With liquidity drained from the Gulf’s banks and economic confidence in their economies still fragile, the rapid expansion of the region’s private equity sector over the past four years has slowed significantly.
According to research from Abu Dhabi-based investment company Gulf Capital, the number of deals closed by Middle East and North Africa (Mena) funds fell by 65 per cent to 12 in the first nine months of 2009, from 34 in the same period in 2008, while the total value of announced investments dropped by 75 per cent year on year to $359m.
Private equity firms have experienced the first major contraction in their business since the Gulf’s private equity boom began in 2005.
More than 14 funds with $3.1bn worth of commitments started their operations that year, according to Gulf Capital. International private equity funds, including the US’ Carlyle Group, the UK’s 3i and Luxembourg-headquartered CVC, started to seek deals in the Middle East for the first time, having previously considered the Gulf simply as a source of limited partners, or private equity investors.
By the end of 2007, the number of private equity funds under management in the Mena region had increased to 108, with $16bn worth of commitments, as a potent mix of economic growth averaging 10 per cent a year, rising oil prices, economic liberalisation and privatisation stimulated the growth of private equity.
The vast majority of these funds are focused on making investments in the Gulf.
Total funds raised by regional private equity firms more than doubled in the three years from 2005 to 2008, from $2.9bn to $6.4bn, according to the Gulf Venture Capital Association.
The funds boast strong performance as an asset class and the number of private equity firms selling on the businesses they acquired soared in 2007, with $13.2bn worth of funds raised by private equity funds that year, compared with $7.4bn in 2006.
Internal rates of return – a measure used to rate the profitability of an investment – achieved by exiting these investments ranged between 31 per cent and 348 per cent.
But over the past two years, there has been a change in the Gulf private equity landscape. Just $500m worth of deals were completed in 2008.
“The private equity industry is in the middle of a major shakeout, with a fundamental readjustment of the way private equity is structured,” says Zulfi Hydari, managing director of HBG Holdings, a specialist private equity investor with offices in the UAE and Saudi Arabia. “I expect about 70-80 per cent of private equity firms will be gone by the time this shakeout is over, and the sector that emerges when we finally do see some green shoots will look very different.”
Most Gulf private equity investors did not achieve the return on investments they hoped for in 2008, because funds had trouble exiting their investments in a slow market. Although $3.9bn was invested in private equity funds in 2005-06, there have been relatively few exits from these investments. And with few exits, limited partners have had little to go on in terms of a track record of returns, which is having a knock-on effect on investor appetite for Gulf-focused private equity funds.
“Investors in this region are asking why are you coming back with a new fund when you have not returned any of the old fund I gave you three years ago?” says one private equity fund backer.
“When you talk to investors, what many will tell you is that they don’t like private equity any more and that our 5-10 per cent allocation to a fund is already more than enough,” says Antoine Drean, head of Triago, a European private equity firm that opened a Dubai office in 2007.
“I expect about 70-80 per cent of private equity firms will be gone by the time this shakeout is over”
Zulfi Hydari, managing director, HBG Holdings
Private equity took off in the Gulf in an environment of booming stock markets, with funds buying stakes in companies that were likely to go public. The drying-up of the initial public offering market over the past year, and the consequent lack of opportunities to invest in companies about to list, has taken a sizeable chunk out of that market.
Fund providers are increasingly wary of pressing the case for capital commitments during the downturn. Now is not the time to be raising funds, with family businesses desperate to hold on to their cash.
“Many private equity funds right now cannot deploy capital, either because their commitments were not firm to begin with or because their relationships with their investors from the region are such that they choose not to call on commitments at a time when their limited partners may struggle to provide the cash,” says Michael Kidd, head of private equity at Dubai-based Rasmala Investment Bank (RIB).
RIB has raised $120m in commitments for its second private equity fund, which is targeting $350m of investment for the Mena region.Many of the 125 private equity funds launched in the region between 2005 and 2009 are nearing the end of their commitment periods and will have to go back to the market to raise additional funds.
But they will find investors in a different mood. “They are looking carefully at track records and for a defined investment style,” says Karim el-Solh, chief executive officer of Gulf Capital, which is set to close its GC Equity Partners II Fund by the end of this year. “They want proof that private equity funds are adding value to businesses every step of the way.”
Gulf Capital says its commitments to the fund already exceed $500m, two-thirds of which has come from outside the Gulf.
Other financial institutions are also seeking to launch private equity funds. In September, French bank BNP Paribas announced plans to raise $300m for a private equity fund in the Gulf region, to tap opportunities arising from the financial crisis – for example, acquiring undervalued companies.
The same month, the private equity arm of UAE’s The National Investor and Kipco Asset Management Company (Kamco) announced plans to set up a $150m Islamic private equity fund. The fund, to be launched before the end of this year, aims to make six to seven investments with an average equity stake of $25m each in mid-sized, family-owned companies.
Kuwait’s Global Investment House set up a $500m sharia-compliant private equity fund in June last year, the Islamic Buyout Fund, together with Dubai Islamic Bank and Mil-lennium Capital.
These institutions may be hoping that limited partners take their cue from one of the few big exits this year. In July, Bahrain’s Unicorn Investment Bank announced the sale of a 10 per cent stake in Regional Energy Services Holding, a subsidiary of the Unicorn Global Private Equity Fund I, to Eastern Industrial & Oilfield Services Holding, a Bahraini holding company, which generated a return on the investment of 124 per cent.
Private equity investment activity is expected to significantly increase in the Mena region in the coming 12 months, according to US consultant Deloitte’s Mena Private Equity Confidence Survey, released in October. The rise is expected as a result of lower valuations, an increasing number of companies in financial distress, and a long-hoped-for improvement in overall economic conditions.
The survey says 78 per cent of the individuals who raise private equity funds that it surveyed in October expect investment activity to increase over the next 12 months.
Private equity fund managers appear to agree. “Since the summer, we have seen an incredible increase in the number of companies seeking capital to grow or to repay lending that they cannot sustain, and from shareholders seeking to sell their interest to raise cash for other purposes,” says Kidd. “We are seeing three companies a day looking for capital.”
One factor that may trigger greater activity is the pressure being exerted on private equity firms by investors to deploy the capital they have raised, or be faced with returning it to their limited partners. Up to $13bn worth of Gulf assets under management at the end of 2008 has still not been invested.
Although many Gulf limited partners are passing up on new private equity fund commitments, some are investing.
“They are more cautious than before and making sure they invest with the right team,” says Kidd.
“But they are still active and the Middle East is one of the places where you still find large numbers of wealthy investors.”
The region is already at an advantage due to its lack of debt, with the exception of Dubai. Unlike other parts of the globe, such as Europe and the US, many Gulf private equity deals did not heavily rely heavily on debt.
Another way of firms raising private equity finance is to sell funds on the secondary market. “This is one positive aspect of the crisis,” says Drean. “It has shown that the secondary market is a very efficient tool and that you if you want to invest in private equity funds, you are not always trapped for 10-15 years. You can still sell at pretty good prices.”
For Gulf Capital, which has just finished fundraising for its $500m GC Equity Partners II Fund, the fact that it successfully raised commitments at a difficult time shows that investors are still out there, so long as funds have a defined investment strategy.
“Investors want to see value creation, and that you can take earnings to a higher level,” says El-Solh. “We are focusing on oil and gas, power and water and infrastructure – the sectors that are benefiting from population growth, or that are the prime beneficiaries of government spending on infrastructure.”
But private equity fund providers will face a stiffer challenge in convincing Gulf family businesses, which represent a significant sector of the Gulf economy and a major investment opportunity, to relinquish control of their assets.
Many family business owners are unmoved by private equity’s selling point of improving corporate governance and unlocking value from companies, particularly when they have been generating strong returns on their equity for years. “They question is, why should they pile on a bunch of debt when they can do that themselves?” says Hydari.
Nonetheless, some attractive private equity investments could emerge in the coming year, linked to the amount of private capital on offer in the region.
“Once private equity firms show an ability to actually deploy money, and at attractive valuations, there will be a moment when appetite will return,” says Kidd. “Oil prices are doing ok, so cash is building up on the sidelines.”
- 12 – The number of deals closed by Mena private equity funds this year
- $20.4bn -The value of Mena private equity funds raised this year