Winter 2014

TRADE TALK: A slow revival

Magnifying glassIn 2008, the private equity industry in the MENA region raised $6.4 billion. In 2013, it raised a tenth of that. We ask regional experts whether the market can recover. AMRITH MUKKAMALA HEAD OF STRATEGIC ADVISORY, MEFIC CAPITAL How is private equity performing in Saudi Arabia, where you are based?
Saudi Arabia’s private sector non-oil growth, at 5.5%, is outstripping the oil sector growth of 0.5%. There is a big push towards diversification from a hydrocarbon-based economy to a private sector/non-hydrocarbon driven economy.  Towards this, the government has identified five industrial clusters and encouraged foreign investment into these sectors with a range of policies aimed at attracting expertise and creating jobs for Saudis. The equity markets in Saudi Arabia have reacted positively to these developments and are in a bullish trend, having outperformed most emerging markets despite a correction in October.  Empirical evidence suggests a high level of correlation between the public and private equity markets.  Taking both the macro environment directional trend and stability coupled with the sentiment in the markets into consideration, the private equity investment climate in Saudi Arabia
is conducive. The main opportunities for investment lie in sectors such as alternative energy, healthcare, education and retail. What are the main risks to consider when investing in private equity in Saudi Arabia?
The nature of the Saudi Arabian private equity industry is different to developed private equity markets. The success of a private equity fund deploying capital in Saudi Arabia depends not on the experience of a fund manager but on softer aspects such as understanding the culture, creating a relationship and having historically showcased trustworthiness. Evaluating such traits in a fund manager is critical before investing. In Saudi Arabia, the concept of private equity has not reached the same level of acceptance as in developed markets. This is due to the feeling of losing control or selling prized jewels maintained over generations when it comes to including a private equity partner.  What will it take for MENA markets to return to the kind of private equity deal volume seen prior to the financial crisis?
The MENA private equity industry had its peak in 2008 with more than $6 billion of funds raised for private equity related investments.  In 2013, the industry raised a tenthof that value. Similar is the scenario from an investments perspective with more than $3 billion invested in 2008 and a quarter of that invested in 2013. This year is expected to be no different with a marginal positive growth rate. A factor that influenced the decline was the onset of the Arab spring, which meant regional private equity markets failed to recover post the financial crisis.  We believe the ranking order of countries which attract private equity investments will change in the future, favouring countries such as Saudi Arabia and UAE in comparison with Egypt, Morocco, Lebanon, Tunisia and Jordan, which attracted higher private equity investments in the past.  Even though the level of activity might not reach 2008 levels in the near future, we believe there will be some attractive exits in 2015 and 2016. CHRIS SIOUFI PARTNER, DECHERT What is the most important piece of advice you can give to a private equity firm making an investment in the MENA region?
Years of frenetic deal making, often hastily documented and executed, and the difficulties that followed, resulted in lessons to the private equity industry in the region, primarily the importance of due diligence. Deficiencies in corporate governance, distortions associated with inconsistent financial reporting and country-specific operational risks make it difficult for investors to have a complete picture of the target company. It is therefore essential for investors to assemble a team of experts and conduct a thorough due diligence as well as carefully screening the target company’s sponsors to identify politically exposed persons.  Equally important is the choice of the deal structure, with offshore arrangements put in place when investing in jurisdictions where  enforcement of rights could be contested by a local partner and to take advantage of international investment treaties. How is the evolving regulatory landscape in the region affecting private equity?
The access to pools of liquidity in the region by international private equity funds or regional players has become more difficult due to the enhanced regulatory regime in most jurisdictions. This is coupled with the fact that investors from this region are no longer willing to invest in blind pools but prefer project-specific vehicles, which renders deal execution more difficult. On the positive side, a greater recognition of dispute resolution mechanisms, particularly arbitration awards, provides more comfort to those investing in the region. In addition, over the past few years, Dubai has emerged as an excellent regional centre for dispute resolution and, in 2011, Dubai allowed regional and foreign firms to file disputes with the Dubai International Financial Centre [DIFC] Courts and obtain swift and effective resolution to commercial disputes. Do you see signs that private equity deal volumes are picking up again?
Definitely. The volume of deals in the region has witnessed a steady increase since 2011. Companies with recurring cash flows and positive net earnings are the most attractive targets. Sectors such as education, healthcare and energy related services are the most popular for investors. Mid-market transactions continue to dominate the volume of private equity deals taking place in the region. IMAD GHANDOUR MANAGING DIRECTOR, CEDARBRIDGE PARTNERS, AND CO-FOUNDER, THE MENA PRIVATE EQUITY ASSOCIATION Is deal volume in the MENA region likely to rise this year?
The deal-making environment for both investments and exits has improved in 2014. Several teams, including CedarBridge, have launched new funds and raised fresh capital, and at least five private equity managers have made first or final closings of their funds in 2014.  On the other hand, the global and regional economic environment has improved in 2014, raising the prospects of fresh investments. Political tensions in the region in 2011 and 2012 have subsided, at least for the GCC and Egypt. In particular, Egypt, which has been historically a leading destination for private equity investments, is now attracting significant capital again with Abraaj Capital and Gulf Capital closing large deals in the country recently.  Deal sizes have shrunk in previous years, as larger funds were unable to match seller valuation expectations and acquisition finance dried up. However, 2014 witnessed the return of larger deals as larger private equity funds notched up their valuations and banks were willing to entertain financing big-ticket acquisitions. It is worth also noting that private equity valuations have remained subdued and did not appreciate to the same valuation levels as public markets. Consequently, private equity funds started playing on a possible arbitrage between public and private valuations by way of an IPO [initial public offering], reverse merger to a listed vehicle, or trade sale to a publicly listed strategic buyer. Finally, 2014 has seen a significant number of exits, especially large exits, by way of IPOs or trade sales. This trend is expected to continue as valuation benchmarks rise across the region. What will it take for MENA markets to return to the kind of deal volume seen prior to the financial crisis?
In 2008, the private equity industry in the MENA region raised $6.4 billion dollars, according to Zawya Private Equity Monitor. Several funds were unable to invest such large amounts despite the opportunities that had arisen after the financial crisis.  This exuberance is unlikely to return, not for the lack of funding and investor appetite, but rather due to the economic structure of many MENA economies. The opportunities for deploying large amount of capital into private companies remain limited, and the number of deals that can absorb $50 million or more is a trickle. This is particularly true in the GCC, where the private sector remains small and the public sector dominates in many parts of the economy.  In order to increase the pool of opportunities in the region, the private sector should grow inorganically either through large-scale privatisation programmes across the GCC and Egypt or by increasing the number of investable countries in the region in the future. For example, if Iraq, Syria and Libya became appealing destinations for investments in the future, we would probably see a doubling of private equity activity. However, for the foreseeable future, both events are unlikely to happen. In the meantime, funds below $300 million have proven to be the most viable sizes for the region. An analysis of the deployment speed and the returns achieved for such funds reveal that this remain the best size for the region as most deals remain below $50 million and majority are below $20 million.  With such fund sizes, it is unlikely that private equity in the region will return to its pre-2008 peaks. NADIM KAYYALI PARTNER, EVERSHEDS  The MENA region has been challenging for private equity since the financial crisis. Are you seeing any signs of growth?
Most definitely. There is a much healthier pipeline and a strong appetite for investment. In addition, there is a lot of dry powder and general partners are eager to deploy. It is also worth noting that there has been a decreased rate of activity in the last few years, first as a result of a mismatch between private equity valuations and principal expectations, and then as a result of the financial crisis. 
However, the crisis now appears to be lapsing and both sides appear more interested in concluding transactions with real opportunities for growth in the region. The main sectors where we are seeing activity are oil and gas, healthcare, education, telecoms, media, technology and diversified industrials. Are you seeing more private-equity capital deployed on a deal-by-deal basis rather than through funds?
Yes. There are a number of reasons. The first is that many limited partners have been stretched thin due to financing needs post financial crises. The other is that, considering the amount of dry powder and the delay in deployment of capital, many limited partners prefer to park the money in their own accounts rather than with the funds. Finally, some limited partners feel that they have better returns investing their money in other assets or in fixed deposit accounts and would therefore consider investments on a transaction by transaction basis. What are the main challenges private equity firms face in raising and deploying capital in this region?
The first challenge is that there have been limited private equity success stories in the region. While there are a few successful transactions and some very successful funds, as a whole the industry has yet to prove that it can deliver attractive rates of return.  The other is that there are a limited number of attractive opportunities in the region considering that markets are segmented and in many instances heavily regulated.  The final challenge is that there may be competition from capital markets as it appears that the pipeline for IPOs [initial public offerings] is heating up and corporates may be more interested in procuring liquidity from the public markets as opposed to accepting private equity terms. Richard Rollinshaw private equity leader, PwC  The MENA region has been challenging for private equity since the financial crisis. Are you seeing any signs of growth?
We started seeing increased momentum since the start of this calendar year which has continued to build as the year has progressed. The private equity landscape has changed in the post-recession period. Some of the weaker players have disappeared, some of the start-ups have been either absorbed or re-built, and you are left with smaller number of players now but all quite serious and keen on doing deals.  While the financial crisis slowed the expansion of private equity deals, the improving economy is opening up fresh opportunities for investment. The investor community appears to be more optimistic, fund raising is on the up and the private equity pipeline looks strong. In addition, we are beginning to see increased interest from international private equity – this could be a game changer for the private equity market in the region. Are you seeing more private-equity capital deployed on a deal-by-deal basis rather than through funds?
There are investors in the region, including family offices, who continue to have an appetite for private equity but prefer deploying capital on a deal-by-deal basis rather than committing to a fund. We continue to see consortium-based deals particularly on larger acquisitions.  That said, we are also seeing an increase in fund raising activity with a number of key regional players having successfully raised or being in the process of raising new funds. Also, we expect international private equity to invest in the region on a selective basis rather than having MENA focused funds, at least in the near future. What are the main challenges private equity firms face in raising and deploying capital in this region?
Regional political uncertainty continues to affect certain markets within MENA. Instability generally causes nervousness among investors.  Secondly, while family businesses seem to be more open now to the idea of a private equity investor coming
in, these deals still remain challenging from an execution perspective, particularly where the ownership rests with a number of different members of a family.  Also, as market sentiment improves, expectation of sellers may also increase, resulting in a valuation gap which could be an obstacle to getting the deals done.  Lastly, traditional obstacles still remain such as the lack of secondary market and financial reporting. VINCENT MARC HEAD OF REGIONAL COVERAGE, CACEIS – ASIA MENA How does servicing private equity assets differ from servicing conventional assets, such as a long-only equity fund?
Much of the processing, and therefore software platforms and services, can be standardised for traditional funds.  However, private equity funds don’t lend themselves to standardisation as there are many different types of fund investing in a wide variety of asset types with a multitude of processes and pricing methods to contend with.  Reporting required by general partners and their investors is also becoming increasingly sophisticated and specific to each fund’s particularities.  Private equity’s non-standard nature has led Caceis to set up a specialised division which understands and handles the specialised needs of private equity and real estate investments. Are there any regulatory issues you must overcome when servicing private equity assets in the MENA region?
One of the first issues general partners must overcome is local investment regulations which differ greatly from country to country depending on the market maturity and specific restrictions in place, such as restrictions on foreign ownership.  As of now, for companies acting as a depositary for private equity funds in MENA countries, the AIFMD [Alternative Investment Fund Managers Directive] stipulates that the depositary has to monitor assets to ensure that all legal obligations are met by the fund and its investments at all times. Which are the most significant markets for your private equity business in the region?
Despite a reduction in the number of new deals and funds in the MENA region’s private equity sphere during 2013, general partners and their investors remain optimistic with regards to long-term growth in the private equity market.  Most funds investing in the Middle East are domestic funds rather than offshore funds, however, the proportion of offshore funds is rising.  For Caceis, the most significant markets in terms of investors and funds’ investments are Saudi Arabia, Qatar, the UAE and Morocco.  In terms of investors, we mainly see other funds, sovereign wealth funds and family offices investing in private equity. ©2014 funds global mena

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