Research report on PE ‘Buy-to-sell’ Strategy Vs. Owners’ ‘Hold On’ Tactic: An Investment ‘disconnect’ in MENA prepared by Growthgate Partners.
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Research report on investing in oilfield services produced and published by Growthgate Partners, the general manager of Growthgate Capital
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Following a period of contraction and consolidation, the private equity (Private Equity) industry in the MENA region is beginning to show signs of a recovery, both in terms of deal volume and size. The total number of investments increased from a low of 23 in 2009 to 48 in 2012 and 38 in 2013, with an increasing focus on non-cyclical sectors such as oil and gas services, healthcare, and education. However, with a large amount of “dry powder” in the hands of general partners (GPs), fundraising continues to be challenging. Part of Private Equity’s challenge has been the perception that Private Equity investors focus excessively on short-term cash flows, and have a negative effect on job creation and the long-term health of the companies they fund.
In this white paper, we seek to debunk some of the myths surrounding Private Equity, by reviewing how these firms have been able to add considerable value to portfolio companies and the broader economy. Drawing on evidence from a number of recent academic studies, in Part 1 of this paper we show how Private Equity funds globally have improved performance of target companies by reducing constraints for companies in need of external capital, focusing on investments in innovation, increasing capital expenditures, and instilling better corporate governance and operational practices including productivity boost and surge in employment.
In Part 2 of this paper, we track the evolution of the Private Equity asset class in the MENA region. Through extensive interviews with a cross-section of limited partners (LPs), GPs, advisors, and portfolio companies, we highlight some of the unique constraints faced by Private Equity firms in the region: the existence of large family offices that compete for deals, the difficulty of sourcing proprietary deals, the lack of management talent, and the challenging regulatory environment. To overcome these challenges and succeed in the region, Private Equity firms need to innovate in their funding model, market their expertise and capabilities more effectively, be creative in terms of deal sourcing, and most importantly focus on improving portfolio company operations and governance.
In Part 3, we review Growthgate Capital’s investment in Roots Group Arabia, which we believe can serve as an effective template for how a Private Equity firm can invest and create value in the region. With the help of Growthgate Capital, Roots Group Arabia has successfully transitioned from being a regional wholesale distribution company to a global, vertically integrated construction company. Through a minority investment model, Growthgate Capital has been able to add considerable value in terms of financial expertise and advice, bringing in best-in-class corporate governance practices and sourcing management talent to scale the company.
We believe that long-term secular macroeconomic trends such as GDP growth and favorable demographics, coupled with company-level factors such as the need for patient external capital for growth, will drive the growth of Private Equity in the MENA region. Evidence from Private Equity investments globally and some early examples in the region show that Private Equity firms have considerable ability to add value, provided they pursue the right investment model and engage with portfolio companies effectively.
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Report on investing in premium and luxury brands, prepared by Growthgate Partners on behalf of Growthgate Capital.
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This research report has been prepared by Growthgate Partners on behalf of Growthgate Capital and addresses the key issues and critical levers that impact the Private Equity industry in the MENA region.
To read full report – see below PDF
An increasing attention has been given to corporate governance in the past decade as scandals have exposed grave governance issues within companies. These concerns were exacerbated during the 2008 crisis which exposed weak controls at many firms. While there were multiple causes to the scandals, the lack of efficient corporate governance was pointed out as a key issue, Enron and WorldCom being perfect examples (ultimately leading to the adoption of the Sarbanes-Oxley Act of 2002 in the United States, a sweeping corporate governance regulation). Citi’s ineffective handling of their mortgage-related holdings during the 2008 crisis is yet another example of lack of efficient corporate governance. As described in a New York Times article1, Citi’s CEO discovered in 2007 that his bank owned about $43 billion in mortgage-related assets and when he asked the head of trading if everything was ok, he took his positive answer as a definitive one. However, “normally, a big bank would never allow the word of just one executive to carry so much weight. Instead, it would have its risk managers aggressively look over any shoulder and guard against trading or lending excesses. But many Citigroup insiders say the bank’s risk managers never investigated deeply enough.” Citi lost more than $65 billion in the financial crisis, more than half of that stemming from mortgage-related securities. A report by the “Federal Reserve took the bank to task for poor oversight and risk controls in a report it sent to Citigroup.” Had Citi had efficient governance systems and processes, they would have probably seen the red flags and potentially cut their losses.
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Private equity (Private Equity) industry in the MENA region enjoyed significant growth between 2002 and 2008. However, the collapse of global financial markets catalyzed a fundamental shift in the industry. According to many industry experts, the pre-crisis playbook for generating private equity returns in the region was to focus more on industry growth dynamics than the company-specific fundamentals. This strategy of multiple arbitrage was especially popular, given that leverage was never widely available for transactions in the region. Therefore, after the financial crisis and the corresponding collapse of trading multiples, company-specific operational value creation (OVC) remains the major remaining tool to generate returns.
With this context, our white paper attempts to understand how the MENA private equity model is evolving to this new world order, particularly regarding OVC. Unfortunately, academic and industry literature on the private equity industry in the region is limited. Furthermore, there have not been enough exits in the region to assess the success of new strategies and business models that have been implemented by Private Equity funds. Therefore, we have conducted a survey and qualitative interviews with General Partners (GPs), Limited Partners (LPs) and portfolio company management to identify the major themes in the industry’s evolution as a reaction to the growing importance of OVC (see Methodology in Appendix).
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Growthgate Partners (GP)–acting on behalf of Growthgate Capital Corp. (Growthgate)- has a long-standing commitment to developing the private equity (Private Equity) asset class in the MENA region with an emphasis on the GCC markets.
We follow a dedicated ‘buy & build’ strategy that invests in companies of the middle market segment that are principally located in the GCC markets, thus offering an attractive investment opportunity to other investors.
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The Private Equity industry in the MENA region is still in its infancy. Substantial investments only began in 2005, and growth was cut short by the global economic downturn. One of the key difficulties that the industry currently faces is the availability of exit opportunities. Over the past few years, IPOs and trade sales have accounted for the vast majority of exits. Given that the public markets have yet to fully recover, most of the recent exit activity has taken the form of trade sales. Going forward, we believe that imminent exchange and regulatory reform has the potential to boost public market activity and re-introduce IPOs as a prominent exit channel. While rising political tensions may deter foreign investors from participating in the MENA growth story, the increasing professionalization of family businesses should lead to more trade sale exit opportunities. Secondary buyouts and management buyouts (“MBOs”), on the other hand, are not likely to capture a large share of exits in the near-term, although some growth is expected. Based on these trends, we believe that governments should take an active role in consolidating exchanges and introducing regulatory changes to attract more institutional and foreign investors. In addition, Private Equity firms should focus more on operational change in portfolio companies and educate family businesses on the value that Private Equity brings to the table.
Private equity (Private Equity) investors worldwide have been rattled by the consequences of the global financial crisis. This has certainly been true of the Middle East and North Africa (MENA) region, where a Private Equity market of limited maturity has taken a significant hit in fundraising and seen its peculiar investment landscape change in different ways: from longer investment holding periods to government reforms that could pave the way for larger deal sizes in the long-term than the existing mid-cap market has to offer. Although the regulatory landscape remains somewhat restrictive, and government control over certain industries quite strict, the MENA Private Equity market has historically thrived in the middle market space and is expected to continue to do so as it exits the recession.
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