On 17 April, the UAE’s Arabtec Holding announced that it had signed a memorandum of understanding with South Korea’s Samsung Engineering to form a joint venture company to work on projects across the Middle East.
Arabtec will have 60 per cent ownership and voting rights in the new company. Known as Arabtec-Samsung Engineering, the entity is expected to be a game changer for Arabtec as it embarks on an ambitious strategy to become a dominant player not only in the regional construction sector, but also in the engineering, procurement and construction (EPC) market.
“This transaction is about building a real powerhouse in the construction industry – creating a company that can compete for, win, and deliver large-scale and complex works of engineering,” says Hasan Abdulla Ismaik, managing director and chief executive officer of Arabtec.
Once formed, the joint venture company will bid exclusively for mutually agreed and selected work across the Middle East and North Africa in the oil and gas, infrastructure and power sectors.
The focus will be on winning large-scale contracts ranging from $3bn-10bn in total value. This marks a step change for Arabtec as it will provide it access to the higher margins of about 15 per cent enjoyed by EPC contractors, compared with margins of about 10 per cent that are made by civil and building contractors.
This transaction is about building a real powerhouse in the construction industry
Hasan Abdulla Ismaik, Arabtec Holding
“The biggest area of activity in the coming years is likely to be in upstream, refining and gas processing, as gas is increasingly important to the region’s energy and industrial ambitions,” says Ismaik. “We are also looking to bid together for upcoming power and infrastructure projects elsewhere in the region.”
The partners say the joint venture will benefit from Arabtec’s extensive regional network, project managers and skilled workforce, and its proven track-record of delivering technically complex projects, together with Samsung Engineering’s leading market position in oil and gas, power and infrastructure.
Samsung Engineering currently has a backlog of $9bn in the oil and gas, power and infrastructure sectors across the Middle East. “This joint venture brings together the regional on-the-ground knowledge, resources and track-record of Arabtec, and the technical expertise and global scale of Samsung Engineering. It will contribute positively, and significantly, to the region’s development,” says Ismaik.
Some analysts have not been so enthusiastic. “We have mixed views on the identity of the joint venture partner,” said Kuwait-based NBK Capital in a note on 23 April.
“This is due, in our view, to the historic weakness of [South] Korean EPC contractors (including Samsung Engineering) stemming from the lack of front-end engineering and design capacity.”
The analyst note also said that US, European and Japanese companies have margins of 15-18 per cent, whereas South Korean firms work with lower margins and take on greater risk. It added that Samsung Engineering reported an operating loss of $188m during the first quarter of this year after provisioning $277m, mainly on three contracts, of which two were in the GCC.
Arabtec has been working in the region for a long time and should be aware of the risks. Established in 1975, the firm has developed into one of the UAE’s largest building contractors. A turning point in the company’s history came in 2005, when it was listed on the Dubai Financial Market and, at the time, was the first private construction firm to go public in the UAE.
The listing allowed Arabtec to take advantage of the real estate-fuelled construction boom in Dubai and also expand to overseas markets such as Saudi Arabia, Qatar, Kuwait, Bahrain, Egypt, India, Jordan, Palestine, Russia and Syria. It has worked on a several key projects and has built seven of the world’s 150 tallest buildings, together with thousands of villas and hotels.
Most notable of all, it worked on the construction of the world’s tallest building, the Burj Khalifa in Dubai, in a consortium with Samsung Engineering’s sister company Samsung C&T.
Today, Arabtec is already one of the region’s largest construction companies with revenues of AED5.6bn ($1.5bn) in 2012, a backlog of AED22bn and a workforce of 42,000. But those numbers will be transformed once the joint venture is signed and it starts winning large-scale $3bn-plus EPC contracts in the oil and gas, power and infrastructure sectors. The joint venture is just one part of Arabtec’s four-pronged strategy for the future, which aims to capitalise on improving market conditions in the GCC, and also the rest of the Middle East and nearby India.
“The Middle East and North Africa region is spending heavily in the areas of oil and gas and power, with around $865bn of projects planned for the coming years. This work is of huge strategic economic importance for the region as it seeks to create sustainable long-term growth and employment,” says Ismaik. “For the next two years, in the GCC, the construction markets in the UAE, Saudi Arabia, Kuwait and Qatar are forecast to grow at rates between 6-8 per cent.”
The strategy will also diversify the company so that it is less exposed to individual market segments and geographies – a lesson Arabtec learnt the hard way in 2008 and 2009, when the majority of its turnover came from real estate projects in Dubai.
“With increasing competition in Arabtec’s traditional construction markets, competitiveness for new contracts is intensifying,” says Ismaik. “It is necessary to focus on higher margin sectors and new geographic areas in order to achieve growth. The strategy is focused on taking Arabtec into new high margin sectors and markets with significant growth opportunities. Arabtec is planning to raise up to $1.7bn to fund its strategic growth plan.”
The financing will come from a $1.75bn capital raising programme that was approved by Arabtec’s shareholders on 13 April. The funds will be raised in two tranches. The first will be a $650m rights issue by May or June this year, and the second $650m tranche will be in the second or third quarters of 2014. A $450m non-convertible bond will only be issued if needed.
The first part of the strategy is to build a larger presence in the region’s oil and gas, power and infrastructure sectors. These major projects currently account for more than $304bn of capital spending and activity is expected to increase dramatically in the coming years.
The new joint venture will be a significant element in achieving this goal. It will build on exposure Arabtec already has to the sector through Abu Dhabi-based contractor Target Engineering – a company in which it acquired a 60 per cent stake in 2007 and will this year buy the remaining 40 per cent.
Operating in the UAE and Qatar, Target Engineering works on smaller contracts valued at AED100m-500m, far smaller than those the Arabtec-Samsung Engineering joint venture hopes to win. It has a backlog of AED1.1bn and in 2012, recorded revenues of AED1.4bn. It has more than 11,000 employees.
Affordable housing is the second part of the strategy and is an area where Arabtec already enjoys a market leading position. The company has built more than 13,500 villas over the past decade, using a tunnel form technology that has enabled it to deliver 55 villas a day.
The third part of the strategy is geographic expansion. This is focused on growth in the GCC and India, together with opportunities in select markets, such as affordable housing in Morocco.
The final part of the strategy is enhancing operational efficiencies with new management systems and cost reductions.
Some 55 per cent of the capital raised will go towards growth in its oil and gas, infrastructure and power business, and a quarter will go towards building affordable housing projects. The remaining 20 per cent will contribute to strengthening existing businesses and systems.
The announcement of the Arabtec-Samsung Engineering tie-up is the strongest possible start to deploying this strategy, which was only publicly announced in March. If Arabtec can deliver the rest of its strategy as quickly and as effectively, then it will certainly be able to become the regional powerhouse it aims to be.