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Country reportsMay 1 2013

Saudi Arabia's investment banking industry picks up the pace

Saudi Arabia's investment banking industry is gaining momentum, thanks in large part to a region-wide uptick in bond issuance, in mergers and acquisitions and growing demand for project finance. But the evolution of this sector is far from over, as the country's bankers turn their minds to deepening the markets and encouraging the liberalisation of the stock exchange.
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Bucking the trend of most banking sectors across the world today, Saudi Arabia’s investment banking market is continuing to go from strength to strength, and setting new records in terms of the size of deals being closed. From project finance to Islamic bond issuance, mergers and acquisitions (M&A) activity to asset management, Saudi investment banks are finding there is no shortage of opportunities for growth.

The huge infrastructure projects that are planned or under way in the country are the driving force behind the growth in project finance; construction and infrastructure sub-sectors in Saudi Arabia grew by 177% in 2012 compared to the previous year, and currently account for 46% of the 2012 to 2013 project pipeline in the Middle East and north Africa (Mena) region, totalling $448bn.

Saudi Arabia's expenditure growth in these sectors is expected to make it the biggest spender in the Mena region over the next 15 years, as it responds positively to pressing social needs such as improved transport links, housing and education.

Sleeping giant

Increasingly integral to the growth in project finance is bond issuance. Dubbed the 'sleeping giant' of regional debt capital markets, there is now no mistaking the fact that Saudi Arabia has woken up to the financing opportunities offered by riyal-denominated debt issuance. In a country that draws no distinction between conventional and Islamic banking, such issuance has been entirely in the form of Islamic bonds (sukuk).  

Traditionally, Saudi corporates and businesses had relied on bank loans and retained earnings to fund their growth, but given the sheer size of the projects now coming to the fore, banks have become increasingly reluctant to finance big, long-term infrastructure projects through their balance sheet because of the mismatch this creates between assets and liabilities. Compounded by a growing desire to diversify funding sources, this has sparked a trend in companies looking to issue sukuk.  

While robust economic growth is ensuring that bank loans are continuing to increase (with lending to the private sector surging by 15.6% to $272bn in the 12 months to February 2013), the growth in sukuk issuance is outpacing it. In 2012, SR27.2bn-worth ($7.25bn) of Saudi riyal-denominated sukuk were issued, up from SR11.3bn in 2011, according to HSBC. The first sukuk was issued in Saudi Arabia in 2005, but the market has only really started to gather pace over the past few years.

“The issuance of sukuk is a relatively new development in our capital markets but it has now become a key part of the banking landscape,” says Abdulrahman Al-Hamidy, vice-governor of the Saudi Arabian Monetary Agency, the country’s central bank. “Sukuk hold two main advantages – they carry longer tenors than bank loans and they also help diversify funding sources. Every time one is issued, it is oversubscribed by two or three times.”

High expectations

The announcement by HSBC in October 2012 that all its future Islamic wholesale banking and sukuk products will be offered to customers globally through its HSBC Saudi Arabia office is as solid an assurance about the future strength of the Saudi sukuk market as any.

“The global mandate for sukuk is now going to be based out of Saudi Arabia, which speaks volumes about the confidence in this market,” says Walid Khoury, chief executive of HSBC Saudi Arabia, a joint venture established between the Saudi British Bank and HSBC in 2005. “Most Saudi issuers have gone into the sukuk format – they are there in practically every issuance. In terms of Middle Eastern markets, the United Arab Emirates and Saudi Arabia are clearly leading the pack when it comes to sukuk today.”

In the first week of April 2013 alone, three big sukuk were issued by Saudi companies. Saudi Binladin Group, one of the largest construction firms in the country, priced a SR1.3bn sukuk, while the world's largest dairy producer, Almarai, and Sadara Chemical Company completed issues worth SR1.3bn and SR7.5bn, respectively.

“The outlook for 2013 is very promising,” says Jawdat Al-Halabi, chief executive of Riyadh-based investment company NCB Capital. NCB acted as the mandated lead arranger on the sukuk issued by Almarai. “Many companies are now expressing an interest in issuing an instrument that is increasingly being seen as a strong alternative to ‘traditional’ funding products.”

Approaching bottleneck

Furthermore, a large number of sukuk in 2012 were issued by banks in order to increase their liquidity and capital adequacy ratios. 

Since 2008, Saudi Hollandi Bank has listed three subordinated sukuk to support the growth of business – the most recent one being in October 2012. Similarly, in December 2012, Banque Saudi Fransi (BSF) issued a SR1.9bn subordinated sukuk to boost its Tier 2 capital. Its investment banking arm recently acted as the sole bookrunner arranging the Binladin sukuk. 

“We have lots of sukuk in the pipeline for clients and we are keen to develop this aspect of our business further through our subsidiary, Saudi Fransi Capital,” says Patrice Couvegnes, managing director of BSF.

“But I’m concerned about the fact that a bottleneck has started to form. The debt market is currently very limited – there is no secondary market and limited public access. It’s not a difficult issue to solve – they just need to open it up and increase its depth by allowing more listings. I dream about selling off some of my balance sheet but there’s no secondary market for syndication.”

Calls from senior figures to liberalise the Saudi stock exchange, Tadawul, have been growing over the past few years. Most recently, in early April this year, Saudi Arabia’s Prince Alwaleed bin Talal publicly stated at a conference that: “Saudi Arabia needs to rely less on individual investors" and that "effective measures to invite foreign investors from any state must be taken”.

A family affair

Retail investors currently comprise about 95% of trades, with institutional accounting for the remaining 5% – virtually the exact opposite of the scenario in the US and Europe. Saudi Arabia currently only allows non-resident foreigners outside of the Gulf Co-operation Council to invest through equity swaps and exchange-traded funds.

“The Tadawul’s performance has been disappointing. Retail investors dominate its trading so it desperately needs institutional money,” says Mr Khoury. “The Saudi benchmark index was trading at about 12,000 points pre-crisis, it dropped to 4500 during the crisis and it is now trading at about 7000 so it is yet to make a full recovery. But the risk appetite is coming back. Family businesses have made a real effort to institutionalise and are increasingly looking to issue initial public offerings.”

The restructuring of family-owned businesses – often in relation to succession-planning – is also helping to drive M&A activity in the country. Increasingly, family businesses are seeking partnerships with international companies, especially with premium brands, in order to gain know-how and market share, while domestic and international companies, alongside private equity firms, are searching for buys.

Growing appeal

Saudi Arabia ranked third among Gulf countries in 2012 in terms of largest number of announced acquisitions – the UAE recorded 77 deals, Qatar 48 and Saudi Arabia 33 – and is expected to see an uptick in M&A activity in 2013, with a number of drivers spurring renewed interest in M&As within the region.

“The influx of a number of M&A advisory professionals into the country is also driving activity,” says Faisal Baassiri, partner at Saudi-based law firm Faisal Baassiri, which established an association with UK-based law firm Ashurst in November 2012.

In the 25 months to February 2013, 33 disclosed M&A deals were closed in Saudi Arabia with a total value of $2.96bn, according to data from Mergermarket. Of these, the consumer sector accounted for 15%, business services for 9%, and pharmaceutical, medical and biotech for 6%. Four disclosed transactions took place in 2012, two in the consumer sector and one each in the financial services and transportation sectors.

In February 2012, Dubai’s Levant Capital and Citi Venture Capital International – Citigroup's venture capital arm – announced that they had jointly acquired a controlling stake in Saudi supermarket chain Al Raya, in a deal valued at $100m. Al Raya, based in Jeddah, operates 25 supermarkets across 14 Saudi Arabian cities, and posted sales of SR800m in 2011. 

The same month, insurance firm MedGulf, one of the leading Middle East insurance companies with operations in Saudi Arabia and other countries, sold a 15% stake to the International Finance Corporation for $124m. 

In July, listed fashion retailer Fawaz Al-Hokair Company acquired NESK Group, which operates a number of leading brands in Saudi Arabia, for $195m. In the transportation sector, Bin Sulaiman Holdings acquired a 40% stake in the Al Tala’a International Transportation Company for $140m.

“In recent months, most M&A activity has been in the food and beverage, healthcare and education sectors,” says Ragheed Moghrabi, head of placement and business development at Sidra Capital in Jeddah. “The majority of firms that are looking to sell are family-owned businesses that have been operating for 20 to 30 years. They are interested in selling a stake of about 30% to a premium international brand to help them re-brand and gain technical expertise.”

Changing conditions

An area of the market that is expected to see increased numbers of mergers is the pharmaceutical sector. Consolidation talks are currently taking place among distributors, with Saja Pharmaceuticals and Banaja Holdings just two of the pharmaceutical companies reportedly in merger negotiations, according to an industry insider. By joining forces, distributors can build financial muscle, making it easier to acquire drug licences, the source says.

“A number of healthcare and pharmaceutical companies are cash-poor and looking for new shareholders to expand their operations,” says Mr Moghrabi.

The deal value of M&A in the Mena region grew by 42% in 2012 to reach $44.8bn, compared to $31.6bn in 2011, according to a report on Mena M&A activity published by professional services firm Ernst & Young at the end of 2012.

However, Mr Moghrabi says the valuation gap between the buyer and seller remains a major stumbling block, particularly when the vendor is a family-owned business, in which case “the asking price can sometimes be as high as 18 times Ebitda [earnings before interest, taxes, depreciation and amortisation]”.

But, according to Phil Gandier, the head of transaction advisory services for Mena at Ernst & Young: "The 42% increase in announced deal values in 2012 suggest that there may be an improvement in the valuation gap among buyer and sellers in the market in comparison to 2012, when total deal values were considerably lower.       

“The increase that we have seen in deal values across all types of deals in 2012, particularly inbound deals when compared to 2011, highlights that the Mena markets still continue to remain attractive to global investors and institutions as they look to emerging markets as attractive regions for growth.

“As 2013 unfolds there is an anticipation that the improvement in deal activity in 2012 will further improve as we start to see market conditions continually improving despite the unpredictable macroeconomic landscape."

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