A major type of alternative equity investment is through venture capital (VC) and private equity (PE), which represent an ownership stake in a private company.
VC investments are typically smaller and made directly with new start-ups or growing companies requiring additional financing.
With the assistance of VC and PE, some companies may grow and become public companies through initial public offerings (IPOs). Early VC and PE investors profit through “exits” which can either be the company being acquired by another larger company or through a public offering.
In 2017, the UAE and Saudi Arabia led IPO activity in the GCC, with five listings in the UAE, four in Saudi Arabia, three in Oman and one in Qatar. Much of the activity has been in the region’s relatively new Real Estate Investment Trust (REIT) market. In 2016, the Saudi Stock Exchange (Tadawul) was opened to REITs and there have been six REIT listings since in Saudi, two in the UAE and one in Bahrain. REITs are traditionally invested in residential and office properties but are now expanding in the region to include alternative assets in education, and health care.
While 2017 did see an increase in the region in IPOs, activity in recent years in the region has not been robust, and has been focused mainly on large state-owned enterprises which underlies the growing importance and momentum of VC and PE to support start-ups, and small-to-medium-sized enterprises (SMEs). Public equity markets in the region are still classified as ‘frontier’ and ‘emerging’. As these markets mature and present more opportunities for more IPOs of companies that started with VC or PE financing, representing profitable exits for the early investors, it will create more VC and PE activity in the region.
In both the UAE’s vision 2021 and Saudi Arabia’s vision 2030, there is a push for more diversification of the economies and an increase in nationals working in the private sector. Indeed, throughout the region, there is a need for more jobs in the private sector. Start-up companies are playing an important role is this transformation and there is increasing government support for SMEs, entrepreneurship and innovation.
Throughout the region, but in particular in the UAE, there is a growing ecosystem of economic free zones, business incubators, co-working spaces, training programmes, seed and growth accelerators, and networking and mentoring opportunities through conferences and awards for start-up companies. There are now more opportunities for start-ups to raise capital from VC firms, PE firms and angel investors.
One challenge in the region is the exit from the VC or PE investment. These investments are less liquid, typically do not pay any dividends and have long holding periods. With the venture capital sector in the region being its early days, there have not yet been many high profile exits or IPO events where investors have seen the big returns on investment. This has kept some investors on the sidelines but as the sector matures, with more success stories, the level of funding will increase and gain momentum.
The reality is also that not all companies that receive venture capital will be successful and have a profitable exit. That is why it is necessary for successful VC companies to have a portfolio of companies that they are invested in, since the few winners cover the losses on the majority. Most VCs estimate that approximately one-third of the investments in their pool or portfolio will generate minimum returns and return their capital, one-third will have losses and on-thirds are the winners with the outsized VC returns that cover the losses.
Careem is an example of a privately held company that started in 2012 in the UAE and went through several rounds of financing. The firm now has achieved a ‘unicorn’ valuation over $1 billion (Dh3.67 billion), with operations in over 50 countries in the Middle East and North Africa (Mena) region and south Asia. Souq.com is another unicorn in the Mena region.
Most of the early VC activity has been consumer-oriented but there is an increasing focus on financial technology (fintech). Both Dubai and Abu Dhabi have opened up fintech hives and hubs respectively.
In February 2017, the Saudi Stock Exchange launched the first parallel public stock market (NOMU) in the GCC. NOMU is an alternative equity market to the Tadawul, aimed at smaller capitalisation companies. Nine companies were listed in the first half of 2017 but there were no new listings in the second half. It is still early days but as of February 12, 2018, all nine stocks are trading below their initial offering prices.
In the future, we should see some start-up companies progress through several stages of financing and then eventually become public companies through IPOs on exchanges like NOMU that cater to smaller listings. Public markets are an extension in the ecosystem to the private markets and an important element in the overall capital markets. Especially when debt financing is hard to acquire in the region, there is not a robust debt market for corporations.
VC and PE investors are looking for companies which are scalable — one of the key opportunities and challenges in the region. There is a large, young population speaking primarily the same language that is driving consumption demand. There are large penetration and growth rates for internet and mobile phones. It is not surprising then that technology driven businesses form the major focus for venture capital investors. On the other hand, the integration of the Mena economies is still challenging as every country has its own regulations, rules and laws.
There is no doubt that the level of VC and PE activity will continue to grow in the region just as the public markets will continue to evolve. Success will breed success and there will be more allocation to this area by high net worth investors, family offices and institutions. Capital is increasingly more mobile and the region will start to attract more global investors.
— Ted Stephenson, CFA, is executive director of CFA Society Emirates.