Robust growth in emerging markets private equity fundraising continued in 2006, albeit at a less explosive pace than in 2005. 162 emerging markets private equity funds raised US$33 billion in capital commitments in 2006, representing a 29% increase over the US$25.8 billion raised in 2005. In 2005, fundraising quadrupled from the US$6.5 billion raised in 2004. (See Figure 1 for historic fundraising totals 2003-2006.)
Figure 1: Emerging Markets Private Equity Fundraising Totals, 2003-2006
Funds with final closes in 2006 averaged US$270 million in size, compared with in US$216 million in 2005. Among the 105 funds with final closes in 2006 were 16 funds of US$500 million or more, including four with final closes over US$1 billion. Funds with final closes in 2006 raised a total of US$28 billion – US$24 billion of which was raised during the 2006 calendar year.
Funds focused on investments in Asia raised a total of US$19.4 billion, representing a 26% increase over the US$15.5 billion raised in 2005. Funds investing in China and India alone accounted for US$6.8 billion, or 35% of Asian fund totals, and nearly 20% of the overall total. Latin America, Sub-Saharan Africa, and Middle East and North Africa all experienced dramatic year-over-year growth in total funds raised, at 109%, 198% and 54% respectively. Strong growth in fundraising in Central and Eastern Europe and Russia continued as well, at a 21% increase over 2005. (See Figures 2 and 3 for fundraising totals by region.)
Figure 2: Emerging Markets Private Equity Fundraising by Region 2003-2006
Figure 3: Emerging Markets Private Equity Fundraising Totals 2003-2006 (US$m)
On the back of tremendous liquidity resulting from high crude oil prices and extraordinary efforts by leading local fund managers, a private equity industry is blossoming in the desert cities of the Middle East.
The Middle Eastern/North African private equity opportunity is not a function of the region’s overall economic size – the Gulf States, Levant and North Africa together comprise only 1.5% of the world’s GDP. However, GDP growth in the region has been a robust 6.1% over the last three years, driven by a threefold increase in crude oil prices over the last four years. The resulting extraordinary liquidity – in excess of US$2.3 trillion, per KPMG estimates1 – has provided an opportunity for those raising private equity funds.
Leading private equity entrepreneurs are tapping this liquidity and a new openness in the region to private investment to fuel explosive growth in fundraising and fund sizes. KPMG estimates that 90% of the estimated US$13 billion in private equity capital currently under management has been raised in the last two years. Whether fund managers are able to develop deal flow and exit opportunities in line with their success in fundraising remains the key question for the market, and one that will be strongly tested in the coming years.
Fundraising Boom and Soaring Fund Sizes
According to a recent report issued by KPMG and the Gulf Venture Capital Association (GVCA), and based on reporting by Zawya, a leading financial publication, fundraising for investment in the MENA region in 2006 reached US$7 billion, a 22-fold increase over the US$321 million raised in 20042. (See Figure 4 for a 10-year history of fundraising.)
Figure 4: MENA Region Private Equity Funds Raised, 1997-2006
Along with the explosive growth in fundraising, the size of funds has soared, with top managers going past the US$1 billion mark. Three US$1 billion-plus funds are already investing – funds managed by Abraaj Capital and Swicorp are investing in the MENA region, and Global Investment House across multiple emerging markets. Several major funds are in the market, including US$1 billion-plus funds by Millennium Finance Corporation and Swicorp (focused on energy), a US$2 billion fund co-sponsored by Abraaj Capital and Deutsche Bank, as well as a family of five US$1 billion funds co-sponsored by Dubai Ports World and the Dubai Islamic Bank. Some estimates suggest that current funds in the market are targeting a combined total of over US$20 billion in fundraising.
Bringing PE to Home Markets
Middle Eastern financial institutions have been investing in private equity globally for a long time as LPs in western-based funds. Beginning in the late 1990s, local funds began to emerge, investing both in western markets and locally.
Fred Sicre, executive director of Abraaj Capital, sees a shift in interests on the part of Middle Eastern LPs. According to Sicre, “Private equity is not new to capital sources in the Middle East. They have long enjoyed relationships with the Carlyles and KKRs of the world. It is only that now we have a tremendous set of opportunities in our own neighborhood that so much of the new liquidity is coming to Middle East-based managers.”
From 1998 through September 2006, Middle East-based private equity funds invested US$6.5 billion globally. Several Middle East-based managers have a history of deals outside the region. Istithmar, for example, manages funds on behalf of the Government of Dubai and has historically been focused on investments in the United States and United Kingdom. (See Figure 5 for a geographic breakdown of the investments made by MENA-based private equity firms in 2005 and 2006.)
Figure 5: Geographical Split of Investments Made by MENA-based PE Funds (US$m)
Of the US$6.5 billion invested by firms from the MENA region, US$2.5 billion was directed to investments within the MENA countries themselves, including Turkey. What is remarkable is that, of this US$2.5 billion, a full US$1 billion was invested in the first three quarters of 2006 alone. A large portion of the private equity investment to date within the MENA region has been concentrated in the Gulf. (See Figure 6 for a geographic breakdown of private equity investments to date within the MENA region.)
Figure 6: PE Investments in the MENA Region, 1998-3Q2006, Cumulative (US$m)
For several of the newly-launched funds focused on the Middle East, fund managers are not limiting their sights to investing in the wealthy GCC countries. The Levant region is one area of focus. There are multiple Jordan funds in the market, including Dubai International Capital’s Jordan Dubai Capital Fund, Byblos Private Equity Fund, Foursan Group’s Jordan Fund II and the Jordan Fund. Other funds are focused on Lebanon and Syria, including Argent Financial’s Constans Lebanon Recovery Investment Fund and a new fund from Levant Capital.
North Africa funds in the market include two Libya funds: Tuareg and the Phoenicia group. In addition, there are several funds focused on North Africa: Tuninvest’s Maghreb Fund II, the Scimitar Special Opportunities Fund, Atlamed’s Morocco Fund and Capital Invest’s North Africa Venture Fund. Bahrain’s VC Bank has sponsored the MENA Small and Medium Enterprises Fund in partnership with the Western alternative assets manager Global Emerging Markets (GEM). The fund has recently closed on US$80 million of its US$250 million target, and completed its first transaction by investing in the drilling services company Challenger, which has its primary market in Libya.
While fund managers seem to be finding increasing deal flow within the MENA region, it appears that some managers also wish to keep their geographical options more broadly defined. The leading fund manager, Abraaj, has pursued a mandate beyond MENA to include the South Asian countries of Pakistan and India, leveraging capital from their MENA fund. A number of other funds surveyed also have a relatively high allowance for exemptions to their geographical mandates.
Fund Returns Pending
While capital flows are clearly surging, a picture of what the return profile will be for these funds has not yet come into focus.
A handful of strong exits – notably, the 2002 sale of logistics company Aramex by Abraaj Capital to Arab International Logistics at a reported 70%+ IRR and the 2005 sale of Mannai Corporation by HSBC to QIPCO – have certainly served as a watershed for recent heroic fundraising achievements. However, exits to date from investments in the region have been thin relative to other emerging markets. According to KPMG, of the entire US$6.5 billion that has been invested by MENA region private equity funds since 1998 both within and outside the region, only 5% has been realised through 13 exits. Perhaps reflective of the tight mix of strategic and financial interests in the region, four of the recorded exits involved sales to a co-investor.
Although MENA region private equity funds have had few exits to date, one possible exit route is through public markets. Most of the 13 private equity-backed exits were executed on the GCC IPO markets, which have been strong in recent years – new offerings have been consistently oversubscribed. As of 2006, there were 21 new issues on regional stock markets, a positive sign for a sustainable exit channel for private equity investors.
For 2007, reports also indicate that 134 companies are waiting to go public, but regulators have been slow to accept applications each year, and so it is unclear how many will actually move forward. This could be a cause for some concern. According to one fund manager in the region, “Things still move at a different pace in the Middle East. Bureaucrats move to their own time schedules, and so we just have to adjust.”
Trade sales are also becoming a more viable option. According to Thomson Financial, the value of M&A activity in the MENA countries was US$70 billion in 2006. Whether the regulatory structures in the MENA region are capable of keeping up with a rapidly growing private equity industry is a key question that is yet to be answered.
Developing a New PE Culture
There are approximately 30 private equity firms3 investing in the MENA region, many of them belonging to the traditional financial houses or family-owned conglomerates. (See Figure 7 for a sample list.)
Figure 7: Representative Sample of MENA PE Firms
Samer Yassa, a partner with EFG-Hermes in Egypt, describes the earliest stages of private equity development: “In the mid-1990s, a number of financial houses started playing with private equity, buying companies with the intention of listing them on the new stock markets. It wasn’t structured private equity, but it was a start. It took some time for investors to see the difference between sitting on a portfolio and really adding value.” The early years of private equity investing produced winners and losers, but according to Yassa, “Nobody really goes out of business. They stay around, sometimes in different shapes and forms.”
EFG-Hermes was founded in 1996 and has become one of the region’s leading investment banking and brokerage firms. The group’s private equity activities started that same year with what could be called the largest private equity vehicle in Egypt at the time. The vehicle was structured as a shareholding company, and the managers accumulated a range of family-owned companies and utilised leverage as much as possible.
According to Yassa, “It was largely a portfolio approach, driven by relationships, but we did fine in the end.” In 2002, the shareholders of the private equity vehicle began to complain about the lack of dividends and mandated the managers to treat the company as a fund and liquidate the assets. According to Yassa, “In the 1990s we focused on dividends, not exits. The big trick that happened for the private equity industry was the beginning of a focus on exits.”
EFG-Hermes has now raised a second private equity fund (Horus Private Equity Fund II) and two smaller sector-specific vehicles. Their main fund has made four investments through majority and control minority stakes in the areas of building materials, food, steel and financial services. Yassa describes a more sophisticated and active approach for the new funds. “Take our financial services company, for example,” Yassa says. “We have consolidated the ownership, revamped the board, applied new technology and appointed people at all levels. We have recognised that human resources are key, so we have restructured contract offers to emphasise incentives and draw back to our country the talented Egyptians who previously migrated to the Gulf. We are now very focused on skills and rewards.”
Samir Assaad of NBK Capital, the private equity arm of the National Bank of Kuwait, concurs. According to Assaad, “In terms of resources, management talent is much scarcer in the region than capital, and that is the primary area where private equity can really have an impact.” Assaad has built his team, currently comprised of seven professional investors, based upon operational and analytical skills gained in industry, consulting and the financial worldly. The resumes for the team include a manager who previously had responsibility for 1,200 employees, a former McKinsey consultant and a former high level Tata manager.
Assaad believes that, “Top people are now drawn to private equity in the Middle East because it is this asset class that is offering a solution to the necessary operational changes in our region’s leading companies. Private equity is a way for change to get started.”
NBK Capital is an independently managed group, although it still maintains an arms length relationship with its parent, the National Bank of Kuwait. Assaad believes the relationship is critical. “We need to have our independence in order to be innovative, but deal flow and credibility in the Middle East are all about relationships, and for that the bank is a tremendous asset.”
While a new generation of fund managers may be taking traditional institutions into more modern private equity structures, they also acknowledge that government leadership has had a lot to do with the rapidly reforming investment context. Government leaders have opened up the coffers for regional investment. Infrastructure development has been one key area of focus, and in the first half of 2006, over US$33 billion of infrastructure finance was raised in the Middle East – a third of the global total4.
A New Leader Coming on Stage
Abraaj Capital is perhaps the exemplar of the region’s newly-found strength in private equity. Arif Masood Naqvi, Abraaj’s charismatic founder, has become a regular on the global private equity circuit and a key proponent of the Middle East as a maturing market ripe for global capital infusion. Abraaj now has over US$2 billion under management and reports that approximately 20% of their capital is now coming from non-Middle Eastern sources. Deutsche Bank has taken a stake in the management company of Abraaj and has been an important source of capital.
When he started Abraaj in 2002, Naqvi led the group’s signature deal in Aramex, the international logistics company that originated from Saudi Arabia. Naqvi described the situation: “After the 9/11 tragedy, the Aramex stock on the NASDAQ was being hit with Middle Eastern risk and so the valuation of this otherwise healthy company was out of whack. We saw a great opportunity and took it.”
Naqvi’s team structured a leveraged buyout with Middle Eastern capital it had raised for its initial fund combined with debt from the Jordanian export finance bank. An ESOP plan was introduced for management, two key mergers were undertaken and a marketing expansion plan was rolled out. From 2002 to December 2004, EBITDA and net profits grew by 128% and 196% respectively, and Abraaj exited its investment by listing Aramex on the Dubai stock exchange, realising an 80%-plus IRR.
Abraaj has now developed into the largest dedicated private equity group in the region, with over 120 employees. Frederick Sicre was brought in from the World Economic Forum to serve as executive director. According to Sicre, Abraaj has had to be careful to shape its organisation to match what he sees as a rich set of investment opportunities in the region. Sicre recently led a re-organisation of the group into key centres of excellence. Sicre stated, “We have tripled our size in two years and yet the nature of the opportunities in the MENA and Southern Asia regions does not yet lend itself to sector level specialisation. Our team must be able to cover five sub-regions, eight industries and sixteen functions, so we now have cross cutting groupings to cover these areas.”
Abraaj believes there are strong opportunities within the MENA region. Sicre points to the 223 privatisations with an estimated value of over US$1 trillion that are planned for the next ten years as one important source of deal flow. Sicre also says much of their proprietary deal flow comes from the group’s local LPs. According to Sicre, “When you have over 200 leading MENA-based investors in your fund, they are not only sources of capital, but also sources of deals. They look to us to be able to add value for assets they may own or opportunities they may see.”
The tightly woven investment and strategic interests at play with Middle Eastern private equity is a recurring theme, and many fund managers point to advisory relationships as a key source of deal flow. In order to further strengthen its deal flow network, Abraaj bought a 25% stake in EFG-Hermes. The group is also serious about extending its geographical reach and has used its current US$500 million MENA fund to seed two new funds in India and Pakistan with US$50 million each. According to Sicre, Abraaj’s goal is to be the premier private equity firm investing in what he calls the MENASA region: Middle East, North Africa and South Asia.
Global Players Getting Serious
The Middle East has long been of interest to major and niche global players, who have traditionally looked to the region as a source of capital rather than as an investment destination. However, those players who realised early that the MENA region was in fact a source of opportunity have seen some strong results.
HSBC was the first global player to initiate a MENA-specific fund when it launched HSBC Private Equity Middle East in March 2003. The bank seeded the fund with US$33 million and the remaining US$85 million was raised from within the region. The group’s exit from Mannai has been one of the shining examples of success for the region.
The Carlyle Group, a longstanding visitor to the Middle East for raising capital, has now decided to set up camp. Last year, Carlyle established a MENA team headed by Walid Musallam, former chief executive officer of the Abu Dhabi Investment Company. David M Rubenstein, Carlyle co-founder and managing director, said that the objective is to “quickly establish Carlyle as a serious and credible presence in this important, growing region of the world.” Carlyle also successfully drew Hassan El-Khatib away from EFGHermes to run investments in Egypt and Northern Africa. Carlyle will have offices in Cairo, Dubai and Istanbul.
The Middle East has also proven profitable for some niche global players such as Swicorp, a group that mined the Swiss-Middle Eastern corridor on an advisory basis before moving into private equity. Swicorp was responsible for the first LBO in Saudi Arabia when in 1994 it took control of the Arabian Company for Detergents (DAC). Swicorp also took advantage of one of its advisory mandates by extending its relationship with the Danone Group to establish a 2003 fund to invest in water-related businesses in the MENA region.
Swicorp’s biggest fund is a US$1 billion vehicle focused on energy-related deals. Nabil Triki, a partner and head of private equity at Swicorp, believes the MENA region’s core energy resources provide an excellent platform for private equity investments. Triki stated, “There are some industries where the cost structure is such that there is a case for moving the entire industry to the Middle East. Take fertiliser as an example. More than half of the cost of fertiliser is tied to the cost of gas. There is a ten-to-one ratio for the cost of gas between the Middle East and the United States, so we see a tremendous opportunity to build that industry in our back yard, and that is already happening.”
Opportunity and Caution
Suneel Kaji, a partner with Global Emerging Markets (GEM) – the co-sponsor of the VC Bank MENA fund – believes that it is important to focus on sectors “where there is a likelihood of creating a critical mass within a company so it becomes possible to attract trade sale buyers.” Additionally, Kaji warns against a strategy overly reliant on the US market for trade sale exits. According to Kaji, “We see opportunities coming primarily from Asian and European buyers, and that tells us that we must further develop those networks in order to be successful.”
Nabil Triki of Swicorp is sanguine about the state of the private equity industry in the MENA region. Triki stated that, “We often find ourselves competing with family investors and their style is much more, shall we say, intuitive, so they can move a lot more quickly than we can.” Triki believes that caution is an important catchword for the industry. “A lot of money has been raised based on connections and not on track record. The challenge for all of the emerging managers now is to invest it properly,” he said.
1 Statistics from this article, unless otherwise noted, are drawn from the Gulf Venture Capital Association (GVCA) Annual Report 2006 produced by KPMG, using data provided by Zawya PE Monitor as of 30 September 2006.
2 This US$7 billion figure includes real estate funds, as well as funds projected to close within CY 2006. EMPEA estimates that US$3 billion was raised in 2006 for traditional PE funds focused on investing in the MENA region.
3 EMPEA estimates. However, only a sub-segment of firms have funds with the traditional GP/LP structure common among US and European funds.
4 Real Deals, “Rising in the East.” 8 February 2007.