M&A reshaping Middle Eastern economies

A wave of mergers and acquisitions (M&As) across the Middle East and Africa is transforming the region into an economic powerhouse to match India and China, say some observers. The region is currently experiencing some of its highest levels of M&A activity ever and, as might be expected, oil and gas deals are at the forefront of this. But they are by no means the whole story.

For while the oil sector is already fairly well consolidated, major tie-ups in sectors such as telecoms and pharmaceuticals may create new international players that will straddle many countries. Furthermore, opportunities are being sought in less obvious areas, such as African hotels, Moroccan wind farms, Algerian solar energy, as well as utilities, car manufacturing and banking.

And while some of this expertise and investment is coming from outside the region, a considerable amount of it is being generated internally. Iran, blocked from entering many Western countries, is looking to expand into Africa, and Libya's sovereign wealth fund Lafico has already blazed a trail in the continent's hotel sector.

Some countries, such as Iraq, are embarking on extensive privatisation programmes and offer huge opportunities. Kamel Ahmed, COO of Bahrain's Economic Development Board, says the Gulf Co-operation Council (GCC) is set to be the next China and India, with each member able to offer investors a specific area of expertise. "While we operate as different states, we are complementary in our business focus and are more efficient as one unified entity," he says.

He points to Bahrain's highly sophisticated and well-managed banking sector as a driver for economic activity across the area, which in turn translates into enhanced M&A activity across the board.

"Third-quarter 2010 has seen the busiest levels of activity on record," says Omar Mehanna, head of advisory for the Middle East and north Africa (MENA) region at HSBC. "Availability of credit coupled with general confidence has meant the market is once again attractive to investors keen to tap into its opportunities."

Valuation is another key driver. Deals are now more accurately valued, meaning investors are more likely to consider acquisitions. Confidence is being driven by local investors keen to invest in long-term projects. This reflects back onto international players looking to expand into promising geographies that offer high returns while operational costs remain low.

Big pharma

Jordanian pharmaceutical companies, for example, are increasingly on multinational businesses' radar, thanks to the long-term lucrative contracts these groups enjoy with governments across the Middle East, Europe and some parts of Africa. Jordan boasts one of the world's premier healthcare systems and also has the most sophisticated and well-managed pharmaceutical industry in the Arab world, producing and exporting medication across the region and beyond. But not all the expected consolidation in this attractive sector will be spurred on from the outside.

Industry bankers have flagged Hikma, one Jordanian pharmaceutical success story, as an ideal target for the Middle East's largest pharma group, fellow Jordanian company Mubadala, which could use Hikma as its vehicle for acquisitions in Iraq, another country strong in pharmaceuticals. According to the same bankers, this would lead to the creation of an Arab-based multinational player and ensure the sector develops across all 22 Arab countries.

Iraq is an attractive target country because its government has embarked on grand-scale privatisations to kick-start its M&A activity. The government is looking to privatise as many as 200 state-owned enterprises (SOEs) in a bid to inject foreign capital and expertise into its local industries, with a particular focus on pharmaceuticals. These privatisations should boost the domestic equity market and add liquidity to a relatively stagnant Iraq Stock Exchange.

Indian pharmaceutical companies have been eyeing Iraq's once flourishing drugs industry for some time, and industry analysts predict a wave of acquisitions by Indian players in 2011. With India shifting its focus towards Iraq, could this be the start of a new trading partnership between the two countries? Probably not, says one industry analyst, arguing that "the Indian pharmaceutical sector is well developed and many players are simply on the lookout for good deals".

With Iraqi companies coming to market at a discount, the most credible contenders are likely to be Indian - unless a Jordanian giant emerges - given their relative geographical proximity and similar scope. The State Company for Drugs Industry and Medical Appliances is one of many poorly managed Iraqi SOEs looking for takers and is likely to come to market in the first quarter of this year.

Iraq factor

In spite of the political turmoil that dominates the news, Iraq remains an attractive market, given its solid balance sheet and opportunities for outsized gains as it looks to implement the Kurdish-dominated part of northern Iraq's business model across the entire country. The Kurdish-led region offers businesses total tax exemption, plus land. There is also the possibility to transfer profits outside the region, which has proven popular with petroleum investors.

Oil companies such as Gulf Keystone have capitalised on these incentives, encouraging many others to consider tie-ups with local firms. US minors such as Murphy Oil have also jumped on the Kurdish bandwagon in a bid to reap the benefits as early as possible. With all these elements, Kurdistan appears set to become the next oil-producing hotspot in the region. However, the central government of Iraq does not see it that way and insists the region is an integral part of the country as a whole. It is threatening to take legal action against any company dealing directly with the local government of Iraqi Kurdistan. This will clearly put a dampener on deals until the legal and political problems are sorted out.

For local banks, this interest in Iraq has forced them to re-adjust. Having suffered badly as a result of two wars over the past 20 years, the country's banking system as a whole had to be restructured. In 2007, Iraq's finance minister, Bayan Jabor, signed a contract with several Western companies to rebuild Bank Rafidain, the country's largest state-owned bank, in a turnkey contract to supply hardware, communications systems and training to staff, across all branches inside and outside Iraq. This model was consequently replicated to other banks. As a result, Iraqi banks are now better equipped to cater to the growing business community within the country and offer services previously unavailable.

And, in a bid to boost lending and support internal M&A activity, the Central Bank of Iraq reduced the reserve requirements of Iraqi banks from 20% to 15%.

Does all this mean the region is gearing itself for a year rich in M&A deals? "Opportunities are aplenty... It's a good time to look out for deals in different regions and different sectors," says Ibrahim Isthwe, head of investment at Lafico.

Further afield

For Morocco, a focus on tie-ups within the clean energy sector is expected to be the long-term driver of economic growth and lead to a flurry of M&A deals in 2011, says Sidi Mohamed Othman, CEO of consultancy Facilito. The north African country has already partnered with German industry stalwarts to develop wind farms on its Atlantic coastline and predictions for further deals are expected on the back of a $9bn solar plan that calls for the commissioning of five power plants over the next decade in co-operation with local utility groups.

The EU and Morocco have also signed a $755m two-year agreement that will focus on economic modernisation and institutional reform, encouraging partnerships between players on both sides of the Mediterranean.

With these deals, Morocco hopes to score a double whammy. On the one hand it should enable it to become less reliant on neighbouring Algeria's oil, while at the same time beating its long-term regional rival in the race to develop renewable energy. For its part, Algeria is looking to capitalise on its vast share of the Sahara desert and develop solar energy, which it hopes to export to southern Europe in the next five to seven years. With regards to M&A deals, Algeria's focus will remain on the oil and gas sector, where robust earnings from hydrocarbon revenue saw its cash surplus for the first quarter of 2010 increased to $3.2bn. Having made interesting discoveries of light, sweet crude in Mali through state-owned giant Sonatrach, Algeria is now targeting small operations in the US and Canada and has appointed law firm Dewey & Leboeuf to advise.

Oil boost

This appears to be the dominant trend for the region's oil-rich economies such as Kuwait, where $16bn has been earmarked by the government for the oil and gas sector. Improved credit-flow from a rejuvenated banking sector is also set to boost M&A activity. Due to high exposure to the real estate sector, Kuwaiti banks are still deleveraging, but the sector remains liquid and profitable, and lending activity continues apace.

According to figures from the International Monetary Fund, total loans to the private sector increased 15.8% year on year in the first half of 2010, account for more than 80% of lending growth and reflect in part an acquisitive appetite from Kuwaiti companies expected to target Canadian and European minors in 2011. While there is nothing extraordinary about these targets, Kuwait is among many GCC countries now eyeing opportunities in an altogether new geography.

The African continent has become the focus of much attention, especially from Middle Eastern investors looking to get a foothold in the region. Although Africa has a long way to go in developing its stock markets, all major capitals have local bourses that experience a decent level of activity. Boasting some of the fastest-growing economies on the planet, the African continent is therefore the place to be seen shopping around these days. With this in mind, GCC players are looking at opportunities in the continent in natural resources, as well as telecoms, retail, leisure sector and banking.

The last frontier

Despite facing some serious political and economic challenges, sub-Saharan Africa is becoming an attractive alternative to eastern Europe and Latin America now risk premiums have started to come down in these regions. With this in mind, Arab companies are looking to Africa for acquisition opportunities in natural resources as well as the leisure industry, with Saudi prince and entrepreneur Al-Waleed bin Talal al-Saud reported to have bought a string of hotels and complexes in Africa, prompting Gulf companies to look for opportunities with countries with which they had no previous historical or cultural ties.

The continent, dubbed the "unseen opportunity region" by Mr Bin Talal al-Saud, is set to see more cross-border activity between the Gulf and Africa, and business events are being staged in a bid to encourage companies to explore the African market in depth. At government level, ministers from both regions are discussing custom and tax exemptions to stimulate collaboration. Gulf financial institutions are therefore prospecting the west African banking market for stakes in a bid to profit from the region's emerging middle class. Given the high proportion of unbanked people in countries on the continent, Gulf players are set to make a noticeable entry in Africa in 2011.

If banking remains the GCC's best export after oil and gas, Iran for its part is eyeing Africa with a view to exporting its car-manufacturing know-how beyond Senegal, where it currently produces Khodro cars. The Islamic republic is looking at acquiring majority stakes in certain industries in a bid to provide its expertise at a discount in exchange for tax breaks and compensate for restrictions it is suffering with other countries as a result of US/UN sanctions.

Iranian utilities could target local energy companies, such as the Democratic Republic of Congo's state-owned SNEL, with a view to opening its capital to foreign investors. Many African states and businesses are focusing on countries with which they had no colonial history, such as China. With this in mind, Iran wants to fill the vacuum left by European players in the 1990s when many central African countries descended into conflict.

With M&A deals shaping up much of the region's economical outlook, bankers across the MENA region are gearing up for a year rich in interesting deals. Opportunities in new territories, previously untapped markets and sectors yet to be developed form the bulk of the motivation for companies eager to recover from the past two years. While MENA remains dominated by its traditionally lucrative sectors, such as infrastructure and petrochemicals, thanks to better regulations and less risk-averse investors, new areas have come up. "The worst is behind us," says HSBC's Mr Mehanna, pointing to the number of deals in the second half of 2010, and auguring a wave of transactions in 2011.