As a World Bank official recently observed, SMEs are the lifeblood of Muslim communities around the world, keeping local economies humming. The number of middle-class and affluent consumers in Muslim communities worldwide remains small compared with the Organization for Economic Co-operation and Development (OECD), yet contained within them one finds emerging conditions for the widespread promotion of venture and growth investment. ARSHAD A AHMED opines that it remains to be seen whether the Islamic finance industry – debt oriented as it is – will find a way to embrace these equity-based investment opportunities.
Fortunately for the Islamic finance industry, the Muslim world comprises numerous pockets of rapid economic transformation, where discretionary consumption is on the rise and structural dislocations abound. These pockets dot Southern Asia from Indonesia in the east to Saudi Arabia and Turkey in the west, albeit the nascent scenes in Morocco and Nigeria must also be noted, as should the rise of Halal-cognizant enterprises in the west.
Review of 2015
Emerging and frontier markets generally lack the business conditions necessary for repeat occurrences of leveraged buyouts (LBOs). In a sense, this is fortunate because in the writer’s own private equity/venture capital (PE/VC) career spanning nearly two decades, the most lucrative PE/VC deals relied on no leverage at all, whether inside or outside an emerging market. They were 100% equity investments in growing businesses that generated returns 10 times over in just a few years. Growth equity, venture capital, and unleveraged mergers and acquisitions (M&A) do not rely on debt, and they generally prefer investing in businesses that are debt-free.
All the ingredients needed are willing entrepreneurs, growing SMEs, and a tolerable corporate governance regime (and having viable exit options would help, although China and India have shown this is not necessary). Growth equity, venture capital, and unleveraged M&A, in that order, continue to be the most common varieties of PE/VC deals in emerging markets generally. 2015 is unlikely to match last year’s record heights in terms of global PE/VC value.
2015 turned out to be the year when legal reforms that favor PE/VC investments did not take place in Muslim countries in key areas such corporate governance and bankruptcy. Legal reform to support PE/VC investment in SMEs continued to be haphazard among Muslim countries vis-à-vis leading emerging markets such as China and India, let alone OECD markets. For example, the Indonesian investment coordinating board’s ‘Negative List’ may be well intentioned to protect infant industries in Indonesia, but digital technologies, including consumer internet – common sectors for PE/VC investment – are designed to ignore political borders, a truth that the Indonesian government in 2015 not only failed to recognize, but as a result failed to develop more nuanced policies beneficial to local entrepreneurs by which locals might gain access to the strategic guidance and best practices that investment from a global investment firm would undoubtedly bring.
Unfortunately, the series of policy measures issued in 2015 by Indonesia’s president Joko Widodo (popularly known as Jokowi) were intended to benefit huge government-level investments rather than to sustain SME funding. “We want to give a strong impression that we are undertaking a fundamental transformation,” Jokowi told ministers this year, but investment regulations relating to SMEs – and by extension to PE/VC – were unimproved this year. In contrast, Indonesia’s smaller neighbors, Malaysia and Singapore, were more active in promoting SME integration into global technology investing scenes.
On the continent’s western end, Turkey remained home to the Islamic world’s most robust native PE/VC ecosystem. In the nearby Arabian markets, regulators continued to suffer unique circumstances and issues to address, such as a general dearth of entrepreneurial talent, a lack of enthusiasm among investors to take PE/VC positions and the overreliance on debt instruments on the one hand, and real estate as an asset class on the other. However, most encouragingly, a Saudi VC and Turkish VC in early 2015 teamed to co-invest in Turkey’s leading online retailer of Muslim fashions, which was organized via Borsa Istanbul’s Private Market platform – a model program for encouraging PE/VC investments in SMEs.
Preview of 2016
Will PE/VC’s exit activity – the generator of returns – be strong enough in 2016 to attract more PE/VC to Muslim countries at a time when dollar rates start to rise? History tells us that regulatory reforms will be lacking, so the force of attraction rests squarely on entrepreneurs throughout Southern Asian emerging markets such as Indonesia, Turkey, Saudi Arabia, Malaysia, the UAE and Bangladesh. These markets can learn from one another because how an economy like Turkey, for example, must deal with secular trends such as climate change, youth demography, mobile and internet penetration, etc, has more in common with Indonesia or Malaysia, than, for example, it does with Germany, Japan or Singapore. It is the recognition of these common traits that leads to the conclusion that one can build an internally synergistic portfolio of PE/VC investments just by diversifying within the Muslim world. PE/VC actors outside of the Islamic finance industry have already started to learn this, and in 2016 we expect to see it start to trickle into Islamic finance thinking, at least a little.
Arshad A Ahmed is the managing director at Elixir Capital, where he led growth equity investments into Malaysia’s FashionValet.com and Turkey’s Annelutfen.com. He can be contacted at [email protected].