also trimmed its involvement in the second phase development of the Masjid Soleyman field in Khuzestan. Work seems far faster at North Azadegan, where engineering, procurement and construction tenders are expected this month after CNPC recently finished the front-end design.

Crude sales slowing

As a supplier of gasoline for Iran, China has become more important since operators including BP, Vitol, Trafigura, Glencore and Reliance ended sales earlier in the year because of threatened US action against suppliers. At the same time, there are growing, if inconclusive, reports that Iran is having difficulty selling crude. This could have a marked fiscal impact as oil sales account for around 80 percent of Iran’s foreign currency revenue and 60 percent of the government budget.

UN and EU sanctions exclude crude sales, but US banking restrictions have impeded the use of letters of credit, while EU restrictions on insurance deter shipping companies from sending tankers to Iranian terminals. Traders had been using Asia-based banks to open letters of credit, but recent sanctions announced by Japan and South Korea obstruct this option, leaving Chinese banks as the main source of finance for Asia’s trade with Iran.

Iran has reduced the amount of crude stored at sea since a peak in June of 40 million barrels, the highest offshore build-up of Iranian crude since 2008. But it still had 20 million barrels anchored offshore in late September, according to Reuters. The Paris-based International Energy Agency (IEA) said in September that Iran might resort to storing more oil in tankers “as new sanctions have the unintended consequence of squeezing crude buyers.”

Thomas Strouse, of Washington-based oil consulting firm Foreign Reports, has used Chinese customs figures to ascertain that Iran remains the third largest oil supplier to China, a position it has held consistently since 2005 behind Saudi Arabia and Angola. But from January through to the end of August, Chinese crude imports from Iran did decrease year-on-year by 24.7 percent to some 391,000 barrels per day.

Scaring the customers

Strouse argues that China’s reduced imports were less a consequence of Western political pressure than of Tehran’s uncompetitive pricing.

“There are a number of reasons for China’s reduced oil imports from Iran and not all of them are political,” he says. “China wants to diversify its supply, and this means reducing its dependence on Iranian oil imports. It would be logical to assume that the Chinese have made a geopolitical assessment that Iran may not be the most secure and stable source of supply in the future.”

But that is far from the end of the story. “Additional reasons for China’s reduced imports from Iran include uncompetitive pricing and reduced Chinese demand for Iran’s heavy crude,” says Strouse. “Japan, the other leading purchaser of Iranian oil, has also reduced its imports from Iran in 2010, offsetting this reduction by a surge in imports from Russia. A new supply of oil from Russia’s Eastern Siberia is seen as more favorable, not only because of its geographical proximity to Japan, but also because of the reduced threat of a potential supply disruption in a place like the Strait of Hormuz.”

 

In general, China wants a diverse supply as it pursues high economic growth, and Iran is not expected to increase production in coming years. But those in Tehran nervous at political and economic dependence on China will note that while China currently imports only around 8 percent of its oil from Iran, more than 15 percent of Iran’s oil exports flow to China. 

The centralization of Chinese buying increases the scope for geopolitical assessments in its decision-making. “Beijing can turn the tap off, if it wants,” says the Iranian business journalist.

China’s only two lifters of Iranian crude — Unipec, the trading arm of Sinopec, and Zhuhai Zhenrong — are both state-run, and they are also among the Chinese companies that have been supplying around half of Iran’s gasoline imports, exploiting the gap left by suppliers fearful of US sanctions. Overall, China will likely continue to take advantage of opportunities in the Iranian market, but will keep a watchful eye on its wider political and economic interests.

US officials have recently been saying that China is violating UN sanctions against Iran, and President Barack Obama has reminded the Chinese of their extensive interests in the United States. The American right wing has China firmly it its sights. “The US State Department estimates that companies have terminated between $50 and $60 billion in energy projects in Iran owing to the threat of sanctions, but European businesses remain concerned that Chinese companies will snap up their voided Iranian contracts if and when they withdraw,” said Mark Dubowitz of the Foundation for Defense of Democracies in September.

Iran knows it still offers opportunities for China. Both in government and among ordinary Iranians, there remains a deep-seated sense of the country’s rich natural resources.

If anyone around the world had forgotten this,  in October Iran declared a hike in its oil reserves estimates by nearly 10 percent to 150.3 billion barrels — just days after Iraq announced a 25 percent increase to 143 billion barrels in its reserves.

Iran also boosted its gas reserves figure by nearly 18 percent to 33.1 trillion cubic meters, cementing its position as the holder of the second richest gas resources after Russia.

But extracting those carbon reserves is far from easy with US, European and many Asian companies eschewing the market. Massoud Mir-Kazemi, Iran’s oil minister, warned earlier this year that the country required $25 billion per year in investment just to maintain current oil production levels. This figure is unlikely to be raised by Chinese investment or by issuing bonds. No wonder the IEA has forecast Iran’s oil-pumping capacity will by 2015 drop about 18 percent to 3.3 million barrels per day.

 

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Finance

Q&A with Stefan Keitel

by Emma Cosgrove
written by Emma Cosgrove

Stefan Keitel is managing director and global chief investment officer at Credit Suisse. He recently sat down with Executive to discuss how to best cash in on today’s investment trends, as well as a Credit Suisse fund that is raising some eyebrows.

E  What is the best way to take advantage of the upswing in emerging markets?

There are many ways to invest in emerging markets, which are definitely a long-term trend. It completely makes sense to go for emerging market equities. It completely makes sense to go for emerging market bonds. In both asset classes, we strongly recommend investment in local currencies.

Another way to invest in emerging markets that is quite interesting for some conservative United States or European investors is buying European or US firms which have a major stake of their business model dedicated to the emerging markets, let’s take Nestle for example. Nestle is a very conservative Swiss corporate and has one third of their business model dedicated to the emerging markets and that is also where one can invest indirectly into the emerging markets, so that’s the way we would like to go; catching the trend by buying a visible stake of the overall equity portfolio into the emerging markets.

E  Is there a reason you have not included [emerging markets index] trackers in this recommendation?

That’s more on the selection side. When we talk about portfolios, on one side we have the asset allocation decision. When we then talk about how to implement the emerging markets, to fill this allocation with life, then of course we have to find the right way to go for that. And here, you can also do it in different ways. I think the mixture is key.

You can go for active managed funds to go for ‘selection alpha’ [when managers’ performance is above market performance]. From my personal point of view, from our point of view, this is a good strategy because the emerging markets are not efficient markets. They are not comparable to the big US markets or the big European markets. The active fund manager can definitely manage ‘alpha,’ nevertheless you can also go for trackers to minimize risk and to go for broad diversification. That means we strongly recommend both.

But, when you compare the emerging markets with traditional markets, then it’s crystal clear that the best strategy to go into the emerging markets is an actively managed fund.

E  Do you feel that investors have lost trust in products coming from big names like Credit Suisse?

I would not say that it has something to do with the products from the big names. I think it is a mistrust of all types of structured products because the financial crisis clearly showed the disadvantages of structured products with regard to transparency and liquidity and sometimes understandability. I think these elements are now more or less a drag for the success of structured products.

E  Have you dropped any products since 2008?

No. Of course there is a kind of shift in thinking; I think now there is a bigger challenge to be able to explain the rationale behind [the product] because a client now puts more requests on the table. This has influenced [the industry’s] strategy in selling structured products. For the advisory space, structured products definitely make sense and can add value.

It is [with non-standardized discretionary clients] where you have to differentiate an individual customized concept, [to make sure] that it makes sense, but [structured products are] not for the standardized discretionary management.

E  Can you confirm that the “Emerging Markets Credit Opportunity” fund launched in August by Credit Suisse contains Israel’s Koor Industries, the Qatar Investment Authority (QIA) and Saudi Arabia’s Olayan Group?

This I cannot. I am responsible for the scenarios of the asset allocation and the concept and the philosophy as a CIO. And I think the fund managers and portfolio managers on the equity and fixed income sides have to deal with the different selection opportunities. This cannot be my job.

E  If you are involved in strategy then this has to affect you, no?

Not really, no.

E  Do you deal with individual clients?

In special cases, because we are explaining how to build up a strategy and how to run discretionary mandates and we do that for them. But in special cases, especially for the premium clients on the private client side or for the institutional clients, I as a CIO of course have to go to the table to be involved in the conversation. And that’s also a request of the clients. I think the big endowments and insurance companies, but also the ultra high net-worth clients, want to see the CIO. They want to hear from the CIO how they see the world and what is going on with the macroeconomics and the GDP and inflation/deflation story.

E  Have you had personal contact with your largest shareholders in the last month?

Every month on a frequent basis.

E  It seems logical then to say that you would have contact with QIA, Koor and the Olayan Group in the last month since the launch of this fund, which would be part of their portfolio…

No not in my specific case, no. We have also some other important people at the bank and I assume that they perhaps have been in contact.

E  Are you advising to buy gold right now?

I would not advise to buy right now but gold is my personal favorite topic since 2003. I think it is an ongoing story. I would buy gold but I would not give that misleading statement to buy it right now. I think my main call was to have bought it 10 years ago and use every consolidation phase and correction phase to add a portion to the gold market. And also on the global basis, I used the first opportunity to go to a 3 to 5 percent gold investment for all of our portfolios — for the discretionary space and also it was a recommendation for the advisory space. And I am still of the opinion that the gold trend is anything but over because I think there is mistrust in the world’s leading currencies right now, not only [regarding] the euro but [also] the British pound and others. And this is a main driving force for the gold price.

Investors definitely mistrust the stability of paper money and that is the reason that all of these big clients have now started to invest step by step into the gold market; to them, gold is a kind of diversification and a kind of insurance against all negative eventualities and that is the driving force for gold.

We are pretty convinced that it is extremely difficult to come back to a scenario where these big investors have trust in paper money because the imbalances are not getting smaller, they are rather getting bigger because [Western governments] are going to stimulate [their economies] further.

When I look at the portfolios of the big clients, many of them are talking about gold, but in their portfolios, they have allocations of 0.5 percent, 1 percent or 2 percent. There’s much room for further gold interest. Gold is not a safe haven — gold is a very volatile asset class. But I think it is extremely necessary for the overall portfolio. And when gold shows volatility, that’s another buying opportunity for the long-term because it is a long-term strategic story and not an asset class you should invest in tactically.

 

 

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Economics & Policy

Food prices in check

by Executive Staff
written by Executive Staff

Food prices in check - LebanonLast month the cabinet endorsed a measure to allow for price controls on food products that would assign levels of “acceptable profits,” according the Agriculture Minister Hussein Hajj Hassan. The ministry reported that prices of tomatoes have risen by almost 100 percent in the past four months alone, with one variety up as much as 400 percent. Hassan also attacked the policy of former Minister of Economics and Trade Sami Haddad for issuing a ministerial decree that annulled a previous legislative decree that had set a profit margin of 27 percent for middlemen dealing in various foodstuffs and household items. The minister also stated that he expected meat prices to remain high until after Eid el-Adha. Hassan said that his aim was to lower the import-export ratio for food in the country from 80:20 to 60:40.

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Finance

Banking Special – Asking for the moon

by Emma Cosgrove
written by Emma Cosgrove

 

When Beirut’s wealth managers talk about the financial crisis, their language is decidedly emotional. They speak of the “support” they gave their clients as they watched their portfolios crumble. They say that their clients “suffered,” that they were “hurt” and “scarred.” Clients felt betrayed and blindsided, as “a major part of these losses were derived from risks that they were unaware of,” said Dory Hage, head of advisory and asset allocation at Banque Libano Francaise. 

Now that the bloodletting is mostly over, the worldwide economic recovery has created a unique financial climate in which wealth managers and their clients are feeding off the slowly healing global economy to mend their own fortunes even quicker.

But while they may both be in a far happier place than they were a year ago, the travails they went through together have changed the nature of the game.

According to consultancy firm Capgemini’s annual World Wealth Report for 2010, the number of high net-worth individuals (HNWIs) — those with over $1 million in investable capital — worldwide grew by 17.1 percent in 2009 after decreasing by 14.9 percent in 2008. The total fortune of these individuals also grew last year, increasing 18.9 percent from 2008 to reach $39 trillion.

But in the Middle East, the number of  HNWIs only grew by 7.1 percent and the collective fortune of the region increased by just 5.1 percent. The region’s HNWIs are regaining their wealth slower than much of the rest of the world, and they’re not happy about it. Lebanese investors in particular are proving to be an especially intractable bunch.

The Where

George Tabet, head of private banking at BLOMInvest said he’s seen a reflexive abandoning of foreign banking hubs in favor of returning home to Lebanon’s alluring interest rates.

“Big clients used to put a big part of their money in big banks in Switzerland, Luxembourg or Singapore. Now, after the crisis hit the big banks of the world, they [decided] to move a big part of this money to Beirut,” he said.

Investors we drawn by the high returns offered on deposits in local currency (averaging 5.72 percent in August according to Banque du Liban, Lebanon’s central bank.) Even dollar rates at Lebanese banks remain attractive on a global scale, with the weighted average rate on offer at 2.78 percent as of August.  And though these rates attracted record capital inflows into Lebanese banks, they also raised expectations and demands from clients who have grown more risk averse but still want to make higher returns than their bank account can provide. 

The Who

After a client decides which institution will guard what is left of his piggy bank, he has to decide how much control he wants over how his cash is invested. And opinions differ as to which way clients are tending.

Some say that discretionary clients, those who turn all their investment decisions over to a wealth manager, have become more prevalent as clients have realized that they have neither the knowledge nor the time to manage their own money in what have proven to be complicated and volatile times.

Nael Raad, deputy general manager of Ahli Investment Group Lebanon is of this belief. “In these kind of markets you can really get hurt. I think people tend more to give their money to asset managers. They are less trusting in their own capabilities.”

Naji Mouaness, head of consumer banking at Standard Chartered Bank Lebanon agreed that some form of discretionary relationship leads to better results.

“There is a science behind investing, and a traditional do-it-yourself approach driving conventional decisions may often not lead to the best result,” he said. “Deciding where to invest and investing is just half the job done, since our needs will evolve over time… regularly monitoring and re-balancing your portfolio is very important so that it is always in line with your changing requirements.”

Others claim that after incurring the losses of the past two years, clients have never been more insistent that every decision regarding their portfolio be their own.

Roula Habis, general manager of Middle East Capital Group, like most of the managers Executive consulted for this report, prefers that clients be involved in deciding the course of their portfolio. “Even if the market goes down, they will understand why their portfolio went down. If you just manage their money discretionarily, you’ll be totally responsible.”

Just as clients’ preferences as to who controls their portfolio have shown conflicting trends, mangers say that their financial behavior has been similarly erratic.

“People either liquidated their portfolios and went into real assets like real estate here in Lebanon because there was a boom, or they took more risk and started trading their portfolios,” said Mohammed al-Hamidi, managing director of AM Financials.

The risk-taking clients looking to take advantage of market volatility forced wealth managers to change the nature of their jobs.  “The period where there is a boom and bust is becoming shorter and shorter. And the reaction of the markets, because of technology, is becoming much faster and much more severe… we have to be more agile,” said Hamidi.

With this volatility, many of the traditional safe stores for capital have lost their utility, making way for other asset classes whose relative volatility seems less in such unstable markets.

“For the last two years or so, more conservative investments proposals were requested by clients; fixed income products, bonds, inflation-hedged products and the like,” said Reto Bartels of UBS’s Beirut representative office.

“Bond prices went up and more risky asset classes like equities became cheaper. In fact, equities look rather inexpensive today, and the next trend might be that the risk appetite of the investor is coming back again and investments in equities and commodities might increase, with rising prices as a consequence.”

Beirut’s financial minds all have their opinions on where these trends are going and how to seize the market as it morphs with fits and starts into whatever the brave new world of the financial recovery will look like. Until we reach that high ground again, the traumas of the crisis will remain fresh in client’s minds, and fully understanding current operating conditions is as important as ever.

To address this need, Executive has pooled the expertise of the best minds in Beirut to help investors be the masters of their own fortunes.

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Last Word

Empire in austerity

by Executive Contributor
written by Executive Contributor

In an article earlier this year for Foreign Affairs magazine, the British historian Niall Ferguson discussed how quickly empires collapse. He noted that while many observers have tended to assume long cycles of imperial decline, a breakdown could come suddenly, “like a thief in the night.”

Ferguson has argued that the American empire is more likely to disintegrate for reasons related to the domestic economy than foreign policy. In his book ‘Colossus: The Price of America’s Empire,’ he argued that imperial America faced a ballooning fiscal crisis brought on by a propensity to consume much and save little, as well as an impending social security crisis caused by Americans living longer and overburdening the fiscal system.

In the Foreign Affairs article, Ferguson focused on the vital matter of perceptions of decline. Even if fiscal shortcomings were not enough to erode American strength, he pointed out, “they can work to weaken a long-assumed faith in the United States’ ability to weather any crisis.” Just look at the relatively minor sub-prime defaults that spread through the global financial system by “blowing huge holes in the business models of thousands of highly leveraged financial institutions.”

 Another scholar, Michael Mandelbaum, recently examined the implications of the financial crisis on American foreign policy in his ‘The Frugal Superpower: America’s Global Leadership in a Cash-Strapped Era.’ He argued that America’s debt obligations following the 2008 financial crisis, as well as its fiscal structure and entitlement programs such as social security and Medicare, prevented the country from continuing to play the leading international role it has for decades. 

 “[T]he public will no longer feel able to afford, and so will not support, operations to rescue people oppressed by their own governments and to build the structures of governance where none exist,” Mandelbaum wrote. “Interventions of this kind, which the United States has undertaken in the last two decades in Somalia, Haiti, Bosnia, Afghanistan, and Iraq, will not be repeated. The American defense budget will come under pressure, and so, too, therefore, will the missions that the defense budget supports.”

 All this raises an interesting question. If, as Mandelbaum affirms, the United States becomes more frugal abroad, will that not undermine America’s long-assumed faith in its ability to weather any crisis, as Ferguson pointed out? In other words: too much realism about American limitations may actually accelerate America’s waning.

Certainly that is true in the Middle East, where, under President Barack Obama, the US has visibly downgraded its commitments. Obama has withdrawn American combat forces from Iraq. He has overseen a significant tightening of sanctions on Iran, in part to better avoid being sucked into an expensive, hazardous war with the country over its nuclear program. Obama’s support for Palestinian-Israeli peace, while it fulfills a campaign promise, may be viewed as an effort to stabilize a region that might cost the US dearly in the event of new conflicts.  Even in Afghanistan, where Obama has deployed 30,000 additional soldiers, information recently published by the journalist Bob Woodward indicates that at the heart of Obama’s thinking were a clear-cut exit strategy and financial worries. “I’m not doing 10 years. I’m not doing long-term nation-building. I am not spending a trillion dollars,” the president told Secretary of State Hillary Clinton in October 2009.

That is sensible. However, America’s view of itself has always pushed in a contrary direction. It was John F. Kennedy who stated in his inaugural address that America would “pay any price, bear any burden, [and] meet any hardship… to assure the survival and the success of liberty.” For Obama to challenge that premise on financial grounds effectively denies Americans the self-assurance — some would say the egotism — a higher sense of purpose invariably brings with it. This in turn could hasten the demise of the American empire that Ferguson discusses.  Balancing national values with national accounts will remain a major difficulty for American leaders. But the process of change may be quicker than some imagine, as Ferguson believes. America may not be able to afford high ambition, nor might it long outlast excessive modesty. 

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Companies & Strategies

Buying back the Love

by Executive Editors
written by Executive Editors

A journalist from Executive magazine and 200 others from around the globe were flown to San Francisco last month on a junket that included airfare, two nights at the Hilton Hotel, gourmet cuisine and a perpetually open bar.

Clearly, hosts Microsoft had something they wanted to say, or more accurately, wanted the assembled hacks to say. While some events make news, others are made news, and the later was certainly the case with the launch of Internet Explorer 9 (IE9) beta.

But why such expense for the trial version of a ninth edition web browser? As Sebastian Anthony, an editor at the AOL-owned technology blog Download Squad said, it’s been a good few years since Microsoft has been able to generate decent media coverage, while at the same time “Apple sneezes and people write a story about it.” Thus, perhaps, the reason for the public relations bonanza.   

Internet Explorer (IE), at one point the default browser of nearly 95 percent of web surfers, has seen its market share slip through the noughties to just over 60 percent today, as competitors such as Mozilla’s Firefox, Google’s Chrome and Apple’s Safari have gnawed away at IE’s slice of the pie. Still, that’s 60 percent of the almost 2 billion Internet users worldwide.

“It’s a fun story to tell sometimes how IE has declined, but it is still very strong,” said Brian Hall, general manager of Windows Live and Internet Explorer. Microsoft officials promised, and in many ways demonstrated, at the September 15 launch in San Francisco that IE9 heralds the next generation of web browsing.

While developers and enthusiasts might ogle over its “hardware acceleration” and the evolution of HTML5 coding, the layman attraction is that web browsing with IE9’s minimalist interface feels cleaner, and is a whole lot faster than competitors when it comes to loading large websites. (IE9 requires Windows Vista or Windows 7, however, so those using Windows XP or older operating systems will have to fork out for something newer).

Weeks before the beta launch, Microsoft gave many of the world’s most popular websites advance access to the new code and offered support to help optimize the sites for EI9, thus securing customer usage and adoption even before the release.

Then it was time for the charm offensive in San Francisco for the beta launch, which Microsoft will use to gather feedback from users and developers before launching IE9’s final version, at an as yet undisclosed date.

Regional strategy

Asked whether Microsoft had a specific strategy to promote IE9 in the Arab world, Hall noted that the company operates in most countries around the globe and while there are some unique local Internet intricacies regarding bandwidth and latency in developing markets, generally, “the market dynamics are quite consistent, which is: enthusiasts set the tone, sites drive the real adoption, distribution helps with adoption.”

He said Microsoft will now work at “encouraging” PC manufacturers to ship IE9 with their products, and Microsoft has more than 1,000 staff who will seek out local partners to work with. “Even in Lebanon, we will have people who are meeting with companies that build the top sites in Lebanon, and we’ll want them to do work for Internet Explorer 9.”

What profit?

This all sounds very expensive, leaving one glaring omission: how will Microsoft make money off IE9?

“We don’t,” said Dominic Carr, director of Windows Communication. “Our business model is ‘happy Windows customers.’”

As Hall explained: “We have a little tiny business called Windows,” an operating system with more than one billion customers. “Especially for home users, the number one thing people do on their PC is browse the Internet… our job is to give the best web experience to Windows customers that we can, and that is the purpose of the browser.”

So will this strategy work? Will IE9 help Microsoft regain browser market share and put smiles on the faces of Windows users?

“No one thought they would succeed with the X-Box, but they threw enough money at it until it succeeded, and now it’s huge,” said Download Squad’s Anthony. “I think [IE9] will succeed — they will throw money at it until it is a very big success.”

“It comes down to how much they value their free browser app, and whether they just want to beat Google — that might be the pure intention: they want to smash Google to pieces.”

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Finance

Regional equity markets

by Executive Editors
written by Executive Editors

Beirut SE  

Current year high: 1,200.49    Current year low: 953.88

>  Review period: Closed Sept 23 at 969.34 points               Period change: 1.4%

Despite a minor improvement in the MSCI Lebanon index, Lebanese stocks are in the mode of attractive pricing; the Beirut market is the biggest loser so far in 2010. Political concerns were unabated in September as market participants marveled at fractious interactions between local, regional and international power brokers. Citigroup analysts confirmed that they continue to regard real estate scrip Solidere as having price potential far above the sub-$20 range it has been traded at lately. Bank of Beirut saw some selling after disclosing plans for a $159 million preferred shares issue.

Amman SE  

Current year high: 2,693.91                Current year low: 2,223.30

> Review period: Closed Sept 23 at 2,309.21 points             Period change: 2.68%

Although gainers outnumbered losers on the Amman Stock Exchange in the review period, the ASE index has a ways to climb to alleviate concerns over the Jordanian bourse’s poor performance and lack of stamina in 2010. One has to wonder if the mid- September announcement of a prime ministerial committee tasked with examining the reasons for the ASE downtrend qualifies as reassurance for investors. On the bright side, the industrial sub-index was the best gainer on the ASE in the review period. Arab Potash gained 11.8% while market cap leader Arab Bank advanced 4%.  

Abu Dhabi SM  

Current year high: 3,239.74                Current year low: 2,467.04

> Review period: Closed Sept 23 at 2,639.33 points             Period change: 5.64%

With a price return that was less than half of what was seen in Dubai, the Abu Dhabi Stock Exchange on Sept 23 nonetheless closed still ahead of the DFM in terms of to year-to-date performance:  3.8% in the red versus Dubai’s 6.3%. But the more important matter is that all GCC bourses recorded a period of gains as the region celebrated the end of Ramadan. Real estate, which was weak in August, was the outperformer among sector indices on the ADX, followed by banking. The consumer index underperformed. Abu Dhabi Commercial Bank gained 26.5%. 

Dubai FM  

Current year high: 2,373.37                Current year low: 1,461.80

> Review period: Closed Sept 23 at 1689.45 points                                 Period change: 13.87%

It seems that perhaps Ramadan prayers and spiritual discipline are as good for the books as they are for the soul, as the Dubai Financial Market had its most bullish moments for some time in September. As the DFM index reduced its loss for the year to date to 6.3% by Sept 23 market close, the telecoms sub-index led all active sectors in double-digit gains. Whether that growth is sustainable remains to be seen. Logistics firm Aramex leapt almost 28% higher; market cap leader Emaar gained 15.6%.

Kuwait SE  

Current year high: 7,882.60                Current year low: 6,319.70

> Review period: Closed Sept 23 at 6840.10 points              Period change: 2.27%

The upward trend across GCC markets allowed KSE investors to breathe easily as the bourse’s benchmark index loss for the year to date narrowed to 2.4%. Industry and insurance were the best performing sectors on the KSE, making September a real “in” month on the Gulf’s northernmost exchange. Share prices of market cap leaders Zain and NBK advanced 8.3% and 7.3%, respectively. Losers in the review period included First Takaful Insurance, down 15.6%, Kuwait National Airways, down 7.7%.

Saudi Arabia SE  

Current year high: 6,929.40                Current year low: 5,760.33

> Review period: Closed Sept 21 at 6,434.90 points             Period change: 5.38%

While the Saudi Stock Market still didn’t return to its former glory after regressing a month earlier, the solid gain in the TASI benchmark index indicated a return to greener pastures for the year-to-date performance, in step with the monthly growth. Petrochemical and agro sectors outperformed the market while retail underperformed. Gains were broad based across sectors and with few exceptions, stocks advanced. Holy and national holidays meant fewer trading sessions than peer markets. 

Muscat SM  

Current year high: 6,933.75                Current year low: 5,968.36

> Review period: Closed Sept 23 at 6,339.29 points             Period change: 3.15%

With a middling performance as compared to its GCC peers, the Muscat Securities Market benchmark index returned to a positive reading for the year to date but remained a bit too close to the drop zone to break out in full cheers. Led by the services sector, the MSM sub-indices for services, banking, and industry all performed modestly above the general index in the review period. The most exciting thing for the Omani market after the holidays was the opening of subscriptions for the Nawras IPO.

Bahrain SE  

Current year high: 1,605.98                Current year low: 1,361.19

> Review period: Closed Sept 23 at 1,445.75 points             Period change: 1.91%

Continued recovery brought the Bahrain Stock Exchange benchmark index back within one percentage point of its value at the start of 2010. With its price to earnings ratio of 11.49x, the BSE ended the review period less pricey than the average 13.69 P/E ratio for GCC bourses. Banking and investments led the market’s gains, while movements in the insurance as well as the hotels and tourism sub-indices pointed in the opposite direction. Gulf Finance House emerged on the losing side with a drop of 13.8%. Market cap leader Ahli United Bank gained 4.3%.

Doha SM  

Current year high: 7,801.33                Current year low: 6,502.93

> Review period: Closed Sept 23 at 7,661.67 points             Period change: 6.03%

The first market trend in the GCC this year that conveys real rally flair is the rise of the Qatar Stock Exchange along a 12-week upward path since early July. By its close on Sept 23, the benchmark index in Doha had worked its way into the gains range of 10% versus the start of 2010. Financial values outperformed the general index on the QSE in September while the sub-index for services lagged behind. Among market heavies, Qatar National Bank and Industries Qatar benefited from the upwind, while market cap leader Ezdan Real Estate was flat.    

Tunis SE  

Current year high: 5,599.28                Current year low: 4,021.14

> Review period: Closed Sept 23 at 5,531.97 points             Period change: 4.07%

From the uninvolved observer’s perspective, the 2010 Tunisian Stock Exchange performance borders on boring, but it must be different from the local investor’s point of view. The Tunindex extended its gains further and by Sept 23 was up 28.9% for the year-to-date. Directly after the Fitr holidays, the index shot up 200 points to yet another record but at least there was some profit-taking in the last two sessions of the review period. Newcomers Carthage Cement and Ennakl Automobiles were among the best gainers, up by 8.6% and 4.7% respectively.

Casablanca SE  

Current year high: 12,457.59              Current year low: 9,997.56\

> Review period: Closed Sept 23 at 11,722.95 points                              Period change: -0.11%

The Casablanca Stock Exchange’s MASI was the only non-gainer in the September review period, and though its performance was a bit choppy the market does not deserve to be labeled as “weakening”. Market cap leaders Maroc Telekom and Attijariwafa Bank were in a good mood, gaining 2.4% and 3.6%, respectively. For Morocco’s top listed banking scrip, the share price at the end of the review period was almost back at its 12-month peak from June 10 of this year.

Egypt CASE  

Current year high: 7,603.04                Current year low: 5,850.00

> Review period: Closed Sept 23 at 6720.00 points              Period change: 4.87%

While volatility on the Egyptian Stock Exchange was more pronounced than North Africa’s other bourses, the EGX 30 continued to move nicely in a northerly direction. The vast majority of stocks showed gains in the review period, led by Arab Cotton Ginning which announced its highest dividend ever on Sept 13. The Orascom corporate values advanced modestly at 2.1% for OTH and 1.7% for OCI. Developer TMG fluctuated heavily after another set of headlines from a business-related court ruling.

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Economics & Policy

Executive Insight – Booz & Co

by Ahmed Youssef, Chady Zein & Raymond Soueid
written by Ahmed Youssef, Chady Zein & Raymond Soueid

Over the last decade, the state of private equity (PE) in the Middle East has gone from virtually nonexistent, to a booming prospect, to an industry facing a shakeup. In 2004, the region was home to just 26 funds, with a total of $3 billion under management; in 2010, 142 funds manage $34.5 billion.

The sector’s breakneck evolution has made it difficult for investors to get a clear picture of the industry’s underlying fundamentals, and they therefore have been understandably cautious about directing their funds to regional PE firms.

In fact, it is now becoming clear that the region’s heady growth over the last decade worked to cover up some critical weaknesses in the PE industry. Some issues are structural: Significant gaps remain in the region’s legal and regulatory frameworks and corporate governance requires development, as the influence of family-owned businesses may hinder corporate disclosure and limit transparency. Another challenge is the fact that PE firms in the region are still sitting on about $11 billion of unspent capital — much of which is contingent on the performance of previous funds.

Even if the appetite for PE investing were to return to the insatiable pace of 2006–2008 (around 70 transactions per year, with an average size of $30 million), it would take more than five years to deploy all of this capital. Considering that most firms average three to five years until they invest their funds, the mismatch could create significant pressure to invest quickly. The PE market in the Middle East would need to develop much faster in order to absorb the available capital.

In order to fulfill its potential and continue attracting global investment dollars, the industry will need to undergo some reform as it consolidates. PE firms that hope to operate in the Middle East should consider five key imperatives.

  • Develop an investment approach based on themes with staying power. Focusing on individual nations or sectors, as many firms outside the region do, might limit Middle East-focused PE firms’ pool of opportunities, thus restricting their ability to scale their assets with superior returns and in a reasonable time frame. Theme-based investments, by contrast, are built around economic trends and span numerous countries and sectors. For example, PE firms that focus on the theme of serving a growing and increasingly wealthy population will invest in sectors such as consumer and mortgage finance, real estate management, retail, and restaurants and leisure.
  • Tighten up risk management practices. PE firms will need to ensure that their portfolios are not over-concentrated. Naturally, this means that they should not be heavily skewed toward any single geography or sector. However, firms must also ensure that the companies in their portfolios are balanced between different stages of their development — i.e., between companies still in the growth stage that demand cash, and those that have achieved maturity and generate cash. Meeting this target is particularly problematic in the region, where many opportunities are at an early or greenfield stage. A better balance in the portfolio will create a hedge against the cyclicality of the business. In terms of individual deals, PE firms will need to practice more rigorous risk management before, during, and after each transaction.
  • Be an active owner. The robust economic growth that preceded the downturn allowed many companies in the region to chase top-line growth at the expense of working capital and profitability. Liquidity issues bubbled beneath the surface while the economy was booming, but rose to the top when the recession hit. These same companies are now struggling to get their house in order. Adopting the appropriate financing approach, anticipating a buildup of operational capabilities and strengthening relationships with key stakeholders and suppliers will require active oversight by existing PE backers, as leading firms KKR and Blackstone have demonstrated.
  • Deepen relationships with limited partners (LPs), especially institutional investors. Historically, the majority of LPs in the region were high-net-worth individuals. However, institutional investors now represent a more significant percentage of LPs — an important development for PE firms as they broaden their investor base. Firms should seek to strengthen relationships with institutional investors, whether regional or international, which are looking to make a play in the region. These may include banks, insurance companies, pension funds and others that have been adding private equity assets in hopes of achieving risk-adjusted returns beyond those possible in public equity markets. Deepening the relationship entails more rigorous relationship management, including continual reporting, and better understanding of the risk-return relationship that institutional investors seek. 
  • Build confidence through new fee structures and fund-raising approaches. Lowering entry fees will encourage investors to come on board and give fund managers the opportunity to prove their worth. Among limited partners globally, the standard “2 and 20” fee structure — in which firms take a management fee of 2 percent of the fund’s net asset value each year and a performance fee of 20 percent of the fund’s profit — has become a source of increasing dissatisfaction. Sensitive to investors’ concerns regarding these arrangements, some big PE firms around the world have lowered their management fees on committed but uninvested capital to 1.5 percent (and sometimes lower for LPs with large commitments); regional firms should consider doing the same. Another peculiarity is fundraising for specific opportunities — while cumbersome, this bespoke option appeals to investors and should be taken into account.

The region’s PE industry sprang up when equity prices were rising, and many local players enjoyed early success in the form of quick and profitable exits from investment positions. However, that dynamic soon reversed. Today, winning will not depend on timing or on external market factors; it will depend on more fundamental sources of value. As firms in the Middle East rebuild, they will need to do the basic things right: Identify sustainable investment ideas, create value within their portfolio companies, reduce their risks, and gain the trust of the best possible investment partners. These are things that will work, and remain important, in good times and in bad.

AHMED YOUSSEF is a principal, and CHADY ZEIN and RAYMOND SOUEID are senior associates at Booz & Company

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Economics & Policy

Turkish delight

by Executive Editors
written by Executive Editors

After a summer in which equity preachers in the Middle East and North Africa found their faith tested by an absence of offerings, Oman’s first initial public offering (IPO) in two years is welcome news indeed. Nawras, the sultanate’s second mobile phone player, has opened for subscriptions to 40 percent of its capital in a month-long offering from September 15 to October 14, with the intent of raising between $471 million and $609 million. The wide range in projected IPO revenue is because the company is using book building to determine the issue price for the $260 million shares on offer, a first in Oman’s stock market history. This method of setting the issue price also gives Nawras greater ability to stir interest among international institutional investors, whereas the region’s other IPOs in the year to date were either inaccessible or short on attractiveness for international money.

But, for all the good signals the Nawras IPO sends regarding the vitality of the Muscat Stock Exchange, it is only a light drizzle after a drought and regional primary markets show only the vaguest promise for the fourth quarter. 

This dusty picture was reinforced by corporate talk around the Gulf from late September when executives of Bahrain’s aluminum smelter, Alba, and United Arab Emirate information technology retailer Axiom, independently from each other touted the possibility of going public in the not-too-distant future. So far in 2010, similar announcements of possible impending flotation have far outnumbered the subscription offers actually put in front of investors. This is not to say that IPOs were a bad idea this year. According to Zawya, the thin crop of 2010 market entrants in the MENA — 21 companies entering bourses in Riyadh, Damascus, Amman, Tunis and Cairo — has seen eight stocks achieve massive growth. By September 20, each of these stocks was quoted at least at twice their issue price.

The list of gainers was led by Egypt’s solitary debutant, juicer Juhayna, which in a little more than three months rose from its EGP 1 par value to EGP 5.49 per share, however the real gain margin was much lower than 450 percent. The actual issue price, which included a hefty EGP 3.66 premium, indicates a three-month return rate of 18 percent since flotation.

On September 20, Three of the new market entrants were quoted lower than at the close of their respective first trading days. One of these underperformers was the largest IPO offered in the first 36 weeks of 2010: Saudi urban developer Knowledge Economic City. Its share price range in September was 12 to 14 percent below the stock’s SAR 10 issue price.

But there is one stock market in the wider Middle East which this year has been outperforming the region and most other finance centers on earth. The Istanbul Stock Exchange’s ISE 100 index, which closed 2009 below 53,000 points, has recently raced from one peak to the next, closing September 22 at 64,479.14 points. After a hiatus in new listings throughout much of the past decade, 2010 has seen IPO announcements bloom on the ISE.

According to the exchange, 14 IPOs in the first half of 2010 raised $842 million, and the official ISE list of current IPO applicants just added its 10th hopeful issuer on September 20: retail group Kiler, which applied to offer 13.05 percent of post-IPO capital of $93.8 million.

Of the IPOs in the Turkish pipeline, almost half are related to real estate — a traditional favorite of the Middle Eastern investor. According to the Istanbul Stock Exchange, four GYOs (the acronym in Turkish for real estate investment trusts) are in the 2010 IPO pipeline, the largest of which is the Emlak Konut GYO with a capital of TRY 2.5 billion, (Emlak Konut is an affiliate of Turkey’s Housing Development Authority).

Another fund is being floated by Akfen Group, which is known internationally for, among other things, construction and operation of airports. The Akfen GYO, which received approval for its IPO on August 25, is a partner with France’s Accor Group in hotel developments in Turkey, Russia and the Commonwealth of Independent States. 

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