PRIVATE EQUITY 2006

Index

International private equity funds, for the first time, have started to look for deal flow from the Middle East after having in the past considered the region solely as a source of limited partners. Imad Ghandour captures the dynamics of this vibrant sector

T he private equity industry in the Middle East and North Africa (MENA) region closed 2005 with a record number of funds launched and announcements made – more than 16 funds with $2.4 billion of paid-up capital started operation last year. Judging by the reports made in the last few months, 2006 will be even more exciting as the industry's size is expected to cross the $8 billion benchmark by the year-end.

According to Zawya's PE Monitor, 2005, $5.8 billion of private equity funds were raised in the MENA region between 1994 and 2005, of which $2.4 billion (41 per cent) were raised in 2005 alone.

Most of the 16 funds that completed their fund-raising in 2005 were promoted by veteran private equity houses, or at least, veteran investment banks. Global Investment House launched two funds targeting the real estate sector ($100 million) and the pre-IPO buyout opportunities ($300 million). Abraaj Capital raised the largest buyout fund ever in the MENA region – the $500 million Buyout Fund II. Ithmar Capital capitalised on its unique experience with Ithmar Fund I, and made the first closing for Ithmar Fund II at $60 million, eyeing a second closing of $150 million in early 2006.

Swicorp, a Swiss investment bank focusing on the Middle East , made their first closing of the Intaj Capital Fund at $60 million, also targeting a second closing of $150 million in early 2006. Shuaa Partners pulled $200 million to its first independently run private equity fund, exceeding its initial target of $150 million.

Fuelled by the excess liquidity in the region, some investors seem to have a growing appetite for this class of investments. Abraaj Capital reported that its Buyout II fund was oversubscribed by 70 per cent. Gulf Capital has also announced significant oversubscription for its capital. This is a significant departure from two or three years ago, when it was rather difficult to raise $100 million for a private equity fund.

However, private equity appeal remains limited to a club of professional, institutional investors and family groups, and less sophisticated investors shy away because of its illiquidity and long-term horizon. “Private equity is an asset class in full expansion throughout the region, and an investment vehicle of growing importance to international institutions such as DIC (Dubai International Capital),” stated Sameer Ansari, CEO of DIC, who committed $25 million with Abraaj Buyout Fund II.

Attracted by the growing appeal and potential rewards of private equity, at least four of the 16 funds that closed in 2005 are first-time funds: The GCC Energy Fund, Athar Al Majd Diversified Private Equity Fund I, Accelerator Technology Fund and Star Point. Combined, the first-timers have only raised 17 per cent of the total in 2005.

READY, SET, GROW...

This upward trend will continue unabated well into 2006 as 26 funds were announced in 2005 and are aiming to raise at least $2.1 billion by the first half of 2006, according to Zawya. Another $900 million are expected to be announced and raised in 2006, raising the total forecasted fund closures in 2006 to at least $3 billion. If realised, this will bring the total size of active funds to around $8.5 billion. If the favourable economic environment is sustained, it is expected that the industry will break the $10 billion barrier by 2007.

Swicorp, for example, is currently raising its $100 million Emerge Invest Fund, and EFG-Hermes will soon be closing three funds. Levant Capital, The National Investor, Daman Securities, Injazat Capital, Al Rajhi, Global Investment House, Byblos Bank, Capital Trust and many others are all actively raising funds.

What is particularly interesting about the new wave of 2006 funds is the growing num ber of venture capital (VC) funds. Fourteen VC funds aim to raise around $1 billion in the MENA region this year, significantly more than what VC funds have raised over the past 10 years. This growth is expected to continue in the medium and long terms because the industry is still small compared to the size of the overall economy.

In 2003, the latest for which aggregate global figures are available, private equity funds invested $115 billion and raised $82 billion. In comparison, in 2005, funds invested were $1 billion in the region and raised another $2.4 billion. Given that the MENA region represents roughly 2 per cent of the world's GDP, the fund-raising activity will maintain its current levels, thus improving the industry at double-digit growth rates in the coming years. Consequently, investments will increase, and it is expected that they will reach between $2 billion and $3 billion in the coming years.

As the industry increases in size, private equity practitioners are catching up with their international peers. “As an independent observer, we see more sophistication amongst practitioners and investors alike. Investors or limited partners are more discerning about the risk-reward trade-off, and are looking for better information, rating, and benchmarking of performance of the various funds out there,” says Ihsan Jawad, CEO of Zawya.

He predicts that the industry in 2006 will exhibit more maturity and increasing alignment with standard global practices. “We are looking to evolve the Private Equity Monitor from a database of funds and transactions to a benchmarking tool for the industry,” he adds.

INTERNATIONAL INTEREST

Until 2004, few international players paid any attention to investments in the MENA region, an area which attracted only 2 per cent of global investments, mainly to Israel 's buoyant technology sector. Some estimates put total private equity funds invested in Arab countries in 2003 at a mere $100 million.

But last year has witnessed a significant shift for international players' interest in the region. In a landmark deal, 3i, a global leader in private equity, bought a 16.2 per cent stake in Sharjah-based Petrofac in 2002 for £22 million, and exited last October during an IPO at the London Stock Exchange for £120.2 million. 3i has also become a strategic partner of Ithmar Capital, a Dubai-based private equity player, for the Ithmar Fund II.

Faisal Balhoul, managing director of Ithmar Capital, said: “The GCC is increasingly a global market for many of 3i's portfolio of companies. Companies, particularly in sectors such as oil & gas, retail, water etc, see the GCC as an important and strategic market. In addition, unlike the American, European and Asian markets, the Middle East is a region which has not been covered by 3i – so there is a gap there which needs to be closed, especially with the above regional factors making it increasingly attractive, and of course private equity and venture capital being a global business.”

Last year has also witnessed Citigroup's first investment as a limited partner in the region through Citigroup Venture Capital International (CVCI). “CVCI's investment in Abraaj reflects our confidence in [Abraaj's] team and its ability to generate superior returns in a region with burgeoning opportunities,” said Dipak Rastogi, vice-chairman, CVCI. DLJ, a global investment bank, also announced its intention to enter the regional private equity scene, and Ascent, a US-based venture capital fund, is also raising $100 million for its regional Ascent Medical Technologies Fund.

Intel Capital was even more aggressive than the others in its plans for the region, and has allocated $50 million to be invested in the Middle East . This followed Intel's CTO Pat Gelsinger's statement in April 2005 that ‘‘[I] feel that the tech industry has underestimated the size of the market and the skill of the workforce in the Arab regions.''

DELIVERING THE GOODS

Raising money, as agonising as it is, is the easy part. But the question remains: can private equity deliver exceptional returns? Most funds promise their investors between 20 and 25 per cent annual return, and some even promise 30 per cent. Top tier funds have, so far, delivered on their promise. In addition to the remarkable 5.5 times return achieved by 3i on its Petrofac investment, Abraaj Capital has already exited Aramex with 5.3 times return over three years. Emerging Market Partnership was able to realise around 130 per cent IRR in two years from its partial exit from SIPCHEM, a Saudi petrochemicals company.

Investments in pre-IPO situations will remain, in the foreseeable future, a lucrative strategy for many private equity players. In a pre-IPO situation, a PE fund, acting as one of the company founders, can realise a decent multiple over a short investment period of two to three years. The IPO, as opposed to a trade sale, secures for the fund a guaranteed exit for liquidating its position.

Many PE houses are focusing totally or partially on this strategy, and some have started to get the promised returns. Global Investment House and The National Investor have both launched specialised Pre-IPO funds. Amwal Al Khaleej, the $266 million fund based in Riyadh , adopts this strategy in many of its investments. It has been a founding shareholder in Dana Gas, Nass Corp, Damas Jewellery, Amwal Invest, and Al Tayer Travel, and all the companies have completed or will soon be completing their initial public offering.

The average appreciation of share prices for the IPOs launched in 2004 was an astronomical 1,142 per cent by the end of 2005. Even IPOs launched in 2005 have realised an astounding 392 per cent price appreciation on average. For example, Dana Gas shares, which were listed in December 2005, have risen by 350 per cent in less than one month, and ArabTech shares, which were listed in January 2005, have appreciated by 517 per cent by the year-end.

“The success of the private equity funds has, to a large extent, been driven by the lucrative pre-IPO deals that have allowed many to achieve quick exits in a predominantly bull market,” states Raed Kanaan of Shuaa Partners. He adds: “The question is whether there will there be enough ‘easy' deals in the next few years to absorb this influx of private equity money. Sooner or later, the fund managers will have to dedicate more time and resources in finding the right investment opportunities and adding value post-acquisition.”

“Those that have not been able to build the right team of professionals today – mixing the technical and regional expertise – will find it harder to deliver the promised returns and in turn raise more funds in the future,” he adds.

Dr Karim El Solh, CEO of Gulf Capital, a large private equity firm, confirms that the IPO route will remain attractive for private equity funds in the foreseeable future, and that “The GCC equity markets will absorb new IPOs for companies with high growth potential.” He adds: “The public markets are still small if measured relative to the size of the economy and the number of privately held companies. The positive structural changes occurring in the GCC economies, supported by the high oil prices, will insure that the public market will continue to be vibrant in the coming years.”

The author is head of Strategy & Research, Gulf Capital, and chairman of the Information & Statistics Committee, Gulf Venture Capital Association.

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