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— Industry Insight —
Historically underpenetrated as an investment destination, the Middle East and North Africa, or Mena, region's emerging opportunity for private equity is increasingly drawing investors' attention. The convergence of several factors -- robust economic and population growth, increasingly stable governments, structural reforms, diversified economies, surging privatizations and better transparency -- has created a growing interest among those seeking lucrative returns. While obstacles remain in the short term, they are far outweighed by long-term opportunities. There is no doubt about the negative effects of the global economic crisis on the Mena region, particularly Dubai's speculative real estate bubble, which warrants a significant market correction. But the greatest opportunities lie in private equity investments in companies operating in the broader Mena region, which is still poised for sustainable long-term growth. The Mena region comprises Gulf Cooperation Council countries Saudi Arabia, Kuwait, Oman, Qatar, United Arab Emirates and Bahrain, plus Egypt, Jordan, Morocco, Algeria and Tunisia. This area is experiencing the largest and fastest population growth in the world, having quadrupled in the last 60 years to 432 million people.
Although the Mena region comprises less than 7% of the total world population, it contains 70% of the world's oil reserves and 46% of the world's natural gas reserves. Windfall profits from high oil prices and rapid population growth have accelerated consumer demand, which has led to GDP growth of more than 6% in 2008. GCC countries in particular are now using oil and gas surpluses to implement policies to diversify their economies into non-natural-resource-related sectors, which can employ the wave of young people entering the work force. The United Arab Emirates, for example, has already increased its non-oil GDP segment to 62% of its economy, and it is expected to grow at a rate of 6% in 2009, mostly as a result of the strong performance of the country's non-oil sector. Further, the UAE government's fiscal accounts would remain balanced even if oil prices fell to $25 per barrel, according to a recent Morgan Stanley report. Until lately, the region has been relatively untapped by private equity investors. There are few experienced local firms, creating opportunity for both regional and international private equity shops. In addition to advantageous demographics, economic acceleration has been stimulated by important government reforms that make investing in the region more attractive. These include freehold zones that allow foreign property ownership, zero-tax incentives and improvements to investment laws and regulations that align them with international standards. In addition, leading financial and regulatory authorities in the region have stressed the importance of increased transparency in business practices and accounting regimes. While there is still considerable work to be done, as these systems develop, capital can be invested with more confidence. Accompanying these reforms has been a surge in privatizations. Regional governments have earmarked $1 trillion in previously state-owned assets for privatization, according to Dow Jones research -- creating an opportunity for foreign investors with technical and operational management expertise to participate in privatizations as part of a consortium. There are also significant opportunities with respect to family-owned businesses. Within the GCC, an estimated 90% of all commercial activity and non-oil-related GDP is controlled by more than 5,000 family firms. These firms hold combined assets exceeding $500 billion and employ 70% of the work force, according to Dow Jones. As their management and ownership move into second and third generations, there is a pressing need to apportion group assets across a number of sons and grandsons of the founders. While some of the successors wish to remain involved in family operations, others wish to cash out. Private equity investors can take advantage of this desire to create liquidity and formal capital structures. Another investment opportunity exists as these families realize the need to be more competitive with professional management and operations. This frequently requires the help of external capital, the breaking up of groups or the divestment of underutilized noncore assets captive in family conglomerates. Because many of these groups are reluctant to reveal financial and structural information about their companies, regional capital markets and investment banks don't always offer the best solution for achieving these goals. PE firms can provide these solutions to the family without intermediation. Further, introducing private equity management techniques to incumbent family-owned businesses is one of the most compelling Mena investment opportunities. Private businesses in the region are marked by operational and structural inefficiencies, making for good PE targets. Today many family firms suffer from low operational efficiency, poor utilization of operating assets and suboptimal capital structures, and few management teams have any equity incentives to align them with the owners. Layering in the private equity model of introducing operating improvements, providing equity incentives and supplementing management with additional operating talent creates the potential for highly profitable investment opportunities. In the past, exit options were limited to sales between family business groups. Today exit opportunities are less of a concern. Greater liquidity options have been created through the emergence of an IPO market via developing regional stock exchanges, as well as multinational corporations looking to expand into the region through acquisitions. Because private equity in the Mena region is still a nascent industry, along with potential opportunities come several challenges associated with being early to navigate the region. The greatest challenge is deal scarcity. Investors must cement strong personal relationships in the region in order to source attractive opportunities. There is also reluctance among cash-rich conglomerates to sell businesses because cash in the Middle East is considered a commodity, thereby creating longer purchase cycles. Western private equity investors may also need to adapt their approach -- away from looking to take controlling stakes in companies, in favor of influential minority stakes -- presenting themselves as partners seeking to grow the company together. More than anywhere else in the world, maintaining strong personal relationships and demonstrating how a private equity investor can improve the company is the key to dealmaking in this region. Another hurdle facing private equity investors targeting this region is the need for a stronger governance system. There is little history of corporate disclosure, and many Mena firms are only now taking the steps to improve transparency and communication with investors. While reporting is improving, there is little precedent for the exercise of minority rights by investors, and the potential for corruption remains high. Private equity will play an increasingly greater role in the development of the Mena region, and a limited number of local private equity firms have all the elements -- experience, operating expertise, local presence and relationships -- to succeed. A foreign player with the first two can team with a local player for relationships and create a formidable partnership with significant early-mover advantage. Shad Azimi is principal and founder of Vanterra Capital Ltd. |
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