Nov 11, 2007 – Arabian Business

The credit crunch in global markets in recent months caused some high profile buyouts to stall - notably those of Boots and Hilton - but activity in the Middle East private equity sector seemed to maintain its momentum. This was due primarily to two factors: the region is awash with liquidity, and, excluding sovereign investment authorities, the deal size in the Middle East is nowhere near as large as in the West.

Dr Karim El Solh, CEO, Gulf Capital, says: "On the local side, we're not seeing much change or difference because local banks are still flush with cash and the economy is doing very well. Remember the local banks are mostly exposed to regional real estate and industry which are both doing very well still."

Sometimes we favour control because that helps us to mitigate some of the risks in the market.

However, many of the international banks have become more risk averse - as have some people in the private equity industry.

"With the international banks we're seeing some hesitancy, a bit more of a cautious stance, but they're still willing to talk, which is good," says El Solh. "I think also what's interesting is the private equity firms realise what's happening globally and that sooner or later it's going to spill over to this region. You'll find that they're being more guarded and they're not asking for aggressive financing, like covenant-light financing and the like, so the proposals they're putting forward for bank finance are a bit more cautious."

Ennis Rimawi, managing partner at Catalyst Private Equity in Jordan, says that the credit crunch has not hindered the firm's transactions.

"Because of our focus in terms of deal size, the credit crisis hasn't really affected us," he says. "With regards to Catalyst, because our focus is more on early growth phase companies, they're not highly leveraged, and we don't rely on significant leverage in our transactions, or much leverage at all. These are typically very high growth companies that are equity funded.

"It's primarily affecting the buyout funds that are dependent on significant debt and significant leverage on balance sheets to make their transactions feasible or lucrative. That's what's happening with the KKRs and the Carlyles, and it's also affecting firms in the region."

The credit crunch may have made emerging market companies a more attractive proposition for international private equity firms and banks, which could either present local players with competition, or with the opportunity to tie-up with firms that have private equity expertise but lack local knowledge.

Ithmar Capital was the first private equity firm in the Gulf to form a strategic alliance with an international player. 3i has invested US$15m in the Ithmar Fund II, which will invest in growth capital and buyout investments in the GCC, and is expected to attract $250m in investment, helped no doubt by the big name attached to the project.

"Early on when we set up Ithmar Capital we realised that no private equity player in the region had any association with a pure-play international private equity player," says Khaldoun Haj Hasan, co-founder and managing partner, Ithmar Capital.

"The region has had initiatives from the likes of Deutsche Bank and HSBC, but at the end of the day they are merchant banking operations with private equity divisions, they're not pure-play private equity players.

"The fact 3i was one of the few publicly-listed private equity firms at the time meant high standards of governance and transparency, an area we could learn a lot from, and an area the region has to a certain extent lacked."

3i's long experience in the industry was also a factor. "They've been operating for such a long time it means they've got tremendous sector expertise, something we could also benefit from," says Hasan. "If you look at most of the private equity firms in the region, they are sector-opportunistic, and that's due to the fact that they probably cannot afford to be sector-specific at this point in time. There is probably not enough quality deal flow in a certain sector to allow you to have that specialisation."

3i is one of the largest oil and gas investors in Europe, so Hasan expects this particular sector knowledge to be extremely useful in the GCC.

He anticipates further tie-ups between international and regional private equity firms. "It's not enough just to be a great global brand in private equity and come into this marketplace and think that you can just succeed based on that," he says.

"I think you need to recruit the right people, have the right alliances, have the right networks.

"A lot of that could come by virtue of you tying up with a regional private equity player that has all these mediums. I expect more and more of this to happen and I think this will be better for everyone and better for the industry."

International firms can also bring staff with skills that may not be widely available in the region. "If you look at most of the private equity companies around, the dominant skill in them is transactional skills," says Hasan.

"We've made sure, other than the fact that we do have transactional skills in-house, we recruit people that are mainly from operational expertise or pure private equity expertise, and that's why we have to go out to the West and seek people with Western private equity experience to bring them to this part of the world."

There are also limits to the benefits of local knowledge. As with any emerging market, there can be challenges when conducting due diligence on some Middle East companies.

"Generally the businesses that are being looked at are family-owned or owner-managed businesses.

"The level of governance has not needed to be extremely robust. From the shareholders' perspective, as long as the business is making money they are happy - which part it comes from doesn't really matter," explains Ashish Dave, partner, KPMG.

"The financial infrastructure supporting the business was not always looked at as an area for investment. Investment was being made in products or inventory or new business ideas - because of the way demand has been growing, this was more profitable..

"When carrying out due diligence, the lack of good quality management information systems and, consequently, management information makes due diligence a challenge."

Specialist sectors

• NBD Sana is primarily focused on the Middle East, North Africa and Turkey region, specifically in the areas of telecoms and media technology, energy and resources, healthcare life sciences, and retail and consumer.

"We believe that the centre of gravity for many of these industries is shifting away from Europe and the US, and to a large extent is shifting eastwards towards Asia and the Middle East," says Mir.

• Ithmar Capital is currently looking at transactions in the education and healthcare sectors, which Hasan says are attractive due to their strong growth and resilience in times of economic slowdown. He adds: "By virtue of our connectivity within the GCC, across three layers - financial institutions, government and family offices - as a value proposition to portfolio companies, we can provide connectivity across the whole Gulf, the region where we believe we can add value."

• Catalyst focuses specifically on companies that provide technology for businesses in the energy and water sectors. It was recently approved for $33m of financing at the fund level. Ennis Rimawi, managing partner, says: "We're a MENA region specialised investment company focused on energy and water technology companies. Of our first three deals, the first two are UAE-based regional companies, and one is a Jordanian-based regional company.

"We're starting to see some local and regional companies develop that are truly value-added suppliers of services, technologies and products for the energy and water sector."

However, he says that this situation is improving, helped in part by a new generation that have been schooled in the West and are now returning to the Middle East.

"They have realised they have to up their standards and they're doing that," says Dave.

"Also, having been exposed to developed business environments, the younger generation has an understanding of what strategic or financial investors such as a private equity house can bring in terms of adding value.

"Prior to having third party investors, the corporate structure may need to be simplified by having a holding company structure instead of having common shareholders in every company of the group. This will make it easier to have outside investors."

If your fund is at a nascent stage, you’re definitely going to wish it was yesterday.

Transparency issues can also decide whether private equity firms take a minority or controlling stake. "Sometimes we favour control because that helps us to mitigate some of the risks in the market," says Abrar Mir, managing partner, NBD Sana Capital.

"There are always some markets which have greater transparency risks, some markets which have greater governance risk or sovereign risk, so there we would tend to favour a majority control because we believe majority control mitigates against some of those concerns. In other circumstances we'd be happy being in partnership with an entrepreneur or a family-owned group where we believe that our long-term interests would be satisfied through minority possession."

Mir says that historically the region has not had the same access to cheap debt as that enjoyed by Western private equity firms, which has been, in some ways, an advantage.

"When we pay for assets in this region, these assets are pretty attractively priced because they're not inflated by big levels of debt coming in," he explains.

"What this means for our equity investors coming in is that the returns, because you're paying a lower price for the asset, tend to be a bit more attractive for the region than they probably will for other investors."

NBD Sana also looks at investment opportunities in Southeast Asia, but Mir says India presents some challenges. "While India continues to be a very attractive market with very solid fundamentals and extremely good prospects, the fact is that there is a lot of cash in private equity for a lot of firms - maybe even over 100 firms in India - that are chasing some good transactions," explains Mir.

"As a consequence we believe that to a large extent the Indian market tends to be a lot more competitive and therefore a little bit more pricey when you talk about pricing transactions compared to places like the Middle East, North Africa or Turkey."

The major challenge in the GCC during the past two or three years has been the performance of stock markets. Private companies that priced themselves against similar listed ones at the height of the markets were likely to be too expensive to offer value to private equity investors, while the severe correction that followed the stock market boom made IPOs a less tempting exit strategy.

"If your fund is at a nascent stage, you're definitely going to wish it was yesterday," says Fadi Arbid, executive vice president at Amwal Al Khaleej, Saudi Arabia's first private equity firm. "If your fund is at the deployment stage, you're very happy because you can say people are reasonable.

"That being said, a good company is a good company, and a sound investment is a sound investment; that being said, you always have to be a value buyer.

"A financial buyer will never match the price of a strategic buyer. If I'm going to buy a telecom company, the highest bidder will never be me, it will be another telecom company buying it."

Trade sales and stock market listings may have proved popular exit strategies, but the Middle East's private equity sector is gradually turning to secondary private equity sales as an option.

Mir of NBD Sana says: "I think in the future we'll see more of the secondary type buy-outs.

"A big chunk of the exit strategy in Europe and the US has been private equity firms selling to other private equity firms, and we've seen less of that in the region. I think over the next few years as PE firms in the region themselves grow we're going to see a lot more of those types of exits as well."

One of the few secondary deals in the region occurred in June, when Abraaj Capital acquired the Egyptian Fertilisers Company (EFC) from Citadel Capital for $1.41 bn, the largest private equity transaction in the Middle East and North Africa to date.

Arif Naqvi, vice chairman and CEO of Abraaj Capital, said at the time: "The size and scope of this transaction represents a landmark for the region and the private equity industry here."

However, there have been relatively few other secondary deals, from a fund to another, to date.

"The market's not mature enough," says Fadi Arbid of Amwal Al Khaleej.

He explains: "Don't forget that our market is a very new emerging private equity market.

"Private equity now in the US is about taking a company public, then taking it private again. We haven't done the first stage where private equity is used to take a company public.

"You don't have 20 companies with billions of dollars of investment that are circulating from one to the other. We're still not there yet."

Specialist sectors

• "Instead of investing in more mature companies, we invest in growth capital companies," says Fadi Arbid of Amwal Al Khaleej. "We just closed a retail deal in Saudi Arabia in the cosmetics industry, and we closed a media deal in Dubai with a company called Right Angle, which does bus shelter advertising in the UAE.

"We've also done a few deals in Cairo: one is in the financial services sector, for consumer finance, and the other one is in the textile industry. This is in Amal II, a 1bn riyal fund fund, which we're almost halfway in deploying. All of these industries are very demographic-driven."


• Dr Karim El Solh, CEO, Gulf Capital, says: "We have identified several fast-growing sectors and we try to drill down within those sectors and find the market leaders." So far, these sectors have included water and oil & gas services. The firm recently acquired Gulf Marine Services and Maritime Industrial Services, which provide services linked to offshore exploration and drilling.

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