Private Equity Opportunities in the Gulf Region

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Since opening our offices in Qatar we cannot but share the momentum that the region poses for Private Equity.

As reported by the CFH Group, the Private Equity in the MENA region can be summarized as follows:

A. Market / Motivation:

1. Interest from International Players: Many international groups are considering the GCC for potential investments owing to:

– Loss of momentum in other parts of the world (like the EU).

– Relatively robust economies of the GCC.

– Generous budgets as a result of oil revenues.

– A high growth potential in relatively underserved markets.

2. Favorable Regulations and Government Support: Especially predominant in the State of Qatar, the Kingdom of Saudi Arabia, the United Arab Emirates.

Some of the highlights include:

– Qatar 2022 world cup and infrastructure projects.

– Saudi Industrial Development Fund: Supports the expansion of the industrial sector with convenient debt servicing cost and pay-back.

– Strong Budgets: In case of KSA, the government announced USD 400 billion to be disbursed on industrial and infrastructure projects over the next 2-3 years.

– Relatively low operating and energy costs.

– Foreign ownership allowed.

– Low tax rates and generous tax incentives

– Availability of export financing programs.

– Favorable labor laws.

3. Key Opportunities:

– Acquisitions: Due to the volatile market conditions, bargain opportunities exist for acquisitions, sometimes at distressed valuations.

– Divestitures: A number of investment holdings or conglomerates are interested in divesting non-core operations as part of corporate restructuring or in order to focus on core operations.

4. Family Businesses: Many family businesses are expressing interest in achieving a “corporate structure” for their operations. This is mainly achieved by inviting new investors and implementing meaningful corporate governance. The rationale behind this is mainly to provide a clear ownership and managerial structure for the next generation.

B. Investor Highlights:

5. Expansion Capital: The most favored type of PE. Funds from the capital increase will have specific uses and are typically used to increase capacity or expand to new markets in the same or complementary line of business. By and large, high backlog is a prerequisite. Part of the funds can be allocated as a cash-out to the owners but should not exceed 20% of the total cash injected by the new investors.

6. Greenfield Projects: Interesting due to:

– Participation at cost or at a slight premium instead of paying the market P/B or P/E valuations.

– Clean financials and reporting.

– Exit options by way of an IPO may be possible over the medium to long term.

– The use of funds is mostly asset based due to the industrial nature of the projects.

7. Emergence of Club Deals:

– Two or three groups partner in a minority stake transaction.

– The groups typically own businesses that have synergies with the investment’s operations.

– The total investment could be a controlling position but usually not a super majority.

– It could as well be a sell-out by the previous shareholders and not necessarily a capital increase.

8. Technical Edge: The presence of a technical partner makes the transaction more appealing. The ultimate objective of the transaction should be to achieve an operational quantum leap as a result of the technical partner’s expertise, operational support of the new investors, in addition to the new available funding.

9. A JV Twist:

– The preferred type is a joint venture between a foreign industry leader who participates with a local group to form a JV in a specialized industry.

– The JV could be in a form of a capital increase from an existing operation or through a completely new greenfield project.

– Future funding will be shared on a pro-rata basis.

– The local group must provide the market know-how, connections, and overall support for growth.

C. Exits and Returns:

10. Exits:

– Given the global market volatility, IPOs may not be the best exit option, at least over the medium term.

– A management buy-back of shares could be an option.

– Trade sales to other specialized funds have been witnessed recently.

– An acquisition by a foreign market leader that aims to achieve dominant market share is a good option. This could be a way to achieve higher valuations for regional companies.

11. Earn-Out Structures:

– In summary, new investors will be entitled to receive free shares if the management fails to attain pre-specified agreed upon targets.

– This structure is crucial to align the interests of management and new investors.

– Evidently, the earn-out structure is meaningless if the operations go sideways. However, PE is all about investing in sound businesses and sharing the risk with credible management.

12. The Mega-Return Delusion: Investors are back to being reasonable in viewing required returns. Currently, a 15%-22% IRR should be regarded as very attractive in comparison with the three-digit returns witnessed in public equities during 2004-2007.

The above thoughts are by no means comprehensive and I welcome any interest for further discussion

Leon Fernando del Canto

Barrister – Abogado

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