“At one point, we had 103 PE funds in the region. That was before 2008. Eventually, the financial crisis and the various other crises that hit the region after 2008 reduced that number probably to a handful - I mean, the fund managers that are active and sustainable,” Imad Ghandour, the founder and managing director of Cedar Bridge Capital, told Zawya in a telephone interview on Sunday.
In fact, the region’s private equity industry has shrunk to such a size that its trade association, the MENA Private Equity and Venture Capital Association, which provided annual reports on the health of the sector, wound itself up at the end of last year (although several venture capital firms later formed their own body, the Middle East Venture Capital Association, in February).
“A lot of members are challenged, and therefore their commitment to the association and their membership was discontinued,” said Ghandour, who was a founding member of the MENA Private Equity and Venture Capital Association. “As a result, the association couldn't sustain itself financially.”
Dubai-based Abraaj Capital grabbed the attention of industry-watchers since February, when it first emerged that a group of prominent investors into a $1 billion African healthcare fund run by Abraaj (including the Bill and Melinda Gates Foundation and the International Finance Corporation) had commissioned an independent review into how their money had been used.
Since then, the affair has spiraled, with accusations that Abraaj Capital commingled funds and raised substantial debt to cover its own operating costs. Eventually, PwC was appointed as provisional liquidator to Abraaj Capital in June, with Reuters reporting earlier this month that it has debts of $1.07 billion.
Assessing the long-term impact of the Abraaj saga on the Middle East’s private equity market is no easy task, especially as it continues to unfold. Yet Ghandour said he does not believe that it will be too far-reaching, because investments in local private equity funds tend to come from local family offices.
“I'm not sure Abraaj has impacted the Middle East specifically. It might have impacted Africa or other parts of emerging markets, and the trust that western LPs (limited partners, who invest in private equity funds) might have in emerging market (fund managers) and their ability to sustain themselves,” Ghandour said.
A dry well
Ghandour said that the main challenge faced by the industry in the Middle East remains a lack of liquidity. While the private equity sector is going through a purple patch globally, with data provider Preqin reporting that the industry raised a record $453 billion from investors in 2017 – up from $414 billion achieved in 2017, giving it more than $1 trillion of ‘dry powder’ to invest into businesses – fundraising remains a challenge in the region.
“Fundraising is linked to liquidity, liquidity is linked to the economic cycle. I think this is the main challenge for the industry players today,” Ghandour said.
“In the US, the economic cycle is positive, the stock market is up, the economy is doing well. So definitely, liquidity is up. But also, the difference between the Middle East and other places is that in the Middle East there is a lack of institutional investors. The investors are mainly family offices and therefore their liquidity is derived mainly from the performance of their businesses,” he said.
Yet if liquidators have just been appointed to the region’s biggest private equity fund, it is reasonable to assume that private equity managers looking to raise funds will face additional challenges.
Last month, Abu Dhabi’s Waha Capital scrapped plans to raise a $300 million private equity fund, as investor sentiment on Middle East private equity turned negative, according to Reuters.
Sulaiman Al-Rubaie, interim CEO of Kuwait’s Global Investment House, told Zawya that it had also postponed plans to raise a new fund by one to two years.
The asset management firm has launched five Middle East funds worth a combined $1.8 billion since launching its first Middle East fund in 2003. All three of its active funds, with a combined value of around $650-700 million, are fully deployed, he added.
“Given a lot of the volatilities in the market, we have delayed any major fundraising for a normal private equity fund,” Al-Rubaie said in a telephone interview on Tuesday, adding that it was instead raising funds on a deal-by-deal basis.
He said that the market for raising new funds was “under some influx”.
“The news of one of the leading private equity houses is not really helping. Unfortunately, it's the one that is really marketed very heavily with international investors, so anything that disrupts that or attacks that will affect the credibility of other private equity funds.... who don't actually have the same issues,” Al-Rubaie said.
Al-Rubaie added that private equity fund managers were facing difficulties as a result of the political standoff among some Gulf Cooperation Council (GCC) states, as business plans for investee companies often involve pan-GCC rollouts. He also said the clampdown on corruption and other welfare reforms had also caused some turbulence in local markets.
"There's a lot of worry between the old merchant families and we see there is a lot of interest to invest outside of the region, at least for this time.”
On top of this, he said that the economic turmoil caused by the oil price decline had led some sovereign wealth funds that had previously made investments into local funds to redeem some funds to help plug holes in government budgets.
“I think this is probably the biggest hit that happened on the regional markets,” Al Rubaie said.
Analysts from Boston Consulting Group (BCG) remain more upbeat on the industry’s prospects. In an email interview with Zawya earlier this month, its analysts argued that with better governance, investors will retain an appetite for the asset class. It said there are currently 24 private equity funds in the GCC that are raising capital, with combined target funds of $6.5 billion.
“There are a number of indicators that signify substantial room for growth of private equity in the region,” Alessandro Scortecci, principal at The Boston Consulting Group Middle East said.
Dry powder (uninvested capital) is on the rise again after a partial decline in 2016, with a total of $5.3 billion ready to be deployed by GCC funds, according to Scortecci. Yet this is still only about 73 percent of pre-crisis levels of $7.2 billion, he said.
More deals being done
“We are also seeing significant pick-up in investment volumes, recovering after a partial slow-down in 2016, with a total of $3.3 billion in 2017,” he added.
Karim El Solh, the co-founder and managing director of Abu Dhabi-based private equity firm Gulf Capital, said that he believed investments were likely to increase again as vendor expectations on pricing was becoming more realistic.
“If you look at the prices that were being asked in 2015 and 2016, they were still legacy pricing - as if oil was still above $100 per barrel,” El Solh told Zawya via a telephone interview last week.
“I think this year will be more productive. You will see more transactions happening at more rational valuations,” he added.
El Solh said that his firm is not currently fundraising, having completed the close of a $750 million private equity fund in 2014, and a $251 million private debt fund in 2016.
“Both of these funds are about 50 percent invested. So we still have a lot of dry powder. We have $350 million left in the private equity fund and about $150 million left in the private debt fund,” said El Solh.
Ghandour said that it was not in fundraising mode, either, given that its current investment vehicle is about 60 percent deployed, with 18 months to run. However, he argued that “even prior to the Abraaj situation, funding was difficult for investors”.
“There isn't institutional capital in quantity here. The big institutions here are mainly the sovereign wealth funds (SWFs) who, by design, don't invest in the same region. If that was the case, we would have more stable funding sources.”
Al-Rubaie said that sovereign funds used to invest in regional private equity because they “were looking at it from a strategic point of view to grow an asset class in the region”.
He argued that although many regional private equity funds – raising $500 million or less – may fall below the typical investment threshold of some sovereign fund managers, they should still be seen as a priority.
“They (SWFs) have decided maybe to move to larger funds. Personally, I think it's a mistake because private equity funds have a very good role in developing and institutionalising a lot of the companies in the region,” Al-Rubaie said.
Despite the challenges, private equity fund managers remain confident about the industry’s long term prospects in the region – even if it remains a substantially slimmed-down market.
Ghandour said that his, and other firms, were continuing to deliver suitable returns for investors.
“The issue is, like every cycle, the good players survive and eventually do better as the cycle picks up. The weaker players will die. It's the natural attrition of the market. Eventually, I think the industry will emerge stronger and in a better place.”
Al-Rubaie said that much of the upheaval regional funds have faced can also be seen as an opportunity.
“There's this geopolitical disruption. We hope that someday (it) will be resolved. And the geopolitical issues are not just in the region - also, if you look at Turkey, once things stabilise there, I think there will be a great opportunity for private equity funds to acquire things a little bit on the cheap.
“I am very optimistic and this industry is very cyclical. A year or two years from now, it will be a very interesting market for a private equity fund to start investing again in a big way,” Al-Rubaie said.
Given the current state in which the industry finds itself, it is difficult to argue that things could look much worse.
(Reporting by Nada Al Rifai and Michael Fahy; Editing by Shane McGinley)
© ZAWYA 2018