Conditions are ripe for private equity in the Gulf region. High liquidity and numerous infrastructure opportunities are drawing the funds in, while the structure of the local economy — mostly made up of small to medium sized businesses — fits well with private equity funding.
Private equity in the Middle East is developing apace in three very different ways. Firstly, Gulf-based investment companies are starting to flex their muscles in international markets, using the excess liquidity in the region to snap up a range of assets overseas.
Take the example of an investor such as Dubai International Capital (DIC), the wholly-owned subsidiary of Dubai Holding, which was established in 2004 to focus principally on global private equity operations.
DIC has not let the grass grow under it feet. Within its first year of operations, it had committed more than $300m to private equity funds covering Europe and Asia as well as the Middle East and North Africa region. It has also made an investment of $1bn in DaimlerChrysler, making it the car maker's third largest shareholder, while in the UK it has acquired assets such as the Tussauds Group, which operates the tourist attraction the British Airways London Eye. More recently, in August 2006, DIC announced the £675m acquisition of the Travelodge hotel chain from private equity firm Permira.
Regionally, DIC is aiming to capitalise on opportunities in the infrastructure market through the establishment, announced in March, of a new $500m infrastructure fund. DIC and HSBC are both investing $50m in the fund, which according to DIC will "target selected investors from across the region as well as from wider international sources. The fund will have a broad mandate to invest in companies and other entities operating within Middle East and North Africa markets in the various infrastructure sub-sectors."
Targeting opportunities in infrastructure in the region is the second trend of private equity investment in the Gulf. It has also been the principal driver of the large influx of cash into private equity funds in the Middle East in the past 12-24 months. By the end of last year there were 27 private equity companies operating in the region, according to a presentation delivered by Arif Naqvi in March, executive vice chairman and CEO of the Dubai-based Abraaj Capital, which was the first pure private equity company licensed to operate out of the Dubai International Financial Centre. Of those 27, eight were in the UAE, four in Egypt, three each in Kuwait, Lebanon and Saudi Arabia and two in Bahrain.
More important than the absolute number of private equity companies in the region is the speed with which they are growing. In his presentation, Naqvi listed 24 traditional private equity funds already raised in the region worth $2.3bn, but he said that a further 17 were being raised that would add $2.6bn of venture capital.
That would suggest that a total of just under $5bn is already in private equity funds in the Middle East, although some commentators believe this total will be doubled soon. An analysis published in July 2006 by the Kuwait-based Global Investment House forecasts that "if the favourable economic environment is sustained, it is estimated that the industry will break the $10bn barrier by 2007."
The third trend characterising private equity in the region, and possibly the most important with respect to long term economic prospects, is also the least developed to date. That is the channelling of private equity investment into the multitude of smaller and medium sized enterprises across a plethora of industries throughout the Middle East, which between them should act as a dynamo of job creation and economic diversification.
An OECD report published in April 2006 points out that the economic landscape of the Middle East and North Africa region remains dominated by small, family-owned enterprises (FOEs). "While specific figures on the contribution of these enterprises to GDP are unavailable, it is known that small and medium sized enterprises in the region account for 99% of companies and two-thirds of jobs, making a substantial contribution to national GDP," explains the OECD analysis. "In the Gulf Co-operation Council bloc alone, 5,000 family businesses with assets of $500,000 each account for 75% of the private sector."
For those smaller companies, despite the high levels of liquidity flowing around the region, financing remains a problem. According to the OECD, access to bank funding is still highly restricted for all but the largest companies, with domestic credit ranging from 49% of GDP in Egypt to 73% in Lebanon — still substantially below the EU average of 105%. For smaller companies, says the OECD, "lack of adequate finance is on top of the list of their challenges. Since few family-owned enterprises can go public, private equity financing may be an appropriate solution for them."
Local bankers say there are a number of reasons why sufficient liquidity has yet to be recycled into private equity investment for smaller and medium sized companies. One is the shortage of credit skills in the region that may dissuade investors from looking at all but the highest profile infrastructure or energy related projects.
Another is the underdeveloped and highly volatile state of regional stock markets, which can make IPOs unreliable exit mechanisms. However, there have already been some highly successful private equity exits via the region's stock markets, with the IPO of logistics group Aramex International the most striking example to date. In 1997, Aramex became the first company from the Arab world to be listed on Nasdaq, but was delisted in February 2002 when it was acquired by Rasmala Partners (the forerunners to Abraaj Capital), in a $65m public-to-private deal. In 2005, its private equity investors exited through a highly successful IPO on the Dubai Financial Market (DFM) which was 80 times oversubscribed.
Looking to the future, local bankers believe the region should be fertile ground for private equity. One reason is that intuitively, shari'ah-compliant financing — with its emphasis on risk sharing — should be ideally suited to private equity investment. As the OECD explains, "since risk capital at its base rests on equity participation, it is well suited to Islamic models of finance."
Again, there has been no shortage of shari'ah-compliant private equity investment targeting very big projects in the region. For example, Abraaj Capital has recently announced a joint venture with Deutsche Bank and Ithmaar Bank for the creation of a $2bn shari'ah-compliant infrastructure and growth capital fund. According to Abraaj, the sectors targeted for this fund are oil and gas, petrochemicals, telecoms, power, water, roads, healthcare and education — sectors with combined investment opportunities valued at well over $1tr.
To date, however, the only specialist shari'ah-compliant venture capital outfit in the region targeting smaller and medium sized companies is the Bahrain-based Venture Capital Bank. In March, it linked up with the US venture capital provider Global Emerging Markets Group and the Saudi Arabian General Investment Authority to establish a fund providing growth capital and late stage venture capital financing for small and medium sized enterprises in Saudi Arabia.