Is this the perfect time for GCC private equity and venture capital to scale up?
After the global financial crisis, private equity activity in the GCC declined tremendously. Fundraising became anaemic, despite the sizeable amount of dry powder accumulated over the boom years, and deals had stalled as acquisition finance became expensive and difficult to obtain. After a long hibernation, value raised under private equity experienced a quantum leap from US$900 million in 2013 to $2.4bn in 2014, but fell to $500m last year.
The recent entry of UAE and Qatar into the MSCI Emerging Markets index has led to many market reforms across the region aimed at improving disclosures and standardising corporate governance. But nascent legal and regulatory framework, with stringent foreign ownership restrictions, weak bankruptcy laws and high set-up costs, continue to dampen investor enthusiasm.
So what has changed in the recent past? Last year marked one of the worst years for oil prices and revenues – the backbone of most of the GCC economies. And the consensus forecast for the next two years indicates only a modest increase in prices, at less than $60 per barrel, a considerable fall from the high of $115 per barrel in June 2014.
Such a drastic drop in revenues has triggered a liquidity fall, affecting several sectors of the GCC, especially in banking and financial services industry.
Growth in deposits are lagging behind credit growth and this deficit is accentuated by falling government deposits and continued remittance outflows.
Government borrowing has also been on the rise, which crowds out the private sector and deprives them of credit facilities. S&P has already forecast that Saudi Arabia is expected to tap international debt markets by 2016-17, as the domestic banking system can lend only up to $100bn, which comprises only one-third of their borrowing needs.
In addition, the looming rate hikes from the Fed could increase cost of capital, which makes it more difficult for the private sector to access funds. The IPO market, which in 2014 had 14 new issues worth $9.7bn, including the listing of NCB, the largest IPO in the region, had a dull year last year, with fewer than five new issues.
Most companies are staying away from floating shares in the GCC markets, owing to the oil price volatility and weak global cues. This hurts small and medium-sized enterprises (SMEs) and start-ups, which were already facing stringent collateral requirements, including personal guarantees.
Banks are reserved about funding SMEs because of their limited size and higher risks as SMEs are more vulnerable to economic fluctuations. Larger corporations in the GCC also rely heavily on bank financing, as it allows them to be less transparent and maintain greater control over their operations. But this leads to crowding out of funds as SMEs compete directly for capital with large corporations. For example, in Kuwait, the percentage of total bank loans given to SMEs is as low as 2 per cent. Fewer options in terms of Sharia-compliant products also imply that many SMEs find themselves excluded from the banking sector.
The number of start-ups have also risen in recent years and require strategic guidance to expand during the early stages. It is in this setting of challenging economic situations coupled with growing number of start-ups that PE & VC funds cannot only provide the required capital but also leverage on their industry contacts to share their domain expertise, streamline operations and thus create value for these businesses.
For example, Saudi Arabia’s STC Ventures provided a $3m venture capital funding for Compareit4me.com, a Dubai- based finance comparison start-up, which is expanding into Saudi Arabia. STC would also facilitate expansion by getting local support, and access to untapped sectors.
Many major sectors in the GCC are set to grow in the coming years, as rising disposable incomes will inevitably lead to higher consumption of goods and services. Expanding retail businesses, from jewellery, beauty and cosmetics, clothing, supermarkets and restaurants are expected to intensify investor interest, with significant opportunities in online retail (general and discount) space, as mobile penetration continues to rise in the region.
Luxury retailing is already a thriving business in the GCC – propelled by affluent locals, splurging expatriates, growing brand-aware youthful population and deep-pocketed tourists. Rising public spending in education has been driven by the need to develop skills of a rapidly growing population in the GCC countries and offer considerable opportunities for PE players.
Similarly, health care has attracted a lot of investments in the PE space, as the need to tackle the effects of lifestyle issues and newly introduced mandatory insurance are driving industry growth. In the energy sector, GCC states have also started exploring alternative sources of energy including solar power, nuclear and natural gas to boost capacity and diversify the energy mix.
Governments are also focused on modernising their transport and infrastructure, in partnership with the private sector. The entry of PEs into the family businesses can help in the greater flow of ideas, realign focus on core assets and competency, and can generate lead to better sustainability.
Private equity funds could fill the existing funding gap and take advantage of the growing regional economy.
M R Raghu is the managing director of Marmore Mena Intelligence, a research house focused on conducting Mena-specific business, economic and capital market research