Chasing Growth in all the Wrong Places by Fawaz Halazon

Chasing Growth in all the Wrong Places by Fawaz Halazon

As the global financial system has seen the very principles on which it has been based tested to the core, the question of what the future holds for the global economy and financial industry has become a permanent feature in every social, media or casual discussion. The one thing that most will agree on is that the world today is a very different place than it was only a few months ago, with dried up global liquidity, negative economic growth, failed 20thcentury corporate icons, and looming government debts threatening the very stability and existence of various countries.

As money presses in the US are working overtime, rushing to create the largest US deficit in history (by a long shot), and banks and automakers failures becoming regular cover stories in weekly magazines, the US is fast heading towards its deepest and harshest crisis since the Great Depression of the early 30’s. With a new administration inheriting a global mess, and interest rates flirting with zero, chances of a swift jump-start to the economy is less than dismal at best. In response to the enormous change of the investment climate the global stock markets have sunk across the board, with the US retreating a whopping 40%+ so far this year prompting market bulls (facing job and asset loss) to pound the tables suggesting valuations are looking ‘screaming buys’, arguing that in times like this, investors stand to make the 5 and 8 baggers (multiples). I beg to differ.

As markets act as leading indicators to future economic realities, and as such, telling us we are heading for a very difficult time, it is times like these where caution should be the only rule to live by. Low visibility, coupled with high volatility and implied risk takes away the lure of any investment in the major developed public markets over the short and medium term, with risk of loss being significantly higher than that of any potential gain. The direction of the markets during the next few years is anyone’s guess, with the only certain fact being that there will be ferocious swings that are likely to punish any daring investor on the wrong side of the fence, and spare only the most accurate of fortune tellers (Having said that, developed markets-though very risky in the short and medium term-do present investors with long term value for those willing to sit out at least 5-7 years to recovery).

The tsunami-like intensity of the meltdown of the western financial system will add to the time to recovery and will put an enormous  burden on its budget to continue injecting liquidity that regulators believe will eventually help soften the landing (correctly) and speed the economic recovery (unlikely). The reality is, and with Obama’s new administration, the US government will likely accelerate their printing program significantly in an effort to inject large liquidity in the system to stave off a full-blown depression. As a result of large scale money supply  increases, along with continued government support (bailout) of ailing corporates, relief rallies will briefly cap investor’s anxiety, giving them a glimpse of hope that will shortly be overshadowed by huge reversals of fortunes under the grip of the market bear {A case in point is Japan in the early 90’s, where the effect of pumping in cash into the economy was negligible, giving the stock markets spurts of short term strength, only to disappear shortly thereafter, noting that the Nikkei today stands lower than its 1989 post-crash levels.

According to famous Nomura analyst Richard Koo in the mid-1990’s, the problem in Japan was the lack of investment opportunities and the need for deregulation, so even if interest rates were near zero, consumers had no incentive to borrow simply because there were no opportunities to invest.  After more than a decade, Japan still suffers the same problem with limited impact from flat interest rates on the growth of the economy (Japan’s nominal GDP growth was 1.7% in FY 2006, 0.6% in FY 2007 and -1.7% in H1 2008 –source JMC K.K. Japan Management Consulting). In addition, government restrictions on the post office savings –among the highest savings in Japan- to be invested in overseas securities had been limited as was the case for many other institutions which were previously limited to investing at least 2/3 of their assets in Japanese equities or Japanese government bonds (JGBs) which in turn drove yields to among the lowest in the world. Until recently, monetary policy has worked in the US but not in Japan}.

The regulators and the new administration will find out in due course that the intensity of such a meltdown does not have any quick fix solutions (something they probably already know), and that even though their monetary policy will help cushion the blow, the economy will have to work off its excess the old fashioned way with time, by making businesses leaner and reducing their level of debt (estimated at $10.6 trillion as of Nov. 2008 –source Wikipedia), narrowing down the budget deficit, improving regulations, encouraging invention and boosting industry and exports (the latter being one of the main contributors to what made post-WWII-America a global super power).

In the last few years, as the developed world witnessed unparalleled liquidity and mergers and acquisitions activity, much of that liquidity spilled over to the BRIC and GCC regions. This global shift from the western economies towards the new ones gave an ever larger role to the emerging economies which witnessed unprecedented growth in their industrial, services and FDI. This led the emerging regions to economic diversification and attracted some of the world’s best talent in a wide range of economic sectors. As the credit crisis propagated further with its formal debut with the collapse of Lehman Brothers, many western businesses accelerated their emerging market build-out, especially in the GCC region, making an already flourishing market even more attractive for the world’s business community.
Today, the GCC economies stand in a strong position, with very large cash surpluses in their SWF’s vaults, and strategic government initiatives racing ahead to achieve their 10, 20 and 30 year economic plans targeting long-term revenue diversification from oil dependence. Some of the sectors that have witnessed uninterrupted growth are in infrastructure, construction and related services and oil and gas.

The GCC real estate sector, on the other hand, is a slightly different story. As commercial and residential prices spiralled to astronomical levels, and the affordability of housing and offices became scarce, the Gulf’s once competitive advantage seemed to dissipate only a few short months ago. Then in September 2008 real estate prices began to precipitously decline, to the dismay of most, where markets started flushing themselves out from the speculators that drove up the markets to unsustainable levels. Though many enjoyed triple digit returns on their equity investments over the last few years, most got caught up in the recent global tidal mood change towards this sector. The GCC is likely to be in its early stages of price declines, as the cycle of consumer defaults spills over to developers then to contractors, and eventually to regional banks. This process of real estate de-coupling, along with what some expect to be an artificial speculative downward spike in oil prices from current levels will likely cause an acute real estate correction sometime in the first quarter of 2009, possibly climaxing in the summer/spring of 2009, when the dust will likely begin to settle and real value will begin to re-emerge. An especially strong rebound in real estate prices in established cities like Dubai and Abu Dhabi is likely in the next 12 to 24 months, as they have both made gigantic steps to becoming the region’s foremost financial and cultural hubs, as well as being one of the few global bright spots with sound economic fundamentals. Other countries like Qatar, Saudi Arabia and Bahrain have also played a major role in the region and are also expected to continue to attract investment capital to this and other sectors. Accordingly, with the US and Europe in a potential multi-year slump, and the GCC in a likely 1 to 2 year recovery track, where does one find growth for investment capital?

From an investment point of view, Equity-i views Africa as a fantastic alternative. With a population of 964 million, a combined GDP of US$ 970 billion, and with an accelerating GDP growth in 2008 of 5.9%, Africa presents great potential. The FDI had accelerated from $17 billion in 2004 to $50 billion today and expected to rise to $80 billion in the next few years. In addition, declining net debt service/GDP in 2008 was less than 8%, with balance of payments steadily improving (Trade Balance: +US$14 bn, Fiscal Balance: +US$7 billion). The political environment has also markedly improved (a case in point is Ghana’s current democratic and transparent presidential elections), with institutional stability measuring high on the historical scale. Stock markets have also been top performers in 2007 and 2008, with very limited correlation to the sub-prime meltdown.

Private equity managers and global corporations are increasingly looking towards Africa as a preferred investment destination, as exits had significantly increased with improved IPO’s and M&A activity. Bankers and corporations view investment risk in Africa now at par with Asia. In a survey by March, Mercer, Kroll and the Economist Intelligence Unit where 1,000 companies that were planning emerging markets M&A in 2008 from North America, Europe, Latin America Asia, and Africa, Africa came out on par with China, India and Southeast Asia. The risk associated to M&A in Africa came on par with the perceived risk of making acquisitions by Chinese, Indian, and Russian respondents in Africa. As in the case of Russia in the later 1990s, India in the early 1990s and Latin America in the mid-1980s, which later translated into a strong growth trajectory, Africa has experienced significant improvement in the strengthening of democratic processes and the deepening of institutional governance capacities were these precursors will also likely change their respective growth trajectories. Greater stability and predictability in the resulting macro-economic and policy outlook will enable firms operating in Africa to better implement their capital budgeting and strategic plans.

Africa has quietly been making steady progress toward sustainable and comparable growth. Encompassing some of the poorest nations in the world, it is surprisingly wealthier across the continent than India. The average gross national income (GNI) per capita across all 53 African nations in 2005 was about $954, more than $200 higher than India’s. 12 African nations (with 100 million people among them) out of 53 had a GNI per capita that was greater than China’s. Twenty nations (with a combined population of 263million) had a GNI per capita that was greater than India’s. That concentration of wealth represents a huge potential market for private equity and private investors. (Sources: The Wealth of African Nations, Vijay Mahajan, 2007)..

Though corruption remains a persistent problem throughout the African continent, significant change has been undertaken in many of the largest countries, including South Africa, Nigeria and Egypt. Local and regional legal authorities have been empowered to investigate and to convict which has begun to have marked success in countries like South Africa, Nigeria, and Botswana.
China and India have also been playing a huge role in the development of Africa as it enjoys among the world’s greatest reserves of raw material. Africa’s exports to China has risen 56% per annum since 2000. It is forecast that trade between China and Africa would reach $100bn before 2010 which would have China overtake the US and Europe as sub-Saharan Africa’s foremost trading partner. Africa’s exports to India have also risen 15% p.a. since 2000. Indian MNCs have initiated bids for large African assets in unprecedented numbers: Bharti, Reliance, Tata, Ambani, amongst others. India is just arriving at the level of hard commodity consumption phase that China entered 10 years ago, driven by industrialization & urbanization. China’s 9% Growth in 2008 and India’s large appetite for Africa will continue to drive global trade, particularly in product areas where Africa has a global competitive advantage: Natural resources & agriculture (Sources: OECD, BHP Billiton, Macquarie Bank, IEA, CRU).

While China and India continue to lead in Africa, GCC African investment activity has been quietly on the rise, with special interest in African mining, telecom and agriculture. GCC governments have strategic interest in securing access to raw materials essential for industrial, infra-structure and construction growth in the region such as bauxite and steel and have been making acquisitions in rich-resource countries like Guinea to secure such supplies. Telecom investment, a favourite amongst GCC investors, will continue to be a bright spot as the average penetration in sub-Saharan Africa is still at its infancy stages with average penetration of around 25% compared to the GCC’s 100%+ . Quasi-government as well as publically listed telecom firms like Zain, Etisalat, EIT and others are on buying sprees of African telecom assets in a fight for African telecom market share. On Agriculture, GCC governments have made it public that they have an interest in securing their uninterrupted food supplies over the next few decades and certain GCC quasi-investment arms have already taken on the responsibility of identifying targets in this sector.
Many today are forecasting gloom and doom for some time to come, but the saying ‘someone’s loss is another’s gain’ still holds very much true. Opportunities will be plentiful, but with meticulous selectivity and due diligence, investors stand to making remarkable investment returns over the coming period. Our region’s transformation has positioned it in an enviable position, with its projected ability to emerge relatively unscathed ensuring it a place on the table as a global player. Africa will also be confirmed as one of the fastest and most exciting places to invest in over the next decades, with early comers building great wealth and strategic presences in Africa for years to come. These growth regions, jointly or individually, will offer phenomenal opportunities to the savvy investor, at a time when most investors are pre-maturely chasing the growth ghosts of the past.

About Equity-I

Equity-I is a Dubai-based private equity firm focused on founding and acquiring businesses under one of four verticals: telecommunication, natural resources, food and beverage, and real estate. The Company was established  in September 2006 in the United Arab Emirates by its two co-managing directors, Mr. Fawaz R. Halazon and Mr. Ziad F. Kawash.

The Management has 27 years of collective in-depth  private equity, deal structuring and banking experience with leading financing institutions. The team has applied a pro-active approach to creating a superior pipeline of proprietary deals for its clients and for its proprietary book;

Equity-I’s  management has advised on major deals in the GCC, Africa and Asia worth over $1bn in equity, with two telecom landmark deals in North and sub-Sahara Africa for key quasi-government clients. The Management has also acted as an equity advisor to one of the major publically listed alumina players in 2005. In addition, Management has also completed successful deals in South Korea, the GCC and China in various sectors. Recently, Equity-I completed the acquisition of the international master franchise rights to one of the largest privately held French F&B players, where one of Equity-I’s subsidiaries is actively  rolling out some of these concepts in the MENA region.

Equity-I is supported by a world-class team of specialized industry Board of Advisors from the MENA, Africa and Europe, where long-term partnerships with world-class industry and country experts has ensured first class product development and delivery


By | 2017-06-19T12:36:27+00:00 January 27th, 2009|Uncategorized|0 Comments

About the Author:

Leave A Comment