Islamic Private Equity
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Islamic Private Equity. Arab Economic Forum. By: Khaled Hassan Rashed. May 2006. What is Private Equity (PE)? .

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Islamic private equity

Islamic Private Equity

Arab Economic Forum

By: Khaled Hassan Rashed

May 2006


Islamic private equity

What is Private Equity (PE)?

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.

  • 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


Islamic private equity

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


Islamic private equity

Private Equity Value Chain

Investor

Relations

Deal

Sourcing

Screening

& Selection

Structuring

& Execution

Portfolio

Management

Exit

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

  • Legal structuring

  • Organizational structuring

  • Financial structuring

  • Documentation

  • Process management

  • Organization & corporate governance

  • Process & operations

  • Management accounting

  • Legal structuring

  • Financial structuring

  • Documentation

  • Process management

Sources: Start Consult Analysis


Islamic private equity

Potential for Private Equity value creation

Levers

Opportunity

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

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

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

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


Shari a principles the diagram below illustrates the shari a principles guiding investments

Islamic Private Equity

Shari’a Principles: The diagram below illustrates the Shari’a principles guiding investments:

* 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


Islamic private equity

Islamic Finance & Private Equity Industry

Islamic Finance has slowly ventured into the Private Equity industry despite the significant growth in the industry as a whole.

- 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 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


Islamic private equity

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, E&Y


Islamic private equity

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

Shari’a Compliant Industries

Favorable

Unfavorable

Source: Abraaj Capital Analysis


Islamic private equity

Islamic Private Equity Value Chain

Investor

Relations

Deal

Sourcing

Screening

& Selection

Structuring

& Execution

Portfolio

Management

Exit

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

  • Legal structuring

  • Organizational structuring

  • Financial structuring

  • Documentation

  • Process management

  • Organization & corporate governance

  • Process & operations

  • Management accounting

  • Legal structuring

  • Financial structuring

  • Documentation

  • Process management

Adhering to Shari’a Principles

Sources: Start Consult Analysis


Islamic private equity

The Fund Structure

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.

  • PE Firm

  • Limited Partner

$$

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


Islamic private equity

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


Islamic private equity

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


Islamic private equity

Marketing challenges faced by Islamic Funds

Perception

  • 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

Client Education

& Spread of

Awareness

by Scholars

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


Islamic private equity

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

  • There’s 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


Islamic private equity

Regional Private Equity Opportunity..

Key Segment

Opportunity

Comments

  • 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

Multinationals

Corporate Refocus

  • 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

Small/Medium Enterprises

(SMEs)

Consolidation

  • 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/

Privatization

Sector Liberalization

  • 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


Islamic private equity

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


Islamic private equity

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