In a region where oil money lines the pockets of many families and institutions, the Middle Eastern investment environment is often made difficult by political turbulence and heavy regulation. Increasingly, Middle Eastern investors are turning to the U.S.-specifically, to private equity funds-to put their money to work.
This westward flow of cash, which picked up about five years ago, has recently prompted conventional U.S. and European banking institutions to cater to Islamic investors. But the trend in banks is only part of the revolution. A growing number of investors from the Middle East are setting up private equity vehicles in the U.S. to invest on their behalf.
“This is not going away,” says John Beauclair, executive director at TransOcean Capital Inc., a Boston-based buyout shop with an Islamic focus. “There’s a real interest in this type of security in the Gulf . . . and we’re very excited about the possibilities.”
Indeed, while Islamic law prevents certain types of investments, it hasn’t prevented many investors from getting involved with U.S. private equity funds. Apax Partners, Morgan Grenfell, Thomas Weisel, 21 Invest Industry Fund, Doughty Hanson and Indigo Capital are just a few of the funds that have recently picked up limited partners from the Middle East.
Where It All Began
Leading the way for Middle Eastern investment vehicles is Bahrain-based Investcorp. Founded in 1982, Investcorp set the standard for all the smaller Middle Eastern shops that have emerged in recent years. Nemir Kirdar, the Iraqi founder and chief executive of the investment bank, was the first to create a way to channel money from the Arabian Gulf for investment in North America and Western Europe. Investcorp, with offices in New York, London and Bahrain, caught the attention of many investors in 1984 through the glamorous acquisition of Tiffany & Co., which was later followed up by investments in Gucci and Saks Fifth Avenue. In its early stages, Investcorp listed on the Bahrain exchange to establish itself in the Gulf and has since become a blue chip in the region.
Charles Ogburn, executive director of Crescent Capital Investments, credits Investcorp for opening doors for many of the successor funds. “Investcorp is the granddaddy here. It blazed the trail for this kind of activity, and they’ve been around for almost 20 years.”
The next big step for Middle Eastern investors came with the formation of First Islamic Investment Bank, also based in Bahrain, and Crescent Capital, its Atlanta-based subsidiary. While Investcorp introduced Middle Eastern investors to the opportunities available in the U.S., First Islamic introduced the practice of investing Middle Eastern money on behalf of Islamically-oriented investors interested in the U.S. market.
An important difference to note is that First Islamic maintains compliance with Shari’ah law, which dictates the ways Muslims should conduct their business transactions, while Investcorp does not.
“First Islamic Investment Bank has been a real pioneer in this area of doing Islamically-structured U.S. buyouts, and we all owe them for just generating the interest in the region on the investor side, as well as educating lenders and investments banks over here in the U.S.,” says Glenn Fortin, a managing director of TransOcean. “They’ve done a great gob of generating enthusiasm on all of those fronts. . . we’re sort of riding the wave that they played a huge part in creating.”
TransOcean Capital was established as part of TransOcean Group, a joint venture between Gulf Investment House of Kuwait and Gulf Finance House of Bahrain, which is backed by Kuwait Finance House, Bahrain Islamic Bank, Islamic Development Bank and other Islamic institutional investors and families in the Gulf.
Several other buyout shops have been making contacts in the region as well. MapleWood Partners in March partnered with Bahrain-based Al-Tawfeeq Company for Investment Funds, forming a fund that will make Islamically acceptable private equity transactions. The Carlyle Group‘s Arabia team has been investing private equity with Saudi Arabian investors since 1994.
Money in the Bank
Unlike investors from other regions, these private equity vehicles set up to invest Middle Eastern capital tend to limit the investors to only those from that region. Additionally, following the model of Investcorp, most do not face the task of fund raising, but invest either from their parent bank’s capital, a blind pool or some combination of those two. National Investors Group, a venture capital subsidiary of National Bank of Kuwait, has invested the bank’s money for its five years of existence, but is currently planning its first fund. Still, that fund will not include investors from outside the Middle East. “We’re going to stay out of the U.S., which is a difficult fund-raising environment right now,” says Jason Bross, head of private equity for the group. “So we’ll basically leverage friends and family of the bank to raise this outside fund.”
The fund expects to raise between $75 million and $100 million.
In reality, firms like this have no need to turn to limited partners outside the region because of the overwhelming demand from Middle Easterners. Why is this demand so great? First and foremost, the region is flush with oil money and in need of a stable place to invest it. “There is a flow of funds into the region because of the energy industry, and that flow of funds exceeds the rational investment requirements within the region,” says Crescent Capital’s Ogburn. “So you have significant excess liquidity in the region that is to some degree the function of oil prices and world economic activity.”
Second, due to the shared Muslim culture in the region, which is not as commonly practiced in the U.S., Middle Eastern investors tend to stick together and seek out general partners who are willing to make investments that comply with Islamic law. “As I understand it, there is not the same sort of separation of faith and business considerations that there is commonly in the U.S.,” says Ogburn. “In fact, there is a code of Islamic business dealings that specifies what can and can’t be done from a business standpoint.”
Lastly, there is a strong desire to diversify investments, as the bulk of the region’s wealth is generated by the energy industry. National Investors Group, which mainly invests in communications and information technology, was created to give Middle Easterners an opportunity to invest in technology. “In that part of the world, they’re very sheltered from a lot of the newer technology,” says Bross. “And if it’s communications or a lot of the buyout-type deals [that interest them], they’re not going to see those deals over there, and they realize that.”
Rules of Engagement
Firms like Crescent Capital and TransOcean Capital also have diversification in mind for their investors, but they are bound by tenets of Shari’ah. Each of these firms has a Shari’ah committee that works alongside its general partners to ensure compliance with Islamic law. Such compliance forbids investment in industries that involve pork and meat processing, alcohol, tobacco, traditional financial institutions, and most media deals. The need for Islamic investors to comply with the Shari’ah is what has spurred a trend among the large investment banks to create Islamic finance divisions.
According to the Shari’ah, Islamic investors can not finance their deals with interest-bearing debt which limits the ways a private equity deal can be financed to mainly sale/leasebacks, known as ijara. With only a handful of banks in the know about Islamic dealings, those banks able to channel that business to themselves were in for a boost. Therefore, Bank of America, HSBC, Fleet, BankOne, BNP Paribas, and Citibank each have developed groups focused on facilitating Islamic financing. “There’s already a fair amount of interest on the part of traditional financial institutions to provide the ijara structured financing,” Fortin says. “And the investment banks and other deal sourcing agents are willing to invest their time and resources in working with us.”
Still others are trying to get their foot in the door. W.P. Carey, a firm which specializes in sale/leaseback financings, is one. “It’s our understanding that a sale/leaseback, by definition, fits the Shari’ah requirements,” says Gordon Whiting, an executive director at the firm. “So, we are talking to an investment institution who is looking to coordinate an institution in the U.S. [where they would] raise the money in the Middle East and W.P. Carey would place the money through a sale/leaseback.”
While the competition for sale/leasback deals is growing among the banking institutions, the private equity firms are happy to see it. “One of our goals is to expand the universe of banks that is doing this,” says Beauclair. “We are trying to get as many banks as possible comfortable with this type of financing.”
To be sure, the limits of Shari’ah are far from crippling, as sectors like manufacturing-a staple of the LBO market-are permissible. TransOcean, which only got on its feet three weeks ago, plans to focus on manufacturing and consumer products in the $50 million to $100 million deal size. “For reasons of diversification we’re staying away from transactions in the real estate, energy and project finance areas,” says TransOcean’s Beauclair. “That’s because our backers already have either groups investing in that area or in the instance of energy deals, they are already heavily invested in it.”
“They want to diversify their risk portfolio with U.S. risk U.S. currency risk, U.S. political risk, etc.,” adds TransOcean’s Fortin. “They want to have a very stable risk component in there. Obviously given the sorts of things that are going on in the Middle East, that’s very important to them.”
Love is Blind, Private Equity Ain’t
Many private equity players are well aware of the Middle Eastern invasion and are ready to participate. While most of the interest from Middle Eastern investors has been directed at the U.S. so far, Western Europe is also catching their eye and will likely become another popular target in the next few years. In the meantime, general partners know where to turn while fund raising in the U.S. is stalled.
For years, Middle Eastern investors not concerned with complying with a Shari’ah committee have found a home for their capital in traditional American and European funds. “Dating back the last 20 to 25 years, a lot of these [Middle Eastern] groups had been some of the sole investors in some of the biggest buyout and venture capital firms that you know,” says Bross, whose National Investors Group does not have a Shari’ah committee. “They’re set up through different subsidiaries to keep themselves sheltered.”
Private equity firms looking to make a global footprint are catching on that it’s good to have the Middle East on your side. “The Middle East is a wealthy region, and unless you’re in, you can’t penetrate,” adds Bross. “A lot of the deals early on and still right now that we’re brought into is because of having ties to the Middle East and being sponsored by one of the largest banks in the Middle East.”
Despite the growing interest from private equity funds and banks, those general partners that currently work with Middle Eastern investors fear that there is a misconception among their Western colleagues that these investors are not private equity-savvy. “Sometimes people will view Middle East investors as nave investors . . . but from what we’ve seen that’s completely wrong,” says Bross. “You’re dealing with wealthy families who are so in tune with what actually goes on in this industry, and especially with the Internet now and the amount of knowledge and information [available]. They keep up to speed on everything, and they are really sophisticated investors.”
TransOcean’s Fortin and Beauclair reiterate this opinion, explaining that many of their investors had been active in private equity in the Gulf region long before their firm was formed.
So, those private equity players and banking groups who take the time to learn the ins and outs of the Middle Eastern investor may find themselves with strong footing in the next big wave.