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People and MarketsCommentGC View

Beware deterioration in asset quality as Gulf IPO boom continues

Dubai skyline of the downtown skyscrapers seen from the coast. Panoramic view of downtown Dubai filled with modern skyscrapers in the United Arab Emir

Saudi Arabia and the UAE have shown impressive progress developing their equity capital markets this year, but deteriorating asset quality is a worry for Middle East IPO bankers

With oil prices set to remain high heading into next year, and the strong capital markets agenda in the UAE and Saudi continuing, few expect the deal making boom in the Middle East to slow down anytime soon as we head into 2023.

But, there is a very real risk there will be a notable deterioration in asset quality in the companies that do list, which is starting to worry veteran bankers.

The deal making frenzy this year in the Middle East has prompted a rush by investment banks to staff up in the region, which is particularly noticeable at a time of severe downturn almost everywhere else. In their ensuing quest for fees, banks may start bringing businesses to market with questionable corporate governance standards and business models. If this is allowed to happen, it will undermine the good work that has already been done in building out the stockmarkets in the UAE and Saudi Arabia.

Flush with cash, Saudi Arabia and the United Arab Emirates have swiftly established themselves as equity capital heavyweights, with a constant flow of large IPOs and other share sales from state owned enterprises and privately owned companies alike. This has come at a time when the global market for stockmarket listings has been battered by rampant inflation, the rising cost of borrowing and the fallout from the war in Ukraine.

Many of the businesses that have come to market this year, particularly in Dubai, have been strong companies with monopolistic business models and close ties to the rulers. For investors it is much easier to place confidence in these sorts of businesses, knowing that if things go wrong, the government will likely step in.

But as the pool of capital deepens, and the hype grows, weaker management teams and companies will seek to exploit this.

The market needs to stay alert and avoid irrational exuberance and regulators need to “stay firm," in the words of one banker in the region. In such bouyant conditions, it is important to protect the market from the risk that could be caused by deals going south, which will undermine all the progress that has been made over the past couple of years.

In any market, the quality of listed companies is very important. Given the relative infancy of Saudi Arabia and the UAE in ECM, they must avoid companies with poor business models and ensure every listed company is a very sound operator. "The danger is that we start seeing much weaker companies, with weaker management teams and poor track records, coming to the market and deals getting done because there's so much liquidity," he added. "And then of course, not performing well over six months, one year, two years, and then investors losing confidence."

Local governments in the region have shown that they are serious about developing the liquidity of their local stockmarkets and attracting more foreign capital. It is just as well because both Saudi Arabia and the United Arab Emirates have an urgent need to diversify their economies away from oil and prepare their societies for a lower carbon future.

The rulers of the Kingdom, Abu Dhabi and Dubai have led to way in privatising state owned assets, but there has also been increasing number of privately owned companies that have followed the state-owned enterprises onto the stockmarket.

More than $21bn has been raised via IPOs in the Middle East this year, according to Dealogic data. That is more than the $15.9bn that has been raised in the whole of Europe, the data show.

These markets have also hit milestones in terms of innovations and improving regulatory standards. This week, Americana, the operator of KFC and Pizza Hut franchises across the Middle East, is due to price the first ever dual listing on the Tadawul and the Abu Dhabi Exchange.

Other transactions, such as the first ever fully marketed selldown of secondary selldown of shares in Saudi Telecom by the Public Investment Fund at the end of last 2021, and Adnoc’s exchangeable bond earlier in the same year, also broke ground for the region’s equity capital markets. Further work can also be done on shortening the lengthy settlement periods on IPOs in the region and introducing reforms that will allow greenshoes as a mechanism on the UAE and Saudi exchanges.