Private equity: Years of oil-soaked expansion are over

By Robin Wigglesworth

Dubai, 21 September 2011

During the Gulf’s oil-soaked years of expansion, private equity was one of its hottest new industries, as local merchant families sought ways to channel their wealth back into their own region, and overseas investors wanted to capitalise on the Arab world’s growth.
This sparked a fundraising bonanza. More than 130 funds were established in the Middle East and north Africa between 2003 and 2008, which raised $24bn according to Preqin, a data provider.
Even in 2008, when the west was gripped in a deepening credit crunch, 30 funds raised $5.5bn.
As a result, dealmaking soared, as firms snapped up stakes in companies such as EFG-Hermes investment bank, Egyptian Fertilisers, Damas, a jewellery chain, Maritime Industrial Services and Spinneys, a supermarket chain.
State-run private equity funds mostly looked abroad, and bought assets such as the Tussauds Group, Barneys, Loehmann and Inchcape Shipping Services.
Yet the industry’s bloom has faded swiftly in the past two to three years, as the global financial crisis hit the region, rattling fundraising, dealmaking and exits through public equity markets.
“Regional private equity activity has dropped significantly over the past two years,” concedes Imad Ghandour, managing director at local firm CedarBridge. The most visible parts of private equity – acquisitions and asset disposals through initial public offerings – have virtually dried up. Dealmaking in particular continues to suffer from an idiosyncratic Middle East problem; enticing owners of companies to sell to private equity.
The private sector is made up mostly of family owned merchant groups which often prefer to build vast, sprawling empires rather than cash out on underperforming or non-core assets. Even family owned conglomerates that have run into difficulties have generally been able to hold on to their assets.
This is partially thanks to the willingness of local banks, sometimes owned by the families themselves, to extend loans to influential customers, and under-developed insolvency laws, which make creditors reluctant to call an official default.
“It’s not in the culture of banks in the region to pull the plug on companies that are struggling,” says Pervez Akhtar, a partner at Freshfields Bruckhaus Deringer, the law firm. “They’re a lot more patient.”
Moreover, when merchant families are willing to sell, they are usually only prepared to part with a minority stake and ask for prices that many firms blanch at.
“There’s still a persistent gap between the valuations of buyers and sellers,” Mr Ghandour says. “Company owners still see a lot of upside, and demand the same multiples as they did before the crisis, but buyers want discounts.”
Exits have also proved tricky. Generally, investor-friendly listing rules have always made IPOs a less-than-ideal exit strategy for private equity firms, but lethargic equity markets have virtually precluded any listings in recent years.
The value of IPOs has slumped from a peak of $13.5bn in 2008, to about $2bn in 2009 and 2010, and only $382m so far this year, according to Dealogic.
“Listing abroad is possible, but not very practical, and Middle East investors aren’t the only ones who are cautious these days,” Mr Akhtar says.
The dearth of exits – and resulting lack of returns – has exacerbated a fundraising shortage. Despite healthy oil prices, most investors remain reluctant to commit capital to new funds. Scores of vehicles have been announced over the past three years, but only 15 funds have been able to close, with $2.4bn of commitments.
Executives say even existing funds are not as cash-rich as the headline figures may indicate. Many investors have promised capital only to renege, and the much talked about “dry powder” has proved wetter than expected.
Middle East private equity firms use far less leverage than is the norm in the west, but rocky credit markets have nonetheless made it hard to supplement scarcer equity with debt.
“The financial crisis put pressure on a lot of investors, and the Arab spring made people doubly averse to risk,” Mr Akhtar says.
Many private equity houses had expected a turnround in dealmaking, fundraising and exits this year, but the eruption of political unrest has severely damped this hope, with risk aversion on the rise among both firms and their investors.
Where does this leave an industry that showed such promise during the boom years?
Experts predict that the result of the past three years of travails will be a more humble industry, with smaller funds and smaller deals.
While larger buy-outs have virtually disappeared, executives say there is a reasonable amount of activity on the less visible, smaller scale, with many deals typically valued at $50m or less.
“The funds are a lot bigger than the regional economy warrants, and there are too many,” Mr Ghandour says. “The regional industry’s sweet spot is in the small-cap market.”

Financial Times article