Feb 27 2013

MENA a promising and growing investment landscape for PE funding

By H. Richard Dallas of Gulf Capital MENA a promising and growing investment landscape for PE funding
27 February 2013

Private equity as an asset class has become a popular choice for investors across the world. With the world becoming increasingly globalized, investors are expanding and diversifying their geographic footprint towards emerging markets, including the Middle East and North Africa (MENA) region, in search of higher returns than may be available in more developed markets with stagnating or slow economic growth. Businesses and investors are recognizing the potential of the MENA region as a promising, growing investment landscape.

The region has undergone structural reforms in the past 30 years necessary to support economic growth for an expanding and youthful population base. The reforms have improved governance and encouraged economic participation of the local population through government financial stimulus, especially in oil producing countries with abundant liquidity. This, in turn, has generated a more stable investment environment for local and international investors and has opened doors to fresh investment opportunities. In recent times, the Arab Spring has also forced governments to further speed up reforms that encourage transparency in government and private sectors in order to shore up investors' confidence and create opportunities for new investments.

However, there is still a relatively limited pool of capital available to support these new investment initiatives in emerging markets. According to the Global Financial Stability Report released in October 2012 by the International Monetary Fund, the total size of MENA equities, bonds and bank assets amounted to around 94% of GDP, compared to other emerging market and world averages of more than 175% and 366% respectively. Therefore, in most instances, traditional sources of funding are not as readily available to support growth for business needs.

With the recent global economic downturn, coupled with the uncertainty from the Arab Spring events, capital raised from local banks and public markets has become increasingly difficult to secure, especially for small and medium-sized enterprises (SMEs). Regional financial institutions are hesitant to provide debt funding to SMEs and other corporate entities that need it for growth. Liquidity raised on the regional stock markets has not yet recovered to its historic levels, IPO markets still lack new issuance and trading volumes on the secondary markets remain volatile. Out of the total primary equity issuance of USD 50 billion since 2005, around only 11% was raised during the past three years. Within this environment, the private equity industry can fill an important part of the large funding gap and, thus, capture an increasing share of the regional corporate financing needs.

The region is predominantly made up of family businesses so the application of private equity varies somewhat to the model typically used in the west. Families are progressively beginning to appreciate the additional value private equity can bring to their businesses as they become educated about how private equity can solve their funding needs and provide much needed strategic re-engineering to their businesses to move to the next stage of their growth cycle.

MENA private equity is evolving from a low base; as such there is significant potential for catch up to other emerging economies like Brazil and China. In 2011, PE investments stood at only 0.01% as a percentage of GDP for the MENA region compared with 0.10% and 0.14% for Brazil and China, respectively. In developed markets such as the UK and US, private equity investment exceeded 1% of GDP during 2010.

PE houses across the region have successfully raised the funds to tap into the array of opportunities, but the real challenge comes in identifying, nurturing, and closing the transactions, not to mention eventually creating ultimate successful exits. To cite a good example of such a process is the Maritime Industrial Services (MIS) which Gulf Capital invested and held for five years, adding substantial value to the business before completing a successful sale to a regional trade buyer, Lamprell , which is listed on the London Stock Exchange. During Gulf Capital 's holding period, MIS revenues and profits were increased by 203% and 184%, respectively.

The transactions that have closed are geographically diverse across the MENA region, but the majority of deals have been concentrated in just a few countries. The UAE, which is home to high-spending citizens and expatriates and one of the most stable and developed countries in the region, has seen the most deal activity, followed by highly populated countries like Egypt and Saudi Arabia. Even though PE investments have been diversified across the MENA region, over 50% of PE investments since 2005 have taken place in these core markets.

Private equity managers in the region tend to target defensive sectors that cater to the basic needs of the population, such as health care, education and power. Health care has been a popular sector for investment, supported by increased demand and spending power for services and facilities. There has been a migration away from patients traditionally travelling to the west to seek treatment. Instead, they now visit regional advanced medical facilities.

Retail and food services related opportunities are also available. Investments in this sector benefit from consumers in the region who are less affected by the economic downturn in the US and Europe. These consumers continue to show significant spending power, particularly in the GCC countries where there is a strong economic support from the local governments. Also, most recently, firms have been on the lookout for services orientated businesses with demographically linked growth prospects.

Another key sector that has been, and will continue to be, instrumental in government and private investment spending will be the oil and gas sector, where an estimated USD 500 billion has been spent between 2008 and 2012. The trend in expenditure does not seem to be cooling down, with a forecast USD 480 billion spend over the next four years. While most of the upstream industry is dominated by the national oil companies such as Abu Dhabi National Oil Company (ADNOC) and Saudi Aramco, there is a large opportunity for private equity money to cater to the underlying services that support them. This opportunity set is further enhanced by the aging infrastructure, where many of the onshore and offshore fields require increased maintenance, modifications, and new construction needed to maintain, if not increase, production targets.

Gulf Capital has actively pursued this sector with a controlling majority stake in an oilfield services company, Gulf Marine Services (GMS), growing it to one of the largest independent operators of advanced self-elevated support vessels in the Arabian Gulf. Upon acquisition in 2007, with a new strong management in place and guidance from its sponsor, GMS has developed a strong state-of-the-art asset fleet leading to a strong mix of blue chip clients while becoming a platform for further growth for international markets, witnessed by its most recent expansion into the Southern North Sea.

Private equity has naturally been cautious about new investments post the Arab Spring and financial crises. PE firms focused attention on the care and maintenance of the existing portfolio. As confidence builds through the coming year and a greater degree of certainty and stability is forecast for the region, more firms are again actively searching for attractive opportunities. In parallel, firms are increasingly focusing efforts towards exits as assets within portfolios mature and general partners are looking to provide the returns to their limited partners.

The current landscape is competitive and ripe for consolidation; a number of the smaller funds are forecast to exit the market. The majority of private equity funds fall within the range of USD 91-192 million, but there are approximately 30 funds that are less than USD 90 million in size. A reduction in the number of funds would help to rationalize price expectations and professionalize the market as only the fittest firms will be able survive in this competitive landscape. The number of transactions taking place in 2012 is a healthier number than that of 2011. It is the firms with regional history and local expertise, like Gulf Capital that are closing deals.

Although the MENA region is undergoing a historic series of changes in its political landscape that cause uncertainty and economic dislocations, it remains a region with powerful demographic trends of a youthful and growing population, growing consumer affluence, appetite and sophistication, rapid industrialization and urbanization, all supported by a number of regional governments intent on using their vast financial resources to drive increasing affluence and opportunity to promote social and political stability.

The MENA is and will remain a challenging environment for private equity, but also represents a compelling, untapped economic region with vast growth opportunities available to PE firms with the local expertise to take first mover advantage of these opportunities.

H. Richard Dallas is managing director of private equity at Gulf Capital , one of the most active and diversified investment firms headquartered in Abu Dhabi, UAE, that invests throughout the GCC and adjacent MENA region.

© Zawya 2013

© Copyright Zawya. All Rights Reserved.

Be the first to comment

Send This Article To Your Friends

All fields are required.

Use commas for multiple email addresses

We'll use your email address to send the article on your behalf and it will not be collected or used for any other purposes.