Pakistan private equity play

Most emerging markets involve a measure of political risk but Pakistan's current instability, following the assassination of presidential candidate Benazir Bhutto last December, might give even the most daring investors pause. Few observers, domestic or foreign, feel comfortable predicting how the country will be governed in six months, let alone a year from now.

Recent events might have been enough to paralyse other economies, but Pakistan has so far coped with the uncertainty rather well. According to statistics from Thomson Financial, Pakistan was the best performing stock market in Asia from 1 January to 23 January of this year, suffering the least decline of any of the major indexes on the continent. Equally remarkable, analysts are still forecasting its economy will grow between 6.5 and 7 percent.

So striking are these facts in light of the turmoil that The Economist recently described the country as the “the world's most dangerous haven”. The magazine credited some of Pakistan's economic and financial resilience to the dearth of foreign investors in the country to panic over recent developments.

“We like to say, instead of giving $50 million to a group in India, give $10 million for us to invest in Pakistan in a similar market with significantly less competition and far lower prices.”

In other words, it's locally based investors who have kept things going. One example is The JS Group. Founded four decades ago, it is as one of the largest financial services companies in the country, with a diverse line of businesses ranging from asset management, microfinance projects – and private equity.

Having made private equity-style investments since 1978, the company launched its first stand-alone fund in 2004, eventually closing on $158 million in January of 2008.

During the fundraising, JS Private Equity completed two investments and is currently on track to complete two more. According to the firm, its strategy is to make growth equity deals in a variety of industries and to rely on its parent's ties to the country's corporate sector to source investments.

TOWARDS THIRD-PARTY CAPITAL
To outsiders, private equity in Pakistan may seem a bold proposition. However, those on the ground point to the country's maturing economy, which they argue is offering private equity operators attractive opportunities. They also say regulation has improved.

“In the past five or six years, the country's really improved its financial regulatory system,” says Veronica John, a long-lime investor in Asian private equity who has been familiar with the JS Group since 2004. “The government has tackled corporate governance and codes of conduct, and the central bank governor is widely viewed as having brought stability and credibility to her role.”

Against this backdrop, the JS Group's private equity team has been working on its track record. The current fund is managed by members of the principal investment team that has been residing inside the JS Group for years and investing from its balance sheet. “Our track record between 1996 and 2006 on our PE-style deals was a gross 55 percent IRR in US dollar terms,” says Steve Smith, a JS partner. “That period obviously included Pakistan's nuclear testing crisis in 1998, which could be considered more serious than the current situation.” The strength of that track record suggested that the team could win third-party capital commitments, and so Smith and his colleagues began marketing a stand-alone vehicle in 2004.

“We could have been more efficient,” says Smith of the fundraising. The founders sifted through their Rolodexes for anyone interested not only in private equity and emerging markets but who could also understand the argument for Pakistan. “Essentially we spent a lot of time in the Middle East,” says Smith. They came away with a large commitment from a commercial bank in the region. Then the International Finance Corporation agreed to be the anchor investor in the 2006 first close, giving the fundraising effort an important push forward.

With the IFC's assistance, the firm upgraded its documentation and targeted a new kind of limited partner. For the final close, JS focused on the large institutions it already had relationships with, and scored support from the Asian Development Bank totaling $20 million, and raised $40 million from the UK-based CDC Group. The firm also employed Axonia Partners, a Paris-based fund placement specialist, to target additional relationships in Europe and went on a two-week road show that resulted in several commitments. “With that new approach, we had our final close this year,” says Smith.

Before the first close, the group began sourcing deal opportunities but eschewed a specific industry focus. “Rather, we decided to build our strategy around some macroeconomic trends that we acknowledged were underway, and then drilled down into specific industries and sub-sectors until we found an opportunity that made sense for us,” explains Ali Siddiqui, the managing partner of the firm.

Pakistan's emerging middle class is one of the macro trends informing JS Group's investment thesis. “Back in 2002, per capita GDP stood at $582, but now it's just past the $1,000 mark,” says Smith. “For the first time many Pakistanis have discretionary income and in a country of 160 million, that spells a massive opportunity.”

RIGHT-SIZING DEALS
Smith also says that while the domestic market for fast-moving consumer products will naturally expand, JS is leaving such plays to the large multinationals. “We know that, say, the demand for mobile communications is exploding, but those deals are out of our price range,” says Smith. However, there are still ways in which the firm can benefit from the communications boom he explains, for instance by addressing the lack of cell towers in the country and investing in the leading provider within that sub-segment.

The firm looks for traditional growth equity opportunities and aims to take an active role in guiding the company post-investment. The fund's debut investment in the auto industry shows the strategy at work. The firm entered the sector through the acquisition of a 60 percent stake of the Pakistani operations, known as Optimus, of global car rental and fleet management group Hertz.

Siddiqui explains that the auto contract leasing company represented a chance to swiftly grow an already successful business by offering leading Pakistani and multinational companies an off-balance sheet, full-service solution to their car fleet issues. JS' stake was priced well within its targeted investment range, which falls between $10-20 million per transaction.

“We made our initial investment in April of last year, and by July we had completely restructured the company's debt, saving an average of 200 basis points,” says Siddiqui, highlighting the JS Group's reputation and strong ties to local banks as one reason why it was possible to renegotiate the company's loans quickly and at attractive terms.

Another initiative was to convince one of the companies' largest clients to stay loyal to Optimus. Just as the team was completing the transaction, Optimus was poised to lose its contract with a large multinational corporation.“ We reached out to that client directly and explained our belief in the enterprise, and stressed that our involvement would ensure their concerns would be addressed, and now they remain the company's second largest customer,” says Siddiqui.

Going forward, the plan is for Optimus to partner with other auto rental companies in the region. “That might mean anything from investing in Optimus to an outright acquisition, but we're looking at ways to put the company on a regional stage,” says Siddiqui.

JS PRIVATE EQUITY AT A GLANCE