Middle East looks west

There has been much talk in recent years about the repatriation of Middle Eastern money from US investments, due partly to fears by Arab investors of the seizure of assets under the US Patriot Act. But other factors, such as the mediocre performance of North American equities compared with the Middle East’s booming stock markets and real estate sector, are also likely to have played a part in the capital flows.

But how have these issues impacted on Middle Eastern interest in European buyout funds and private equity investments?

First, it’s very difficult to say to what extent there has been repatriation of Middle Eastern funds from the US and whether such capital flows have been due to the US becoming less attractive as an investment destination or the Middle East becoming more attractive. It is clear, however, that with soaring oil prices and heated stock markets in the region, Middle Eastern investors have huge sums at their disposal.

“They’re outrageously cash-rich right now and looking to diversify their investments into, among others, European buyouts,” says one observer.

Claude Angéloz, a partner at alternative asset management firm Partners Group, says he has been seeing increasing levels of investment from the region, but that more investment has also been going into Gulf States’ stock markets or in real estate developments in Dubai, Qatar and Bahrain.

One placement agent, who asked not to be named, says: “Some investors are saying to me: ‘Why should I invest in private equity when I can make massive returns in my home country?’ But the longer-standing private equity investors are still interested in Europe.”

These investors tend to be high net worth individuals and families, and quasi-government investment agencies, such as Dubai International Capital, Abu Dhabi Investment Authority and Kuwaiti Investment Authority. Often the agencies are actually the investment arms of governing families, with Dubai International Capital, for example, effectively representing Dubai’s royal family.

According to Mounir (Moose) Guen, chief executive of adviser MVision, the current interest of Middle Eastern investors in European private equity is cyclical. He notes that along with the Japanese banks, Middle Eastern investors were among the first to invest in private equity in the US and Europe in the 1980s and early 1990s.

Following the dotcom crash, many of these investors scaled down their activity but thanks to the current high liquidity, are now back in the market and taking stakes in European companies.

However, Guen says he is unaware of any favouring of Europe vis-à-vis the US. In fact, he says, many Middle Eastern investors have closer ties to the US because they were educated there and so have built up links with GPs in North America.

There are other challenges for Europe when it comes to attracting Middle Eastern money. One is that Middle Eastern economies are generally linked to the US dollar. This can make Europe less attractive because of currency exposure fears and Angéloz points to the substantial appreciation of the euro against the dollar in 2003 and 2004 as a factor that might have deterred some Middle Eastern investors from Europe.

There is also the attraction of Asian private equity, he says. The Middle East has close links to parts of Asia and the under-investment there combined with very high growth rates make it attractive.

“Having said all that, there are some very good reasons to invest in Europe, such as the restructuring that is going on and the fact that there are still a lot of good buyout opportunities,” says Angéloz.

There is also the fact that the bullish Middle Eastern stock markets have been relatively flat so far this year, and there is a widespread belief that they have overheated. Continued flat markets there could release more funds for overseas private equity.

In terms of the kind of funds that Middle Eastern investors prefer, according to one adviser they tend to be pan-European rather than country-specific and while some investors are looking to the very large buyout funds, a large proportion prefer mid-market funds for diversification reasons.

“They like brand names and established funds, generally in the €400m–€500m to €1bn–€1.5bn range,” says one adviser.

A London-based private equity executive working for one of the biggest Middle Eastern funds, who asks not to be named, says: “We invest across the board in Europe, ranging from the very large funds to country and regional funds, such as those covering Scandinavia or the Benelux region.”

He adds that the fund is UK-biased but that is simply a reflection of the relative importance of the UK market in European private equity. He notes that funds generally have got bigger and that what would have been regarded as a large fund a few years ago is now seen as mid-market.

He says: “We do still invest in large funds but now that they’re often working together on mega-deals you can find that you’re represented twice on the same deal, which means additional risk.”

The executive adds that in terms of its investment strategy, the fund is probably more invested in the mid-market, especially when it comes to Continental Europe, than it would have been in the past. “We see a lot of opportunities in the mid-market in Continental Europe,” he says.

The size of investment per fund has increased in the last few years, he adds, but not to the extent that the average size of European buyout funds has increased.

“In the large funds, we’re putting in a higher financial investment than in the past but that investment represents a smaller overall percentage of the fund,” he says,

In terms of direct investments by Middle Eastern investors, it has long been the case that investors have taken stakes in European blue chips. What has changed, says Ewan Cameron, who heads law firm Linklaters’ Dubai office, is that now they are taking controlling stakes.

These investments are made almost on a cross-subsidy principle, he notes, with Middle Eastern quasi-government funds attempting to build up assets in regional and international transport and tourism.

For example, Linklaters advised on Dubai International Capital’s acquisition of UK tourist attraction Tussauds Group from Charterhouse last year in an £800m (US$1.4bn) deal.

“The proposition is along the lines of: ‘If you fly Emirates you can stay in one of our hotels on your journey and maybe visit one of our tourist attractions,’” says Cameron.

He also points to other deals, such as January’s acquisition by Istithmar, an investment arm of the Dubai government, of Inchcape Shipping Services for US$285m from Electra Investment.

Meanwhile, in other deals Dubai International Capital acquired UK engineering company Doncasters Group last December for £700m (US$1.23bn) and earlier in the year took a US$1bn stake in Daimler Chrysler.

Arcapita (formerly First Islamic Investment Bank), a Bahrain-based investment firm, has also been active. In February, it acquired Norwegian oil and gas technology company Roxar for around US$200m. Previous European acquisitions include UK water company South Staffordshire, bought for £245m (US$430m) in 2004 and French kitchens and bathrooms retailer VGC, also acquired in 2004.

Arcapita’s approach is to buy companies and then re-sell up to 80% of them to Middle Eastern investors. Executive director Mounzer Nasr says the Roxar acquisition arose following a decision 18 months ago to include a focus on oil and gas in its strategy. It subsequently acquired a US gas storage facility and Roxar fitted its investment profile in Europe.

Nasr says: “As you can imagine, a lot of our investors are very knowledgeable on oil and gas and already have exposure to exploration and production, but Roxar represents the high end of the food chain with a significant technology element.”

Roxar supplies products and services that enable oil and gas companies to develop fields more cost-efficiently, maximise reservoir performance and improve recovery rates.

“Given that Saudi Arabia is no longer able to play a role as a ‘swing’ producer when the world needs higher oil production, the kind of technology Roxar has developed is the key to the future,” says Nasr.

Many of Arcapita’s investors are wealthy Middle Eastern families who have built their businesses as agents for Western multinationals, such as General Motors and Procter and Gamble.

“They’ve made money in distributing these goods but the margins are falling so they are looking to diversify and protect the next generation,” says Nasr, adding that often these investors like to invest in sectors about which they are already knowledgeable.

MVision’s Moose Guen agrees. “A lot of Middle Eastern investors like to have some personal knowledge of the business they’re investing in, so a family in the auto distribution business may look to invest in automotive businesses elsewhere,” he says.

But Arcapita’s Nasr says that his Middle Eastern backers have strong views on the kinds of European companies they find attractive. Given the proximity of the Middle East to parts of Asia, and the use of low-cost labour from the Indian sub-continent, investors are perhaps more aware than Europeans of Asia’s competitive advantage in areas such as manufacturing, he argues.

“They know that Europe can’t compete on cost with economies like China and India,” he says.

Consequently, Arcapita focuses on technology and services companies in “English-speaking” Europe, notably the UK, Ireland and Scandinavia, as well as niche luxury goods companies in Continental Europe. It is also interested in companies in Central and Eastern Europe because of advantageous tax rates and other business-friendly measures.

“We’ve looked at auto parts businesses, industrial tooling companies and so on in Europe,” says Nasr: “But even if they are outsourcing most of their production to Eastern Europe or Asia, we’re not really interested unless there’s something very special about them.”