Since the beginning of the financial crisis, private equity funds in the Middle East have had to contend with a dilemma of largesse. According to a study during the downturn from Wharton and Amwal AlKhaleej, a Saudi-based private equity firm, by the time the crisis hit the local market, there were 100 regional funds with US$19.5 billion of capital to invest. But during 2008, only about US$2.7 billion of deals were made, noted the Gulf Venture Capital Association (GVCA), a Bahrain-based non-profit. In 2009, the value of deals fell to US$561 million.
The lack of investments was felt by the funds. A report from the GVCA said the total value of funds raised in the Middle East and North Africa (MENA) region in 2009 plummeted 80% to US$1.1 billion from US$5.4 billion a year earlier. And excess remains. As a July report by INSEAD and Booz & Company about the region’s paucity of deals asked: How to spend US$11 billion?
With hindsight, uncertainty was the main reason why few deals were done, says Purshotam Ramchandani, a principal at Dubai-based Abraaj Capital, one of the Middle East’s largest private equity firms with around US$6 billion of assets under management. Since joining Abraaj six years ago, Ramchandani has been helping the firm launch new funds and set up offices in Saudi Arabia.
Fundraising continues and Abraaj is making deals, Ramchandani says. For the first time in a long while, he senses optimism in the market. Ramchandani recently spoke to Arabic Knowledge at Wharton about what happened to the Middle East’s private equity market during the financial crisis, what strategies Abraaj Capital is taking as a result and the market outlook for Middle Eastern private equity in 2011.
An edited transcript of the conversation follows.
Arabic Knowledge at Wharton: What investments are you looking at right now?
Purshotam Ramchandani: We are working hard on two deals that we hope to conclude before the end of the year. Both of them are regional firms, financial services and technology. We are fortunate, as deal activity has finally started to pick up after a lull. Our pipeline is currently quite healthy. In general, we look to make "control-themed" investment, which allows us to influence how a company is run in a positive manner or take control of it in case things are going wrong.
We do not like to take passive minority stakes and wait for exits to happen to collect our returns. We are generally sector agnostic, but we have identified certain sectors that we think will be the biggest beneficiaries of what’s happening in the macroeconomic landscape: health care, education, infrastructure, consumer [goods and services], financial services, logistics and transportation [and] food.
Arabic Knowledge at Wharton: What was the reason for the lack of deals in the last two years?
Ramchandani: There was a lot of hesitation among both buyers and sellers to consummate a transaction because there was a lot of uncertainty in general, and no one really knew how the dust would settle. The malaise and opacity continued throughout 2009. That started to change earlier this year, and we also started to see a slight adjustment in the valuation expectations of [sellers]. This region, contrary to what people may think, didn’t really have a lot of distress, because there wasn’t too much leverage in the system — with certain exceptions — compared with the West. So you didn’t see companies [struggling] under the pressure of debt and looking to raise equity as such. However, capital is scarce and companies have realized that they can’t defer capital expansion plans forever, and with the continued constraints in the credit environment, private equity can be a good source of capital for firms looking for growth equity.
Arabic Knowledge at Wharton: How much fundraising is Abraaj seeking now?
Ramchandani: We are in the process of raising US$2 billion for the Abraaj Buyout Fund IV (ABOF IV). We had a successful first close some time back, and we raised substantially more than US$1 billion. We plan to close the fundraising at the end of the year with a target of US$2 billion. We are also working on the first close for ASAS, our Sharia-compliant real estate fund, with a target size of between US$250 million and US$500 million, and we are also fundraising for Riyada Enterprise Development — our small and midsized business investment initiative — which has a target size of US$500 million.
ASAS, Riyada and ABOF IV have completely different investment mandates. ABOF IV looks at control-themed, large transactions, with an average "sweet spot" equity ticket size of anywhere between US$100 million and US$200 million. Riyada looks at growth capital transactions (minority stakes) with an average "sweet spot" equity ticket size of anywhere between US$5 million and US$10 million. ASAS, on the other hand, looks at acquiring income-generating real estate in defensive sectors, with a focus on generating periodic income.
Arabic Knowledge at Wharton: ABOF IV’s initial target size was cut from US$4 billion to US$2 billion. Will Abraaj reduce or cancel any funds?
Ramchandani: No. The target fund size is a function of the investment opportunity and appetite. Our first fund was a US$116 million fund, the second was a US$500 million fund and we launched ABOF IV after successfully deploying our third, the Infrastructure and Growth Capital Fund (IGCF), which was capitalized at US$2 billion. And alongside IGCF, we deployed US$600 million of co-investor capital. So the initial targeted size of ABOF IV was in line with the investment opportunities — with many deals requiring equity tickets of US$300 million to US$500 million, some even higher — and investment appetite.
Historically, there had been a significant rise in the number of transactions we were looking at and an increase in average deal size. This was why fund sizes grew in general for most firms in the industry. If the deal flow is there to support them, you will see large fund sizes coming into play.
Arabic Knowledge at Wharton: Is Abraaj planning any exits from investments?
Ramchandani: Yes. We are constantly looking for exit opportunities for investments that achieve our business plan. There is a good mix of size and types of assets in our portfolio right now and for many of the investments in our older funds — such as 2003 and 2005 — we are looking for appropriate exit opportunities. In the next 12 months or so, we should see exits from those funds. We have been fortunate to have had exits using a variety of routes — trade sales, IPOs, management buyouts and secondary transactions. However, so far the majority of exits have been through trade sales, and that is going to be true going forward.
Arabic Knowledge at Wharton: How has the global financial crisis changed Abraaj’s strategy and outlook?
Ramchandani: Our investment philosophy hasn’t changed much since inception. We look for control-themed stakes in defensive yet growth-oriented industries. Eventually, it’s the investors who enable and validate our investment strategy. But one thing that we will try to avoid is making investments in highly cyclical industries. While a significant majority of our investments performed extremely well over the past couple of years, certain investments — accounting for less than 2% of capital deployed — in leisure yacht manufacturing and the distribution space didn’t perform as well.
Arabic Knowledge at Wharton: What is the outlook for the Middle East’s private equity industry in 2011?
Ramchandani: We haven’t deployed a single dollar in a new transaction over the last two years or so because seller expectations had not adjusted to the new economic reality and because there was limited certainty on the macroeconomic environment in general. Things started looking much better from first half of 2010 compared with the previous two years.
Not only Abraaj, but also the industry will see more people closing transactions in 2011. We are looking at a pretty significant pipeline and the opportunity to deploy several billion dollars of capital in the next few years…. Over the next 12 months, you will also start to see a good amount of exits. In the industry as a whole, a lot of players have deployed a considerable amount of capital in the past, but haven’t exited those investments — and the investors are going to start asking for the returns. We have been fortunate to have exited a decent number of companies over the last eight years and demonstrated a full cycle of raising, deploying and returning capital. We have returned about US$3 billion to our investors and stakeholders.
