Making the IT embryo grow

Emirates Intellectual Embryo, a technology, media and telecommunications venture capital company, has a mandate to invest $15 million in the Middle East

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By  Massoud Derhally Published  January 30, 2002

|~||~||~|As the debate about liquidity and the difficulty that start-ups face in accessing capital goes on, it is interesting to note the arrival of Intellectual Embryo on the VC scene. Intellectual Embryo has opened shop in Dubai Internet City and its chief operating officer Firdhose Coovadia is attempting to deal with many of the issues that have been raised so far. The company intends on investing in several sectors and industries across the region and is one of the first technology, media and telecommunications business incubators at Dubai Internet City.

The company’s target investments are quite interesting given the amalgam of industries in its portfolio and how it chooses to pursue its strategy in the region. Especially, since London-based Al-Hayat newspaper recently reported that the Arab world’s investments in the telecommunication sector totaled $34 billion in 2000. This figure translates into a seven percent rise compared with the previous year. Telecom investments were particularly high in Saudi Arabia, Syria, Egypt and Morocco.

Essentially, Intellectual Embryo was born two years ago and the model is very different from what you might call normal venture capital or investment banks in the region. The company has four lines of business: asset management, corporate advisory, Intellectual Embryo solutions, and Intellectual Embryo recruitment. The company’s asset management division includes venture capital, with incubation facilities currently in Australia, South Africa, England, and Dubai. Its corporate advisory segment, essentially, is a technology, media and telecom business advisory for mergers and acquisitions, company valuations, and restructuring strategy.

The company is also looking at financial projections and capital raising for pre-initial public offerings. Within its advisory section, Intellectual Embryo believes venture capital incubation is an important facet of the emerging markets region.
The third line of business, Intellectual Embryo Solutions, is a division that takes care of marketing the products that come out of the company’s investments in the region and making sure they manage the channels. “Our vision is to globalise emerging market solutions. Some of these solutions are in the areas of: e-support, medical diagnostic systems, RDBMS technology, m-commerce solutions, asset security management, school management systems, mobile entertainment and content management,” Firdhose Coovadia, chief operating officer of Intellectual Embryo, told Arabian Business.
The fourth segment of the company’s business is also the smallest, which is recruitment, and will be launched in the first quarter of 2002. Intellectual Embryo recruitment deals with human resource needs, which constitutes a big cost for growing companies and could occupy a large percentage of the annual salary of an individual.
The company chose to locate in Dubai for several reasons and it considers infrastructure as one of the most important. “I think in terms of deal flow we are not seeing a hell of a lot out of Dubai. We see much more out of Jordan, Egypt, and also out of Qatar and Saudi Arabia,” says Coovadia.

“But from an infrastructure point of view, in terms of living infrastructure for a diverse team, Dubai is important. The thing is we are strong believers that diversity equals creativity and to attract a diverse team to a particular place you need to have a certain level of infrastructure, social and physical, and I think Dubai enforces that,” adds Coovadia.

Coovadia also believes that the pace of development in Dubai is aligned with what Intellectual Embryo wants to see, which is an open economy, and keeping in stride with technology. “You still have a lot of flashiness, sometimes a lack of substance but I think that is changing and the calibre of people is also improving,” says Coovadia.
“In Dubai we have some questions regarding the protection of intellectual property, but the way we have structured our businesses to be offshore ensures certain levels of protection,” explains Coovadia.

So what can Intellectual Embryo capitalise on from being in the region? The company believes that Dubai can be serviced by its corporate advisory segment and estimates that merger and acquisition activity in the region will increase.

For instance, the tourism sector could be funded in a variety of ways, but eventually it will have to go to markets for capital. “There is going to be consolidation of hotel groups and of tour operators, and there is enough and sufficient deal flow to say that advisory activity in the Middle East region is going to pick up over time, so for us Dubai is a hub for that,” explains Coovadia.

So is Intellectual Embryo a traditional VC? In light of the downward spiral of the tech sector globally is there a case for its presence here or a guarantee for its success? The region is without a doubt lagging behind Europe and the US when you look at the size of Western capital markets and the difficulty media, telecommunication and technology companies face. To be more precise, the return on investment (ROI) abroad makes a much more convincing argument to invest elsewhere given the ability to realise returns on initial investment which can be in the range of 34%.
“Yes markets have fallen and for the investment opportunities we are seeing now, the valuations are very realistic. Second we haven’t been dot-com investors in any of our incubators to date, so even when the markets were at their peak our view was that there was no business,” says Coovadia. The company has minimised risk by diversifying the industry base of its portfolio at a realistic value that may well produce high dividends when the time to exit takes place. “While we have always said that we must encourage creativity and new technology we still had a fundamental principle in our business that if we cannot invest in a company that will be profitable from a cash point of view within 18 months to two years we don’t invest,” says Coovadia.

With company valuations down to earth, and an investment horizon that includes exiting some investments two years from today, the chances are that markets will have rebounded. But what if they have not rebounded? Since that major correction in March of 2000, people have been saying that markets are bound to recover lost ground.
It has not happened so far, what indication do we have it ever will in two years? “If markets don’t recover I am still not worried, because the key is the way you structure your involvement with the company. In emerging markets, guys are desperate for capital, but that doesn’t mean that you screw the investment, so what you need to do is have a win-win partnership with your investment,” explains Coovadia.

“Typically the way we structure our investment begins by believing in the technology,” says Coovadia. What exactly does that mean? Intellectual Embryo helps companies meet their projected targets, and is willing to share the equity risk with them. “We incentivise entrepreneurs to an extent who will then make that company work. If you look at any of our seven investments we are involved in at the moment, none of them have required further capital in the last six months and some of them have already started to show excellent sales,” says Coovadia.

The company’s portfolio of investments includes: PreWorx, a South African-based software development house; Zen Computing, a South African-based company that has developed a content management system called Insite; Vaman Technologies, an Indian-based software development house that develops RDBMS products; Wavetrend, an international company that provides real-time wireless identification of physical assets, people, and intellectual property; VK Ware, also an Indian based software developer that manufactures system and application software for the education and media sectors; and Fort Knox, a mobile commerce banking software product developed by South Africa-based Surecom.

The company has not exited any deals yet but it believes all of its current investments have massive global potential. “I think the one we are closest to exiting at the moment is Preworks, which has unique technologies with no real competitor and has proven itself in the last four years,” says Coovadia. The company’s investment strategy is to incubate five deals a year. However, according to Coovadia, it is capable of targeting six to seven transactions per annum on the advisory side. Intellectual Embryo is very selective in the deals it chooses to undertake and emphasis is placed on whether there is a global market for the transaction, rather than an interest in regional technology.
“The market size must be at least $2 billion worldwide and the reason for that is that we find taking an emerging market to the industrialised world, it is very difficult to assume that you will have a massive market share right away up front. So either you will have to create a new market that has massive potential or you have to have a big market that you can start biting little bits and pieces of so you can have enough critical mass,” says Coovadia.

The company’s target return when looking at an investment is a 50% internal rate of return (IRR) and it also has an internal benchmark whereby the market size for the product should be around $2 billion. The minimum investment is $250,000 in any particular deal with a maximum infusion of $1 million. Over the next three years the company will be investing a maximum of $15 million and that is mainly because of the nature of its investment parameters. Thus far it has committed $3.5million and funds will be applied to seed and early stage investment opportunities in India, the Middle East, North Africa and Korea. It is primarily looking at investing in technology, media and telecom. “In this region in general there is a lot of talk about convergence between technology, media and telecom and I see a lot of opportunity in these sectors,” says Coovadia.

“We are looking at Libya quite closely, Jordan is also attractive because the intellectual capital there has risen, and the deal flow from there is currently superior to other places in the region. Egypt is an interesting market but it is a difficult market to break into, but we are also looking at Saudi Arabia and Oman,” adds Coovadia.

Most venture capital firms traditionally exit investments through initial public offerings (IPOs) or private sales. However, Intellectual Embryo’s primary exit strategy is trade sales to companies in the US and Europe. “IPO is an option. But to get your management team from an emerging market to be ready for an IPO in the US is a challenge and then to get people from that market to complement that team and then take it to market creates cultural problems. Trade sales are more important for us because the deal is generally a cash deal and I prefer to have cash in the bank,” explains Coovadia.

So does Intellectual Embryo believe there is potential for companies from this part of the world to float on equity markets in the West? “You have to separate what drives equity markets and emerging markets,” says Coovadia. “What has been driving IPOs in most emerging markets over the past ten years has been a thrust towards privatisation and I think that is an important element because that could generate significant IPO interest in the region. I think there is room in the telecom, retail and tourism sectors for IPOs,” continues Coovadia.

But with many dot-coms out of business, is there a need for incubators in the Middle East? Incubators have not exactly been a success story in Europe or the US. A critical success of an incubator is the business model. In times like now, what is needed is strong leadership and that has been lacking, so what can differentiate Intellectual Embryo from the likes of beleaguered Internet company CMGI? “What makes an incubator successful is positive cash flow, good business model and strong leadership with minimum overhead. An incubator is no different from anything else,” says Coovadia.
“You want to make your money work, and the way you do that is by reducing costs and making sure you have an international presence. The fault of incubators to date is they are not a network but rather a single incubator and they have been greedy and want to make all the returns for themselves and it does not work like that in this world. You have to give some of that revenue away to make sure that the company you have invested in, actually benefits and generates cash all the time,” explains Coovadia.

What will make Intellectual Embryo successful? Will it be limited competition in the region’s VC arena? Or will it come down to the size of capital for investment? The company certainly has advisory experience, it has closed large corporate finance deals, and its people seem to have the ability to add value to enterprises through consulting services. More impressive is the fact that it has not made a loss yet within the group and that also includes all of its partners.

“You don’t get poor by making a profit, if my return is not 160% that is fine, but if my return is 60% or 30% in the proper risk management framework then that is acceptable because a lot of work goes into the investment and decision process. We will be successful because our business model is not solely dependent on capital revenue streams when we exit. We have revenue streams that pay for the expenses in the business and from our point of view we don’t have to rely on new capital to break even. We can break even on our existing revenue streams and the capital return is the cherry on the top,” says Coovadia.

Unless innovation and entrepreneurship are encouraged and nurtured by VCs like Intellectual Embryo, public sector enterprises and family owned businesses will continue to dominate the region. This essentially means that you will continue to have small, segmented markets without developing economies of scale; inadequate management experience and limited deal flow, leaving traditional merchant families who have long established businesses with a larger market share. By Massoud A. Derhally

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