Comeback kids

Arabian Business talks to Unicorn's CFO to discover why Islamic finance is now in higher demand than ever.
Comeback kids
By Tamara Walid
Fri 13 Jun 2008 04:00 AM

Bahrain's Unicorn Investment Bank needed to travel to London last December to raise funds to refinance debt after being snubbed by the local banking sector. Tamara Walid talks to CFO David Pace to discover why Islamic finance is now in higher demand than ever.

Seated in a lounge high up in Dubai's Emirates Towers, David Pace is eyeing the city's six o'clock rush-hour traffic with disdain.

The chief financial officer of Bahrain's Unicorn Investment Bank may have to get used to it.

When the bank conducts deals in the US, it competes against the biggest PE houses in the world — namely Silicon Valley.

He will find himself visiting Dubai with increasing frequency after getting an upgraded licence from local regulators that will allow the bank to ramp up its business across the region.

The growing demand for Islamic finance services and products, not only from regional individuals but increasingly from Western companies, has helped the bank increase its first-quarter profits fourfold to US$20m.

Yet when Pace went to the market last December with the intention of raising about US$100m in a debt financing facility, he was surprised to discover, despite the turmoil in credit markets as a result of the US subprime crisis, that there was little interest from local banks.

"We were in a position saying we want to raise a three-year US$100m debt financing for our company by January," says Pace. "Appointed advisors said ‘it's not the right time to raise debt. You must be mad'."

Pace decided to look for financing elsewhere and so took off to London on a roadshow.

"We invited 20-odd banks and they all turned up and stuck for lunch on a Friday, which having worked in the city for 17 years, is very unusual. Most of them came to the transaction. It was over-subscribed and we ended up raising US$125m as opposed to US$100m," he says.

For an unlisted and unrated bank, Pace believes Unicorn has done well. Other institutions have since shown interest in lending to the bank. This, Pace says, was an incredible vote of confidence.

"Isn't it disappointing that it's not the local financial institutions, let alone the local Islamic institutions coming in? We rely on the large conventional banks because they see the upside potential in this market even if the local banks don't recognise it," says Pace.

"The rest of the world has woken up to the potential of this business and it seems to me that locally we still have not been able to see that potential."

So exactly why is Islamic banking so promising? Pace explains that the budding market's strength can be attributed in part to the Gulf's economic boom, along with the expansion of other Islamic finance hubs in Malaysia, Turkey and Indonesia.

What these economies have in common, says Pace, is that their GDP growth has been outstripping GDP growth in Europe and the US for several years.

"Those regions are going to continue to outperform the West in terms of GDP growth," he insists. "There are 1.5 billion Muslims in the world and this is a rapidly-growing population and one that is becoming increasingly sophisticated."

The secret, however, is presenting a quality and competitive product range - as most Muslims are no longer willing to bank with a financial institution just because it plays the Sharia card.

"It's not enough anymore and it shouldn't be enough," Pace says, adding: "Most Muslims will say to you ‘there's no cost for faith. If you can offer me the same level of sophistication, product range, and experienced management team, at the right price, why wouldn't I bank with you?'" he says.

This is why Pace believes there is huge potential in the region for "professional" investment banks that are also governed by Sharia principles.

But while the industry has grown dramatically over the past few years, notes Pace, there is still a very long way to go.

"Total Islamic banking assets are still less than 1% of total global banking assets. Not a drop in the ocean.

"Sukuks have done very well but the total Sukuk outstandings are still less than one tenth of one percentage point of total global outstandings. Even a drop in the ocean is an exaggeration," he says.

As the industry develops, Pace anticipates demand for staff and scholars to increase significantly, but in the meantime banks such as Unicorn will have to seek expertise from conventional banks.

"We've actually hired the top people from around the world to help us build the business here. It's not quite the tipping point yet but it's getting very near."

An increasing number of people are showing interest in Islamic financial products and services.

Regionally, not only individuals but even national governments are insisting that local pension funds actually invest in Sharia-compliant assets, according to Pace.

"Corporate institutions in the region are increasingly looking for a Sharia alternative as long as it's on the same level of sophistication. So you have that inbuilt increased demand coming," says Pace.Moreover, companies and people in the West are increasingly looking for a different asset class, according to Pace. "The subprime crisis actually worries people and everyone is now looking to diversify into different sorts of assets."

While Pace is not implying that Islamic banking is risk-free, he notes that the advantage in Sharia-compliant banking is that you have an asset. The value of that asset could diminish over time, but ultimately there is still an asset, he points out.

"I'm not lending based upon your cash flow projections, I've actually got your assets. That makes it less risky, which makes a lot of Western institutions very interested now in the concept," he says.

Pace adds that many Western borrowers are looking to tap into GCC wealth.

"A lot of wealth owners in the region will only invest in Sharia-compliant assets. From a supply and demand point of view, it has actually increased demand," he says.

Pace cites private equity as a good example. The risk, however, lies in certain limitations of private equity (PE) in a Sharia-compliant manner, compared to conventional banking, notes Pace.

"One of those so-called limitations is that you can't have preference shares; everyone has to be treated the same. It also means you can't have any actual preferential players. Secondly, you can't over-leverage so you don't do highly leveraged buyouts," he says, adding that Unicorn's Sharia board will only accept a leverage level of 30%.

When Unicorn deals with proprietors looking to sell their business, the bank will insist that they keep a stake in that business and keep a degree of involvement.

Pace explains that when the bank conducts deals in the US, such as its most recent US$190m acquisition of a 75% equity stake in Open-Silicon, it competes against the biggest PE houses and the most competitive PE markets in the world, namely Silicon Valley California.

"When we spoke to the people there and showed them our business model they said ‘it doesn't look like you're trying to take my business from me, but rather you're partnering with me to take my business forward'. Even conventional customers were attracted to what Islamic banking can do," he says.

The Open-Silicon deal is an example. The company has been a venture capital business for several years and reached a stage where existing owners wanted to IPO.

Unicorn's Chicago office representatives heard about the deal, got in touch with Open-Silicon, looked at their books, their manufacturing facilities, and decided the company wasn't ready to IPO yet.

"We said to them: why don't we come in and take up the existing venture capitalists, take up the existing debt providers, provide you with new equity owners, new financing that is Sharia-compliant, then in two to three years you'll be more marketable and your upside potential will be even more?" says Pace. And the deal was sealed.

Furthermore, Unicorn took to arranging a road show for Pierre Lamond, chairman of Open-Silicon and one of the "grandfathers" of Silicon Valley, as Pace calls him.

"We bring Lamond to the GCC on a roadshow and next thing you know he's looking at maybe setting up a manufacturing facility in Qatar or Dubai. He also decided to stay on the board and realised this was an exciting opportunity," says Pace.

With an international presence in the US, Malaysia, the UAE, Pakistan and Turkey, Unicorn is looking to continue its growth around its five core business lines: asset management, corporate finance, capital markets and treasury, PE and strategic mergers and acquisitions.

"We're looking to diversify our assets and add to our private equities. We're not interested in start-ups; they have to be cash flow positive, normally consumer electronics or manufacturing," says Pace.

And with its category two licence, the bank is now able to build its investment securities portfolio from Dubai.

"More importantly we can actually engage as an Islamic investment bank out of Dubai so we can start doing transactions with other Islamic financial institutions.

Now we have moved from being a rep office to a fully-fledged part of the Unicorn family, which meets our ambitions of having our subsidiaries as a mini-version of our office in Bahrain," he says.

So perhaps the next time the bank goes to the market, it will receive a warmer response than before. If not, there's always London again.

Sealing the Sharia dealsUnicorn has advised, structured and placed deals with a total value of over US$3bn - including a US$1bn Sukuk for Saudi real estate developer Dar Al-Arkan, marking the largest Islamic bond sale to be issued by a Saudi corporate in the international capital markets.

This was preceded by Dar Al-Arkan's US$600m inaugural Sukuk, where Unicorn was also the joint lead manager. Apart from the deals it advised on over the last year, the bank was able to strengthen international operations through the acquisition of a 75% stake in Inter Yatirim Menkul Degerler, a brokerage and asset management company in Turkey. In September Unicorn established T'azur, an independent regional Takaful company.

The bank also completed the initial capital raising for the Unicorn Strategic Acquisition Fund, with a group of investors committing US$150m towards Unicorn's target of creating a US$1bn fund to take strategic stakes in and manage financial institutions.

The end of the year saw Unicorn sealing two major private equity investments in the US, namely the acquisition of a 75.6% stake in Open-Silicon, a leading chip design and outsourced manufacturing services company, and an 80% stake in Victron, a provider of electronics manufacturing services in California.

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