As the conventional private equity sector struggles on the back of gloomy news from Europe and the US and fears of recession and credit defaults bring its post-crisis revival to a screeching halt, investors are looking to new markets. Emerging economies now account for around 25% of raised capital, and Islamic finance hubs in the MENA and Southeast Asia regions are seeing a boost in activity. So what is the Islamic sector doing to take advantage of this growing interest?
Plenty of data is available on the conventional sector, which is reported to have seen private equity investments of around US$210 billion in 2011 – down from a peak of US$395 billion before the global credit crisis. The Islamic side is far more difficult to quantify, and Jamaludin Bujang, CEO of Malayia Venture Capital Management (MAVCAP), explains that: “We have no similar data for Islamic private equity.”
However in a recent speech Malaysia’s second finance minister, Ahmad Husni Hanadzlah, claimed that the private equity industry worldwide had raised US$184 billion via Islamic financing in 2011: a very respectable number compared to the conventional side, if only a fraction of the reported US$680 billion in Islamic financing raised in 2008. However, other figures suggest that the industry is approaching just US$9 billion in Islamic funds, most of this in the MENA region.
Whatever the data, private equity as an asset class has struggled in 2012, with tough times predicted for fund-raising and returns in the future as firms slam on the brakes following the Eurozone debt crisis. The industry is also struggling with its commitments, with over US$1 trillion in uncommitted capital (‘dry powder’) and over US$2 trillion in total assets sitting on the books waiting to be offloaded. “Similar to conventional private equity”, says Jamaludin, “2012 looks set to be a difficult year for Islamic private equity given the continued struggles in the Eurozone, as well as in other developed nations, which are facing the prospect of a recession.”
This is bad news for an asset class that has become an increasingly popular investment avenue into emerging markets. The Emerging Market Private Equity Association estimates that the US dollar amount raised by developing market private equity funds increased from just US$6.6 billion in 2001 to US$66.5 billion in 2008, accounting for 14% of the total market. And although the sector was hit hard by the global financial crisis in 2008, recent signs suggest that it is staging a revival.
For private equity in the GCC, the years since the crisis have not been kind, and a backlog of companies searching for an exit has built up. According to a 2011 report from the Wharton School of Business, around 218 investments were made by MENA private equity funds between 2004-09, of which only 14 have been exited. Richard Clarke, the managing director of transaction and restructuring services for Deloitte Middle East, pointed out in a recent interview that: “The private equity market in the Middle East makes up only a small part of the overall M&A marketplace”, and “the financial crisis has impacted the number of active PE funds in the region, resulting in a reduction in total active firms.” In addition, political unrest in the region led to an estimated fall in foreign investment flows of 16% in 2011, leading to a sharp drop in private equity investments with investors backing out, sellers demanding overly high prices and increasing competition as firms began to feel the pinch.
There are some signs that the market is opening up again and the cycle is coming round full circle. Even Clarke admits that: “The positive side for PE firms is that there is reduced competition for assets.” Nevertheless investors remain cautious, and according to Deloitte in 2012 they are seeking opportunities in defensive sectors including education, oil & gas services and basic consumer necessities.
However according to Fadi Arbid, CEO of Saudi private equity firm Amwal Alkhaleej: “People talk about investments a lot but 2012 and 2013 are going to be periods of exits for us.” On the 4th July the firm announced the successful IPO of Al Tayyar Travel Group which raised US$2.2 billion and achieved the highest average per retail subscriber since 2009. Arbid believes that Saudi Arabia can expect eight to 10 more IPOs this year, as the market opens up: “Saudi Arabia is the largest and most sophisticated market in the region and is on everyone’s radar.”
In fact, Saudi Arabia represents just one of a number of promising Muslim-majority markets which offer excellent prospects for Shariah compliant investment: a sector that is looking increasingly attractive for private equity. In a recent interview Ihab Asali, the head of private equity at Qatar First Islamic Bank (QFIB), explained that: “The growth of Islamic private equity comes at a time when there is a controversy over the credibility of the conventional financial system. Islamic private equity is the purest form of Shariah compliant financing since it is structured on a partnership basis. We will continue to see an increased focus on the value and potential contribution of Islamic private equity as new markets emerge.”
And indeed, as the global markets shift new opportunities arise. For example, Deloitte notes that many institutions are tightening their lending criteria leading to difficulties for small and medium enterprises (SMEs). Private equity firms can take this opportunity to bridge the gap left by the banks, and with the SME sector a strong focus for Islamic finance this gives the industry an excellent platform from which to work.
In addition, as privatization continues in many Gulf states and family businesses are restructuring while credit remains severely limited, the “capital overhang” is beginning to narrow.
“There is no doubt that there is a huge potential for growth in the Islamic finance arena since today Islamic assets represent less than 1% of total global assets. High Muslim populated countries, like Turkey, provide great opportunities for Islamic financing in general and Islamic private equity in particular,” concluded Asali.
Beware the barriers
The Gulf Venture Capital Association (GVCA) estimates that by 2008 Islamic banks in the Middle East had invested less than 5% in total private equity capital, with their reluctance stemming from concerns over long maturity periods, illiquidity and volatile debt liability.
In 2010 KFH Research estimated the total size of the Islamic private equity fund industry at US$8.9 billion – compared to an estimated US$500 billion in the conventional space. In addition, the firm estimates that because of the lack of suitable investment projects, only 50% is currently invested leaving around US$4.8 billion in dry powder. Finding viable investments can be difficult in the Gulf region in particular, where apart from the giant state-controlled corporations the majority of companis are family-owned and reluctant to sell even minority stakes to private equity firms. And although the global financial crisis was expected to trigger an increase in distressed sales, these have been lower than expected. Bassam Yammin, co-CEO of Credit Suisse Middle East, commented that: “Many family groups were affected in the wake of the crisis, but banks in the region normally enable them to hold on till they regroup.”
There is also a problem with transparency and weak governance. One regional expert explains that this can make finding deals a real problem: “You have a layer of companies that look like great investments, but they are just so haphazardly run, audited and structured that a private equity firm won’t touch them. There are actually very few that are of a quality that a private equity firm could contemplate an investment in.” Even listed companies are a challenge, as there is little regulatory support, making hostile takeovers almost impossible. Arbid explained: “There are no squeeze-out provisions, and it’s virtually impossible to take a company private in the strict western definition. You can take sizeable ownership in public markets and try to take control, but even that can be complicated as each of your moves will be overly scrutinized by the regulator. You will need to create value while working around these hurdles, but this is a tedious task.”
Foreign ownership limits and a shortage of qualified professionals also limit activity, as do the complicated differences in cross-border regulation. Jamaludin believes that the most important factor needed to propel the market forward is: “The harmonization of standards in Islamic private equity, i.e. to ensure a transaction that is deemed as conforming to Shariah laws in one part of the world, is also deemed Shariah compliant in other parts.”
Most jurisdictions do not have specific guidelines for setting up and managing Islamic private equity. However, Malaysia is an exception. In May 2008 the Securities Commission Malaysia (SC) issued the ‘Guidelines and Best Practices on Islamic Venture Capital’, and in November 2012 new equity guidelines will come into effect to tighten the rules for Islamic involvement with ‘unethical’ companies, which it is hoped will increase Malaysia’s competitiveness and encourage private equity investment.
The country’s private equity industry has been going from strength to strength, with recent news predicting that PE investments are set to quadruple in five years to on the back of government incentives. Darawati Hussain, the chairman of the Malaysian Venture Capital and Private Equity Association (MVCA), confirms that although “the industry is still in the nascent stages and has a lot of room to grow”, she has seen increased inflows. “Our private investors who have been stagnant in terms of outsourcing funds due to the global economic crisis are now re-looking at this part of the world again,” she announced at a recent conference.
The 28 members of the MVCA are currently estimated to hold a total of around US$5.4 billion in Islamic assets under management, of which about two thirds is invested. Hussain bases the positive outlook on increasing investor confidence, particularly in the Middle East, the US and Europe. Jamiludin explains that MAVCAP is now working on a program to raise funds from private equity counterparts in these regions. “This program is looking at matching contributions from us and our counterparts, and if all goes well…we should be able to bring in about US$100 million this year.”
Nor Mohamed Yakco, a minister in the prime minister’s department, at the Fourth International Islamic Venture Capital and Private Equity Conference in May 2012 noted that Malaysia’s Economic Transformation Program required private sector investment of RM120 billion per year (US$37.8 billion) which will need to be driven by higher value-adding activities such as private equity and venture capital. “The government firmly sees a role for private equity and venture capital in transforming the Malaysian economy and investment landscape in the form of promoting innovation, invention, job creation and the development of high growth industries.”
So what lies ahead for Islamic private equity? Jamaludin is positive on growth prospects. “There is likely an ongoing trend for bigger migration to Islamic financial services in certain markets due to the loss of faith in the conventional system arising from the global economic and financial crisis.”
According to MAVCAP, market drivers for Islamic private equity next year include “a robust economic outlook in the GCC supported by high revenue from the hydro-carbon sector and higher public spending.” In addition, there is growing interest in private equity from leading sovereign wealth funds (SWFs), particularly in the Middle East, which could result in large capital injections. Several have already registered interest in alternative investments, and according to research released in June 2012 by Bain & Company, the 10 largest SWFs investing in private equity could result in between US$30-90 million being injected into tne industry over the next few years.
“As market conditions continued to improve”, concludes Jamaludin, “expect investors to increasingly look for Shariah compliant investment opportunities which are more transparent and ethically structured. This bodes well for Islamic private equity.” — LM