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Fri 20 Nov 2009 04:00 AM

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Regional private equity industry shake-out and consolidation has already begun

Private equity in the GCC continues to grow notwithstanding the current difficult economic climate. In fact, the fundamentals that contributed to its growth are as valid today as they were a couple of years ago.

Regional private equity industry shake-out and consolidation has already begun

Private equity in the GCC continues to grow notwithstanding the current difficult economic climate. In fact, the fundamentals that contributed to its growth are as valid today as they were a couple of years ago.

Leading private equity firms such as Gulf Capital have enough dry powder from recently raised funds to finance future acquisitions for years to come.

It is estimated that around 55-65 percent of the funds under management are still not invested, leaving a big overhang in the industry. With so much dry powder left, regional private equity firms are under considerable pressure to close transactions and deploy the considerable amounts raised; otherwise they will be forced eventually to return the capital to their limited partners in the funds.

In the West, the private equity industry has come to a virtual halt due to lack of acquisition financing, which was the key ingredient to fund transactions in the past. In a typical US or European leveraged buyout, private equity firms would historically put minimal equity in an acquisition (as little as 10-20 percent), funding the rest with corporate debt provided by eager banks chasing fees and higher interest income. This business model is viable in boom times when debt is plenty and cheap but is broke and unsustainable in today's environment where debt is scarce and very expensive. 

How has the global and regional liquidity crisis and the disappearance of acquisition finance affected the Middle Eastern private equity scene? The short answer is nowhere near their Western counterparts. Regional private equity funds never leveraged their deals in the first place and their main business model relied more on private to public multiples arbitrage and, selectively, operational improvements rather than financial engineering to deliver returns.  

However, deal activity in 2009 did indeed sharply drop in the MENA region.  The number of closed deals in the first nine months decreased by almost two-thirds, from 34 in the comparable period last year to 12 in 2009. On the fundraising side, only two funds were successfully raised this year, the most notable one being Gulf Capital's GC Equity Partners II, which raised almost half a billion dollars from some of the largest global investors.

In the Middle East, private equity investments flowed primarily to the region's three largest economies: Saudi Arabia, the UAE and Egypt. The three countries accounted for 67 percent of the total number of deals announced year to date, and this is in line with historical trends. Investments have focused post-crisis on selected defensive sectors such as education, healthcare,  utilities, telecommunication and food or long-term technology bets. The majority of the Middle Eastern transactions (by value), year to date, were control buyouts, a clear shift from the minority investments historically pursued by regional private equity firms.

"First-generation" investment strategies focused on acquiring numerous minority pre-IPO stakes are losing appeal with investors, for two principal reasons: 1) with the continued weakness in regional stock markets and the long lock-up periods on founders post-IPO, the pre-IPO investment "bet" and the desired post-IPO share price "pop" are no longer a viable and reliable option to deliver returns; and 2) investors today want private equity firms to be in clear control of their portfolio companies and to drive significant value enhancement and profit growth irrespective of market conditions. The former strategy is no longer viable and will lead to the exit or disappearance of a number of regional private equity firms.

The inevitable consolidation of the highly fragmented regional private equity industry has already begun and sadly, the bulk of the 125-plus industry players will not be able to raise additional funds and will be confined to the annals of history as one-fund wonders. Only a select few will be able to progress to the next stage and raise additional funds. Regional and global private equity investors are clearly interested in only one "next-generation" investment strategy: control buyouts focused on clear operational improvements and true value enhancements.

Dr Karim El Solh is the CEO of Abu Dhabi-based private equity firm, Gulf Capital. The opinions expressed are his own.

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