Islamic Private Equity

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Islamic Private Equity
Arab Economic Forum
By Khaled Hassan Rashed
May 2006
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Private equity provides long-term, committed
share capital, to help private (unlisted)
companies to grow and succeed. It can be used to
develop new products and technologies, to expand
working capital, to make acquisitions or to
strengthen a companys balance sheet.
What is Private Equity (PE)?

• Investments in unquoted companies
• Equity Capital by nature
• Targeted at companies with growth potential
• Medium to long term investment

• Buyouts
• Venture Capital
• Growth Capital
• Angel Investing
• Mezzanine Capital

Key Elements
Categories
Private equity investment helps in nurturing
young companies throughout various stages of
growth as per the diagram below
Source Abraaj Capital Analysis
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PE Has Outperformed the Other Asset Classes Over
the Last 20 Years

• The current regional PE industry size is less
  than USD 2.0 billion
• The regional allocation to PE ranges from 0-5
  with only a fraction in the region.

Current Industry Size

• Investors can achieve supernormal returns on
  their PE investment in the region.

Value for investors

• Investors should choose funds with a credible
  performance track record and a strong management
  team.

Choice of Fund
First Quartile PE firms have consistently and
significantly outperformed the US large stocks
for 20 years
Source Venture Economics
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Private Equity Value Chain
Screening Selection
Deal Sourcing
Investor Relations
Exit
Portfolio Management
Structuring Execution
Core Skills

• Industry expertise and credibility
• Networking
• Communication presentation
• Trust building
• Responsiveness

• Industry analysis
• Market intelligence
• Contact management

• Data gathering
• Structured problem solving
• Communication
• Industry analysis
• Company analysis
• Financial analysis modeling
• Process management

• Organization corporate governance
• Process operations
• Management accounting

• Legal structuring
• Financial structuring
• Documentation
• Process management

• Legal structuring
• Organizational structuring
• Financial structuring
• Documentation
• Process management

Sources Start Consult Analysis
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Potential for Private Equity value creation
Opportunity
Levers
Low degree of intervention

• Leverage management incentive systems and
  influence through board representation to create
  value in portfolio company

• Across industries, owner-driven companies with
  strong but non-incentivised management

Passive ownership

• Acquire under-valued company to generate value
  through leverage as well as arbitrage between
  entry and exit multiples

• Companies with potential strategic buyers
• Industries with stable cash flows and heavy assets

Financial engineering/leverage

• Create arbitrage by divesting separate divisions
  of conglomerate to distinct strategic buyers and
  reducing the conglomerate discount

• Expat-owned mid-sized conglomerates due to higher
  trader mentality and financial pressures

Financial engineering/conglomerate break-up

• Improve market value through new strategic focus,
  re-branding and improving key operational levers

• Companies with under-utilized products and/or
  strong market position across industries

Strategic re-positioning of single company

• Acquire platform company and expand/diversify by
  acquiring similar companies through leveraged
  build-up

• Most industries with private ownership fragmented
  
• Focus on high potential company to serve as
  platform

Consolidation through bolt-on acquisitions
High degree of intervention required
Source Abraaj Capital Analysis
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Sharia Principles The diagram below illustrates
the Sharia principles guiding investments
Islamic Private Equity
Investments in financial services, tobacco,
breweries and cinemas are examples of non
acceptable industries to investment in according
to Sharia ethical guidelines.
Source Abraaj Capital Analysis
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Islamic Finance has slowly ventured into the
Private Equity industry despite the significant
growth in the industry as a whole.
Islamic Finance Private Equity Industry
- Islamic financial institutions worldwide has
risen from 1 in 1975 to over 300 in more than 75
countries. - Total assets and financial
investments of the worlds Islamic banks are
estimated to stand at US 262 billion and over
US 400 billion respectively. They are estimated
to grow at a rate of 15 annually over the coming
years. - The Islamic equity funds worldwide
total assets is currently estimated over US 5
billion and is growing at rate of 12-15
annually.
 
Growth in Number of Islamic Funds
The Islamic Space is still missing out on several
high return areas due to limitations that can
easily be overcome by creative structuring and
innovation. PE is one such area.
Source www.failaka.com , Abraaj Research
Database Zawya
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Islamic Banking Assets Global Sukuk
Total Global Islamic Banking Assets - (US
billion)
Islamic Banking Assets in GCC - (US billion)
CAGR 18
CAGR 38
Global Sukuk Issuances - (US billion)
Islamic Debt by Country (Feb 05-Feb 06) - (US
million)
CAGR 129
Source Islamic Finance News Feb 2006, Mckinsey,
EY
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Private Equity is a natural fit for Islamic
Investments
Islamic PE Concept
Natural Fit
PE Concept
Equity Investment
Equity Investment
Partnership- shared risk reward
Musharaka- shared risk reward
Alignment of Interests
Alignment of Interests
Long Term Value
Long Term Value
All Industries
Sharia Compliant Industries
Favorable
Unfavorable
Source Abraaj Capital Analysis
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The Fund Structure
The private equity Islamic private equity fund
structure are essentially the same, however the
Islamic PE funds will be Sharia complaint such
as type of investments, industry, etc.
Limited Partner
PE Firm

Mgmt. Agreement
Mgmt. Fees, Carried Interest
Partnership (the Fund)
- closed-end fund with a finite life
Screening Due Diligence Post Acquisition Mgmt Exit
Investments
Source Abraaj Capital Analysis
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Islamic Private Equity Value Proposition
Islamic investors should apply the model of
private equity firms whose strategy evolves
around taking majority stakes in privately held
companies engaged in the real economy. This will
enable them to maintain control, which ensures
the companys adherence to Sharia principles.
Better value proposition compared to other
assets classes in terms of
Value Proposition

• Performance

• Diversification

• Higher long term returns

• Price stability

• Lucrative investment opportunities

• Sharing risks rewards

Source Abraaj Capital Analysis
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Islamic Private Equity Issues
Governed by Sharia principles, the parameters
set for Islamic Private Equity investors will
cause

• Increase in research costs compared to
  conventional counterparts.

Islamic PE Issues

• Specialized skill set needed to screen,
  evaluate, negotiate, execute, manage and create
  value, sourcing commercially viable deals that
  are Sharia compliant and structuring them
  accordingly is a very exhaustive task.

• Holding a majority control in companies to
  ensure their compliance to Sharia principles on
  a continuous basis and maintaining a
  diversified portfolio become a challenge for
  Islamic investors with small amounts of capital
  to invest.

To address the issues above, the concept of
creating Islamic Investment Funds was cleared in
accordance with the definition and parameters set
by the Accounting and Auditing Organization of
the Islamic Financial Institutions.
Source Abraaj Capital Analysis
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Marketing challenges faced by Islamic Funds
Perception
Client Education Spread of Awareness by
Scholars

• Perceived to be restricted to Muslims
• Viewed as a complex form of conventional finance
• Regarded as Emotional Behavior
• Perceived to yield lower returns
• Association with Terrorism

Breadth of Products

• The number of Islamic products and innovative
  Islamic structures is very limited compared to
  conventional products.

Innovation

• Islamic product providers charge premiums due to
  the added complexity of structures, added layers
  of screening, higher research costs and scarcity
  of products.

Competitive Fee structures
Fee Structure
Distribution Channels

• Direct marketing efforts are lacking and the
  industry is dependent on a pull strategy.

Push Strategy
Source Abraaj Capital Analysis
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Investment challenges faced by Islamic Funds
Lack of Information

• Research originated by Islamic product providers
  is very scarce and updated industry data is very
  difficult to find.

In house research, research houses
Training focus on top talent recruitment
Human Capital

• Theres a limited pool of skilled talent in the
  industry due to limited education.

Structures

• Acquisition finance and mezzanine instruments are
  not available.

Limited investment opportunities

• The pool of available investments is limited by
  Shariáh screening requirements.

Innovative structuring
Control

• Due to the requirements of ongoing Shariáh
  compliance monitoring, a majority stake is
  mandatory, further limiting investment
  opportunities.

Source Abraaj Capital Analysis
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Regional Private Equity Opportunity..
Opportunity
Comments
Key Segment

• Groups may divest their business due to
  generational issues, strategic focus or to
  diversify shareholder base. PE groups can provide
  them with viable exits with minimum risk to the
  reputation of the family. In addition, PE groups
  can resolve succession and ego issues

Family Groups
Divestment

• Groups could also partner with PE funds to
  benefit from their value creation discipline,
  corporate governance, compliance, etc

Partnerships

• Companies may sell their non-core business for
  strategic reasons such as concentration on core
  businesses or region

Corporate Refocus
Multinationals

• Alternatively they may need to sell part of or
  all their business for financial reasons or to
  raise capital for organic and acquisitive growth

Distressed Sale

• Fragmented nature of industries and regulatory
  changes such as WTO and GATT are likely to fuel
  consolidation

Consolidation
Small/Medium Enterprises (SMEs)

• Credible management looking for opportunities to
  own a stake in their business

Management Buy-outs

• A number of industries are affected by
  liberalization and lowering of entry and exit
  barriers which provide investment opportunity

Sector Liberalization
Sector Liberalization/ Privatization

• There is a paradigm shift in the mindset of
  regional governments from an ownership role
  towards regulatory role to promote the
  privatization of state-owned enterprises to
  attract foreign investment, greater efficiencies
  and higher returns

Privatization
Source Abraaj Capital Analysis
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Main sectors that offer substantial value
creation potential
Sector
Opportunities

• High growth due to low historical penetration and
  lowered pricing
• Availability of privatisation and acquisition
  targets with strong brands and significant market
  share

Telecom

• Directories businesses among the most successful
  business models worldwide
• Regional market is underdeveloped and has
  potential for significant growth and value
  extraction

Print Media

• Financial Planning slated for high growth, driven
  by mature investor base and rapidly increasing
  demand for FP products. Exchange houses
  presenting another opportunity

Financial Services

• Large sector with approximately US 3 billion
  premium revenues in GCC alone, with growth rates
  over 5 per annum across the region

Insurance

• India, a major supplier of bulk drugs worldwide
  has various consolidation and pre-IPO
  opportunities.
• Growth opportunities for small ME companies
  particularly in Jordan, UAE and Saudi Arabia

Pharmaceuticals
Power Energy

• Privatization of power assets and new IPP
  projects currently in progress in a number of
  countries including Jordan, Algeria, Oman and
  Pakistan

Source Abraaj Capital Analysis
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Thank You