The macroeconomic changes of the past five years have opened up possibilities for private equity firms to operate in the Middle East and North Africa (MENA) on both a fundraising and investment basis. Industry experts agree that the region is developing and is awash with liquidity, and that it needs regulatory procedures to monitor and tame the activities of new market entrants. 

MENA governments are welcoming private equity capital and expertise through the creation of

an industry-friendly environment through free-trade areas, lenient taxation policies, and strong appetites for imports. Ever mindful of their burgeoning youthful populations, governments in the region are seeking a macroeconomic environment which encourages wealth creation and social mobility.

Rami Bazzi, principal of private equity at Injazat Capital, believes that “over the last four to five years, investors had mainly invested in the equity and real estate markets.” He goes on to attribute the growing popularity of private equity as an asset class to a number of factors, “such as the volatility of the stock markets and the overall enticing business climate.” Regarding the regulatory changes toward protecting minority interests and attracting foreign direct investment (FDI), Bazzi thinks that they are “improving the speed and ease of doing businesses with major efforts that translated into apparent progress.”

The liquidity that has flooded markets should be supervised as excess capital is not a permanent fixture in the region and private equity houses will face increasing competition. According to Junaid Jafar, general partner of EMP, the GCC’s liquidity “impacts what your angle is as an investor — are you a buyout shop, a private equity infrastructure player or a sovereign wealth fund?”  As the private equity game is played out in the region, firms will have to pay attention to specialization. 

2007 Top 5 closed funds

Population as an impetus for change

Governments are increasingly looking to better management practices for their excessive liquidity and have identified ways to improve conditions for their constituents through social infrastructure projects. From schools to hospitals, this new infrastructure will serve the dual purpose of providing services for citizens, while at the same time acting as an engine for white-collar job creation as the services will need staff to man them, nurses to care for patients, doctors to treat illnesses, and teachers to educate the next generation of professionals.

Regional population growth rates show no sign of slowing in the coming decade. Izzet Güney, managing partner of Millennium Private Equity, cited a 25% growth in Dubai’s population on top of similar growth in 2007. “In their development plans, master planner Nakheel is said to envision a Dubai in 2015 which has a population of 10 million. These are astounding levels of population growth, and create the demand for healthcare, education, insurance, and other services.”

According to him, “the nature of the population growth is such that a significant percentage of this increase is expected to come from educated workers/white collar jobs, who consume these services at a much higher rate than the average per capita consumption today. So as the population mix changes, the averages will change too.”

Fadi Arbid, executive vice president of Amwal al-Khaleej, an up-and-coming industry player based in Saudi Arabia and connected with a well-stocked rolodex and portfolio of family firms, looks to demography-driven sectors. Especially in the Saudi market, where under-21 year-olds constitute 70% of the kingdom’s population, noting how “in five years, when oil is no longer at $100 a barrel, you are going to need an educated and healthy population,” necessitating a string of social infrastructure projects.

Governments are trying to build this social infrastructure as soon as possible because of “chronic under-investment in the region, most notably in infrastructure, but also in industry. So we are really trying to play catch-up here. For example in healthcare, the healthcare spending as a percentage of GDP in the GCC is 7-8% lower than in developed markets even today,” according to Bazzi.  Most industry watchers are witnessing the take-off of sectors such as health care and education, which in his estimation, “need more aggressive levels of investment.”

Diversification

Izzet Güney, of Millennium Private Equity, believes there is a drive towards economic diversification in the region and a consequent desire to reduce dependence on the hydrocarbon industries. This creates new sectors of the economy that did not exist five or ten years ago. “In particular, the services industries that are being developed in the UAE for example are relatively nascent and need access to capital to grow.”

EMP’s Junaid Jafar explained his firm’s own experience with macroeconomic winds changing, as they monitor the firms they brought to market by wryly pointing out, “the subprime crisis and global slowdown that have happened over the last couple months haven’t helped.” 

However, because his firm’s investments are in developing markets in Southeast Asia, in addition to others, he remains confident, saying “we should see their valuations slowly start to rise again. Our toll road investment in Malaysia should benefit from the development being undertaken in Johor, especially with its proximity to Singapore. With the announcement of the Iskandar Economic Region and the lack of good roads, we should see a lot of growth and traffic in the region.” For the institutions on board at EMP’s forays abroad, the looming recessionary fears in Western markets have not caught up with developing economies.

EMP’s Energy Fund might not have attracted the same level of popularity from the region’s investors had ideas of diversification not entrenched themselves in the minds of petrodollar financiers. 

According to Jafar, “There are certain regional institutional investors that do not wish to invest in funds that are correlated with the hydrocarbon industry. However, outside the region many institutional investors are looking to gain that kind of exposure. There has been interest in our Energy Fund from institutions as far a field as Finland, Australia and the United States.”

EMP’s experience remains close to the idea of a dual diversification with the West looking to the MENA region as a possible source of returns and safety from less abundant Western markets, while regional investors look elsewhere for other asset classes and sectors into which they can invest their energy riches.  

Founder and managing partner of Ithmar Capital, Faisal Belhoul, noted the interest paid by international firms as they are “aware that the GCC markets are not yet dominated by one single player and are looking to hedge risks and compete in an increasingly globalized market.”

By understanding private equity as an asset class, Middle Eastern investors can diversify their capital from a range of regional deals or natural-resource industries by taking advantage of private equity firms who are willing to court them now, as investors, to generate deal flow down the line. 

Wealthy members of the largest family groups, as well as institutional investors seeking to diversify to other markets in the West or neighboring developing markets in Asia and Africa, would then be cultivated by the fund manager to gain their trust for the future. Then that family firm can assist a nascent private equity player with gaining a toehold in a new market or approval from a new regulatory body. 

In this way, private equity firms are the thoroughfares into other markets, both geographically and by sector, as the region’s investors can become institutional or individual backers of funds in other developing markets less affected by global economic conditions than Western Europe and the United States.

For Bazzi, “government strategies to reduce their oil-income dependency and focus on the development of services have boosted the growth of the economy in general and the private equity sector in particular.” The increasingly favorable macro environment and encouragement of private companies will maintain a strong demand for private equity in the region.

2007 Top 5 announced funds

Employing equity

Research from the United States indicates how the effects of private equity deals in the MENA region differ from the Western experience.  One study shows that regional companies acquired and revamped by a private equity house increased internal employment figures by 17%. 

Private equity transactions 2007

When cited to industry leaders, the response was mixed, and differences exist between industries and within companies, but most agreed that if this number were to be true anywhere, it was certainly in the MENA region where private equity finances expansion plans or movements into other markets, both of which improve employment figures in the long term. The traditional idea of a private equity shark, which cuts jobs for the sake of efficiency, was rebuked in favor of value creation and the need for efficient employees.

Although the details of the figure are not provided and do not explain different experiences, Jafar thought it was “an interesting fact, as normally private equity gets blamed for cutting employment rather than increasing it.” In his own firm’s experience, especially EMP’s infrastructure projects in the MENA region, “there are a couple of greenfield projects in the petrochemicals and power sectors, which have obviously resulted in increased employment in the region or country.”

Yahya Jalil, senior vice president of private equity at The National Investor (TNI), believes “the reason why private equity really has potential to accelerate job creation in the MENA region is because private equity flows are going into non-hydrocarbon sectors, especially knowledge industries, which do require human capital.”

Jalil also indicated that, “private equity managers are just good at creating alignment of incentives through a carrot and stick approach. So the workers that are employed at private equity-backed companies in the region are more likely to be incentivized to maximize the shareholder value of the company in which they work, since there is a strong motivation from the private equity managers to drive high returns.”

Privatization plans in the pipeline or finalized deals have, however, brought the opposite, as government bureaucracies are rife with inefficiencies. According to Jafar, “the only transaction where there has been a significant impact on employment is our telecom investment in Turkey where, post-privatization, there was a cut in the workforce. Originally being a state-owned public monopoly, the company was somewhat overstaffed.”

Firms will have to partner with public bodies as they seek to address the new problems created from privatizations in the economic short run.  For Jafar’s deal in Turkey, his firm worked in collaboration with the Turkish government “as there were local considerations to be addressed.”

If governments can attune the economies for growth in labor-intensive sectors and new infrastructure projects, then it is possible to accommodate the strong demand for job creation. Sheikh Mohammed, ruler of Dubai, saw the need for governments to accommodate firms by setting targets of non-oil sector portions of GDP for Dubai at 70%. Jalil believes the Sheikh’s Vision 2010 “envisions some major steps” toward better labor laws.

Bazzi echoed this view. “I am certain that there is real value creation,” he said. “Judging from our own experience, we have seen growth much higher than that. In certain cases, some companies were increasing their labor force by more than 100% a year for a period of two to three years. On average, for many of our portfolio companies the number is higher than that. I would not be surprised if the region exhibits an average increase of 17% or even higher.”

Private Equity transactions 2007

Private equity transactions 2007

According to Robert Wages, executive director of private equity for the Abu Dhabi Investment Company, “governments don’t necessarily know how to optimize the processes as best they could, but they are heading in the right direction.” He believes the UAE, along with Egypt and Jordan, is “quite serious about privatization” and that the moves towards privatization stem from motives, which range from raising cash for themselves to using privatization as a way of making the economy more efficient. “All economies have a mix of motive. When they are focused on country efficiency, it tends to make transactions work well because commercial consideration is very important.”

Regulations

Private equity players understand the need to work through regulations established in developing countries. The policies are a mixture intended to safeguard the governments as their economies move to another stage, while ensuring that enough air is available to fuel the flame. 

Jafar, whose firm EMP operates in developing countries in the Middle East, as well as Africa and Asia, believes that “having a diverse mandate, both geographically and across industries, you have to know about the regulatory regimes and environments. On the funds side there have been considerable developments in the region.” He attributes success in establishing his fund in Bahrain in large part “to the regulatory developments undertaken by the Central Bank of Bahrain.” For other players, Jafar believes that “regulatory developments such as the formation of the Capital Market Authority (CMA) in Saudi Arabia in 2003 and the Tadawul (Saudi Stock Exchange) or other such developments in the region, provide exit options to many financial and private equity investors.  Five to seven years ago, this would not have been possible.”

Jamil Brair, senior vice president of SHUAA Partners, believes his firm’s first fund succeeded by “learning the particular rules and regulations of the GCC with local sponsors and side agreements and rules that have to do with local ownership. It’s not rocket science, they can get the gist of it from a lawyer or an accountant, but that is when you get to see the complexities of the local markets and the necessity when doing the deal and closing the transactions to be aware of these issues, since it’s not the same elsewhere.”

Brair thinks what “needs to happen is more education about private equity toward target investment companies. And the other is that people should realize there are voluntarily regulations in the industry and the presence of international firms will encourage local players to adopt local financial reporting guidelines and other standards.”

In the future, Ithmar Capital’s Belhoul believes that if inconsistencies in restrictive regulatory regimes can be improved, “the GCC has the potential to become a truly global player in the private equity industry,” and indicated that, “the high proportion of private companies in the region, in comparison to the more significant numbers of public companies in the West, means that private equity in the GCC can perhaps be considered as a main-stream asset class rather than an alternative investment.”

Private equity transactions 2007

The 49% hump

Although improvements are moving forward and there is a “gradual relaxation of foreign ownership requirements, including in the Free Economic Zones, which is again an enabler of new business,” according to TNI’s Jalil, firms must still break the 49% cap on foreign ownership of regional firms. 

The 49% rule is one way for regulators to guard against further liquidity, the market and economic pressures associated with it. By capping the amount of foreign money a firm can use, the regulators are effectively telling regional businesses to use the region’s available liquidity to grow, yet allow for capital from private equity houses because they offer benefits and knowledge of due diligence and corporate governance. 

The 49% ownership limit does not remain a serious impediment to most firms. This is because regional private equity groups advocate for limited stakes in acquired firms to hedge against a losing horse if the investment turns sour, but more importantly because the synergy between firms and family groups is important to future deal flow.

However, for larger firms, like Wages’ Abu Dhabi Investment Company, or firms looking to become major stakeholders as family-firms grow comfortable with the idea of private equity, the current ownership caps are a hamper on the industry’s progress. As he pointed out, “we are looking to be very influential in the company we invest in as we are not sector specific, but we look at all sectors in a market.” 

Jalil said that when the 49% cap will be lifted is “anyone’s guess,” as the spirit is certainly there and reflected in various alternatives and mechanisms to create economic ownership for foreign entities in ventures in the region. “That is what a lot of our business is based on. Partnership with TNI gives international firms access to the regional markets, and since TNI is a regional firm and not subject to foreign ownership caps, we have a lot of latitude pursuing our private equity transactions.”

Wadah Al-Taha, head of strategies at Emaar Financial Services, would “prefer to keep the foreign ownership of all companies at a maximum of 49% but not to exceed it, not now. Not until we get a more mature investment behavior. We are in a stage of growth, not in a stage of mature investment.”

The figures indicated by Al-Taha point to an excited market where investments might provide higher returns from merely the volume traded, especially since January 2008 received trading levels of over $100 billion, which is the equivalent to all trading that had taken place in the market over the last four years.

As advice, Al-Taha cautioned that “we need to provide support and enhance growth and then maybe we can open a little bit wider.  Now the level of growth in UAE markets is not fully supported by a legal environment here. The level of growth is higher than the legal growth would support. I mean, there is a gap now, a legal gap, which is not yet filled.”

Looking forward, he believes that, “in two to three years the market would be more mature for more tools to be listed in the market, including funds and bonds.” Allowing firms into one’s country, does not, however, mean they can do their jobs and create value for acquired firms. Granting the thumbs-up to private equity players and liberalization in general is not the only measure needed by governments to ensure an efficient system. 

According to Güney, of Millennium Capital, “the private equity industry really thrives in an environment in which there is real transparency in the information that companies provide to investors. This is improving in the region, as the GCC attempts to catch up to more global standards on the regulatory front. An adjunct of this is the institution of good corporate governance at the company level, in which we also see a positive movement.”

Abe Saad, partner in Rasmala’s  private equity wing, noted that “you have the World Trade Organization (WTO) regulations being implemented in lots of countries joining the WTO and you need to see more opening up of ownership laws in countries to be able to become competitive.  In the next five to ten years I expect it to happen.”

Liberalization as a condition of access to the WTO is an important point echoed by Ziad Maalouf, senior vice president of MENA Capital, who said that “there is no doubt that the regulatory structures in the MENA region are gradually becoming investment-friendly and the economic liberalization is allowing a greater role for the private sector.  This coupled with the rapid economic growth and the availability of vast capital resources that had previously been channeled to investments abroad, have made the region riper for the expansion of private equity activities.”

Private equity transactions 2007

Legal structure

Once fund managers are able to court the favor of regulators in MENA countries, the regulators must work with the legal system to establish better contractual procedures to govern private equity firms and the deals they make with businesses in the country. 

TNI’s Jalil used the example of “an arbitration body set up by the Government of the UAE to settle business disputes faster. Free Zones such as the Dubai International Financial Center have established their own dispute settlement and arbitration rules.” 

Developing their arbitration systems is a choice that governments can make as a precursor to revamping their judiciary system. Arbitration tends to take less time and allow for new appellate procedures, and thus most industry experts consider it business-friendly, or at least considerably more business-friendly than a bureaucratic court system. 

According to Jalil, arbitration bodies could help develop the “enforcement of intellectual property rights, which is a big enabler of a whole slew of businesses that wouldn’t have been possible before.” Capitalizing on the opportunity to further relationships with foreign firms, regulators are on course to increased, if however gradual, economic liberalization.

Pointing towards a possible compromise between external procedures and local traditions, Richard Dallas, managing director  of private equity at Gulf Capital, explained that “a lot of people decry the whole notion of having elaborate documents, because the courts are slow, but I got news for you, they are slow in the United States as well as really expensive. But the process of negotiating that deal reconciles expectation and risk, I think that is a really important thing to do. And I think that by doing that you are bringing a process that is somewhat foreign to the region.  And that is where we try to make a good interface between investment technology and cultural sensitivity.”

Regulatory relationships

The scuffle with regulators to create the proper environment is a burden shared by private equity players looking to become a mainstay industry in new MENA markets. However, to do so, according to Dallas, “they need to adopt best practices from the West for those pension funds, those endowment investors that feel comfortable with seeing the same investment rigor and the same investment style they see in the West.”

He is not alone when he comments that people “want to invest in a system where after they have done their diligence, they know how it’s going to work, they know the rigor, they know the processes, and they’ve made a bet on the region, a bet on the management team that is putting the money out for them. So I think it is incumbent upon the private equity firms here, if they want to engage the Western world in inward-bound investment private equity to do that.”

Injazat Capital’s Bazzi also noted the rise of foreign capital coming to MENA, one measure which indicates the attractiveness of the region’s markets. Bazzi believes that “there are plenty of opportunities for local and foreign investors. According to the recent Emerging Markets Private Equity Association (EMPEA) survey, limited partners planning to invest in the Middle East increased to 11% in 2007 compared to 5% in 2006 and to 20% in Africa in 2007, compared to 4% in 2006. The improvements in the regulatory system and the development of the overall business climate have been enticing factors to local and international investors. International players are already investing and raising funds in the region.”

Like most other industries, the private equity industry follows a typical cycle consisting of several phases that exhibit typical characteristics.  Each phase, however, may vary across markets and over time in its duration and magnitude reflecting different extrinsic and intrinsic factors. The following is a high-level description of private equity cycle and a number of observations on where this industry stands at this point in time in the MENA region.

The private equity cycle starts to gain momentum by a booming economy and increased prospected investment, which create an attractive environment for investors’ interest in this asset class.  This phase exhibits high level of fund raising activity and the entry of new private equity firms into the picture. This is also the phase where some funds are able to achieve high returns without significant involvement in their investee companies and/or simple financial engineering. 

The region started entering this phase over the past few years with high level of fund raising activity taking place in 2005-06 and the entry of new players into the market.  We remain, however, at an early stage since private equity, as an asset class in its current form and scale, is relatively new to the region and when compared to the enormous scale of investment opportunities driven by robust regional economies, market liberalization initiatives, privatization programs, generational succession of family-controlled businesses that are open to divestments/ inviting of external capital, and expansion aspirations of local/ regional firms that are seeking growth capital. This favorable climate is further accentuated by the notable development of capital markets, which is a critical venue for exits.

With time, the market is expected to move into a phase where too much money starts to chase after a declining number of good investments.  This is likely to bid up valuations leading to lower returns on investment.   

The next phase is where private equity firms can differentiate themselves through a more selective/ patient investment approach and, more importantly, by taking on more challenging investments that require significant involvement in the investee companies and focusing on strategy-based value add. This is the phase when we can expect to see funds that pursue disciplined investment strategies (e.g., buy-out, sector-focus) stand-out and outperform the less-focused opportunistic funds.

Some of the PE firms in the region have already started moving in this direction.  This can be observed as several new funds have started positioning themselves as buy-out and/or sector focused funds.  In parallel, many of these firms started attracting talent from the management consulting industry to build post-acquisition capabilities with the aim of creating strategy-based value-add in their investee companies. The interesting question here is whether the buy-out funds have arrived too soon to the market and the extent to which they will be able to successfully implement their investment strategies in the next 1-2 years and overcome the perceived reluctance of many enterprises in relinquishing control, especially since such enterprises have access to other private equity investors that are willing to provide capital against minority stakes.

Moving forward along the cycle we can expect to see that the average return of private equity investments decline, and the exit of the less-focused private equity firms.  As a result, investors’ interest in private equity as an asset class is held back. The interesting question is see how fast we will arrive to this phase and what will happen to the smaller/ less established firms in the region.

As the private equity investment activity slows down, competition is expected to soften, gradually leading to lower valuations and ultimately to higher returns. This, combined with favorable economic environment, is a prelude to complete the private equity cycle and start to gain momentum once again under favorable market environment.

Overall, the private equity industry started to establish itself as an important and visible asset class in the region. So far, the growth has been spectacular in terms of fund raising and in attracting talent.  The challenge now is to see a growing number of good investments taking place, successful exits/ divestments, good returns on investments, and the maturity of this industry in terms of a more active involvement of PE firms in their investee companies and their ability to attract more local and international institutional/ sophisticated investors. Furthermore, it would be interesting to see how fast and how accentuated each phase of the private equity cycle will be in this part of the world over the coming years.

Maher Hammoud is Senior Vice President at SHUAA Partners

Over the last five years, MENA’s private equity industry has experienced remarkable growth. As of March 2007, the market is estimated to have crossed the $24.5 billion mark, reporting a 22-fold increase over 2002 figures. This continuing growth constitutes the building block for the development of a secondary market. Expected to emerge in the medium run, the secondary market will contribute to the long-term growth of the industry.

Private Equity in MENA has grown in scale, depth and reach. It has risen as an attractive option to capital markets and real estate investments. The industry is also growing in sophistication, as more institutional investors have been investing in private equity funds, or as a matter of fact, launching and managing their own funds. In addition to regional managers, some prominent international players have already ventured into the region through direct investments or co-branding, while others are planning to enter at a later stage as the industry further matures. According to a recent Emerging Markets Private Equity Association (EMPEA) survey, limited partners (LPs) planning to invest in the Middle East increased to 11% in 2007 compared to 5% in 2006 and to 20% in Africa in 2007 compared to 4% for the previous year.

While the industry progresses from fund raising to the deployment and investment stages, investment managers will experience a new set of challenges. The breakdown of the market reflects that only few managers have proven their ability to successfully source deals, add value and profitably exit investments. Today, some 2% of total funds are fully vested and only two funds are at the liquidation stage. On the other hand, 40% of total funds are currently investing while 28% are still at the fund raising stage. Competition is a challenge not to be taken lightly. It will certainly create an overheated environment giving way to the costly bidding process and reducing proprietary deals. Most importantly, investors’ patience over a six- to eight-year period is yet to be tested in the MENA region. Investors were accustomed to making high returns over a short period of time. In that sense, the market is undertaking a transition in terms of investment horizon, risk levels and asset class diversification.

The rise of the secondary market offers a valuable opportunity supporting the long-term growth and attractiveness of private equity as an alternative asset class in MENA. First and foremost, it addresses the liquidity issue that LPs might face over the life of the fund. Secondary funds offer to buy LPs’ interests in the event that LPs’ needs change or in case they prefer to deploy their capital in more attractive opportunities. The secondary market will also empower investment managers with the flexibility to shift their strategies, change their investment policy or rebalance their portfolio allocations. In a fast changing environment such as emerging markets, managers may seek opportunities in a new sector, or opt to focus on a specific number of opportunities to improve their results.

For secondary funds, secondary markets represent a channel to confidently access one of the most promising emerging markets, overcoming obstacles faced by first movers, while managing vintage year exposure and diversification. Typically, secondary funds recoup their investments faster than primary funds. Not only do they have access to more information by monitoring the performance of primary funds, but they are more flexible in terms of diversification. They have access to a pool of company portfolios with concrete results and evident operational and structural improvements.

While the growth in private equity has been remarkable, the potential for future development is even more impressive. It is developing at a faster pace than anywhere else in the world. Driven by regional and international macroeconomic factors and an enticing regulatory environment, we believe that the growth cycle may even be extended over the medium and long run by the surfacing of a secondary market. Secondary markets will undoubtedly attract international private equity houses and prompt the development of local or regional secondary funds.

Rami Bazzi is principal of private equity at Injazat Capital.

Infrastructure assets are typically characterized by their capital intensive and long term nature. Historically, such assets were funded and managed by the state. Today, however, the role of the state as the provider of public services is increasingly being questioned. Both in terms of whether the private sector can provide such services more efficiently and effectively than the state and also in terms of how the costs for these services and assets should be borne. These factors have led to a greater involvement by the private sector in the provision of infrastructure through public private partnerships, BOT and BOO schemes, as well as other forms of joint ventures and concessions.

Demand for infrastructure is set to continue to expand significantly in the coming decades creating a large number of investment opportunities. These opportunities are attractive for a number of reasons.

1. In today’s current economic climate of capital readily available at low interest rates, the search for yield is driving institutional investors away from stocks and bonds and towards alternative investment products.

2. Pension funds are beginning to think of infrastructure as a substitute for long duration fixed income products, and some, such as CALPERS and Ontario Teachers Pension Plan, are even directly investing into this asset class. Investments like toll roads and water systems offer a steady, stable income stream that grows as economies expand, and which is protected from volatile economic cycles.

3. The low historic correlation of infrastructure investments versus other investment classes has also encouraged the entry of both institutional investors and pension funds into this asset class.

4. The rise in global population mainly in the developing world, and the ageing of the current infrastructure in the developed world, is expected to create billions of dollars of demand for new infrastructure services. The rise of the middle class and expectations for better living standards are heightening demand for electricity, water and transportation, and other components of infrastructure.

5. The continuing desire of governments to push the funding burden to the private sector will also create new investment opportunities, especially in countries where public financing is limited. Alternative players such as private equity and sovereign wealth funds represent a significant new source of capital for these investments.

A report published in 2007 by the Organization for Economic Cooperation and Development estimated that $65 trillion would be required for roads, railways, electricity generation, transmission and distribution, telecommunications and water services over the next 25 years. Of this amount, about $33 trillion is estimated to be for the needs of emerging markets.

As countries in the MENA region scramble to modernize their economies, broaden their industrial base beyond the traditional sectors, and provide jobs for rapidly growing populations, unprecedented levels of infrastructure spending are foreseen. According to one estimate, infrastructure investment in the GCC alone could reach $700 billion by 2010.

Like in the West, across the MENA region there is an increasing realization that infrastructure needs cannot be met by the public sector acting on its own. Normally countries with few natural resources and strained public finances may choose to invite private investment in infrastructure mostly to obtain additional financial resources. However, despite the petrodollars pouring in, these countries are increasingly realizing the benefits of inviting private sector participation in infrastructure projects, which also allows them to obtain efficiency gains through new models of corporate organization and management, as well as benefit from the latest technological developments.

Early examples of private investor participation in the infrastructure sectors of MENA countries have been encouraging. Some of these have taken the form of public sector disinvestment but many others have consisted of some sort of PPP. For example, Jordan, Morocco, Saudi Arabia, Tunisia and United Arab Emirates have all attracted large private investment flows into their infrastructure sectors. The main areas of activity have been telecommunication, petrochemicals and power generation.

Infrastructure development in the Middle East is far outpacing most other regions. With the windfall in revenues from petrodollars and the increased levels of spending on infrastructure and world scale projects, the MENA region has seen a number of funds being set up over the last 18-24 months. By some estimates $10 billion has been raised by private equity firms for infrastructure and related investment during this period.

The definition of infrastructure in the region is generally broader than the Western definition of infrastructure, mainly relating to toll roads, transportation such as ports and rail, power utilities — industries where you normally have long-term arrangements. The sector mandate for the IDB Infrastructure Fund included airlines, natural resources such as forest projects, pulp, paper and agribusiness, as well as financial services relating to the development of Islamic Finance. Similarly in the recently launched Growth and Infrastructure Fund by Abraaj Capital, social infrastructure and soft infrastructure like education and healthcare has also been included.

The challenge for these funds, with their relatively high target return benchmarks, is to find the right investments at the right price. Already in the power sector we have seen high investor interest driving up prices and driving down yields. Increased competition from non-fund players such as the large private groups and eventually regional pension funds with lower performance targets could also cause problems for these new funds. However what is certain from the global experience is that private money will continue to flow to infrastructure assets in the region.

EMP has been investing in infrastructure in the MENA region since 2001 with considerable success. EMP Bahrain is the Manager of the $730 million Islamic Development Bank (IDB) Infrastructure Fund, the first private investment vehicle of its size to focus on infrastructure development in the member countries of the IDB. By the end of 2006, the Fund was fully committed to 11 investments in Turkey, Saudi Arabia, Malaysia, Oman, Jordan, Guinea, Pakistan and Bangladesh. The Fund’s portfolio includes investments in the transport, power, petrochemicals, telecommunications and metal and mining sectors.

EMP Bahrain is a subsidiary of EMP Global, an international private equity firm serving as the principal adviser or manager with funds under management of $6.1 billion. EMP Global has invested in infrastructure for over 10 years through its funds in Africa, Latin America, Asia, Eastern Europe and more recently the IDB Infrastructure Fund. The IDB Infrastructure Fund’s approach to investing has been a little different from other private equity players. It prefers to partner up with leading industry players and technical partners taking large minority stakes. EMP provides strong corporate governance standards, financial and technical assistance and strategic guidance to its portfolio companies.

Junaid Jafar is a general partner at EMP.

The face of Middle Eastern private equity is young and vibrant, but its age does not exempt it from the challenges of the next five years as it matures through its adolescence. The enormous potential for new projects is countered by the still present, but shrinking, lack of understanding of the private equity business. As the macroeconomic winds change, private equity firms must understand how closely related they are to the forays of financiers into the developing markets of years past.

During the development of another growth prospect — that of Sub-Saharan Africa in the 1970s and 1980s — firms financed ships to deliver concrete to the plethora of countries looking to the West for an example of how they should pursue their development. Concrete was the necessary commodity for the slew of infrastructure projects planned, for transportation channels and infrastructure, including the ports in which the boats would dock, as well as other structures for industry.

When the projects turned sour, however, the ships of concrete waited at the ports until their cargo solidified. Fund managers in developing markets must realize that they are today commanders of new ships and commodities, and they should learn from the experiences of previous developing markets.

Many in the region desire the efficiency that private equity can bring, but countries are choosing different rates at which they want to import private equity as a commodity and to allow the financiers to bring their know-how to a host of regional businesses. Saudi Arabia and Kuwait are looking to attract private equity at a slower pace than their more liberal neighbors in the rest of the Gulf Cooperation Council. However, the question is not what private equity firms can do for the region, but how can they do it?

Finding the right balance

How will a private equity player tailor Western-style value creation, restructuring principles and due diligence procedures to family-owned and operated businesses with a history spanning several generations, some of which precede the modern state in the region? What can we expect to see as the next generation changes their ideas towards competition, growth, and efficiency by welcoming private equity firms to develop and turnover their businesses in new markets?

Private equity strategists must learn the geography, the climate, and the competition as they seek not only to expand their reach, but the reach of their investments. Regional firms can offer their product to the rest of the world if they receive the proper blend of Western expertise and regional know-how.

One successful deal with a regional player — whether they are an investor or investee — establishes a relationship which can be harnessed and synergized to create more deal flow and generate returns. Private equity firms understand this and pride themselves on the relationships they have been able to establish over the past few years of the industry’s infancy in the region.

As the industry matures and goes through its adolescence, private equity firms and private businesses will realize the importance of their relationship, but the conditions in which firms operate will change and a consolidation in private equity players will ensue.

A new mathematics will combine Western metrics with regional logic to create a new brand of due diligence for acquisitions, managing corporate governance and preparing investments for a host of exit options — of which the IPO is increasingly gaining speed on regional capital markets. The new logic will find businesses implementing the most efficient of procedures, colored by a local accent and a nod to the Middle Eastern market.

Much of the region continues to depend on imported knowledge to increase efficiency and thus make development schemes more effective, but it will take the efforts of everyone involved — including family-firms, private equity players, and regulators — to make sure the ships of private equity reach their ports before the cement dries.