Private equity players poised for consolidation

Frederic Sicre of Abraaj Capital.

Despite the global credit crunch adversely impacting financial markets in the Western world, the private equity sector in the region is set to witness unprecedented growth in the next few years as oil reaches record highs, believe experts.

"The GCC private equity market offers promising prospects with potential for significant performance. The development of the market is supported by the increase in committed capital and the move of international players into the region," said Rami Bazzi, Principal – Private Equity, Injazat Capital, in an interview with Emirates Business.

In the latest annual report of the Gulf Venture Capital Association (GVCA), Amr Al Dabbagh, the Governor of Saudi Arabian general Investment Authority (Sagia), said: "The Mena [Middle East and North Africa] region is going to be a different region for doing business in the 21st century. The private sector in general, and private equity in particular, will have enormous investment opportunities on a scale never seen before. The trend to make Arab economies more competitive is irreversible, and the economic policies adopted by most Arab Governments will sustain today's growth into the future."

According to Bazzi: "The industry will definitely have to consolidate at one point. Right now, the [region's PE] industry is rather fragmented. It has evolved from being a collection of random investments to more structured types of funds with a well-defined investment policy and a well-articulated investment strategy. I believe this trend will be reinforced going forward. We will witness a shift from opportunistic or generalist funds to specialised funds, either with an industry or an investment focus such as buyout, mezzanine and/or turnaround."

What is working for the local players is the fact that the region's economic fundamentals remain strong and are supported by aggressive fiscal policies and high oil prices. Moreover, governments' reserves continue to trickle down to the rest of the economy – sustaining corporate profits and public investments.

"While the recent sub-prime meltdown has led to a slowdown in private equity investment in the US and Europe and a surprising 21 per cent decline in PE investment in Asia (excluding South Asia), the Middle East, North Africa, South Asia [Menasa] region recorded a phenomenal 90 per cent growth in PE investment in 2007. With PE investment of more than $17 billion (Dh62.4bn), the Menasa region has finally reached a critical mass and many experts in the industry believe it will emerge as the world's fourth centre of PE," said Frederic Sicre, Executive Director, Abraaj Capital, referring to Carlyle Group co-founder David Rubenstein's assessment that the Mena region will become the "fourth centre" of global private equity after the United States, Europe and Asia.

"Overall, the industry has experienced strong growth in terms of fund-raising, as well as an increase in the size of the funds and the size of the transactions. We have seen in 2007 the transaction size cross the $1bn level," said Bazzi.

"The increase of fund sizes and transactions will continue as fund managers start focusing on fewer investments of larger sizes to drive value and profitability," he reckoned. "Compared to other private equity markets worldwide, the GCC private equity is still emerging." Recently, Egypt's EFG-Hermes Holding announced its plans to quadruple the value of its private equity funds to $4bn in four years as it expands in the Middle East outside of North Africa.

"We're targeting to become more regional," said Hany Al Sonbaty, a partner at EFG-Hermes Private Equity. "We haven't scratched the surface yet."

"Although PE has entered a new era in the region, there still remains tremendous opportunity for growth," added Sicre.

"In comparison to more developed markets such as the United States, where PE funds under management are six per cent of GDP, private equity funds in the Menasa region are still comparatively low at less than two per cent of GDP. But with the positive underlying fundamentals, the untapped nature of the regional PE market has started to attract both international PE firms as well as local heavy-weights," he said.

"This increase in competition will be positive, even for existing local PE firms, because it will serve to attract the talent necessary to support the industry's growth. Ultimately, however, the real beneficiaries of the local PE industry will be the region's broader business community," Sicre said.

Nevertheless, the next few months will be difficult for all financial players, including private equity companies operating in the Mena region. "The sub-prime problem is now snowballing into a global recession. Banks are hesitant to even lend to each other. Central bankers are panicking. Yet the prospects for private equity in the Mena region remain bright," noted the GVCA annual report. However, as Bazzi pointed out, there remain challenges to this growth.

"In terms of challenges to this, improvement to corporate governance and transparency frameworks, right management teams, investors and investee companies' awareness to PE benefits [smart money] need to be taken into account," Bazzi said. The entry of international players holds a number of positive indications, he said.

"First and foremost, it is an indication of the region offering promising growth prospects. It is also an indication of the improvement of the business and regulatory environment.

"The move of players such as the Carlyle Group and other international pioneers in the PE industry into the Mena region take the industry to new levels in terms of professionalism, maturity and sophistication, not to mention co-investment opportunities," he said.

The region's private equity sector has continued to perform remarkably well since 2005, with the wealth created from oil spreading further inside the GCC and into the Mena region.

Improving investment conditions, increased liquidity and mounting international interest in these emerging markets have all acted as catalysts for private equity to emerge as a viable regional asset class.

While foreign direct investment continues to flow into the region, a greater share of GCC funds is being invested locally as a result of increasing liberalisation, privatisation and greater regional integration. This is attracting capital that would have otherwise been invested elsewhere.


Fund boost

The last three years have seen a boost in the fund-raising activity in the region. The number of funds raising capital has more than doubled in this period, reaching at least 22 funds in the first close in 2007, compared to 16 in 2006 and 12 the year before that. In addition, the average fund size raised in 2007 was $274 million (Dh994m), while in 2005 this figure was $204m.

Total funds raised in 2007 were $6 billion, compared to the 2005 total of $2.4bn. Of the 22 funds raising capital in 2007, 14 were announced in 2006 and six in 2007. The time for making a close has gone up since 2005, when it took three to nine months to make a first close. By 2007, it took six to 18 months to make a first close.