AMMAN, 9 August 2004 — Private equity funds are usually closed-end funds that operate for a specific period of say 7 to 10 years from their closing date, with the aim of generating long-term capital gains to those investing in them. While the returns that these funds generate are usually very low in the first few years, nevertheless they promise superior performance for the whole duration of the fund in excess of 20 percent annually. Before such funds are listed on the local stock exchange, entering and existing the funds would be extremely limited. At the end of the investment period, the fund is either extended or liquidated, and the returns generated plus the principal amount will be distributed to the shareholders.
Private equity funds invest in companies at various stages of development ranging from start up businesses requiring “seed capital” to commence operations, to companies who are in the process of expansion and need “patient capital” to fuel business growth, as well as, companies who require “smart money” to propel them to higher level of profitability and growth or where top management wants an ownership stake. Private equity funds would usually partner with the owners of companies, to provide capital, as well as, financial restructuring, operational enhancement, management expertise and value creation. To enhance their income, private equity funds would also invest in cash generating businesses with stable revenue streams.
Family or privately owned companies in the region have generally been closed to outside investors. They have been quite successful at growing their businesses organically, i.e from within. They usually draw on the company’s retained earnings and/or the financial strength of the owners to raise the required amount needed for expansion. Furthermore, privately owned companies do not generally possess the skills needed to successfully acquire or merge with other businesses. However the next generation of family managers are more open to the separation of family and corporate interests and are willing to consider bringing in a private equity fund as a respected investor that would add value by providing financial and advisory expertise. Such funds would also provide an exit strategy for companies with multiple owners where one or more desire to sell.
Private equity funds would have the talent needed to identify prospective companies, valuing them and deriving the optimal capital structure to finance the acquisition. Such funds usually have strong relationships with commercial banks, investment companies and investors in the region, and are able to secure both equity and debt to the companies they invest in. Private equity funds typically put in the initial equity investment of say 10 percent to 30 percent of the cost of the acquisition and then draw on commercial banks and other investors to come up with the balance. Private equity funds could also help top management wanting an ownership stake in the company to succeed by participating with them in a management buyout structure.
In the Middle East, the private equity market is poised for a period of sustained growth that should help provide profitable opportunities for investors and financial institutions. At present, the organized institutional private equity market in the region is relatively small, estimated at slightly less than $300 million. But it is to growing fast with expectation that it would reach $1billion by 2007. Local and regional private equity funds can deliver the right combination of international best practice and understanding of the local market. These funds have deal structuring and execution skills, value-creation discipline and the ability to create exit opportunities. They also have access to other sources of financing, both equity and debt.
Several positive developments were recorded in the region recently these include improvements in the regulatory structures which are gradually becoming more investment friendly, and the availability of capital resources that had previously been channeled to investments abroad. Economic liberalization is allowing a greater role for the private sector, while more mature stock markets now provide an important exit strategy for the investment holdings of the private equity funds. If a successful IPO cannot be effected, the issuing companies could sell part of their equity to a strategic buyer or other financial investors. These conditions are likely to trigger opportunities for private equity funds in industries like telecommunications, financial services, technology, energy and power. These sectors, once the sole preserve of governments, are now increasingly being operated by the region’s private sector.
There are, of course, still challenges to be overcome. Arab governments have to accelerate the speed of liberalization by addressing issues such as ownership, agency and labor laws. Once this happens, it is expected that the private equity industry will act as a catalyst in the development and growth of businesses and industries in the region and will serve as a focal point to attract investment.
The successful leverage buyout of Aramex, a Jordan based international courier company, is an example of how investments by a private equity fund can help boost the value of an already profitable company and generate higher returns for shareholders. Aramex, which was the first Arab owned company listed on NASDAQ, has seen a remarkable transformation since it was acquired in February 2002 by Abraj Capital, a private equity firm operating out of Dubai. Abraaj acquired the company through a $65 million tender offer. Some $25 million of that was in equity provided by Abraaj accounting for 52.04 percent of the company’s capital, with Aramex’s management holding 24.6 percent, and the balance of $40 million was raised through debt. Aramex’s revenues grew by 43 percent for the year ending December 2003, to $167 million, and net income was up 151 percent, to $10 million. The Aramex story is likely to reach a successful conclusion in the coming months, with an exit strategy that could see the company issuing stocks on the regional capital markets through a well prepared initial public offering (IPO).
(Henry T. Azzam is chief executive officer at Jordinvest).