More Than Money

The scale of infrastructure development in the Middle East, and particularly of course the Gulf, continues to astound. Dubai Waterfront, set to be the largest man-made development in the world, is to be seven times the size of Hong Kong. In Saudi Arabia alone, where five new cities are planned, infrastructure worth US$350bn is scheduled. Abu Dhabi’s up-to-US$875m sovereign wealth fund Abu Dhabi Investment Authority has recently hired an infrastructure team aimed primarily at the MENA region.

The opportunities for the PE investor are clear then, and not just available but undoubtedly attractive. With the credit crunch restricting deals in the US and Europe, to turn to another market and find low risk, government-backed infra deals providing steady returns is to find an ideal destination to redirect capital.

Governments have had little need for private equity thus far, however, with funds from increasing oil prices more than adequate to cover infrastructure requirements. This is exacerbated by the tendency to highly leverage in the sector, stretching equity investments even further. It’s no coincidence that the US$500m MENA Infrastructure Fund is headed up by Mark Lemmon, and also includes Richard Cole – previous heads of HSBC’s project finance desk.

The lack of demand for private equity investment has meant a low level of supply – just six funds specifically targeted at the sector have launched in the last five years. Increasingly though, governments are turning to the private investment sector to form partnerships. What’s changed?

Some people have pointed to the ever-increasing ambitions of the infrastructure developments planned and suggested that even the immense oil-fuelled funds of the Gulf countries are not sufficient to cover them anymore. The power and utilities sector needs an estimated US$155bn extra investment, according to Abraaj Capital, manager of the largest infra fund in the region, and water availability per capita was just 17% of the global average as of 2006, requiring US$133bn of investment.

Debt plays a key role in financing these developments, however, and with a typical debt:equity ratio in the region of 3:1, allied to the reserves of the sovereign wealth funds, the numbers look manageable. As the worldwide reach of the credit crunch goes, the Middle East is amongst the least affected regions (“that’s something we read about in the Financial Times” one banker jokingly exaggerated), and the project finance market generally has remained more robust than most, with pricing squeezing up slightly but the vast majority of deals still getting done.

Neven Hendricks, of Deloitte’s new Middle Eastern corporate finance arm, suggests that there is a realisation emerging in the Middle Eastern governments that despite their massive liquid reserves, there is a huge value to be exploited in the private sector, in the form of intellectual capital. In a recent Deloitte MENA Private Equity Confidence Survey of PE houses, one question asked: “What do you believe are the most important competitive differentiators between private equity firms when it comes to winning deals?”. Two categories out of eight took over the half the votes: “reputation” (27%) and “ability to add value” (25%). “Price/terms” (15%) came third.

Reputation has become increasingly important as the market has matured. In a sufficiently junior market, inexperience can undervalue reliability in the face of aggressive pricing and terms, but as the reliability of the market has improved, the reliability demanded of its participants has risen correspondingly. “There’s no benefit of the doubt”, Hendricks says: “reputation for execution, and execution on time is paramount”. The ability to add value largely covers access to technical advances. In the desalination sector, for instance, most current projects use chemicals, whereas newer methods that don’t use chemicals operate at a third of the cost.

One of the top four responses that took 81% of votes was “networks”, with 14%. One investor can be significantly more attractive by providing control of other levels of the supply chain. In the desalination plant example, a partner that can offer power supplies from a clean energy source is offering something the Middle Eastern governments do not have without that partner, even if they have little need for their equity investment.

The most important differentiation Middle Eastern governments must make in choosing partners is perhaps more difficult for them to identify in prospective candidates; which are going to stick around? Looking to best serve growth means ensuring growth is sustainable, and attracting the right people in this respect will be crucial; ex-patriots working in the region on individual projects for three to five years are of less benefit than dedicated investors establishing themselves in the region, taking a holistic, long-term approach to investing. An investor that can prove their intentions in this regard will be a popular one.