Lower valuations, success of bolt-on acquisitions, COVID-19 has changed the private equity playbook

Sachin is a partner in Reed Smith’s Energy and Natural Resources practice and Office Managing Partner of the firm’s Middle East offices. He has over 24 years of experience advising the Government and the private sector on privatized and publicly procured infrastructure and development works, particularly across the Middle East and India. He has advised on some of the most important airports, road and rail networks, power plants, commercial and residential developments, oil and gas facilities, water supply plants, hotels, and education facilities throughout the Middle East and Sub-continent. For the last three years, Sachin has been listed among the 100 most influential figures in the Middle East construction industry by the region’s leading construction publication, Construction Week; is listed in the Who’s Who Legal Guide to the best Global Construction Lawyers; and has most recently been named in the top 100 international lawyers by Indian Business Law Journal. Sachin is ranked as a leading individual for construction in Legal 500 and Chambers & Partners and a leading India expert based abroad (Construction) in Chambers Global. Sachin is frequently called to speak and write on the Middle East and Indian infrastructure sectors.

Website: https://www.reedsmith.com/en/perspectives

PE tends to be a GDP-linked business, and the bigger risk facing the industry amid COVID-19 is a genuine economic deterioration

  

The Middle Eastern private equity market at a glance

Nascent in the 1990s, the GCC private equity industry (and particularly its emerging champion, the UAE) underwent significant growth over the following decade, booming just before the 2008-2009 global financial crisis, establishing itself as a player on the international market. The recovery that followed brought about a period of consolidation and solidification of a handful of market players as regional, and in some cases, global powerhouses. Unfortunately, the downfall of UAE’s most prominent private equity manager, Abraaj, has brought about a moment of reckoning and highlighted the need for a realignment of the local industry and a reconsideration of the regulatory environment within which private equity funds operate in and from the region. The fall of high profile Abraaj and of other major companies, such as NMC, coupled with some of the other established local investment funds coming to the end of their term, has affected the level of private equity investment activity in the region. It is to be expected that it will take some time for regional investor confidence to be restored. That said, while the market may be undergoing a period of resetting and realignment, there are also good news stories that show that there is a lot of potential in the region – for both local and international investors.

Investment trends for 2020

As per S&P’s market intelligence report EMEA Private equity, in recent times, most local private equity deals have been exits (some related to some of the older investment funds coming to the end of their term). In some cases, such exits give way to substantial investments by foreign, sophisticated and well-known foreign funds (for example, the acquisition by CVC Capital of a 30% stake in GEMS Education). On the investment side, there is still a significant level of venture capital investment activity especially in sectors such as tech and healthcare (which predates the COVID era and which we expect to continue, not least because of the opportunities brought about by the pandemic and recent lockdown). Early-stage investments generally benefit from a range of government-led support and stimulus measures which makes this asset class attractive. Sovereign funds are also continuing to invest in the region, as well as beyond. It is also expected for international private equity funds to continue to search for potential future ‘unicorns’ in the region and invest accordingly. The recent success of bolt-on acquisitions such as the acquisition of Careem by Uber and souq.com by Amazon is likely to give rise to a stream of such deals, as businesses expand their geographical reach and diversify their offerings. Bolt-on acquisitions are an attractive way of scaling up a business but can also be fraught with challenges. The existence or lack of harmony between company culture, alignment of interests between central and local management and clarity of chain of command can be some of the issues that may affect the success of such acquisitions and ultimately of the private equity investors behind the organization.

Going forward, we expect that local private equity houses will continue to look at their own portfolio and that cash will be reserved for dealing with liquidity issues caused by the COVID-19 crisis and new investments will be focused on mid-market COVID-19 – proof business sectors, such as healthcare, tech (including e-commerce, healthtech and fintech), business services (including cloud based services).  In parallel, some of the world’s biggest private equity funds will likely continue to invest in the biggest opportunities that arise in the Middle East, infrastructure being a prime sector for such investments. This trend is well illustrated by last year’s acquisition by Blackstone and KKR of a 30% stake in ADNOC, and by the very recent USD 20.3 billion investment by a consortium between Global Infrastructure Partners, Brookfield Asset Management, Singapore’s sovereign wealth fund GIC, Ontario Teachers’ Pension Plan Board, NH Investment & Securities and Snam into a gas pipeline joint venture with ADNOC, which was announced on 23 June 2020.

COVID-19

The effect of the COVID-19 pandemic on the private equity industry around the globe cannot be underestimated. Globally, the industry is undergoing a period of contraction, after a decade-long period of growth. Deal making has generally been put on hold, while valuations are being revisited and new calculations are being made. It is generally expected that, as opposed to the post-financial crisis period, we will not see a period of panic selling, but instead holding of investments will increase as the markets stabilize and economies recover. This is not likely to last long however – the private equity industry is known for its dynamism and private equity funds will look to deploy the dry powder they are currently storing and take advantage of drops in valuations.

In the Middle East, and in particular the UAE, local market players will continue their inward looking strategies. It remains to be seen whether local private equity funds will follow the lead of the global market and hold on to investments for now. Regional governments, including notably the UAE federal government (alongside emirate-level governments) have been quick to  launch a number of measures aimed at supporting local businesses and helping them navigating the current COVID-19 climate. Substantial stimulus programs have been deployed. Existing substantial government backed investor incubation and acceleration programs (such as DIFC’s Fintech Hive and ADGM’s fintech accelerator, among many others) will likely continue to support promising businesses and help them navigate these uncharted waters.   Complementing such stimulus initiatives, we understand that banks have been directed to be mindful of businesses circumstances during the current times, and to be more lenient as they would normally be, with a view to returning their policies to normal once the economy stabilizes. This should help businesses secure or restructure financing in a way that allows them to continue doing business.

Some legal consequences of the impact of the COVID-19 era on the private equity industry

COVID-19 has brought about a new reality, which has and will likely affect for years to come the way business is done. In the short term, it will cause ongoing deals to be renegotiated, or put on hold; it will reinforce the need for GPs to have deep business sector expertise. It will direct companies to reconsider and restructure some of their contractual agreements with suppliers, customers and other third parties. Clauses such as force majeure, material adverse event, other financial covenants as well as insurance contract exclusions will be poured over and revisited as the market adapts to the new reality. The fast moving reality of disputes arising out of such clauses will help shape the new market practice. At fund level, sponsors and investors in private equity funds will seek to amend some of their fund terms, to ensure that funds have enough flexibility to model their investment strategy in such a way as to plug any capital demands during troublesome times In the case of funds reaching maturity, they will seek to extend the term of funds so that exits are not achieved at detrimental valuations. Legal advisers will be essential to this process and will be able to advise their clients and help them protect their interests.

* Any opinions expressed in this article are the author’s own

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