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Private equity comes of age in the Middle East, says Booz

Over the last decade the state of private equity in the Middle East has gone from virtually nonexistent to a booming prospect to an industry facing a shakeout, says consulting firm Booz.

The sector’s breakneck evolution has made it difficult for investors to obtain a clear picture of the industry’s underlying fundamentals.

This being the case, they have been understandably cautious about directing their funds to regional private equity firms.

Booz says this hesitation could come with serious costs for those who miss what is becoming a burgeoning opportunity. The Middle East remains a region of increasing wealth and growing popu­lations that require new and better services. GPs and LPs looking to take advantage of these opportunities can and should equip themselves to better manage this transition, the firm says.

Part of the challenge will be resetting expectations, both for liquidity and returns, as the mirage of easy money dissolves.

Additionally, private equity firms will have five imperatives in the coming years if they are to attract capital and prove their worth: develop an investment approach based on an investment theme with staying power; tighten up risk management practices; be an active owner; deepen relationships with LPs, especially institutional investors; and build confidence through new fee structures and fund-raising approaches.

The market dynamics in the Middle East – in particular, the pursuit of the same limited opportunities by so many firms – point to a shake­out. Many PE firms operating in the region were founded at the height of the industry’s boom in 2007 and early 2008 as investors poured onto the PE bandwagon. But few knew where to invest. Some invested in real estate and listed equities, and some did nor invest at all. Their investors will start to lose patience over the next few years as funds reach the end of their terms and exits remain elusive.

"In fact, only three per cent of the aggregate capital across all funds raised from 2000 to 2010 is under liquidation, representing only 15 funds, or about 11 per cent of the total number of funds," says Peter Vayanos, partner, Booz.

The opportunities for those that remain will be substantial, brought on primarily by two factors: sound long-term fundamentals and a management void to fill.

The Middle East has a young and promising population that with increasing wealth and increased political stability could constitute a major driver for economic growth and increased demand for products and services.

"A survey of 46 PE professionals conducted by Booz & Company and Insead in April 2010 confirmed that 73 per cent of industry leaders will be looking to tap this demand over the next five years through direct investments in compa­nies," says Vayanos.

Family-owned businesses, which play an extremely important role in the Middle East’s economies, offer an equally sizable opportunity for PE firms. The "restless entrepreneurs" who have run many of these family-owned businesses for the past few decades are giving way to a rising second or third generation of family members who see the need to develop more focused strategies and more professional management approaches. In the years ahead, these businesses will look to divest some of their scattered holdings, scale up the businesses they retain, and seek to improve their overall performance. To do so, they need to acquire good management capabilities with a breadth of strategic, financial, and operational knowledge, a scarce resource in the region.

"The size of the opportunity is evident from the role that these compa­nies play in GCC economies: They account for roughly 40 per cent of the region’s non-oil GDP and 50 percent of private sector employment," says Ahmed Youssef, partner, Booz.

Investors looking to participate in the Middle East’s next stage of growth will still need to be cautious: The region’s heady growth over the last decade worked to cover up some critical weaknesses in the PE industry. As these weaknesses come into full view, investors will need to trust that they will be addressed.

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