The luxurious Dorchester Hotel in London was the setting for an uncomfortable meeting between the world’s private equity (PE) chiefs, where there was no doubt nervous exchanges as to how the global financial crisis has impacted their companies and what the future is for private equity. Some analysts are claiming that PE is at death’s door due to the huge amounts of leverage that PE firms took on. This led PE firms, it is argued, to get caught up in the asset bubble and to pay grossly over-inflated prices for companies landing them now in serious financial trouble. The value of companies owned by PE firms, according to The Economist, fell by 50 percent and, according to Deloitte, they expect the same percentage of PE houses to close or to return whole funds next year. However, others are not so pessimistic as to global prospects for PE in 2009 and the affect of the global financial crisis. Coller Capital, in their ‘Global PE Barometer’ report, stated that although large buy-out funds — in excess of $3 billion — will find it difficult in 2009, smaller PE firms will still be able to find good value on the market. Further to this, as companies forcibly deleverage, some PE firms will be able to step into the breach.

Good news in bad times

If the global financial crisis was inevitable, then for PE firms in the Middle East the timing was fortuitous. The sector has managed to side step the worst of the crisis primarily due to the fact that regional PE firms were not highly leveraged. “The crisis has had an affect but only limited. We are still raising funds, investing and divesting, this is the core of our business,” said Gilles de Clerck, a senior manager at Capital Trust. However, the drop in Initial Public Offerings (IPOs) has hit PE firms as it has cut the possibilities that they have to exit their investment. PE firms in the region are taking a serious look at their portfolios, reassessing their business plans, delaying exits and fund raising. So there is a general expectation among analysts that PE will see a lot more portfolio management and a lot less buyouts in the Gulf.

PE chiefs in the Middle East are all congratulating each other on the limited amount of leverage they took on. “In Europe or the US you could see deals with 80 percent leverage, but here leverage was only used for the large deals and even then it was 40-50 percent,” explained de Clerck. This low level of leverage is seen by many as the central reason that PE in the region has escaped the worst affects of the crisis. However, with leverage now severely restricted and becoming much more expensive, there will be significant constraints on PE operations in 2009. The key to the regional PE market is that the economies of the Middle East continue their robust growth, as this is how they have been able to escape the use of significant amounts of leverage previously. “We [Capital Trust] are currently raising a fund so we know there is still cash out there. In terms of investments, the companies in the region still need to grow. There is less growth but they are still going to grow at 20-30 percent so they need more funds to invest in machinery and so on, with banks becoming more cautious and the stock market being a no go PE has an important role to play,” said de Clerck of Capital Trust. “If you have the right companies which are ones that are regional and have the right management and team you will always have a market [in this region].” PE houses in the region may be breathing a sigh of relief, but they also know 2009 will be a difficult year — only the fittest will survive.

The immaturity of PE in the region has been a highly beneficial attribute with regard to the global financial crisis and its affects on the industry, but the learning curve ahead will be steep. Ziad Maalouf, vice president of MENA Capital explained that, “[PE] is so new to the region, it only started in the last three or four years. Not a lot of companies have been taken public so many PE investments have yet to be realized.” Thus, many of the PE firms in the region — especially the micro PE houses — feel they can take the hit delivered by the financial crisis and wait it out. As Gilles de Clerck of Capital Trust stated, “PE is a five to seven year investment so a loss of a year is not a big deal. Our firm continues to invest because we want to be there when growth picks up again because some of the players will not be here when things pick up.” When the economy of the region does ‘pick up’ again, it is clear that PE will have to be a leaner and more astute industry than before the financial crisis. Sitting back and letting the exponential growth of the region and the hype of Initial Public Offerings (IPOs) do the work for PE firms will no longer be an option. “In the past people were bullish and PE firms were investing in a wide array of companies in the hope of taking them public, when the stock market was booming and investors would buy in to that story. But with capital markets affected as they are, with less liquidity, PE firms have to be more selective,” said Maalouf. He also stated that those PE firms that survive will be those that are, “more careful and selective in the type of industry invested in, the quality of management, the structure of financing, the structure transaction and the legal structure.”

P.E. houses in the region know 2009 will be a difficult year — only the fittest will survive

Buying at the right price

However, for those PE players that bought at a high valuation, there will be a tougher lesson to learn and they may have a long wait before they get a return on their investment, if ever. “The key in the PE game is buying at the right price… Probably some of the other players, due to the excess liquidity of that time, might have paid higher prices and some places where we were competing with these players we pulled back,” said de Clerck of Capital Trust. For those PE firms that bought at highly inflated prices and conducted badly constructed deals, the future is going to be a lot less forgiving. The Middle East is getting what is probably a well-needed purge of the PE industry. For 2009 and beyond, the industry will have to be much better managed and the result should be more sustainable and productive deals. PE firms in the region may have escaped the crisis in part because of their immaturity, but now it will be those which show their maturity that will survive. 

OPEC is in a state of panic, as the downward trend in the price of oil shows no sign of abating. OPEC’s move to stem production has not managed to shift the market upwards and oil prices have seen a drop of 68 percent, since their record high in July 2008. While the gloomy global economic data is the primary reason for the inability of OPEC to push up the price of oil, the inability of OPEC to confirm the amount of oil their member countries are producing is also a major obstacle. This dilemma was illustrated at the recent OPEC gathering in Cairo where the market was expecting an announcement that oil production would be cut further. Instead OPEC was still striving to ensure previous production cuts had been carried out. The challenge of verifying whether production cuts — agreed to by its members — have actually been carried out or not is a near impossible task for the organization. OPEC is unable to deliver either accurate or timely oil production data with the figures that its member countries submit. Thus, it was a long time ago OPEC decided not to rely on its member country submitted oil production numbers but on ‘secondary sources’. This severely prescribes the effect OPEC is able to have on the price of oil.

For national security reasons, OPEC member countries guard information about their oil output as state secrets. The consequence of this is that the member countries are leaving themselves exposed to the whim and competence of Western ‘secondary sources’ in influencing the price of oil. The realm of secondary sources is murky, unaccountable and replete with espionage. Considered ‘secondary sources’, many organizations use a huge range of resources to try and uncover more accurate oil production data than that issued by national agencies. Tanker tracking companies are seen by most traders as the principal method in which real-time oil production data is gathered. Three companies lead the market: Petro-Logistics, Oil Movements and Lloyd’s Intelligence Marine Unit. Tanker tracking companies gather information regarding the number of tankers leaving ports from spies at oil ports and ‘friendly’ officials at oil companies leaking data. Conrad Gerber, the owner of Petro-Logistics, runs his small team from an office on Lake Geneva. Gerber first learned the trade of collecting and analyzing data of the world’s oil supplies in the 1970s when he was ‘helping’ Zimbabwe (then Rhodesia) circumvent international sanctions and procure illegal oil. Despite the obvious difficulties in obtaining accurate data that Petro-Logistics face, their figures are seen as more reliable than the OPEC member countries’ data, hence they have considerable clout in affecting oil prices.

Dodgy business with dodgy numbers

Oil producing countries do not appreciate tanker tracking companies and many prohibit reporting vessel data. There have been unconfirmed reports that informants for tanker tracking companies have even paid for their collaboration with these companies with their lives. Yet, despite the lengths tanker tracking companies go to gather this data, many oil analysts are doubtful as to the accuracy of the figures. Alexander Wöstmann, Director of www.gas-oil-power.com, stated that, “oil is transported in many more ways than just tankers and the figures that these tanker tracking companies gather from the Middle East are notoriously vague. The information they are collecting has little to do with production figures.” Rafiq Latta, Gulf and OPEC editor for MEES, which is one of secondary sources that produces oil production data and is used by OPEC, explained that, “There is a big difference between exports and well head production, with the latter essentially being what [oil] quotas are about.” Latta pointed out though that it is possible to get accurate figures through tanker tracking companies for a country like Iraq where there is very little storage. But for countries like Iran the tanker tracking data is useless as, “Iranians typically bring in a lot of offshore storage and put oil in tankers [but] wait for the market to improve before selling them on. So you can get wild oscillations in Iranian exports that do not accurately reflect oil head production at all.”

Rafiq Latta explained the complex process that he goes through in order to get more accurate oil production data than tanker trackers and official country figures. Latta’s system depends on the adding up and deducting of certain variables that range from news wire services looking at “what has happened in terms of disruptions over the month or anything coming down for maintenance,” to taking into account seasonal changes, for instance “Gulf domestic usage often goes up for air conditioning” in summer. Latta also uses the information gathered by tanker tracking agencies, as well as informers in oil companies that are somewhat reliable. All this, Latta admitted, “is a very imprecise science and it is astonishing how much relies on it. There is no oracle out there.” Ultimately, even with secondary sources, exact figures for how much oil is produced are not attainable. Secondary sources simply have a more accurate figure than the official figures produced by OPEC member countries. This is accentuated by the fact that Iran and Venezuela are seen as the two main offenders in terms of quota busting by the core Arab countries, but as Latta explained, “the secondary sources for both these countries leave a lot to be desired.”

Slippery statistics

Wöstmann is at a loss as to why a region wide metering system has not been established to solve this problem. OPEC however, has not been passive about the lack of transparent oil production data. In the late 1990s, due to the high volatility in oil prices blamed on the lack of transparent oil data, the Joint Oil Data Initiative (JODI) was set up in June 2001. JODI was created with the objective of trying to “provide a complete, timely and comprehensive database that is accessible, reliable and gives an accurate assessment of the global oil situation.” To circumvent the problem of national agencies not releasing data, JODI tried to put pressure on the oil industry to provide oil production data. But this has failed and eight years on JODI is still not seen as a credible source of data. Rafiq Latta stated that the problem with JODI is that the data received is just not trustworthy. “For OPEC, JODI can never be relied on that much. Ironically, I actually think that because analysts mistrust [JODI], they are quite accurate but the moment people start relying on JODI, or they become more timely, they will be wide open for abuse.”

Thus, the mysterious industry of secondary sources will continue to have an overbearing influence on the price of oil for the foreseeable future. As the price of oil continues to slide beneath that needed for OPEC countries to balance their budgets, there may be renewed effort to improve the transparency of oil production data. This is unlikely however, due to the internal political animosity between OPEC members and the limitations that OPEC has as an organization. As Latta pointed out, “If there was a high level of coordination and OPEC had a system that everyone trusts, then OPEC would be a far stronger organization. But there is a reason why this has not happened that goes beyond small mindedness. It is because each country has very different reasons for being in the organization and so for OPEC to have a greater level of control would make it a very different organization.” For those producing secondary sources the only threat to their business is oil running out, as the internal political squabbles of OPEC appear to be anything but finite.

About a year ago, Abu Dhabi’s sovereign wealth fund (SWF) injected $7.5 billion into an ailing Citigroup. Kuwait’s fund also invested $2 billion into Citigroup and it put another $3 billion into Merrill Lynch. At the time, officials in the US and Europe suspected SWFs posed a possible threat to western nations’ economies and national security. They rang alarm bells over the funds’ lack of transparency. However, with the financial crisis sweeping the globe, western governments are now begging for investment from the GCC, as the Gulf countries have some of the few large pools of available cash in the world.

British Prime Minister Gordon Brown toured the GCC in November, asking the governments of Saudi Arabia, Qatar and the UAE to pump money into international institutions and British companies to help dampen the effects of the global crisis. During his trip, Brown told reporters the UK “welcomes investment from sovereign wealth funds.”

Just before Brown arrived, the United State’s Deputy Treasury Secretary Robert Kimmitt made a similar trip. Partly due to the new “Santiago Principles” agreement between 23 countries that outlines funds’ code of conduct, and partly because of the need for cash to free up frozen credit markets, Kimmitt wanted to make clear that GCC SWF money was also welcome in the US.

GCC funds are largely uninterested right now and much of the West’s charm offensive has gone to waste. The financial crisis has hit the SWFs’ overseas investments, destroying tens of billions of dollars of wealth. Low oil prices have only compounded the problem at a time when GCC economies need their cash to prop up ailing stock markets, real estate investments and the banking sector.

Just after Brown’s visit in November, the mood in Dubai ranged from gloomy to outright apocalyptic. The bunker attitude was evident at a private equity fund conference in Dubai. As a speaker used a PowerPoint presentation to summarize the growing role of SWFs in the global economy, fund managers from around the world drank coffee and nibbled biscuits in an adjacent ballroom, which one fund manager called “the trading floor.” There didn’t appear to be much trading going on however. Many of the managers, like Ejaz Shamsi, a senior vice president at Pakistan Private Equity, came here looking for cash. Unfortunately, everyone else Shamsi ran into was looking for cash too.

Liquidity drought

“One and a half years ago when I attended there were so many investors available,” Shamsi said. “But at this point in time, the scenario’s totally different… [the SWFs] are sitting on their cash.”

“They’ve already made a lot of losses on investments, so they are reluctant to invest money right now. So it’s difficult for us to convince them, and for them to trust us, and for them to trust the market.”

The private equity fund managers would be lucky to get just a fraction of the cash sovereign wealth funds are currently estimated to possess — the United States Treasury estimates the world’s 26 SWFs currently possess two to three trillion dollars in assets. In the next five years that amount could mushroom to between seven and 11 trillion dollars.

Of those assets, Gulf SWFs have an estimated 700 billion dollars invested overseas, according to the Institute of International Finance. That includes investments across the world, across a variety of sectors, with a majority in Europe and the US. SWF’s are estimated to hold broad portfolios valued at $200 billion in the US alone that include stocks, real estate and bonds, and their exposure to the financial crisis has been just as extensive.

Eckart Woertz, GCC economic program manager at Dubai’s Gulf Research Center, estimates the Abu Dhabi Investment Authority and the Kuwait Investment Authority have 60 percent of their investments in equities, and just as anyone with a retirement plan knows, those equities aren’t worth nearly as much as they were one year ago. But because of the secrecy surrounding SWFs, it’s hard to be sure exactly how much they’ve invested and how much they’ve lost.

Brad Setser, an expert on SWFs at the Council on Foreign Relations, told BusinessWeek the Abu Dhabi Investment Authority may have lost $100 billion over the last few months. Woertz estimates ADIA may have lost up to 25 percent of its investments and the same for KIA.

KIA’s chairman, Bader Al Saad, told Al Arabiya Television in September that his fund had lost around $270 million from its investment in Citigroup. Woertz says Saudi Arabia’s fund is best positioned as the fund was largely invested in bonds. But Saudi’s experience is the exception to the rule and now many Gulf investors have hidden their money under the allegorical mattress.

“Frankly speaking, I don’t want to invest right now,” Dubai International Capital’s chief executive Sameer al Ansari told a business conference in November, according to the Associated Press. “It’s not the time to be brave and go out there and try to hit the bottom of the market.” Al Ansari added that the world is going into a “a deep recession,” which may last two or three years, and he said his fund would be “extremely conservative” and would try to protect its assets, valued at $12 billion.

As the financial crisis took down Lehman Brothers and Merrill Lynch, KIA was less enthusiastic about bailing out US banks or seeing cheap prices as a good investment opportunity. “We are not responsible for saving foreign banks,” Al Saad said. “This is the duty of the central banks in these countries. We have social and economic responsibilities towards our own country.”

Simon Williams, HSBC chief economist for Gulf markets, says SWFs are taking a wait-and-see attitude. “I think most prudent investors, even those with time horizons as long as [the] region’s Sovereign Wealth Funds, will wait for clarity in the global financial markets before establishing positions,” he said. “I think some deals will go through, but I think they’ll be small in number.”

Braving the storm

There has been a big one recently. Late last month, Abu Dhabi’s royal family bought $11 billion worth of shares in Barclays, Britain’s second biggest bank. That gives the family a 16 percent stake in the bank, making it the largest shareholder. Barclays also sold 15 percent of its stock to investors from Qatar’s government, and reports reveal the bank had to promise to pay higher interest payments to their new partners from the Gulf.

But with oil prices falling, economists don’t expect to see a lot of these deals going through. The Institute of International Finance (IIF) estimates oil prices in 2009 will average $56 per barrel — dangerously close to the break-even mark for many Gulf governments who need higher oil prices to keep their budgets out of the red.

The Organization of Petroleum Exporting Countries has been trying to stabilize prices in the $70 per barrel range. Woertz noted that if oil can’t be stabilized, the Gulf economies will need to “plug a lot of holes in their economies at home… Some research shows that with oil prices at $50 per barrel, everyone but Kuwait will face a deficit in 2009,” Woertz said. “The International Monetary Fund is more optimistic. At $60 the GCC should have a significant income, but both reports are pretty negative.”

Meanwhile, the low oil prices come at a time when “pressures have risen on Sovereign Wealth Funds to redirect their investments to the local markets,” said IIF first deputy managing director and chief economist, Yusuke Horiguchi, in a press release.

If oil prices remain in the $50 range, most GCC countries “will need to take recourse to savings — not only for bailing out local banks and propping up local stock markets but for their normal ongoing expenditures and operations,” Woertz told the Oxford International Review.

There are already unofficial reports that this has been occurring. Reuters reported in November that Kuwait repatriated $3 billion to back up its beleaguered stock market and banking sector.

Williams says he doesn’t think funds will start selling foreign assets en masse, but he says their level of aggressiveness in the long term will be decided by this crisis.

“I think what’s going to be interesting over the next months, or years, is what conclusions Sovereign Wealth Funds draw about investing overseas,” he said. Either the funds will see the crisis as a “great time to increase their position,” or “they will look at losses they incurred over past few months and say these were markets we perhaps didn’t understand as well as we thought we did, and can’t control, and maybe it’s better to keep the money in markets we understand.”

Sovereign wealth funds “will look at losses they incurred over the past few months and say these were markets we perhaps didn’t understand as well as we thought we did.”

The region’s top developers have been shedding hundreds of jobs over the past two months in order to cut costs in the face of a regional real estate bubble burst. Damac (200 jobs cut), Nakheel (500 jobs cut) and Dubai Properties (estimated 600 jobs cut) have all made staff redundant, while other major developers such as Emaar are still reported to be reviewing their staff numbers.

However, the most disconcerting aspect related to the job cuts at some of the largest real estate employers was the fact that they seemed to have been caught completely unaware by the magnitude of the crisis. “We were told more than once by upper management that we have nothing to worry about,” said Raja Khouri, former senior public relations executive at Dubai Properties. “What was told to us was, ‘We are going to cut all expenses, however, the one thing we are not going to do is fire employees.’ In fact, exactly one week before I was fired, the CEO of Dubai Properties gave a speech telling everyone not to worry in order to put us at ease.” Another senior executive at Dubai Properties who preferred to remain anonymous commented, “It just goes to show that they had their heads in the sand the whole time.”

Furthermore, the employees that were let go at some organizations appeared to be those that were deemed expendable and most costly. “The firings were based on two things. One was the tenure of how long people had been there. Everyone who was still on their probationary period of six months was let go. On top of that, all the highest paid people in their departments were let go, so all the seniors were let go,” said Khouri. “The three major senior managers in the marketing department were let go, moreover they kept all of their national employees.”

Severance practices were reported to have varied, but ultimately people have been put in a tough spot. “People that are getting fired are getting three months severance pay,” said Tarek Akkad, former IT policies & procedures coordinator at Nahkeel. Khouri added that: “They gave us one month severance pay as well as unused holiday days, which is the amount contracted to employees who spend more than one year in the company… Basically they are giving us what we are due, but they are not giving us anything on top of that.”

Leave on your own or get the boot

The process that some real estate developers took when it came time to give their employees the axe further pointed to desperation. “The director of each department gave the employees two notes. One note was a resignation letter and one was a termination letter and we were asked to choose which one we wanted to sign,” explained Khouri. Moreover, neither letter stipulated any reason why the staff was being laid-off. “We are still in discussions with the [former employer] in order to attain a specific reason for being made redundant,” said the source who formerly worked at Dubai Properties. “The fact that they are not acknowledging that they made some mistakes is what really leaves a bad taste in your mouth,” he said.

For many expats who work in the Gulf, the next few months will be crucial to finding out if they can hold onto their jobs or even find new ones. “I think that under normal circumstances, two months would have been enough time, but under these [economic] circumstances I don’t think it is going to be enough time. Now everyone who has been fired is looking for a job and nobody is hiring,” said Akkad. “I’m scrambling against the last three weeks of my visa validity to basically try and find something, because otherwise the bank will freeze my account, seize my car and probably take the money in my account. It’s just messy.” Indeed the mess that started only a few months ago in the US has begun to surface in the Middle East and only time will tell how many pieces of how many lives will have to be picked up, before this is all over.