January 10, 2012
The Coming Age of Exits in the Middle Eastern Private Equity Industry
By Dr. Karim Al Solh, co-Founder and Chief Executive Officer of Gulf Capital
The Middle Eastern private equity (“PE”) industry is a relatively young one with the overwhelming majority of existing players having launched funds in the last three to five years. One can denote the last five years as a period of farming and harvesting and the reward of this hard work is about to materialize in the coming few years as exits start materializing. Private equity firms typically hold an investment for about five to seven years, giving them enough time to restructure and grow their portfolio companies before actively seeking exits. The typical legal life for a private equity fund is 10 years (with possible 1 to 2 years extensions if agreeable to limited partners (“LPs”) in the fund), therefore the PE firms start actively trying to sell their portfolio companies mid way through the legal life of the fund to give them enough time to exit before the legal life of the fund expires (at which point they would become forced sellers at disadvantageous fire sale prices). A number of MENA PE funds are at the half way point of their fund life and are starting to actively explore the disposal of their investments, especially those that have grown substantially over the last few years. The end result? Investors can expect a series of upcoming exits at an increasing pace over the next few years. A number of industry skeptics have lamented the lack of exits and proven investment track record of regional PE firms. That was a fair comment up to now and was reflective of the immaturity of the industry (that went through the typical J-curve). As it matures, the MENA private equity industry has now a chance to cement its reputation and track record as exits materialize and returns to investors become real.
Not all exits will be profitable or successful. So what constitutes a successful exit and how can PE firms maximize their chances for a profitable exit? Typically, global private equity investors, in return for a legal commitment of 10 years per fund, expect a double digit IRR (circa 20-25%) over the holding period and around a 2x multiple on invested money (MoM). In emerging markets, LPs expect a higher return in light of the higher risks they are assuming. The risk premium for the MENA region has certainly increased in recent months and global investors expect higher returns (circa 25-30% IRRs and 2.5-3x MoM) in light of the increased regional geo-political risks. That is the new benchmark for successful private equity exits in the region.
How can PE firms maximize the odds of a successful exit? The investment strategy at entry is the same as the one adopted by growth-oriented stock pickers around the world: buy the right business in a high growth industry, with a strong franchise, sustainable and defendable margins, high entry barriers and a strong management team capable of executing an ambitious growth strategy. When it comes to deal structure at entry though, regional PE firms can borrow a page from Western buy-out firms: it is paramount that they have enough authority and governance to exert substantial influence on the direction of the business – this includes the ability to restructure the financial and operating aspects of the business and to replace or augment management if and when warranted. The sooner PE firms start acting and taking corrective measures in difficult situations, the higher the odds that the investment can be salvaged and restored to profitability and growth. Given that PE firms are paid higher fees than passive listed equity funds, they are expected to take on a much more pro-active and constructive stance when it comes to their investment, especially in difficult situations. EBITDA growth and value addition to investments have become key criteria for LPs when selecting PE firms. An equally important measure is the ability of PE firms to trigger a trade or financial sale or an IPO of the entire business at the right juncture. This is an important right that has to be clearly negotiated upfront with the other existing shareholders to secure the timely and profitable exit of the PE firms. These important measures and negotiated rights will make the difference between average lackluster exits and superior exits with strong returns at the levels expected today by global and regional investors.
About the Author: Dr. Karim El Solh is the co-Founder and Chief Executive Officer of Gulf Capital, one of the largest and most active private equity and alternative asset management firms in the Middle East. Gulf Capital is currently invested in a large number of diversified sectors including oil and gas, water, healthcare, education and construction.