Middle East private equity looks forward

April 2013 | SPOTLIGHT | PRIVATE EQUITY

Financier Worldwide Magazine

Rewind to 2005 and ‘private equity’ was a buzzword in the UAE. The stars were aligned. There was global liquidity. Regional fund managers were lining up potential investments in the region in all sectors. With the introduction of the Dubai International Financial Centre (DIFC) and the Dubai Financial Services Authority, the Dubai government had made significant headway in providing a legal and regulatory framework in which foreign investors could have confidence. The establishment of a regional equity capital market, the DIFX (which has subsequently been renamed NASDAQ Dubai), by the DIFC completed the framework to nurture a growing private equity industry in the region.

Raising capital was relatively easy. Funds were established in a wide range of industry sectors, including infrastructure, energy, real estate and healthcare. Some investors were so confident about the region’s prospects that they would invest in ‘blind pool’ funds. The fund terms offered by fund managers/GPs were generally accepted by investors with few concessions.

2008 – grey skies

The global financial crisis did not hit the Middle East immediately and, initially, industry participants thought that they might withstand the shockwaves from the breakdown in the global financial system. Banks in the region were less exposed to the US subprime mortgage lending that had precipitated the crisis. Private equity investments in the region were not highly leveraged and oil and gas revenues were strong.

The financial crisis was certainly slower to reach the Middle East but it did hit the region, and it hit hard. Obtaining finance became a lot more difficult. Property prices in the UAE collapsed. Tourism fell and growth stalled. Now regional fund managers/GPs had a whole new set of issues to deal with.

An immediate concern was whether LPs would be able to deliver on their commitments. This needed to be addressed early – no GP wants to invoke the default provisions under a limited partnership agreement. Transfers of partnership interests have been a common theme since the economic downturn and this has generally been the way in which the liquidity issues of LPs have been addressed.

Other issues were as follows. Would they now be able to deploy LPs’ remaining commitments (were the fund’s investment objectives too narrow)? Could they still meet their anticipated returns? How would they exit investments? Would they need longer to exit? Would they need to extend the term of the fund? Did they want to raise new funds? If they did, would they be able to do so and invest in what?

The new reality

There were no easy answers to any of the questions above and fund managers/GPs continue to grapple with these issues. Where the investor base for a fund has been smaller, fund managers/GPs have been able to discuss, with the investors, amendments to fund terms (for example, to extend an investment period or a fund term or to amend the fund’s investment objectives) to try and alleviate some of the problems.

A common reaction by fund managers/GPs to this change in the economic climate has been to focus attention on existing portfolio companies to drive growth. The lack of anticipated exit routes and regional political instability mean that an exit might be much further away than originally anticipated.

The number of potential targets in the Middle East & North Africa (MENA) is still strong but because LP’s appetite for investment through a fund structure has diminished, fund managers/GPs have had to adapt their strategies accordingly.

Abraaj Capital is an interesting example. It recognised early on that it could bridge the finance gap that small and medium sized enterprises (SMEs) were suffering. It invested in country teams to identify the best investment opportunities and it developed a strategy to target LPs with a mandate to invest in the type of investments they were focused on in MENA, i.e., government development finance institutions such as the Overseas Private Investment Corporation and the European Investment Bank.

Other industry participants recognised that LPs with cash to invest do not want to take the credit risk of other investors with whom they have no connection. LPs now want to team up in small groups or co-invest with funds.

The industry participants that we are seeing active in the market are regional development finance institutions sponsoring energy and infrastructure development mandates, or banks pursuing an investment mandate that offers more than management fees and carry, for example, advisory fees or finance opportunities.

If you are an LP, your negotiating hand will never have been stronger, especially if you are an anchor investor. Cash is king and fund managers are being required to make all manner of concessions to obtain it. LPs have much tighter control over fees. They may restrict what additional fees a manager can earn over and above a management fee, and may even be able to link the amount of management fee to achieving targets for the deployment of capital during the investment period. LPs may be able to negotiate an opt-out of particular investments. They may also be able to shift the burden of costs for unconsummated deals on the fund manager.

The lack of liquidity following the global financial crisis has dramatically shifted power to LPs in the new private equity landscape, and the strategy of fund managers/GPs in the region is being led by LPs’ agendas and on LPs’ terms.

Jane Clayton is a partner at Norton Rose (Middle East) LLP. She can be contacted on +971 (0)4 369 6312 or by email: jane.clayton@nortonrose.com.

Jane Clayton

Norton Rose (Middle East) LLP