Private equity sector in the region expected to witness consolidation

Amid hope of a revival, the private equity (PE) sector in the region is likely to see much activity in terms of consolidation within the sector, said industry analysts.

Rising concerns over slowdown in deals and tightened liquidity have made PE firms have a relook at their business models and effect changes.

Globally, private equity firms saw a drop of about 70 per cent in investment activity in the first quarter, while the number of deals saw a significant squeeze.

"For a PE firm, it needs to show that it knows its business. However, it is expected that the weaker and last quartile firms would end up not raising enough assets and not being able to prove that they can make the right decisions and right kind of investments. If they have good people, they are likely to join stronger firms. Such firms would want to merge. The industry will definitely consolidate, we would see more teams than firms," said Tamer Bazzari, Chief Executive Officer, Rasmala Investments.

With credit crisis hitting the PE business hard, firms are seeking stronger platforms.

"We have received offers from about half a dozen companies who want to merge, who have the teams that can join us and they are looking at merging simply because they need a platform that can provide them with track record, distribution, client relations and deals," he said.

Abdulla Al Awar, Chief Executive Officer, DIFC Authority, said: "The present environment places private equity and venture capitalists on the threshold of a period of expansion and acquisitions owing to the availability of well-managed but cash strapped firms in the Middle East and North Africa (Mena).

"Though the global financial crisis has transformed the private equity and venture capital landscape – just as it has transformed the general financial landscape – creating an increasingly challenging environment, it has thrown up many highly attractive opportunities for those who have been prudent and have investible surpluses," he said.

"This is true in Mena in general and the Gulf in particular given that after a dip new data is projecting increased mergers and acquisitions activity in the GCC, led by the UAE and Saudi Arabia."

In response to the challenges of limited leverage, tough fund raising, increasing holding time scales and a significant amount of "dry powder", the PE firms are re-assessing their business plans, rationalising the investment teams and going in for a more robust pre-acquisition due diligence, which will have a positive impact on this industry in the long run, said analysts.

"There are better reporting frameworks being put in place and they are re-assessing their business plans," said Vikas Papriwal, Partner, Private Equity and Sovereign Wealth Funds, KPMG. "We are likely to see an increase in bolt on to existing portfolio companies as well as a rise in equity stakes especially in defensive sectors.

"With a rise in investment holding timeframes due to scarcity of attractive exit options, the focus of many private equity firms is on the workout of their existing portfolio companies – with operational improvements, debt restructuring and working capital management at the core.

"Discretionary spending is being restricted, including expansionary capital expenditure, and business timelines are being re-assessed as entities look to weather the storm," he added.

The coming days are expected to see operational improvements and focus on expansion, said analysts.

"As the credit market dries up and the direction of regional stock market becomes less certain, the approach for the next few years will be about operational improvements and expansion of the acquired business. It will be about private equity investors getting down to business and rolling up their sleeves," Bazzari said.

The industry continues to face numerous challenges in the present environment.

"Private equity in the Mena has been all about buying companies using lots of debt and making healthy returns as relative valuations in the stock market improve. The involvement of private equity investor has been limited to board representation with little value add in the underlying business," he added.

Private equity, being relatively illiquid, with a relatively long-term time horizon makes it tough to recover investment. Besides, it faces performance-related challenges, said analysts.

Amid all the challenges, those in the industry said private equity has already started to show signs of revival even as a significant turnaround is expected only by the end of this year.

"Signs of revival, more in terms of bolt ons of existing portfolio companies, increasing equity portfolios of existing companies are already there. It would definitely revive, there is much better resetting of sellers expectations it has to happen," said Papriwal.

Stability in economies will also bring positive news for the PE industry, which is waiting for large fund flows, said analysts. "We have started to see some deals, though it is likely to be slow. People are still trying to figure when would the downturn be over, they are also talking of green shoots, a major pick up would take some time," said Gavin Steel, Director, Capital Markets Group, Middle East, PricewaterhouseCoopers.

With firms seeing sporadic fund flow, industry leaders said the last quarter of this year and the first quarter of 2010 is expected to record better activity in fund flows.

As per estimates, investments by PE firms hit a low of $12.8 billion (Dh46.9bn) in the first quarter, down 75 per cent from the first quarter of 2008 in contrast to a record $177bn in the last quarter of 2007.

"The sentiment is improving, trading volumes have increased in brokerage business, interest in PE will also happen, lot of interest will happen towards last quarter as market stabilises.

"Fund raising side will grow quite a bit. But it does take time to conclude transactions, so if dialogue starts by end, lots will conclude by first half of next year," said Bazzari of Rasmala. He said firms expect funding to improve and with banks reporting a narrowing of gap between loans and deposits, economic stability would favour PE deals, too.

Analysts also pointed out to the "dry powder" capital under management, which is yet to be deployed.

According to a Gulf Venture Capital Associations (GVCA) 2008 report on Private Equity and Venture Capital in the Middle East, there is an estimated $11bn in capital under management that is to be deployed.

"The amount has already been committed to PE funds, it is just a matter of calling it. The trick is whether it would be called, that is the challenge," said Papriwal.

Dynamics of PE have undergone a change and while some time ago there was much focus on value creation through financial re-engineering, multiple arbitrage and active ownership, with lesser leverage and other issues the focus now is active ownership, said Dr Pablo Fetter, Member of the Gulf Venture Capital Association.

"It is a positive development for this region," he said.

The Mena markets are better positioned due to strong growth potential to see an upward move in PE investments, said analysts. Steel said: "The Mena markets are well placed. There is a fair amount of liquidity due to oil prices and there should be a good amount of activity within the private equity business in the Mena."

Saudi Arabia, Egypt and UAE are the markets being viewed as holding high potential whereas in terms of sectors the industry is opting for healthcare, retail, utilities, and transport .

"In terms of sectors, it is the defensive sectors such as healthcare, education, retail we are optimistic on.

"But in many cases there could be a good company in a sector that may not be a particular target for us," said Bazzari, adding that companies have started to look in for conducting business with those who have their corporate governance issues well addressed.

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