The way to market

History may repeat itself, but we know at the same time that times change, and some things may never be quite the same again, including in this region.

As to the development of regional equity markets, it's a much-aired criticism that, whereas they have grown over the years, they still need to grow, and fast, to provide further depth. Thus, the same condition still exists, with evolution still due. But, in one notable respect, it's probably coming: more businesses, whether private/family-owned or public companies, will be offering public equity.

"The big change is going to be the government — government enterprises coming to the market," Mark Mobius, Executive Chairman, Templeton Asset Management, declared when he visited Dubai last December. "That will be as important as, if not more important than, the family enterprises, with a few exceptions."

The timing of such a statement was not lost.

Mobius's visit to the Gulf coincided with Abu Dhabi extending $10 billion (Dh36.7 billion) to Dubai to help pay off immediately pending debts. In the aftermath of Dubai World's request to reschedule payments, regional markets slumped, and fears of global recovery being damaged gripped the world for a few weeks.

Transparency and corporate governance, and what exactly government support means, became hot topics of debate. Dubai World, with a total of $56 billion in debt, has since been in talks with its creditors to restructure its obligations.

Inter alia, company financing methods generally are being reappraised.

In recent years banks have continued to dominate the sources of funding for corporations in the GCC (and Mena) region. A 2008 IMF study gave the figure at 93 per cent of total. Naturally, however, equity should be an alternative source. Last year, a relatively small number of companies also went for bond issues.

Privatisation rationale

Looking forward, how likely is it that the Gulf's government and government-related enterprises will divest of themselves by public offering of stocks?

Talking to fund managers, bankers and economists, they indicate that the motivations of the different Gulf states to privatise — partially or wholly — varies, and there are challenges both before and after listing that have to be dealt with.

Tapping the capital markets is one of the obvious means of privatisation. Economic literature, typified by Jason Draho in his book The IPO Decision, suggests that a government decision to privatise is motivated, among other factors, by a desire to pursue economic diversification and market efficiency as well as develop national capital markets.

In the Gulf over the past decade we have seen privatisation occurring on a case-by-case basis — never really as part of what one would call a structural reform programme (the kind seen in many of the post-Communist regimes of Eastern Europe and also in other developing countries such as India, Brazil and Russia).

There has not been an overall policy as such, or regulatory framework, driving such a strategy, and government enterprises have been only partially divested, with a reasonable chunk of government control retained. That may not be such a bad thing, especially when there is a rationale for maintaining control over strategic sectors such as oil and gas and infrastructure, crucial for the development of the economy.

In Saudi Arabia, the objective behind Sabic and all the oil and petrochemical companies has been to develop the capital market and transfer wealth-creating opportunities from public hands to private hands.

"That was a very conscious decision," says Anais Faraj, CEO, The Regional Investor(TNI), Saudi Arabia.

"The listings were not made because capital was required. [They] started from a very clear position of strength, and wanted to open up the core of the economy to private capital as a means of building up the financial system effectively and having what in other countries is called ‘popular capitalism' — to spread dividends to both retail and institutional investors (such as pension funds)."

Another objective of public enterprises going for listings is to accelerate the process of economic diversification. In the UAE Emaar Properties in Dubai and Aabar and etisalat in Abu Dhabi may be cited as examples.

"It is quite likely that greater involvement in the stock market will reduce public firms' reliance on oil revenue — a decoupling of the two," says Syed Basher, Research Economist, Qatar Central Bank.

There is a risk, however. "If these firms mess up, in terms of investing in toxic assets for instance, they will have to rely on government intervention, essentially undermining economic diversification," he adds.

Martin Kohlhase, Vice-President, Corporate Finance Group, Moody's Middle East, points to the likely diversification of funding sources too.

"Those entities that are closest aligned with the government in terms of their public-policy mandate and type of work — for example, sovereign wealth funds, infrastructure, urban development, public works — are more likely to go to market with more ease," he adds. Though his allusion is essentially to bond issuance, the point applies well enough to equity offerings as well.

Kamran Butt, Director and Head of Middle East and India, Private Banking Equity Research, Credit Suisse, agrees: "When we talk about state-owned enterprises, they could be departments, or sub-segments within government control that could be privatised — such as power generation, for example Dewa, desalination. Also airlines, hotels, downstream oil and gas are possible."

Faraj sees a driving logic. "The focus will be on the non-real estate-affected companies in which the government can rebuild value more quickly and look to cash [in] on those companies as a way to recapitalise its broader balance sheet."

Market reform

Looking at the broader Gulf, most of the stock markets in countries such as Saudi Arabia, Qatar and Kuwait accommodate government-controlled companies at the large-cap end of the spectrum, with varying degrees of free float. Oman, in fact, is ahead of the others, with a very considerable expansion of the private sector stemming from the sale of a number of government companies.

Also, markets in the region are heavily weighted towards financials — banks, insurance companies — and telecom. That's only a partial reflection of the real economy.

"So we need to have more depth in the markets," Butt says. "Sixty per cent of the region is weighted towards financials."

Of course, that's not the only concern. In the developing markets of the region, there are issues of liquidity, tradability and lack of market-makers. "Capital markets are still improving, but we are nowhere near the optimal situation," he adds.

Jeff Singer, Chief Executive, Nasdaq Dubai, says government companies may come out and list simply to make a statement about the strength and health of the government, as well as the transparency and corporate governance they are promoting… for Dubai, for the financial centre in Dubai and the UAE in general."

The DP World IPO set an unfortunate precedent. "Yes, people like to see more being done," says Singer. Acknowledging its relative lack of retail liquidity, he sounded confident that the offshore market's merger with the onshore Dubai Financial Market (DFM) would resolve the issue once and for all.

The difficulties may run deeper, however.

Some are doubtful of the development of the region's stock markets, by their fragmentation still potentially a disincentive for companies.

"Whenever you allow a proliferation of exchanges, or have a financial system that is over-brokered or over-banked, you are compounding your fundamental problem as a small, insignificant market," says Faraj of The Regional Investor (TNI), Saudi Arabia. "You need to do everything possible to have one single, very deep, very efficient mother market. That remains work in progress I think for most of the Gulf, with the possible exception of Saudi Arabia."

Outlook

What, then, is the likely timetable for the pending capital-raisings? The development of the market here may be like those seen in developed countries already.

"You look at the more established markets of the West. They started with the telecoms going public, and then utilities. They followed up with investment arms; something like that spun off. Dubai will follow with the same evolution," says Singer.

In fact, he believes that as the global crisis recedes, there will be a point when companies in the region will have to tap the capital markets. "Some time in the second half of 2010 we will see things pick up in the Middle East," he says.

As far as government companies in Dubai and the UAE opting for an IPO are concerned, they would look at market conditions, valuations, timing and appetite, but also "at how Dubai is being viewed, and the UAE being viewed vis-à-vis the rest of the emerging-markets world."

There may still need to be adjustments locally in that regard.

"In order to draw more capital into the UAE, into the private sector, specifically into Dubai, you need to be much more aggressive in how you do it," says Faraj.

"One of the issues will be board composition, about regulatory reform — that really has to be fast-tracked. Anyone can draft an excellent template for a legal system — that's very easy, and there are many jurisdictions in the Gulf that claim to have that. But it's the enforcement mechanisms that will distinguish it: how realistic is it to actually work within this regime."

There are going to be two further, specific issues for public enterprises going private, he adds. "One is the learning curve for the managements. [For example,] Emaar had to go through a very painful [period] in terms of corporate communications and investor relations. That's beginning to pay off now."

The second issue is whether the board and management of these organisations are prepared to absorb the cost of equity. "After all, [it's] not just a financial metric: that you are paying X per cent on debt and Y per cent on equity. The reason why equity is more expensive than debt, effectively and realistically, is that equity gives the investor more control over and voice in the operations of the business," he says.

In terms of private-public partnerships, depending on how much equity you need from the market, the government really might have to be prepared to view it as an equitable partnership, he goes on. "There has to be a sort of transformation within many of these companies."

Moreover, "as a prelude to that, that there needs to be lot of consolidation, UAE-specific," he argues.

On those terms, we're talking about a changing landscape indeed.

Likewise in respect of family-owned companies, privately held, for which equity markets are a way to tap into the pool of capital not available through the usual channels of retained earnings and the banks.

Here again, there are some inherent issues to be dealt with.

"That's something of an educational process," says Butt. "For example, there's a bit of the unknown — what it means to move away from ownership/management that has been held [closely] for decades, if not centuries." Naturally, that's inhibitive. "But another aspect is just the volatility in the equity. Regional markets have created a sort of uncertainty, some nervousness. If we get improvement, and reduce reliance on the retail and bring in more institutional money, family businesses may start to go to the markets more often."

Some experts cite negative investor sentiment towards family-owned conglomerates following the Algosaibi and Al Saad case in Saudi Arabia, which could be a stumbling block.

But Mark Mobius believes that, given the size of the market in Saudi Arabia, the opportunities for family companies in the economy will be good.

Jeff Singer has words of advice for any private company wanting good liquidity and institutional investors to be part of its shareholder base.

"First, the minority should have the same options, the same opportunities, as the majority." That's an insider's special knowledge.

The second is more familiar: "A company needs to adhere to standards of transparency and corporate governance."

That is what's known as a constant refrain.

China syndrome

During a freewheeling chat with the local media last December, emerging markets investor Mark Mobius shared his views about the Gulf.

Which sectors of the governments do you see opting for market listing?

I am referring to all government enterprises, including hydrocarbon and non-hydrocarbon. Governments will see the China example — where money can be gained from privatisation, and government enterprises put on a sound business platform — while the state still has a majority-controlled company.

But that would mean the Gulf government-related enterprises having to open up, being more transparent. How do you see that progressing in this part of the world?

We are seeing a lot of change [among] governments in the region, and more companies becoming more transparent. The recent instance of Dubai World is a case in point. The government wisely realised that it was important to become more transparent, not only at the government level but at the company level.

Public enterprises which have come to the market in the past have not been so transparent, and because of that markets and investors in the region suffer. What would force them now to become more transparent?

Disappointing earnings and balance-sheet disasters will force them to become more transparent, because investors will demand it and banks will demand it.

You have said that many governments around the world are looking at China and realising there's a way to ‘have your cake and eat it too'. Can you give a couple of examples, from China and elsewhere?

In the case of China, they privatised parts of almost all the major state enterprises, raising billions of dollars, but those companies are still majority-controlled by the government. For example, the largest banks — ICBC, Bank of China, Bank of Communications. All those are still controlled ultimately by the government but have been listed and are run like private enterprises. The same is true in Brazil (Petrobras), and Russia (Rusal). The Chinese model is appealing because it gradually transforms inefficient wasteful government enterprises into efficient and prosperous companies able to contribute more to the economy's growth and prosperity.

Are Chinese examples necessarily a recipe for other parts of the world, noting issues of the rule of law and corruption?

Corruption is something that is found all over the world, in the developed and emerging countries. The degree to which a country has the rule of law will determine its private enterprise success. One advantage of the Chinese experience is that it shows how privatised companies have had to rely more and more on the rule of law in order to operate effectively. So, in some ways, privatisation has encouraged the rule of law.