Alkhabeer Capital assesses opportunities and challenges for private equity in Saudi Arabia

Alkhabeer Capital has today announced the launch of a research report which studies the investing landscape in Saudi Arabia and the attractiveness of the Kingdom’s economy to regional and international Private Equity players.  

“In recent years, market reforms initiated by the government, a growing youth population and the uptrend in investment cycles in the Kingdom have been very supportive of PE investments and fund inflows into the Kingdom. However, investing in the largest GCC economy worth $750 billion in GDP does not come without challenges.

“In 2013, Saudi Arabia ranked the lowest in the GCC on its economic activity, depth of capital market, investor protection laws, corporate governance and entrepreneurial opportunities.

These factors put the Kingdom in the 26^th place amongst 118 countries as the most attractive to PEs and VCs within the GCC; with Kuwait in the 61^stplace, ranking as the least attractive.

“Saudi Arabia has consistently outpaced global growth at an average of 5.5 per cent for the last 5 years; a growth rate which is higher than that of MENA and the GCC. This growth is primarily driven by the large infrastructure investments initiated by the government and the non-oil sector contribution.

“Additionally, the political stability of the Kingdom which was largely unaffected by the Arab Spring, made the Kingdom a safe haven for international investors with foreign assets worth $717 billion as of 2013.

“Alkhabeer points out that the youth in Saudi which make up 50 per cent of the total population, which is growing at a rate higher than the global average, presents a great potential for the growth of the consumption-led sector. Investors are willing to invest at higher valuations if the proposition and supporting factors are right. A successful example is Abraaj and TPG’s acquisition of fast food chain Kudu, at an earnings multiple of close to 20X.

“A successful story in the manufacturing sector is GE and the Saudi Industrial Property Authority which announced setting up a facility in Industrial City in Dammam; part of a $1 billion plan to create jobs for the Kingdom.

“The GCC education sector, valued at an estimated $36 billion, is receiving heightened interest from Saudi investors and is being endorsed by the Saudi Education minister who recently approved a $22 billion 5-year plan to build 1,500 nurseries and train 25,000 teachers, in addition to establishing educational centers to improve the education levels in Saudi and drive job creation.

Healthcare also receives significant investments from the government driven by a rising population and growth in lifestyle-related diseases.

Evident is the oversubscribed Al Hammadi Company IPO.

“Lending to SMEs and family owned businesses in the Kingdom stands at two per cent compared to a global average of 20 per cent.

This is a very good opportunity for the PE funds to tap into this engine of growth which contributes almost 12.8 per cent of the Kingdom’s GDP.

“The investment cycle in Saudi is on the upturn and many funds seem to have good traction in fund raising. In thesix months through June 2014, Saudi Arabian companies raised $760 million through share sales. Examples are:

• Jadwa’s exit from Abdul Mohsen Al Hokair Group for Toursim through an IPO which was oversubscribed by 11.9 times.
• Carlyle Group’s sale of 30 per cent stake in General Lighting Company to Royal Phillips.
• NBK Capital’s sale of 38 per cent stake in Nayifat Instalment Company to Falcom Financial Services.

“The government’s economic and regulatory reforms will help in bringing in much needed funds.

As part of these efforts, the CMA recently approved the opening up of the Saudi Stock Market to Foreign Institutional Investors which is expected to promote transparency, corporate governance and better reporting systems to attract PE investments.

“Alkhabeer suggests that several challenges need to be overcome to support a stronger investment environment in the Kingdom. Challenges consist of regulatory delays, legal and corporate governance issues, dispute resolution procedures, lack of protection of minority shareholders, resistance to non-family control and unrealistic valuations.

“When it comes to generating healthy deal flows, the investor and the investee have to keep in mind some key winning considerations such as; understanding the social setting and the business culture in Saudi Arabia, strengthening aspects of corporate governance such as succession planning which addresses the sensitive issue of ownership rights.

PE partnerships depend on value creation and positioning the company for future growth and profitability, therefore, a successful PE investment in a company must have a pre-decided exit strategy to avoid conflict, and a stipulated lock in period for 2-3 years to ensure management does not lose interest in the venture.

Finally, families could incorporate an exit clause that allows them to buy back the investor’s stake to mitigate the risk of losing the controlling stake.

“Alkhabeer concludes the report by confirming that the kingdom is largely becoming a very attractive private equity destination with various promising investment propositions.

The encouraging performance, favorable macroeconomic activity and government initiatives to expand the non-oil sector supported by a young and active population are major factors driving PE investments in the Kingdom.

PE investors, however, should be aware of the unique local market and the cultural aspects of doing business and building relationships.

The opening of the market to foreign investors is definitely a step in the right direction but there are several challenges that need to be addressed.”