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WorldFebruary 2 2015

Will Middle Eastern private equity maintain its momentum

The Middle East's private equity market had a successful year in 2014, with several notable deals, a number of vehicles closing their fundraising and increased international interest in the market. James King investigates how likely it is that its popularity will extend into 2015.
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Will Middle Eastern private equity maintain its momentum

In 2014, the Middle East’s private equity market began to exhibit signs of positive growth. For industry insiders, this development had been a long time in the making. Since the global financial crisis, in which private equity funds in the region were hit hard by imploding real estate markets and tumbling stock prices, the sector had failed to regain anything like the activity it registered in the mid-2000s. This slowdown was compounded by the fallout from the Arab Spring, as political instability escalated and investor sentiment dampened.

“Since the financial crisis and the Arab Spring, we have been waiting for a recovery. We thought conditions were improving in 2013, although it wasn’t until 2014 that progress really began to take hold,” says Amir Arab, a director at regional fund Havenvest Private Equity.

Returning appetite 

By the first quarter of 2014, investor appetite had returned to the Middle East, as stability returned to the larger regional markets, including Egypt, stock markets posted strong growth and the price of oil remained high. With confidence restored, the regional private equity market has surged, characterised by new acquisitions, high-profile exits and a greater interest from international firms.

In October 2014, Gulf Capital, an Abu Dhabi-based asset manager, closed its third private equity fund for $750m. This was the largest example of private equity fund raising in the region since 2011, according to news agency Bloomberg.

“The private equity firms that have kept a more coherent team, invested in and supported their portfolio companies have been able to successfully raise money for their subsequent funds. This is true for Gulf Capital, which raised $750m, and NBK Capital which successfully raised $310m,” says Walid Alameddine, chief executive for the Middle East and Turkey of consulting firm Promontory Financial Group.

An improving political and economic environment attracted the attention of larger international private equity players looking to diversify their portfolios. Warburg Pincus, a US private equity firm, purchased a stake in Mercator, an Emirati aviation group, in April last year, and US private equity firm Blackstone Group took a stake in Dubai-based education group GEMS Education, in conjunction with local private equity firm Fajr Capital and Bahrain’s sovereign wealth fund, Mumtakalat, in October.

“The global private equity firms generally do not look at a ticket size of less than $200m, but in 2014, off the back of improving valuations in the region, some regional sellers had interesting deals that were also sizeable, including Mercator and GEMS Education, which attracted these global players,” says Mr Alameddine.

Positive momentum

While many of the larger deals have been dominated by global players, the regional private equity scene, characterised by a handful of mid-sized players, also made appreciable gains in 2014. Dubai-based Abraaj Group purchased a stake in Algeria's largest logistics company, La Flèche Bleue Algérienne, while Fajr Capital, also located in Dubai, led a consortium to acquire United Arab Emirates-based National Petroleum Services, a global oil field services firm.

The vibrancy of the market has enabled both international and local players to co-operate to a greater extent than at any time since the financial crisis. "The private equity space, particularly in the Middle East, is moving more and more towards the co-investment model," says Mr Arab from Havenvest. In most cases, this partnership has emerged out of a need for local expertise and contacts on the part of the large internationals, and requirements for additional capital on the part of the local players.

While this positive momentum has been cause for greater optimism, the outlook for 2015 is less clear. Notably, greater political instability, both regionally and beyond, coupled with plummeting oil prices, has cast a shadow over the sustainability of these trends.

“A number of unexpected events occurred in quick succession towards the end of 2014. The Russia-Ukraine crisis quickly escalated into a global issue with implications for the region. This was followed by the emergence of [terrorist group] Islamic State, which really came out of nowhere. Then, the oil price started to fall. Towards the end of 2014, everything that could go wrong was going wrong,” says Mr Arab.

These factors, coupled with growing uncertainties over the succession plans of some of the Gulf region’s key monarchies, have reined in expectations for the region’s private equity market in 2015. “I expect most of the funds with a long-term understanding of the region to remain active, though many outside players looking for a short-term gain are likely to leave. Much will depend on their risk appetite this year,” says Ashish Dave a partner with consultancy, KPMG UAE.

For the private equity market in the Gulf Co-operation Council, in particular, a sustained oil price drop is likely to have significant implications. Though most governments are well supported by strong fiscal reserves, few observers expect their current spending plans to be maintained without a recovery in the oil market. “[This year] private equity firms and investors in general are likely to view certain sectors, including construction and activities related to infrastructure spending, with more caution,” says Mr Alameddine.

Middle of the market

These sentiments may lead to difficulties with respect to new fundraising, while potentially delaying planned exits, as well as initial public offerings, in the region. Though it seems unlikely that the market’s trajectory will be hit in a lasting and meaningful way, it may temporarily arrest the upward momentum generated in 2014. The Carlyle Group’s decision, in late 2014, to abandon plans to market a second Middle East and north African (MENA) private equity fund reflects the reduced risk appetite of many international investors in the region.

Nevertheless, while these trends may slow overall activity in 2015, they are likely to provide established regional funds with more favourable pricing. “The suppressed sentiments about the investment attractiveness of the region may help reduce pricing valuation pressures. If you have money to start with and you can source deals, there may be some excellent opportunities available,” says Mr Dave.

This price suppression could provide independent acquisition opportunities for local players in the mid-market segment, in conjunction with co-investment prospects in the larger market category. It may also serve to increase competition at the local level, particularly among the established family offices. Though little data exists for the activities of these entities, lower valuations will undoubtedly stimulate acquisitions among the region’s leading family groups for deal sizes between $100m to $200m, according to Mr Alameddine.

Mr Dave says: “When people think about private equity they think of the well-known international groups. Yet, there are a tremendous amount of family office transactions that occur as well. If you look at how the Middle East region has built itself, it has achieved a lot it by investing profits into local businesses and ideas,” says Mr Dave.

Future growth

On the ground, few private equity groups with an embedded interest in MENA are concerned about their longer term prospects. Attitudes remain bullish about the fundamentals offered by a region with a positive demographic profile and changing economic structure. As such, most have an eye to the longer term prospects of the MENA region, with a particular focus on the opportunities presented by recently stabilised Egypt and the continued growth potential of Saudi Arabia.

“The proposition that this part of the world offers remains unchanged. It’s a young population that will require a higher number of jobs. Long-term growth is not going to come from energy-related sectors, it’s going to come from the private sector, from small and medium-sized enterprises. In turn, this is going to drive the consumption across the region. The sectors that benefit from this trend are education, healthcare, retail and entertainment,” says Mr Dave.

While 2015 will bring new uncertainties to the private equity market, the success of existing local firms targeting the mid-sized market is likely to offer some continuity from 2014. Blessed with the requisite local knowledge, contacts and flexibility, these groups will benefit from improved valuations and the prospect of achieving successful exits in the coming years.

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