The long view

Despite the current economic problems, private equity to anticipate a profitable future, writes Philip Borel.

No question, Dubai is feeling the pressure. Visitors to the city, including delegates to PEI's 5th annual Middle East Forum in March, do not have to look hard for signs of the city's sudden slowdown. The global crisis is taking its toll on the erstwhile poster child of MENA's great leap forward, and the consequences are widely visible. One clear indication that Dubai isn't as busy as it was: less traffic on the usually notorious Sheikh Zayed Road, the city's main transport artery.

The Forum reflected the downturn, too: the crunch and its economic consequences were firmly on top of most delegates' agendas. In the short term, many of the region's private equity firms are expecting to have to deal with crisis-related issues in their firms, funds or portfolio companies. Given the intensity of the crisis, some general partnerships are unlikely to solve all problems fully; their long-term survival must be considered doubtful.

Despite this, many of those present spoke with measured optimism about the private equity industry's future in MENA. Some were even downright bullish. “Private equity in the region is going to enter into a phase where I believe historical returns will be dwarfed,” predicted Arif Naqvi, founder of Abraaj Capital, MENA's largest provider of private equity capital.

largest provider of private equity capital. Naqvi spoke of a “serious” investment opportunity arising from the fact that family businesses and entrepreneurs looking to finance growth are left with limited alternatives when it comes to sourcing capital. The region's stock markets have been decimated; banks are retreating. Private equity firms on the other hand still have capital to invest and are open for business. On the day before the PEI Forum, for example, The Carlyle Group closed its first dedicated MENA fund on $500 million.

Consider also that the region is forecast to deliver significant annual GDP growth of approximately 5 percent in the coming years, and that MENA's governments are now looking to deploy a greater share of their still vast financial resources in the region rather than overseas. More emphasis on regional engagement among the region's vast sovereign funds, as opposed to the investment activity overseas many of these funds have favoured historically, could make significant amounts of capital available to MENA general partners. “It all bodes well for private equity,” Naqvi said.

One recent example of a government-backed investor switching its focus away from international markets in favour of a more regional strategy is Dubai International Capital, which invests on behalf of Dubai's ruling family. Faced with realised and unrealised losses on its international portfolio of listed and unlisted businesses, DIC has rapidly dismantled its Europe-facing buyout strategy in recent months. It has also announced plans to concentrate on its investment operations in emerging markets, including MENA and other parts of Asia.

As a result of the restructing, the group's senior international deal makers Sylvain Denis and Alan Hyslop have left. Now the focus at DIC is on people such as Alykhan Nathoo, head of emerging markets, who joined the firm late last year.

The DIC experience confirms that until world markets stabilise and better times begin, the way forward for private equity groups in the region will be complicated. For the time being, the priorities are strategic repositioning and capital preservation.

Firms including SHUAA Partners in Dubai and Investcorp in Bahrain have already announced job reductions. Others are likely to follow as pressure on fee income continues to rise.

At the PEI Forum, everyone agreed that a shakeout of managers was inevitable and in fact already ongoing. “The sector in this part of the world must consolidate: too many funds have been created without differentiation and without a good enough reason,” said Charbel Abou Jaoude, chief executive officer for Investments at Agility, a pan-regional logistics group based in Kuwait.

The bloodletting will ultimately make life easier for those who survive it. Those funds which make it through the crisis will have the opportunity to lead MENA's still nascent private equity business into a new phase of development. Compared to other parts of the world, private equity's penetration of the MENA economy has only just begun. The crisis marks an inflection point, but beyond it lies another period of growth.

Should private equity embrace regulation limiting the use of leverage in buyouts?

Private equity must help fix current problems in the world's credit markets by doing everything in its power to repair the balance sheets of aggressively leveraged portfolio companies.

This was the message delivered at the PEI Middle East Forum in Dubai by Hugh MacArthur, head of global private equity at consulting firm Bain & Company.

MacArthur described private equity as one of the main beneficiaries of the liquidity boom, which now meant the industry had a responsibility to help deal with the consequences the credit binge had brought about.

As part of this effort, private equity should be supportive of regulation aimed at limiting the use of leverage in buyouts, MacArthur added. “The industry has shown itself incapable of self-management in using leverage sensibly,” he said.

Patricia Cloherty, founder and chief executive of Russia-focused mid-market investor Delta Private Equity Partners, sat on the same panel as MacArthur. A 40-year private equity veteran, she told the conference: “For as long as I have been in this business, there has been a liquidity bubble every decade. And there will be another one after today's. Cheap debt is simply seductive, and everyone is complicit on the upside.”

MacArthur also urged general partners to work closely and actively with portfolio companies to bring about value-enhancing operational improvements. “There are some well-known exceptions, but the majority of private equity firms have so far only been paying lip service to operational improvement as being a part of their strategy.”

He said now that purchase price multiples were contracting and portfolio companies were getting hit by the recession, operational improvements were absolutely essential if sponsors were to preserve the capital they invested in pre-crisis deals – “never mind delivering returns” on 2006 and 2007 vintage investments.

MacArthur also argued the nascent private equity industry was still poised for significant growth in the long term, provided it managed to overcome today's difficulties. “The industry should face the future with optimism,” he said.