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CAPITAL FLOWS INTO PRIVATE EQUITY FUNDS
BY GEOFFREY CRAIG
The worldwide growth of private equity has pushed
numbers into record territory. Last year, private equity funds pumped
more than $737 billion into the global mergers and acquisitions
(M&A) market, and raised a record $401 billion, with over 600
new funds created. This year promises even more impressive figures,
and financial experts anticipate a greater distribution of capital
as investors seeking better returns put their money in emerging
markets, including the Middle East and North Africa (MENA) region.
But what’s even more interesting is the palpable increase
in capital contributions from investors in the MENA region. The
Washington-based Emerging Markets Private Equity Association (EMPEA)
estimates that private equity fundraising in the MENA region totaled
$2.9 billion in 2006, a 54-percent increase over the previous year,
and a figure that jumps to $7 billion when real estate funds are
included.
There are currently more than 50 private equity firms based in the
region. In addition, some blue-chip firms have begun opening offices,
such as Carlyle, the US-based firm, which now has a Cairo office
to oversee investments in the region. Other big financial institutions
are creating funds to invest in the region, such as Citibank, which
last January unveiled plans for a new $200 million fund dedicated
to Africa.
From 1998 to September 2006, MENA-based private equity firms invested
$2.5 billion in the region, sinking 28 percent of this total, or
$683 million, into Egypt. Over 90 percent of this Egypt investment
came during the first nine months of 2006 – including the
$230 million acquisition of an 18.7-percent equity stake in Commercial
International Bank (CIB) by a consortium led by US-based Ripplewood
Holdings.
Analysts attribute this interest in Egypt to the size of its economy
and number of businesses relative to the other countries in the
region. “In the Gulf, you have the money, but where are the
businesses? Their markets are small, so they have to go out,”
says Khaled Abou-Zied, a former research analyst at ABN AMRO-Delta.
“In Egypt, you’ve got over 70 million people, a growing
economy and companies. The workforce may not be so well trained,
but that’s the next step. We have the companies, now let’s
train our workers. That’s why the flow is coming.”
At least six private equity firms currently operate in Egypt. EFG-Hermes,
the largest and oldest, launched its first fund in 1997 and now
manages eight funds worth $500 million with stakes in over 70 companies.
Other key players include Concord, Citadel Capital, Oasis Capital
and ABN AMRO-Delta.
Despite increasing fund sizes, there is not much precedent to measure
the profitability of these investments. In private equity, fund
managers take controlling stakes in companies, which they hold for
several years. During that time, they are supposed to lend their
expertise to steer the company, and, they hope, cash in at some
point through an exit. To date, however, exits within the MENA region
have been relatively thin. According to consulting firm KPMG, of
the entire $6.5 billion that has been invested both within and outside
the region since 1998, only 5 percent has been realized through
13 exits.
Safia Hachicha, a Tunis-based analyst at Swicorp, a corporate advisory
and private equity group, notes that the private equity industry
in the MENA region is still in its early stages of capital raising
and investing. “Given that approximately half of the aggregate
funds raised in the region are yet to be invested, it is still premature
to talk about exits at this stage,” she points out.
The nature of the Egyptian market also restricts investment in other
ways. In the US and Europe transactions are highly leveraged with
debt and firms often wait up to a decade until stock values rise
before selling the company. In Egypt, however, high interest rates
make leveraged buyouts more costly and restrictive capital market
regulations make some exit strategies, such as an initial public
offering (IPO), more difficult.
WHAT IS PRIVATE EQUITY
The nuts and bolts of a private equity deal are fairly straightforward.
Private equity firms buy equity stakes in companies, restructure
them, and then “exit.” The firms typically raise
capital for these investments by creating funds, which are
registered as limited liability companies or limited partnerships.
The private equity firm acts as a general partner, taking
a fee for managing the fund’s investments and a share
of the profits, while profits above a target rate of return
are distributed to the fund’s investors, mostly financial
institutions and wealthy individuals.
Profit is generated if the private equity firm is able to
improve the company’s performance, and sell it for a
higher price than it was bought for. Since the profit is realized
entirely at the end, the exit strategy is crucial. Most firms
aim to hold onto a company for five to seven years, but if
there is no mechanism for unloading the company, then the
firm and its investors have no profit.
One strategy when acquiring a public company is to delist
it from the stock exchange, manage it as a private firm, and
then re-list it in an initial public offering (IPO). Alternatively,
the fund manager may chose to sell the company to either a
strategic investor, back to the original owners, or to another
private equity firm. |
Instead, local private equity firms focus on selling their stakes
to strategic investors or even back to their original owners. Samer
Yassa, partner at EFG-Hermes, says that less than 20 percent of
the firm’s transactions have ended in IPOs during the past
five years. “We don’t rely on an IPO unless it’s
really an ‘IPO-able’ case. From our experiences, the
bulk of our exits are basically going to strategic investors.”
But one of the biggest obstacles facing fund managers is acquiring
a majority stake. As many businesses in Egypt are family-owned,
they are often reluctant to allow an outsider a controlling interest.
A minority stake is problematic, Abou-Zied points out, because the
firm does not have the same ability to influence the company. It
can also make the exit strategy more difficult when it comes time
to sell if potential investors are less interested in minority ownership.
At a minimum, managers usually insist on a seat on the board of
directors. “When you are on the board, you have a voice. You
can say, ‘I don’t like that,’ or ‘why don’t
we do this,’” he explains.
A private equity firm brings seasoned management to the table, and,
therefore, wants to use that expertise to influence the company’s
direction. It may also increase the firm’s capacity to restructure.
“If a company is overburdened with debt, the company official
knocks on the bank manager’s door for awhile, saying: ‘Please
restructure the debt.’ The banker will probably not agree,”
says Abou-Zied. “But if you have a former banker who now works
for a private equity firm, the banker will listen and sometimes
even agree to restructure the debt.”
Yassa can speak from experience. “One of the transactions
we did was a reconsolidation because the banks were charging ridiculous
amounts in fees and interest,” he says. “We went in
and negotiated with the banks and used our weight to bring down
the cost of the fund to market practices.”
Nonetheless, the fund managers must work with the existing management,
making due diligence a crucial step. “We get calls from many
people who say, ‘look at our company,’” says Abou-Zied.
“The idea is good, but you sit down with the guy and you don’t
trust him. You have to think to yourself: ‘How can I spend
the next four years with this company and with these people.’”
In that case, he says, the firm will not invest in the company.
The lack of a good exit strategy might temper the risk of fund managers
to stay away from ailing firms with the greatest need for management
restructuring, despite their exceptional potential for profitable
growth. Firms such as Concord International Investments prefer solid
performers with lower, but more assured, growth potential. “We
see a different type of opportunity,” says Mohamed Younes,
the company’s chairman. “We focus on acquiring companies
that have a good track record and are profitable, but might need
some capital to expand and develop.”
The buyout of Amoun Pharmaceuticals Company is a case in point.
Amoun was Egypt’s largest privately-owned drugmaker, with
a posted net profit of LE 155 million in 2005, up 190 percent from
the previous year. But with the company’s founder and owner,
66-year-old Sarwat Bassily, looking to retire knowing the company
was in good hands, the Bassily family agreed to sell its controlling
stake to a private equity consortium able to manage the company’s
development and expansion.
Concord was part of the international consortium that acquired a
93-percent stake in Amoun for $459 million last November –
one of the largest private equity transactions in Egyptian history.
But contrary to some expectations, Amoun’s new majority stakeholder
left the firm’s management intact. “We have no intention
of changing the management,” says Younes assuredly. “When
you have a very successful management that has taken the company’s
value from zero to $500 million in 10 years, what on earth do you
want to change? It would be suicide.”
Despite the surge in growth, private equity firms operating in Egypt
still operate in relative obscurity. While the names of Egyptian
private equity firms carry weight, what they do is more or less
a mystery to most investors. According to Yassa of EFG-Hermes, an
increasing number of people understand how private equity works,
but the vast majority do not even know what private equity companies
do. “They mix up our role with an investment bank [or] an
advisory service,” he says. “So you have to give a full
presentation each time.”
But the presentations appear to be paying off. Yassa points out
that while fund sizes have increased, fundraising time has decreased.
And when new funds open, investors are rushing to join.
FOCUS GROUPS
Is it time to diversify? Fund managers argue that the Middle
East market is still too small to target specific sectors.
With the exception of EFG-Hermes, which manages two $50 million
sector funds focused on technology and agribusiness respectively,
most funds invest across a range of industries.
For most fund managers, the key determinant in acquisition
strategy is solid fundamentals. “We look for good deals
and we don’t care about the industry,” says Mohamed
Younes, chairman of Concord International Investments. “If
the company is good and sound we’ll go into it. We don’t
predetermine sectors.” |
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