Arindam Banerjee, Assistant Professor of Finance at S P Jain School of Global Management provides a holistic view of the UAE’s private equity market.
The 1970s witnessed a series of developments in the GCC states with the peaking of oil prices mainly resulting from the twin price shocks in 1973 (oil embargo) and 1979-1980 (Iranian revolution). The excess wealth contributed positively to the growth of both physical infrastructure and social services in the region. This increasing wealth led to more private investment.
The GCC private investment scenario can be broadly studied in cycles (waves). The first wave comprised of the years dominated by the unorganised market of private investors and wealthy families, dating back from 1970 and continuing until 2005. Post-2005 can be considered as the second wave that witnessed the sudden surge in private equity fundraising and growth in increased deal making. The buoyancy in the market came to a halt with the coming of the financial crises in 2008/2009. The third wave typically can be categorised as 2010 and beyond that witnessed significant turmoil in the region with its epicentre in the Arab spring starting December 2010.
The past few years
Of late, many countries around the Middle East have diversified their economies beyond oil production. This has been as a result of regional construction boom, increased tourism and an uptick in Western-style consumerism and as a result private equity has found a home in the region’s various sectors, such as the food and beverage (F&B), education and healthcare sectors.
But at the same time, it’s not all been a smooth sailing for the industry. Low oil prices and market fluctuations led to decline in regional M&A transactions activities in 2016 as well as less deal flow in PE in some sectors. However, F&B along with health care and education continued to be the favoured sectors for both M&A and PE that maintained its momentum in the overall Middle East and North Africa (MENA). 2016 saw relatively weak private equity deal flows within the GCC and can be best described as a watershed year as demand and supply gap further narrowed promising well for more activity in 2017.
The first quarter of 2017 saw valuation expectations coming down, implying that there are good prospects for more and more attractive deal flow in 2017. In later part of 2017, it is expected that private equity activity in the Gulf will pick up significantly, both in terms of investments and potential exits.
With banking liquidity tightening, and the fact that the regional capital markets are not favourable to IPOs, business owners will possibly look towards private equity firms for growth capital or as a liquidity option to monetize their stakes in their businesses. It is to be noted that private equity in the GCC is increasingly being accepted as a serious alternative to bank financing, potential IPOs or trade sales.
In terms of investment opportunities in 2017, sectors that are fast-growing or defensive in the GCC such as food, FMCG, logistics, business services and consumer-led sectors will attract more capital.
Another area to focus would be the rapidly-growing ecommerce sector. After registering nearly 30 per cent growth in 2015, the region’s digital economy is set to double over the next three years, passing the $30 billion mark by 2018. E-commerce in the UAE and Saudi Arabia is expected to grow at an even faster pace over the next four years; at around 40 per cent.This will be primarily driven by young, tech-savvy population that will propel the GCC digital economy at a much faster pace than the traditional economy.
In terms of potential private equity exits, as oil prices recover, regional markets stabilise and investor sentiment becomes more bullish, more liquidity events over the next two years are expected. There would also be the rise of secondary transactions, where private equity firms sell portfolio companies to other private equity firms that will become an accepted exit route in 2017, similar to recent trends in Europe and the US.
With government and privates both lobbying for more SME investments, private debt and mezzanine financing will emerge as a serious, alternative financing option for SMEs in the region. Companies with low assets still find it difficult to obtain financing from the traditional banking market. Several PE firms are launching private debt fund to fill this market gap and to provide growth capital to promising companies. Private debt will increasingly supplement local lenders and provide much-needed growth capital to promising businesses in the region.
Overall, 2017 promises to be a productive year. While the last year was marked by a soft economic environment and low oil prices, it is expected the prospects for the GCC to recover in the coming year on the back of much-needed structural reforms, successful diversification drives and the recovery in oil prices.
For long-term investor, GCC will remain as one of the most appealing investment destinations and many PE firms will continue to increase their investment and real estate development activities in the region in 2017. Market volatility and lack of good returns on more liquid investments are making institutional investors look for locked-up investments. Additionally, new legislation is starting to remove obstacles to investment.
In the UAE, with the newly formed insolvency law coming into force there is now more clear guidelines and structures for commercial bankruptcy. The passing of this law gels well for the introduction of the long delayed UAE foreign investment law, which would allow 100 per cent ownership in key sectors. Local private equity firms and notable regional entrepreneurs have started investing in tech start-ups, attracting support from government entities such as Saudi Arabia’s Public Investment Fund—and piquing interest from outside investors. A new trend is that a number of PE firms will now also consider earlier-stage and venture capital type investments. Smartphone penetration is high and there is a lot of tech entrepreneurship in the region which—when compared to India or Asia—is meeting limited availability of VC funding.
The road ahead
Cautious optimism will be the theme for GCC private equity in 2017. Private equity in the region is expected to pick up as oil prices stabilise. Early stage venture-capital style deals with technology start-ups will attract international and local interest, boosting M&A activity in the region. This is also synonymous with many countries and cities in the region are aiming for economic diversification through development plans and national visions.
Dubai has implemented a grand Industrial Strategy 2030, with initiatives in F&B, pharmaceuticals & medical equipment, aluminium & fabricated metals, aerospace, maritime and machinery & equipment. Its recent investments in construction and tourism have caught the world’s attention. The destination can leverage its infrastructure and airports to serve the growing demand for food, specifically Halal products. Additionally, Dubai is strategically located to facilitate distribution throughout the region.
Saudi Arabia also has a vision for diversification with its National Transformation Plan, also to be implemented through 2030. Over the next four years the overall F&B market is projected to grow by 6.5 per cent annually. Some analysts consider the country’s growth opportunity as the country is underserved, from grocery outlets to foodservice locations. A major event likely to positively impact economic prospects in Saudi Arabia is the planned IPO for ARAMCO, considered the world’s highest valued company. It’s expected to yield a significant economic windfall for KSA, resulting to improved consumer optimism and spending.
Similarly, Qatar’s National Development Strategy provides an integrated agenda for policy formulation, as well as regulatory and institutional framework changes and implementable projects linked to overall national and sectoral outcomes.
In totality, many opportunities in the region remain. The GDP in the greater MENA region is expected to reach $2 trillion by 2020. The largest markets are KSA (at $902 billion) and UAE ($502 billion). As economies in the region diversify and household income levels rise, the several industries stands to benefit, especially in casual dining and fast food, education and healthcare where PE activity has been focused in recent years.
It is to be noted that the private equity business is becoming more difficult, and in recent times, firms have made only small gains in operating efficiency. By reviewing the lessons learned over the past few years, CFOs have recognised their prime objectives, empowering them to tackle the intricate demands facing their firms.
In the near future, both managers and investors will need to know what tools are required for private equity funds to steer the challenges which lie ahead in this uncertain global economic environment, and also look forward to continuing to offer insight and analysis across the broader asset management industry, including the private equity market.