El-Khazindar: “There are four facts which may make our answer to this question very different from other MENA-based PE players.
We are based in Cairo and are really focused on Egypt and the frontier markets of the MENA region such as Syria, Iraq, Sudan, Algeria and Libya. We have, in fact, very limited investment exposure to the Gulf Cooperation Council (GCC) economies. We also have an Africa focus, particularly in East Africa, so in addition to MENA we have investments in Kenya, Uganda and Ethiopia and are actively looking across most of the COMESA countries. Because of our geographic focus on markets which are generally short on both risk capital and/or business expertise, and are perceived as being more challenging — we have continued to be very active and face little or no private equity competition.
Because of the wide variety of deal types we pursue, including control, growth, Greenfield, leveraged and distressed, we tend to be influenced not only by regional fundamentals such as energy price volatility, but also the general global investment cycle. So, for example, while many of the international leveraged players have been on the sidelines for the past two years, we have been actively completing distressed acquisitions and new greenfield investments that we hope will be reaching their peak just as we get into the leveraged phase of the investment cycle.
Unlike many private equity players in the MENA region, we have an $800m balance sheet of our own, which has allowed us to continue to invest in and support our platform companies when other sources of capital, particularly debt, simply dried-up. Because we went into the global recession with a very liquid balance sheet, we were able to weather the storm, and re-started new investment activities in early 2009.
We are a control investor in generally larger-scale platform companies, which is our term for the local companies we look to build into regional champions. As such, we have a greater ability to manage and respond to business and financial risks than, say, pure minority private equity investors. Control is one of the key risk mitigants in our investment strategy and it proved vital during the last two years. The scale of our investments has clearly allowed us to take advantage of the global turmoil and recruit the very best global management talent available. So within our existing portfolios there has been a great deal of progress.”
Murphy: “The challenge is that the MENA region is really an emerging market within emerging markets. As a whole, it would constitute the sixth-largest economy in the world – $6.8trn at purchasing power parity in 2010, according to the IFC. However, it is not a homogenous market, and very few people look beyond its role as the world’s largest energy exporter. In addition, the facts remain that global allocations to private equity have basically been halved to around $350bn annually, and that most LPs have a higher degree of comfort investing in markets closer to home where they have historically seen solid returns.
As a result, we have found that attracting international LPs to invest in the region has been challenging. The MENA region is likely to attract about $1.5bn in new institutional private equity commitments in 2010 and at this level it would be close to the bottom of the chart for traditional emerging markets capital raised, perhaps just above Russia.
Having said that, while it has been challenging to convince prospective LPs to focus on our region, we have generally found it comparatively less of a challenge to convince those with an appetite for MENA that we are the player of choice. Consider this: In 2010, Citadel Capital will have raised new commitments to our various opportunity specific funds and our two new joint investment funds of around $1bn.”
Would you say the Middle East or Africa was the more overlooked region?
El-Khazindar: “Both Africa and MENA are still too low on the list of where global institutional investors want to put money to work in private equity. Within the emerging markets universe, China is attracting the most attention, then India and Brazil. This is somewhat ironic: while Western money is pouring into private equity in China, the Chinese are choosing to invest significant resources into Africa.
We’re obviously actively working on changing this situation and putting our region on the radar. Both Africa and MENA, but particularly Africa, are starting to get greater attention at conferences and from the general financial press.”
Why would you say that is? Is it just that the opportunities aren’t there?
El-Khazindar: “If you are just looking for “plain vanilla” transactions involving well-established, profitable businesses then you will only see a handful of deals annually and you will likely be competing with both strategic and financial investors.
In some sub-regions within the Middle East, particularly the GCC countries, governments will see the opportunities first, and they also have the wherewithal to take advantage of those opportunities – think of Emirates Airlines, SABIC, Saudi ARAMCO or ADNOC.
In other parts of the region, such as Egypt and the frontier markets, you do get to see and control the opportunities that arise with much greater regularity. So we operate in regions where we get to do controlled transactions. Essentially, you are talking about countries, some of which are post-conflict countries, which cannot finance or manage some of the opportunities that we can as part of a larger platform company play. The role we play is that of industry builders.
This leads to very a different perception of private equity in our region versus the way it is seen in developed markets. For example, if you look at the value of M&A deals done by private equity firms in developed markets, circa 50 per cent of total activity is secondary purchases (in other words one PE firm buying from another). Long-term this may not be sustainable and clearly is very different from our industry building investing.”
Do you agree with the sentiment expressed recently that private equity in the Middle East is going to drift back towards SME investments and fewer of the large buyouts we’ve saw in the peak, before the crash?
Murphy: “Firstly, MENA was never a mega buyout market. Citadel Capital was the seller in the largest -led buyout deal in the MENA region, which had a total equity value of $1.4bn in late 2007. This is very far from mega land.
If you look at the facts, between the Gulf Venture Capital Association figures and our own investments at Citadel Capital, the total MENA market has seen about $2.5bn of capital that has been invested and then fully realized. We account for about 40 per cent of the above total.
Secondly, our largest deal is a $1.1bn equity investment in a greenfield public-private partnership that is just about to close. This deal is a one-off as our average equity check is typically around $250m. We believe we are one of the few “larger-scale” players in the MENA market and so $250m of equity would be at the top end of value range, but certainly not mega buyout territory.
Thirdly, there was always limited acquisition finance available via the banking system in the MENA region and this continues to be the case, so mega buy-outs were never really possible as they required too much equity.
The most popular regional PE model is not a buy-out model, but a growth capital model with improved corporate governance. The financial storm that hit the region in late 2008 and 2009 has filtered-out strategies that work from those that don’t work, but I wouldn’t say that it has all shifted back to SMEs. I would say that there are some minority firms that were adding value and doing the right thing, and they are still around and thriving, and there were others who were doing very little — and they are gone.”
What are the strengths and weaknesses of the opportunity-specific fund model Citadel Capital pursues?
Murphy: “Our largest regional investors are experienced industrialists or savvy financial professionals. All of them by nature have an aversion to investing in blind pools, so when we go to talk to our regional investors, a network of 50 to 60 families, we go not as a manager but as a principal partner, as we always invest in our own deals. The fact that we are generally the largest investor in the deals we do and LPs are able to invest on a deal-by-deal basis has contributed to our growth from $400,000 in capital in 2004 to around $4.0bn of assets under management today.
However, this model has limitations: While it’s very attractive to high-net-worth individuals and families in the region, global institutional investors prefer a more traditional fund model. Therefore, we have complemented our opportunity specific fund model slightly to add in a layer of institutional capital, and that is what our MENA and Africa Joint-Investment Funds are all about: giving worldwide institutional players the opportunity to invest alongside us in a more traditional structure that they’re more comfortable with.”
What was the thinking behind Citadel Capital’s new Africa fund?
El-Khazindar: “We see strong potential in the Common Market for Eastern and Southern Africa (COMESA), the 17-nation agglomeration of countries that are cooperating to eliminate customs barriers and other trade issues.
The five-country East African Union is also now a full customs union, and these sort of regional initiatives are creating bigger markets. When you create bigger markets you can create bigger companies, and what is happening now in Africa is just like the birth of Europe, where idiosyncrasies that prevented smooth import-export trade were eliminated.
We particularly like the large East African and COMESA countries: Uganda has close to 30 million people, Kenya has 35 million, and Ethiopia has a population of over 75 million. These population numbers mean there are large domestic markets and they are growing fast. For example, Ethiopia has been growing at an average of over 10% a year for the last 9 years.
Do you agree with the idea that it would be desirable to have regional exchanges in Africa?”
El-Khazindar: “I think that the exchange question is a real issue. We use the Egyptian Stock Exchange, which is a well-established, well-governed exchange and has a market cap of about $100bn and an average daily trading volume of $300m. As you go down into the smaller geographies, an individual country exchange doesn’t always make sense, but the difficulty with a common exchange is always finding a location that all the individual countries agree to.
That’s the difficulty, and I think that local markets will realize that they have to cooperate, and I believe they will develop individually and merge later, especially as an increasing number of them are electronic anyway.
I think that eventually the local stock markets will become like Euronext in Europe. The key issues are critical mass and transparency. It needs quite a large amount of professional infrastructure, deal infrastructure.”
Copyright © 2011 AltAssets
Next week on AltAssets, Hisham and Stephen discuss the ups and downs of life as a listed private equity firm, and the potential of infrastructure investment on the African continent.