Cash flows under the rubble

Alexandra Dubsky reports on the lucrative side of investing despite the bleak reality that clouds the region. The figures didn’t look good. Just two days after the last bomb fell in Southern Beirut, Kofi Annan put the total damage in Lebanon at close to the US$5 billion mark. With the Beirut stock exchange suspended, investors are running for the hill, and the threat of yet more conflict breaking out in Iran, you would be forgiven for thinking the region’s economy is in chaos.

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By  Alexandra Dubsky Published  September 17, 2006

|~|beirut-200.jpg|~|Down but not out: The rebuilding of Beirut presents opportunities.|~|Alexandra Dubsky reports on the lucrative side of investing despite the bleak reality that clouds the region. The figures didn’t look good. Just two days after the last bomb fell in Southern Beirut, Kofi Annan put the total damage in Lebanon at close to the US$5 billion mark. With the Beirut stock exchange suspended, investors are running for the hill, and the threat of yet more conflict breaking out in Iran, you would be forgiven for thinking the region’s economy is in chaos. Well, think again: the trend in private equity across the Gulf shows no sign of abating – war or no war. “As tragic as the war in Lebanon has been, from a private equity point of view the Levant has especially now great potential for us, since we can buy there at low levels,” says Abe Saad, managing director, Shuaa Partners, the private equity arm of the investment banking firm Shuaa. He has a point: private equity, which serves several purposes when investing in the region is relatively stable against political insecurities due to its long-term investment character. It tends to be highly profitable with a moderate risk potential, and it is per se Shariah friendly, as the investor functions more as a partner than a creditor. The private equity investors’ profile includes wealthy individuals, governmental investment arms and institutional investors, with a minimum entry investment of several million dollars. “Private equity fits better to local investor schemes, since they are more ownership-oriented than hedge funds which are more trade-oriented. Various aspects such as the stock market boom until last year, the progress of globalisation and privatisation and, most of all, the soaring oil price that created tremendous liquidity increased the need for more diverse investment vehicles in the Middle East,” says Saad. The high private liquidity, in the MENA in excess of US$2.3 trillion with some US$1.5 trillion of those within the GCC, combined with the repatriation of Arab money into the region has made private equity an attractive investment vehicle. Last year, a staggering 41 per cent of the total of the US$5.8 billion of private equity funds that have been raised in the MENA between 1994 and 2005 has been invested. A report of the Global Investment House suggests that the private equity industry will break the US$10 billion barrier in fund raising by 2007. Another aspect is clearly the need to invest into a relatively stable class without being affected by short-time economical instability or hostile political climate. “Many investors have been harassed abroad and now look to find opportunities in the region,” says Saad. He underlines, however, that “most sophisticated investors will naturally continue their ventures in the US and Europe.” Besides the Middle Eastern funds, more and more foreign investors are keen to tap into the lucrative gulf market, since, as most emerging markets, the Arab region has a higher return potential than industrial countries where most markets are almost saturated. Saad warns that private equity is booming to an extent that there is almost too much money being raised. “It is very easy to raise funds in the GCC, the economy is booming, there are huge funds in the market which increase the risk potential due to their large size.” Private equity funds usually have a life span of around seven years, with the investment bonded in an organization for one to four years, depending on the performance and business climate. They usually encompass family businesses, international companies, organizations that are being privatized and expat-owned businesses. They can offer exit options, so-called buy-outs, or provide money and expertise for companies that aim to launch an IPO. Whereas private equity investments in industrial nations consist mainly of buy-outs, most investments in the region are now being used to provide cooperative governance and prepare companies to go public, according to Saad. Most promising sectors have traditionally been infrastructure, energy, real estate and hospitality in the gulf. Healthcare and education are further sectors with much growth potential. Private equity investment in the gulf generally offers minimum returns on investment of some 25%, compared to around 15% for hedge funds. Dubai International Capital (DIC), the investment arm of Dubai Holding that primarily focuses on private equity, has made headlines in its first year of operations with acquisitions such as the US$1 billion investment in Daimler Chrysler, making DIC the company’s third largest shareholder, or the US$1.5 billion acquisition of London’s Tussauds Group last year. The firm is now in the process of raising a US$500 million fund to invest in infrastructure opportunities across the MENA region in collaboration with HSBC bank. “The MENA region is highly conducive to private sector investment in infrastructure for several reasons,” explains Sameer Al Ansari, CEO of DIC. “We expect to see a strong drive for privatisation and project finance in the region and particularly interesting investment opportunities in the infrastructure sector such as in utilities, energy, transportation and public - private partnerships. Recent oversubscribed infrastructure-based IPOs demonstrate the rapidly growing regional appetite from both individual and institutional investors.” “Infrastructure expenditure over the next ten years in the MENA is estimated to be in excess of US$300 billion”, states David Hodgkinson, former CEO and Deputy Chairman of HSBC Bank Middle East. “Not only does this sector provide good returns, but it also has a low correlation with other asset classes which allows investors to reduce their portfolio risk and decrease the overall volatility of their returns.” He also argues that the MENA Infrastructure Fund will provide a unique opportunity for investors to gain exposure to a portfolio of assets that are otherwise difficult to access, concluding that “Underlying asset valuations are generally stable over the short-term while offering potential for strong long-term capital growth.” Whereas private equity used to suffer from a bad image in the 1980s, when the term was associated with hostile takeovers of struggling companies by big private equity firms with mostly borrowed money, the firms now are keen to support their funded companies to grow and to create value with so called “smart-cash”. The trend is backed by research conducted by the OECD (Organization for Economic Development and Cooperation) – it found that, when dealing with family businesses which partnered with private equity firms in Europe, two thirds of those companies outperformed their competition, increased their exposure to new markets by over 60 % and recorded an almost 50% increase in employment. Private equity firms today aim to empower the employees of the partnering company, offering incentives to the employees such as a stock option plan, Saad explains, “The involvement of a private equity firm in an organisation is highly beneficial for all parties involved, with their interests being aligned.” The private equity market is likely to continue to grow at strong rates for the next upcoming years, and will probably become more competitive since it is still under-performing regarding its potential. While the private equity trend is still in its infancy in the Middle East, Western markets are not just more developed – but, according to the figures, proven success stories. In the US, private equity has outperformed the stock market over the past 20 years, both in long term as well as in short term. During the past two decades the industry flourished to an extent that US private equity funds have grown from US$5 billion in 1980 to over US$800 billion in 2005. Average annual returns for private equity over the past 20 years have averaged 13% compared to 11.7% for the S&P 500. Private equity has also outperformed stocks over shorter, five and three-year frames with average annual returns in excess of 20% for the year that ended March 2005, according to data from the Cambridge Associates. In emerging markets, an estimated US$12-13 billion has been returned to investors to date in 2005 from funds investing in Asia, Latin America, Central and Eastern Europe, the Middle East and Africa. At this rate, the best is yet to come for private equity in the Gulf.||**||

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