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Opportunity in Troubled Times

Global markets may be facing recession but the fact is that the long-term outlook for the Middle East and North Africa (MENA) region in general — and Egypt in particular — is very positive.

In large part, this positive outlook is a result of changes the region has witnessed since the events of September 11, 2001, which helped lay the groundwork for where we now stand. As Arab investors were no longer welcome in the West, billions flowed into the MENA region. There was US$ 18 billion in intra-regional investment in 2006, more than 70% of it from the Gulf into non-oil countries such as Egypt.

Of course, the region has seen significant inflows of capital in the past. What’s different this time around is that MENA countries are working hard to channel oil wealth into the development of non-petroleum sectors, encourage private-sector participation in the economy and attract new, non-oil foreign direct investment.

Meanwhile, MENA equities markets have boomed, adding US$ 550 billion in new value — even after we take into consideration the market slump. The key here is that with 315 million inhabitants and over 1.4 trillion dollars in aggregate GDP, the MENA region is the world’s tenth-largest economic bloc — and growing. Even faced with the current global slump, it is still fair to expect positive regional GDP growth above 3%. That is be a far cry from the 7% or more we expected just a few months ago, but it does not even compare to forecasts of recessions in Western markets.

In addition to these very visible macro changes, there are a number of more subtle — but equally important — factors that are reshaping the Arab private equity landscape. To start with, MENA states are loosening their once very-tight economic controls to open new industries to private participation. At the same time, they are also easing regulation of the private sector and reducing market-distorting subsidies, thereby encouraging private-sector growth. A significantly improved legal framework across the region has helped, as have larger, more experienced professional services firms and investment banks, which are providing valuable support to the growth of private equity. Finally, limited personal income tax and low or no capital gains taxes are helping the private sector provide outsized rewards for success. This has made the region a magnet for the best management talent in the world at both the private equity and platform company levels.

However, our industry does face several challenges that may slow our deal pace and see us exercise particular caution as bargains start appearing in the coming period.

To start with, there is the simple fact that investors around the globe have become increasingly cautious. The plunge in BRIC [Brazil, India, Russia and China] and MENA equity markets has eroded the belief that emerging markets are decoupled from the global economy. Equally obvious is that debt markets are frozen. Foreign banks are not lending, and the majority of regional banks are adopting a “wait and see” approach despite (in many cases) having excess liquidity.

However, after suffering through the worst of the financial crisis, Arab money is likely to be more willing to invest in the region in the near term than foreign capital will be.

The private equity industry will likely see five phases over the medium to long term.

In phase one, private equity firms will take a critical look at their existing portfolios, postponing certain investments at the platform-company level and phasing out other investments, all to accommodate the new realities of a global slowdown. They will also need to make sure that the business plans of their companies continue to be fully funded — under these circumstances, nothing is worse than an unfunded business plan. Moreover, private equity firms will look critically at the management teams of their platform companies, complementing existing staff with international talent as a large pool of managers becomes available over the next period.

In phase two, probably six to nine months from now, distressed assets will start appearing. Nibbling at those investments may become the order of the day, and turnarounds will be prevalent. Many distressed assets will be on the market over the next three years.

Phase three will be marked by consolidation plays. With many of the top companies in the region being de facto family businesses, few large assets will be for sale, particularly to control investors. Large numbers of smaller businesses will be available, placing more emphasis on consolidations as we must create large assets of our own.

In a climate in which under-valued assets are being pursued by fewer and fewer bidders, regional gover nments are likely to place their privatization programs on hold for the next year or two. In phase four, starting two to three years from now, privatization will reappear as part of the investment menu.

Although greenfields remain an option in this region, the depressed prices of existing businesses will cause greenfields to recede in importance.

In the fifth phase, finally, we will see exits. The only thing more rewarding than raising money is giving super returns to one’s investors.

Ahmed Heikal is Chairman and Founder of Citadel Capital, a Cairo-based private equity firm whose 19 Opportunity-Specific Funds control platform companies with investments worth more than US$ 8.3 billion in sectors ranging from energy and agrifoods to transportation and logistics.