RIYADH, 30 April 2007 — Record amounts of liquidity have been flowing into the GCC region in the past three years, adding to the already high levels of wealth built up from past oil booms. This is encouraging many private equity firms to enter the region, mobilize this wealth and invest it in the region’s growing investment and economic opportunities. Not only local and regional firms, but also major global private equity firms are setting up shop in the GCC to share in this pie.
Globally, private equity is a growing business. According to the Private Equity Intelligence, a London-based tracking firm, there were over 6,000 private equity funds with assets totaling $1.4 trillion in 2005. In 2006, 684 new funds were launched that raised another $432 billion of new funds for investment.
The vast majority of the new funds were buyout funds ($212 billion), followed by real estate funds ($63 billion), venture funds ($44 billion), fund of funds ($31 billion), mezzanine funds ($19 billion), infrastructure funds ($12 billion), and distressed debt funds ($8 billion). In the Middle East and North Africa region, private equity fund investments grew from $316 million in 2004 to $5.2 billion in 2006, according to Zawya Private Equity Monitor.
The bulk of the funds are invested in Islamic funds and closed-end real estate funds.
Because of religious sensibilities, there has been little interest in the region for fixed income or bond funds until the recent development of sukuk (i.e., asset-backed securities).
These developments have been recognized by major Western institutions, and big names such as Carlyle, Deutsche bank, UBS, Credit Suisse and BNP Paribas have set up shop in the region.
There is, however, a big difference between private equity business in the advanced Western countries and in emerging markets like the Middle East. Private equity in the West is called “alternative investment”, but, in emerging markets like the Middle East, it is part of the mainstream.
In the West, companies have been corporatized, institutionalized, listed, regulated, traded, and re-traded, hedged, swapped, acquired, merged, and divested until profit has been almost completely squeezed out of the system. The potential investment universe is a “pyramid,” populated by public companies, maybe 80 percent at the base, and the tip, only 20 percent private.
In the Middle East, the pyramid is upside down. Public companies are a small minority while private companies occupy maybe 90 percent at the tip. In Saudi Arabia, for example, out of over 14,800 companies operating (not including proprietorships), only 158 are joint stock companies, and only 88 of them are listed.
A second difference is over-regulation in the West. High net worth (HNW) investors in the West have become fed up with onerous rules, regulations, restrictions and the disclosure requirements of public companies.
As a result, the main business of private equity firms in the West has been to “turn the clock back,” by acquiring public firms and turning them private, squeezing even more profits out of them through exotic strategies that only a less-regulated private firm can engage in, and then selling them off at a fat profit.
In the Middle East, there is much less opportunity to do so simply because the universe of public firms is still small. The main opportunities for private equity firms in the region are to invest in private companies, greenfield/venture projects, real estate and Islamic assets.
But, there is another difference that makes private equity business difficult in the region — the lack of reliable data on potential target companies. In the West, one can get the company financials, throw them into a fancy model and come up with target opportunities. But, in the Middle East, companies, even if they have the numbers, may not be willing to share them with an outsider.
Thus, a firm with a “Western approach” will end up bobbing up and down on the surface trying to catch big fish, just like many others in the field. What they have to do instead is to dive deep into the water — look for small fish to feed and grow or group them together into big fish, find firms with hidden value, a franchise — waiting to be unlocked.
(Khan H. Zahid is chief economist and vice president at Riyad Bank. He is based in Riyadh.)
