The murder of Saudi dissident and journalist Jamal Khashoggi in the Saudi consulate in Istanbul in October was shocking. His killing provoked international condemnation – including from the private equity industry. Blackstone chief executive Stephen Schwarzman and BlackRock CEO Larry Fink were among international business luminaries that staged a boycott of the Future Investment Initiative, a high-profile investment summit held in Riyadh later that month.

The FII event – dubbed “Davos in the Desert” – was sponsored by the $230 billion Public Investment Fund of Saudi Arabia, the kingdom’s sovereign wealth fund, and was intended to promote inbound foreign investment and economic partnerships. Khashoggi’s killing prompted renewed scrutiny of Saudi Arabia’s controversial human rights record and unease among some investors. Saudi PIF is a major investor in both Blackstone’s $40 billion open-ended infrastructure vehicle and SoftBank’s $98.6 billion Vision Fund. If the PIF is to meet its 2020 target of 1.5 trillion Saudi riyal ($400 billion; €357 billion) of assets under management with 25 percent held overseas, it needs enthusiastic international partners.

However, short term geopolitical strains do not undermine the Gulf as a significant source of international investment capital, including for global private fund managers. “That doesn’t change in response to events, given the stock of wealth,” says Jeff Schlapinski, senior director of research at the Emerging Markets Private Equity Association. “The Middle East will always be a global private equity stopping point.”

Middle East markets are well attuned to volatility. “The boycott of the FII event is old news,” says Tarek Fadlallah, CEO of Dubai-based Nomura Asset Management Middle East, who points to the success of Saudi Aramco’s oversubscribed debut international bond issue that raised $12 billion in April as an indicator of investor appetite for the kingdom. The order book stood at more than $100 billion according to reports.

Also in April, Dubai-based payments group Network International held a £2 billion ($2.6 billion; €2.3 billion) initial public offering on the London Stock Exchange. The oversubscribed issue reiterated overseas interest in Gulf companies – Mastercard acquired $300 million of shares – and marks a success for US managers General Atlantic and Warburg Pincus that reduced their joint 49 percent stake.

The share sale followed Uber’s announcement in March that it had agreed to acquire Dubai-based taxi hail service Careem, which operates across MENA, for $3.1 billion. “Finally the global strategics are arriving, and that is providing a new exit avenue for us,” says Karim El Solh, CEO of Abu Dhabi-based Gulf Capital, which sold hotel aggregator Destinations of the World in November to Melbourne-based digital travel agency Webjet for $173 million.

Tough times

For private equity in the Gulf, it is welcome news. The industry has endured a tough few years, undercut by plummeting oil prices from more than $100 a barrel in mid-2014 to less than $30 a barrel in 2016, and political strife within the Gulf Cooperation Council and the isolation of Qatar, as well as regional friction with Iran, and the war in Yemen.

An economic downturn, depressed asset prices, sluggish stock markets, an absence of exit opportunities and extended hold periods have resulted in disappointing returns for many GCC managers who raised money 10 years ago, says Fadlallah.

As a result, fundraising has not been easy. From a recent peak of $2.4 billion in 2016 when 13 MENA-focused funds closed, only six funds closed in 2018 raising a total of $800 million, according to PEI data. For GPs, the drop in fundraising has been compounded by restricted debt financing, says Fadlallah. “Lack of liquidity has been a big issue,” he says.

The collapse of Dubai-based Abraaj Group in June last year – until then one of the region’s flagship managers – and the US criminal investigation and subsequent arrest of three top executives has not helped. The scandal has eliminated a key dealmaker and pushed corporate governance concerns to the fore.

“For LPs, Abraaj is top of mind,” says Cairo-based Actis partner Sherif Elkholy. “They are asking, is it a manager-specific governance issue or a regional one? We’ve been clear it’s manager-specific. [For GPs] it’s had an obvious impact on the volume of dealflow and has resulted in a longer deal cycle, more meticulous due diligence and closer scrutiny of assets being considered.”

But there is a benefit. “There will be a flight to quality and well-governed GPs with a track record,” Elkholy says. It seems this has already begun. Compared with 10 years ago when the market was crowded with managers seeking to deploy the $6 billion in dry powder raised to invest in MENA, today only a handful have graduated to their second or third investment vehicles, says El Solh.

The combination of manager consolidation, low levels of dry powder, limited competition and assets valued at reasonable prices creates an attractive buying opportunity, El Solh says. “There is much more upside from our current entry multiples. We are seeing better quality deals and are buying controlling stakes without paying a premium – 2019 and 2020 will be nice vintages,” he says, noting the firm’s $750 million Gulf Capital Equity Partners Fund III is two-thirds deployed.

New spaces

The rising price of oil, which hovered around $70 a barrel in April, has boosted confidence. But it is the ongoing diversification of Gulf economies away from oil that is creating an uptick in dealmaking. According to EMPEA, funds focused on the Middle East (excluding North Africa) completed 26 transactions with a total value of $516 million in 2018, compared with 24 deals totalling $256 million the year before.

In addition to defensive sectors such as healthcare, education and logistics and transportation, which have enduring appeal across the MENA region, GPs in the Gulf are scouring for opportunities in fintech and e-commerce (where penetration is low), as well as fast-moving consumer goods, and newly created sectors such as entertainment and hospitality in Saudi Arabia.

Recognising another opportunity presented by tech-intensive growth, at the end of last year, General Atlantic made a $120 million investment in Dubai-based online real estate classifieds business Property Finder. It is in good company. Amazon acquired Dubai-based online marketplace souq.com in mid-2017 for more than $500 million. “The underlying fundamentals are appealing to investors and there are a lot of promising companies emerging in the new economy spaces,” says EMPEA’s Schlapinksi.

A young, wealthy, tech-savvy population with the highest mobile phone penetration globally and willing to spend is driving growth of the new economy in the Gulf, says El Solh. Mining this seam, Gulf Capital acquired a strategic stake in Saudi online payments business Geidea Solutions in May last year. At $267 million, the transaction was the largest disclosed private equity investment EMPEA has recorded for the Middle East since 2012.

The days of acquiring a minority stake and surfing the rising tide of economic growth in the Gulf are long gone. Looking forward, managers investing across the MENA region must find a way to create value. The rising prevalence of buy-and-build strategies and the recruitment of operational teams suggest that they are.

Go north
North Africa sits apart from the rest of the Middle East and the Gulf, Albert Alsina, CEO of Barcelona-based Mediterrania Capital Partners is careful to point out.

“There aren’t strong trade links between the Middle East and North Africa or companies that have subsidiaries in both,” says Alsina, whose firm invests in North and sub-Saharan Africa. “Few managers invest in both the Middle East and North Africa and the politics, resources and cultural background are different.”

Increasingly viewed as part of a pan-African strategy, North African markets also benefit from close ties to Europe. And rather than oil wealth, the expansion of the middle class and its spending aspirations coupled with urbanisation support historically strong dealflow. Two particular markets are grabbing investor attention: “More stable countries in terms of geopolitics like Morocco and Egypt are playing a bigger role these days,” Alsina says.