Islamic Private Equity
Arab Economic Forum
May 2006
By: Khaled Hassan Rashed
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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 company’s balance sheet.
What is Private Equity (PE)?
Key Elements
Investments in unquoted companies
Equity Capital by nature Targeted at companies with
growth potential Medium to long term investment
Categories
Buyouts Venture Capital Growth Capital
Angel Investing Mezzanine Capital
Source: Abraaj Capital Analysis
Exit
Consolidation
Maturity
Expansion
Early Stage
Buyout
Venture Capital
Private equity investment helps in nurturing young companies throughout various stages of growth as per the diagram below:
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PE Has Outperformed the Other Asset Classes Over the Last 20 Years
Current Industry Size
• 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.
Value for investors
• Investors can achieve supernormal returns on their PE investment in the region.
Choice of Fund • Investors should choose funds with a credible performance track record and a strong management team.
0
10
20
30
40
50
60
70
80
901st Quartile Venture
1st Quartile Buyouts
US Large Stocks
First Quartile PE firms have consistently and significantly outperformed the US large
stocks for 20 years
Source: Venture Economics
4Sources: Start Consult Analysis
Screening & Selection
Deal Sourcing
Investor Relations
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
Private Equity Value Chain
Exit Portfolio Management
Legal structuring
Financial structuring
Documentation
Process management
Structuring & Execution
Legal structuring
Organizational structuring
Financial structuring
Documentation
Process management
Core Skills
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Potential for Private Equity value creation
Low degree of
intervention
High degree of
intervention required
Passive ownership
Financial engineering/leverage
Financial engineering/conglomerate break-up
Strategic re-positioning of single company
Consolidation through ‘bolt-on’ acquisitions
• 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
• 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
• 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
• 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
• 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
OpportunityLevers
Source: Abraaj Capital Analysis
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Islamic Private EquityShari’a Principles: The diagram below illustrates the Shari’a principles guiding investments:
Musharaka-shared risk &
reward
Real goods & services
Non speculative
Ethical*
33% leveragecap
Interest free
Alignment ofinterests
Equity investment
The Principles
* Investments in financial services, tobacco, breweries and cinemas are examples of non acceptable industries to investment in according to Shari’a ethical guidelines.
Source: Abraaj Capital Analysis
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020406080
100120140160180
<19941994 1995 1996 1997 1998 1999 2000 2001 Feb.2006
- Islamic financial institutions worldwide has risen from 1 in 1975 to over 300 in more than 75 countries. - 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 world’s Islamic banks are estimated to stand at US$ 262 billion and - Total assets and financial investments of the world’s 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. over US$ 400 billion respectively. They are estimated to grow at a rate of 15% annually over the coming years. - The Islamic equity- The Islamic equity funds worldwide total assets is currently estimated over US$ 5 billion and is growing at rate of funds worldwide total assets is currently estimated over US$ 5 billion and is growing at rate of
12-15% annually.12-15% annually.
Source: www.failaka.com , Abraaj Research Database & Zawya
Growth in Number of Islamic FundsGrowth in Number of Islamic Funds
Islamic Finance has slowly ventured into the Private Equity industry despite the significant growth in the industry as a whole.
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.
Islamic Finance & Private Equity Industry
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Islamic Banking Assets & Global Sukuk
Total Global Islamic Banking Assets - (US$ billion)
80
190
262
500
1996 2000 2003 2005
CAGR 38%
Islamic Banking Assets in GCC - (US$ billion)
33
38
46
2002 2003 2004
CAGR 18%
Global Sukuk Issuances - (US$ billion)
2
7
10
8
2003 2004 2005 YTD 2006
CAGR 129%
Islamic Debt by Country (Feb 05-Feb 06) - (US$ million)
61 80 134 200500
42504710
Source: Islamic Finance News Feb 2006, Mckinsey, E&Y
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Private Equity is a natural fit for Islamic Investments
Source: Abraaj Capital Analysis
All Industries
Equity Investment
PE Concept
Partnership- shared risk & reward
Long Term Value
Alignment of Interests
Islamic PE Concept
Shari’a Compliant Industries
Equity Investment
Musharaka- shared risk & reward
Long Term Value
Alignment of Interests
Favorable
Unfavorable
Natural Fit
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Sources: Start Consult Analysis
Screening & Selection
Deal Sourcing
Investor Relations
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
Islamic Private Equity Value Chain
Exit Portfolio Management
Legal structuring
Financial structuring
Documentation
Process management
Structuring & Execution
Legal structuring
Organizational structuring
Financial structuring
Documentation
Process management
Core Skills
Adhering to Shari’a Principles
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The Fund Structure
Limited PartnerPE Firm
Partnership(the Fund)
Investments
$$$$
Mgmt. Agreement
Mgmt. Agreement
Mgmt. Fees, Carried Interest - closed-end fund with a finite life ScreeningScreeningDue DiligenceDue Diligence
Post Acquisition MgmtPost Acquisition MgmtExitExit
Source: Abraaj Capital Analysis
The private equity & Islamic private equity fund structure are essentially the same, however the Islamic PE funds will be Shari’a complaint such as type of investments, industry, etc.
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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 company’s adherence to Shari’a 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 Shari’a 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 Shari’a compliant and structuring them
accordingly is a very exhaustive task.
• Holding a majority control in companies to ensure their compliance to Shari’a 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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Perception
Breadth of Products
Fee Structure
Distribution Channels
Marketing challenges faced by Islamic Funds
The number of Islamic products and innovative Islamic structures is very limited compared to conventional products.
Islamic product providers charge premiums due to the added complexity of structures, added layers of screening, higher research costs and scarcity of products.
Direct marketing efforts are lacking and the industry is dependent on a pull strategy.
Client Education & Spread of Awareness by Scholars
Innovation
Competitive Fee structures
Push Strategy
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
Source: Abraaj Capital Analysis
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Lack of Information
Human Capital
Structures
Limited investment opportunities
Control
Investment challenges faced by Islamic Funds
Research originated by Islamic product providers is very scarce and updated industry data is very difficult to find.
There’s a limited pool of skilled talent in the industry due to limited education.
Acquisition finance and mezzanine instruments are not available.
The pool of available investments is limited by Shariáh screening requirements.
In house research,In house research,research housesresearch houses
Training &Training &focus on top focus on top
talent recruitmenttalent recruitment
Innovative Innovative structuringstructuring
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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Opportunity CommentsKey Segment
Divestment
Partnerships
Family Groups
• 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
• Groups could also partner with PE funds to benefit from their value creation discipline, corporate governance, compliance, etc
Corporate Refocus
Distressed Sale
Multinationals
• Companies may sell their non-core business for strategic reasons such as concentration on core businesses or region
• Alternatively they may need to sell part of or all their business for financial reasons or to raise capital for organic and acquisitive growth
Sector Liberalization
Privatization
Sector Liberalization/Privatization
• A number of industries are affected by liberalization and lowering of entry and exit barriers which provide investment opportunity
• 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
ConsolidationSmall/Medium Enterprises (SMEs)
• Fragmented nature of industries and regulatory changes such as WTO and GATT are likely to fuel consolidation
• Credible management looking for opportunities to own a stake in their businessManagement
Buy-outs
Regional Private Equity Opportunity..
Source: Abraaj Capital Analysis
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Sector Opportunities
Power & Energy
Print Media
Financial Services
Insurance
Pharmaceuticals
Privatization of power assets and new IPP projects currently in progress in a number of countries including Jordan, Algeria, Oman and Pakistan
Directories businesses among the most successful business models worldwide
Regional market is underdeveloped and has potential for significant growth and value extraction
Financial Planning slated for high growth, driven by mature investor base and rapidly increasing demand for FP products. Exchange houses presenting another opportunity
Large sector with approximately US$ 3 billion premium revenues in GCC alone, with growth rates over 5% per annum across the region
High growth due to low historical penetration and lowered pricing
Availability of privatisation and acquisition targets with strong brands and significant market share
Telecom
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
Main sectors that offer substantial value creation potential
Source: Abraaj Capital Analysis
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Thank You