Middle Eastern oil producing nations seem to have learned their lessons about how to invest surplus cash in an oil boom. In the 1973 to 1976 boom, 60% of the increase in OPEC’s export revenues was spent on imports of goods and services. In 1978-1981 that proportion rose to 75%. But only 40% of the windfall created in the current oil boom has been spent, according to IMF estimates.
These figures would imply that OPEC nations are saving but figures from the Bank of International Settlements, which tracks worldwide deposits, show that, in 2002 and 2003, OPEC deposits actually fell. Since that time, they have increased but only modestly, whereas Russian bank deposits rose sharply from US$73bn in 2003 to US$161bn by the end of 2005. A large chunk of Middle Eastern money is not held as official reserves, but as foreign investment by government oil stabilization and investment funds and by national oil companies. But official reserves of Middle East oil exporters only rose by US$70bn in 2005, accounting for less than 30% of the surplus. From January 2005 to August 2005, OPEC members holdings of US government securities, according to the Treasury Department’s data, fell from US$67bn to US$54bn.
So where is all this money going? For a while it was going into private equity funds abroad. Remember in January 2005, when Dubai International Capital took a US$1bn stake in DaimlerChrysler or in March 2005 when it bought the Tussauds Group.
But of late it seems that Middle Eastern investors are keen to keep their money closer to home and there is plenty of it in the Middle East: the estimated investible net worth is US$1.5trn to US$2trn. Whether this change in investor mindset is prompted by the increased investment transparency required after September 11, 2001 or by opportunities for growth in the region at the moment, Middle Eastern-based private equity managers are benefiting. Last year the US$500m buyout fund by Abraaj Capital, one of the leading private equity firms in the region, was considered large. Abraaj Capital’s latest offering tops US$2bn, allowing the firm to join leaders such as Commercialbank, Dubai Islamic Bank/Dubai Ports World, Gulf One, and Global Investment House in offering billion dollar-plus funds. In the first half of 2006, 31 private equity funds are already on the road seeking US$18.2bn, compared to a total of US$5.8bn raised in the Middle East-North Africa (MENA) countries between 1994 and 2005. Rod Palmer, managing partner of Walkers in Dubai, says: “The Gulf Cooperation Council (GCC) region seems to be ahead of the curve in a major trend of more rapid fundraising, with funds being fully drawn down after 18 months instead of five years. This allows managers to quickly establish follow-up funds, often much larger than the original.”
The increased size of funds in the Middle East mirrors recent developments in the U.S., where US$6bn is no longer considered a very large fund and multi-partner, multi-billion dollar funds are increasingly common. Palmer adds: “A confluence of factors in the region such as high oil prices, the real estate boom, a marked increase in infrastructure development and privatizations – as well as the stellar returns for PE from the IPO market over a short history – could lead to a tripling of the size of the region’s private equity industry over the next five years.”
Palmer may be right as some of the regions largest banks and government authorities are moving into private equity investing. The National Bank of Kuwait, set up NBK Capital in July 2005. One of NBK Capital’s main lines of business across MENA and the GCC is private equity and venture capital. The NBK Capital Private Equity Fund was launched in the second quarter of this year and aims for assets of US$300m. George Nasra, the CEO of NBK Capital, says in the Middle Eastern Economic Survey that ‘If done properly, we can take a small or medium sized company and grow it so it can be listed or targeted for acquisition by a larger company’. Despite the inevitable market crash of Dubai’s fledgling exchange in the spring, from which it is now recovering, it is still a liquid stock exchange serving the Middle East.
Other regional banks moving into the private equity space include Gulf One Investment bank in Bahrain and First Energy Bank, also headquartered in Bahrain. First Energy will target private equity investments in energy, hence the name, and is looking for a capitlisation of US$1.5bn.
Several regional banks and government authorities are partnering with foreign private equity firms on large projects. For example, Millennium Finance Corp has been chosen to manage a US$5bn family of funds for Dubai Islamic Bank but full details have yet to be revealed. The Saudi Arabian General Investment Authority (SAGIA) and Geneva-based private equity firm, Swicorp, are expecting assets of US$5bn for their joint venture investing in energy sector projects.
Local Middle Eastern private equity firms are also partnering with foreign private equity firms, such as, Dubai International Capital and HSBC, which have recently launched a US$500m MENA Infrastructure fund. Abraaj Capital is also working with Deutsche Bank and Ithmaar Bank to launch a Shari’ah-compliant alternative assets fund.
The coupling with foreign partners has forced Middle Eastern private equity funds to use more sophisticated structuring. “A few years ago the market was dominated by ijara-structured funds, which use leasing strategies targeting assets in the U.S. and Europe. Political concerns and changing yields saw a period of concentration on the GCC markets, but now we are seeing a new and growing trend for investment in other MENA economies, as those countries embark on the process of deregulation. We expect to see a significant growth in the number of funds investing in Pakistan and India. But local institutions play to their strengths. Only a few high-profile funds are going for global deals at present,” says Robert Varley, a Walkers’ partner based in Dubai.
So why has private equity become so popular in the Middle East? Under Shari’ah law, it is frowned upon to make money from money. Therefore, Middle Eastern investors enjoy owning physical assets, whether they are factories, industrial sites or real estate. For the Shari’ah observant investor, the private equity partnership is about the most illiquid security available so it fits well with current investment practices.
Until the mid-90’s the Middle East was second only to the US as the largest source of capital for private equity funds. Middle Eastern governments have also been significant investors into private equity. Though in the 1978 to 1981 oil price boom, when 75% of the surplus was spent on goods and services, many of those services were from foreign builders to put up ego-driven construction projects that did not actually create jobs or economic growth for the region. This time around Middle Eastern Governments seem to be investing in the oil and energy infrastructure of their countries which will benefit the general populations and provide continued, stable growth for decades.