Gulf private equity firms switch from buyouts to lending

Asa Fitch

• Last Updated: October 18. 2009 4:57PM UAE / October 18. 2009 12:57PM GMT

Private equity firms are shifting their focus to providing the capital to help companies grow, notably in the Gulf, as financing for the headline-grabbing buyouts of recent years dries up.

“Some firms were riding the credit bubble and not thinking about creating value,” says Antoine Drean, the chairman and chief executive of Triago, a French private equity firm that does business in the region. “Now that credit bubble is gone.”

Only two years ago, loans to buy stakes in private companies were easy to get. When the financial crisis struck last year, however, all kinds of financial firms suddenly found themselves unable to raise cash for deals. The bank loan market imploded and investors started to shun the high-yield bonds that were once a cornerstone of buyout financing.

Meanwhile, direct investors in buyout funds grew scarcer, making it harder for private equity firms to raise capital.

For buyout firms globally, this brought deal making to a halt.

“Deal volume jumped 30-fold between 1995 and 2007,” says David Rubenstein, the co-founder and managing director of the Carlyle Group, one of the largest private equity firms in the world.

“And then all of a sudden things stopped.”

The same story played out in the Middle East. More than US$3 billion (Dh11.01bn) of deals were done in the region in 2007, but the total fell to just $500 million last year. Only a handful of deals have been reported so far this year.

This titanic shift has triggered a new era of intense reassessment for private equity firms, many of which are re-examining their business models and formulating strategies to adapt to new economic realities.

Even the term “private equity” is itself passe, some commentators say, and ought to be replaced. The suggestions are “change capital” or “value-added equity” to reflect the shift from buyouts to providing money and management expertise to help businesses grow.

While a response to the new financial realities, this shift is bringing the industry back to its roots of making money by helping small businesses grow into large, efficient firms.

So instead of booking easy returns by flipping stakes in companies, private equity firms will hold stakes longer and work intensively to improve the companies in their portfolios.

“I think there will be a far greater emphasis on that,” Mr Rubenstein says. “Many more private equity firms will add operational people to their talent pool and spend much more time working on a company post-investment.”

This growth capital model is also widely seen as a better fit for the Middle East, which is dominated by closely held family businesses that often do not want to give up control of their companies. The recent private equity model, which rewarded firms that accumulated assets and sold them quickly at a profit, is fundamentally unsuited to the region’s business community, many observers say.

Ammar Alkhudairy, the chief executive and managing director of Amwal AlKhaleej, a Saudi private equity group that started in 2005, says he had never been in the asset-accumulation game, partly because he did not see it as an apt model for the Gulf.

The firm now was reaping the rewards of having shunned buyouts and investing growth capital, he says.

“What has been our strategy and what continues to be our strategy in the next months is what we should be doing in the first place, which is creating value,” he says.

“We were not created to accumulate assets and live off the 2 per cent. We were created to leave a lot of wealth for our children, and people seem to have forgotten that.

“We did nothing but private equity, we did one fund at a time, and we never got into the asset accumulation business like a lot of other people.”

The region’s cultural aversion to buyouts has historically been a bugbear for global private equity firms seeking to do deals in the Gulf. While many of the largest international firms have a presence in the region – Carlyle Group came in 2007, Kohlberg Kravis Roberts came this year and the Blackstone Group plans to open a regional office in the near future – they have been somewhat stymied by their lack of a history in the region and their adherence to western ways of doing business.

Many family businesses also do not have a huge need for capital from private equity firms, given their large market shares and healthy revenues in a region where oil revenues drive economic activity.

Still, many global firms are eager to tap into family conglomerates, perhaps by buying stakes in subsidiaries that families no longer want or taking over businesses during generational control shifts.

They are also increasingly open to bringing growth capital to the table instead of looking for control.

But getting in has proven difficult.

“The first question is can you work with a standardised franchise model, put a local team in place and then assume you can become a global player in the private equity field?” says Luc Nijs, an academic and the founder and chief executive of the Talitha Group, an investment bank that does private equity work in emerging markets.

“The question there really is ‘can you develop a corporate model for private equity that can be global and still be localised enough to tap into the opportunities that a certain region has’?”

That question remains an open one, and will probably be key to the fate of private equity in the Gulf, at least for international firms. Many global firms are shifting focus to minority stakes and growth capital when they look for investments in the Gulf.

Some are also looking to help local companies by giving them the expertise and money they need to expand internationally.

“It will be somewhat difficult to deploy large amounts of private equity in the region given the [oil-based] surplus nature of the region,” says Stephen Schwarzman, the co-founder and chief executive of the Blackstone Group, the world’s largest private equity firm.

“That does not mean that there won’t be some opportunities, and particularly there may be opportunities to invest with companies in the region that want to expand outside.”

As growth capital supplants buyouts in the region, many experts also expect to see a proliferation of smaller deals and purchases of minority stakes, given the new constraints on financing.

Those constraints may also mean future deals will be financed in large part with cash instead of loans.

They may also put local firms on a much more even keel with their international counterparts thanks to the relative availability of investment money in the region and the eagerness with which sovereign wealth funds such as the Abu Dhabi Investment Authority, which is estimated to have more than $300bn in assets, want to reinvest oil revenues locally.

“The debt markets haven’t opened up sufficiently to permit previous levels of activity, particularly for higher-value deals”, says Kuljit Ghata-Aura, a partner at Eversheds, an international law firm with an office in Abu Dhabi.

“We are seeing more interest in deals focused on specific sectors, such as education and health care, and smaller deals where the equity component is higher.”



afitch@thenational.ae