There are growing opportunities for private equity investors as regional businesses realise the advantages of external funding and demand for infrastructure projects increases
The high profile private equity deal of the moment may be Dubai International Capital's proposed US$304.9m takeover of Liverpool Football Club in the UK, but there are signs of a growing appetite for such deals from Middle East investors.
Private equity firms in the GCC raised $10bn last year, almost double the amount for 2005, according to the annual report of the Gulf Venture Capital Association (GVCA).
"The size of private equity funds under management is doubling every year," said Ihsan Jawad, board member of the GVCA. "We expect funds managed by regional companies to exceed $25 billion by the end of 2007."
The increased interest in private equity investment is likely to be at least partly due to the correction in many regional stock markets, which has left many investors looking elsewhere for returns. There also seems to be less resistance from local businesses to private equity, now that they can see cases where the cash injection has made a positive difference.
The drop in stock market value also means that company valuations are less inflated than they were two years ago and there is more value to be found.
"It's good and bad," says Mustafa Abdel-Wadood, managing director, Abraaj Capital, which was the first pure private equity firm to be regulated by Dubai Financial Services Authority when it opened in March 2006. "From an exit perspective, you always want to time it when the markets are good, especially if your route is public markets, but even if your route is not public markets and you're looking at strategic exits, people are pricing off public markets. In an ideal world you're investing in the down cycle and exiting in the up cycle.
"Interestingly, from a fundraising perspective, it's always easier to raise money at the peak of the cycle, even though that goes against logic because that's the time when asset prices are inflated, yet people are more willing to give you money at that point in the cycle."
He says that listed companies that feel they are undervalued in current market conditions may seek to delist and pursue an aggressive development plan with the help of private equity before returning to the market.
Amwal Al Khaleej was responsible for the largest private equity deal in the first half of 2006, its $75m investment in Amwal Al Arabia, an Egyptian-based textile firm.
Fahad Al Deweesh, vice president, Amwal Al Khaleej, a Saudi Arabian private equity firm, has also seen benefits following regional market corrections.
"There was a lot of fundraising going on [following corrections] and we've been able to successfully raise two funds now," he says. "What has happened is the market has made it a lot better to do private deals because the valuations have become much more realistic. Previously the companies used to look at the market and say ‘I'm worth that much because company X is trading on the exchange for that much' and they expected the same valuation, but now I think the valuations are much more in line with where we would like them to be."
Abdel-Wadood believes that the regulatory environment in many Middle East countries has improved in recent years, but says there is still more that could be done to encourage private equity investment. "I think the GCC countries, from a capital markets perspective, have only recently started evolving their capital markets regulation, opening it up a little bit more to foreigners, having a proper pricing process," he says.
"But for a private equity investor, the issue is that if you're doing public to private deals you need capital market regulations that are clear and allow you to do that."
He cites the UAE's rules restricting the purchase by investors of more than 50% of a company's shares as a regulation that poses challenges to private equity. "If you're doing buyouts that is what you're looking at ultimately: control," says Abdel-Wadood.
"It's obviously a bit of a hindrance when you're not allowed to have that structure that gives you proper ownership. But at least everything is evolving in the right direction, and to be fair sometimes these inefficiencies give us an edge because we know the landscape."
One recent change in the landscape is that privately-owned family businesses are becoming more and more receptive to the concept of private equity, he says, and not always because they want to sell out.
"Increasingly, you're seeing a number of family businesses who have passed through the generations, and they have issues of succession, issues of different members of the family wanting to do different things," says Abdel-Wadood. "They see the value of sometimes detaching the ownership from the actual management, and sometimes they look at the option of monetising the value that's been built up over generations."
Abraaj recently launched a fund that will invest in infrastructure, an area where it sees major demand over the coming years. Deregulation of many government-industries has also helped create opportunities for growth.
"That is important, that creates plenty of opportunities for private equity," says Abdel-Wadood. "You've seen it in Egypt, Jordan and Pakistan. I think what's interesting is that even in the GCC where governments don't need to privatise for the proceeds, they're privatising to create a level playing field by getting out of certain industries and that's providing opportunities for private equity players."
Abraaj's fund looks for opportunities across the Middle East, North Africa and South Asia, an area that Abdel-Wadood says is ripe for investment.
"Across that geography you're talking about over $600bn of investment in infrastructure that's required and no way can that come entirely from governments," he says. "More importantly, it's more efficient when the private sector invests.
"Having said that, the government still needs to act as a catalyst sometimes for some of these projects. That's where the public-private partnerships do make sense and with the huge liquidity around, it's getting out of the business of investing and more into the business of being that catalyst. So there's plenty of room for public private partnerships in infrastructure: power, utilities, ports, airports, things like that."
Millennium Private Equity, which is backed by Dubai World and Dubai Islamic Bank, has also seen opportunities in the sector. It has two funds, one of which will invest in telecommunications, media and technology (TMT) and one that will look for opportunities in the energy industry.
All of its investments will be Shariah compliant, something that gives the funds an added selling point without greatly restricting the companies in which Millennium can invest.
Izzet Güney, managing partner and head of the TMT fund, Millennium Private Equity, says: "Shariah used to be an obstacle. That's an angle where so much progress has been made.
"For almost every conventional instrument out there, each one has a sophisticated counterpart on the Shariah side. You don't have the obstacle that might have existed in the past."
He adds: "It gives us access to a pool of capital that has been truly starving."
Millennium's backing from Dubai Islamic Bank also gives it access to a strong syndication capacity, as well as the bank's board of Shariah scholars, who adjudicate on a deal by deal basis.
Güney says that the perception of private equity firms as asset strippers is not necessarily correct, and is certainly not a good long-term strategy.
"Asset stripping did happen, but these are exceptions to the rule," he says.
"Private equity makes investment into an undervalued asset. If you milk this company, you would never make the second deal."
Dr Laurent Lavigne du Cadet, managing director, oil, gas & energy, and head of Millennium's energy fund, says: "In the region we know there is a solid growth rate, but one of the peculiarities is a lack of equity funding.
"Firms are looking for funds to expand but it cannot come only from debt. Private equity firms can fill the gap between banks and companies who need money to grow."
The firm's energy fund is looking particularly at prospects in countries like Algeria and Libya, which have been starved of foreign investment and may not have fully developed downstream services.
Although Asia is often considered the strongest growth market, Africa is developing quickly when it comes to telecoms. "Africa is one area where penetration is low," says Güney. "It's perfect for the next three to five years."
In an increasingly crowded market, private equity investment firms are having to look to new markets and find alternative strategies to deliver good returns.
Istithmar made equity investments of $1bn last year, with about $6bn in assets. It expects to increase investment to $1.5bn in 2007 and foresees a 30% increase in the value of its portfolio. David Jackson, CEO of Istithmar, says: "Prices are going up. You have more capital and more players than a few years ago."
This competition is driving up the price that people are paying for assets, meaning that private equity investors are having to look harder to find value.
"We have to be a bit smarter than the others in what we're trying to do," says Jackson. "We don't do every industry. We don't do oil & gas because we don't need that exposure."
Private equity investment firms in the Middle East are responding to increased competition with new approaches to finding value and delivering returns.
As more family firms open themselves up to outside investment, the next few years promise to see growing activity in this area.