PRIVATE EQUITY: Growing pains

16 December 2005
The private equity business in the Gulf remains in its comparative infancy. But its growth in the recent past has been spectacular. In 1998, the industry was worth about $200 million; now it is estimated at more than $1,000 million. 'Less than two years ago, fewer than five firms in the region would claim to be in the private equity business,' says Fahad Almubarak, managing director of the Saudi-based Amwal al-Khaleej private equity fund. 'Now there are more than 40.'

In the past, the leading regional private equity firms were heavily focused on foreign pickings. Bahrain-based First Islamic Investment Bank, now renamed Arcapita, is a case in point, starting off in US equities, before moving to Europe - and in 2004 staging the eye-catching public-to-private acquisition of UK utilities provider South Staffordshire Water.

But the industry has returned home to roost and the perch is becoming increasingly crowded. 'The drivers of private equity in the region are macroeconomic, regulatory and the product of economic restructuring, including privatisation,' says Abdullah Shahin, vice-president of another of the industry's regional pioneers and the largest private equity company in the region, Dubai-based Abraaj Capital.

The rapid expansion of the private equity landscape is positive in the signals it gives out of the health and growing maturity of the GCC economies. It is also a product of the conversion of regional government to restructuring and hence privatisation, and the search by blossoming family businesses for expansion capital. Nevertheless, the increasing competition inevitably stiffens the challenge of finding profitable deals. 'The number of firms in the market means the valuation gap narrows between a private equity deal and a public offering,' says Almubarak. 'If deals are done on price alone, companies will price themselves out of profit.'

The route being widely adopted is differentiation. 'The challenge over the coming 18-to-24 months will be to find niches, select particular countries or sectors where we can add value to a deal,' says Almubarak. 'The questions you have to ask of an acquisition are the opportunities for regional and wider expansion prospects, to buy and then consolidate.' It is a route very explicitly being followed from the start by London-based Capital Trust Group's EuroMena fund, which was set up in mid-2005 to invest in firms across the Middle East and North Africa - although outside the Gulf. The fund is focused on a small number of key sectors, in each of which it will take a controlling stake in a few firms, aiming to merge them to create regional entities or use them as a platform for further acquisitions. Unlike many in the business, it is not aiming to do turnaround work.

A similar approach to management is being taken by The National Investor (TNI), based in Abu Dhabi. 'We would look to avoid deals that have been shopped around,' says TNI chief executive officer (CEO) Orhan Osmansoy. 'Our aim is to be more proactive and to look for firms where good management is already in place. We don't want to micromanage.' TNI's ideal investment horizon is three-five years, in common with most of its counterparts, although this is not set in stone. 'The time period is not so essential for TNI since we are not a fund, so the money is coming from the balance sheet,' says Osmansoy. Nevertheless, the company is looking at the possibility of establishing a dedicated private equity fund.

As regional stock markets soar, two questions arise: why would firms want to accept a private acquisition when so much cash in the short term is available through the initial public offering (IPO) route, and why invest in private equity funds rather than on the bourse? 'The advantage of investing in private equity over the stock market is the consistency of returns,' says Robert Bush, senior vice-president at Dubai-based Istithmar, part of

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