Benefits of forging a strategic partnership with PE companies

Over the past few years there has been an accelerated impetus towards development of deeper and more sophisticated capital markets within the region.

The combined capitalisation of the GCC stock markets has grown at a phenomenal rate, increasing 84 per cent in 2003 and a further 74 per cent in 2004.

The total combined market capitalisation has gone from $120 billion (Dh440.4 billion) in 2000 to $525 billion (Dh1,926.75 billion) at the end of 2004 representing a Compound Annual Growth Rate (CAGR) of 45 per cent. The appetite of the local investor for opportunities, and especially for regional equities, has clearly been illustrated by the recent series of exceptionally successful IPOs.

The Addar Properties IPO on the Abu Dhabi Securities Market, for example, was over-subscribed 448 times, pulling in about $102 billion (Dh374.34 billion). In Saudi, the new mobile phone company, Etihad Etisalat IPO was oversubscribed 51 times raising $13.6 billion (Dh49.91 billion).

This investment hungry capital presents an excellent opportunity for local and regional companies to realise value or raise capital through public stock offerings. However, there are only a handful of regional companies that are presently in a position to entirely benefit from such an offering.

On the other hand, there are a multitude of private companies across various sectors that have very strong underlying business models but need to go through a rigorous process of institutionalisation in order to capture the maximum value for the company in an IPO a few years down the line. In order to do so, these companies need to adopt corporate governance best practices, improve operating efficiencies, optimise financial structure, set a long-term strategy, and capture regional growth opportunities through organic expansion and add-on acquisitions,

These companies that are gearing up for IPOs will benefit from a strategic partnership with Private Equity (PE) companies, who can steer them through the institutionalisation process and help them realise their optimal value in a public offering.

Historically, the leading global PE companies have not only produced superior returns for their investors but have also redefined the concept of corporate value creation. Similarly, the top PE companies in the Middle East region are increasingly providing their portfolio companies with a wealth of management know-how, a deep understanding of the regional corporate landscape, reporting structure and discipline, creative financial engineering skills and an extensive network of relationships.

These companies, like their leading international counterparts, are taking a hands-on approach to ownership and management of portfolio companies. The buyout of a company is only the beginning of a long-term commitment by the PE company towards the growth of shareholder value and success of the company. Prior to the buyout, a rigorous due diligence process is undertaken, based on which a detailed and comprehensive post acquisition plan is developed in collaboration with the top management and sometimes owners of the company.

The post acquisition plan includes key value creation strategies and initiatives such as optimal leveraging and financial restructuring, incentivising management and employees, aligning shareholder and management interests, and developing and implementing regional growth strategies.

Companies in the region have historically had an aversion to debt. Further, a lack of understanding of the benefits associated with debt has meant that these companies are often overcapitalised with high asset balances.

In such circumstances, PE companies can create substantial value by implementing more efficient capital structuring. An optimal level of leverage is essential to achieving long term strategic and operating efficiencies. Too much leverage imposes large demands for debt repayment on the company's cash flows and can undermine the performance of the company. However, returns to equity holders cannot be maximised with underleveraged companies.

In addition, it has been explicitly demonstrated that debt imposes a discipline on the management of a company forcing efficiencies and creating a lean organisation.

A strong management team is one of the most crucial components in the future success of a company. PE companies look for companies with dynamic management teams, very often strengthening the incumbent team by recruiting top professionals with complimentary industry and management expertise. These companies work very closely with the top management of their portfolio companies while developing and executing the post acquisition strategic plan.

Portfolio company management teams in turn get access to extensive resources, be it specialised financial and business analysis skills or the PE companies' extensive relationship network to source new business. Company employees, especially top management, are incentivised in order to achieve predefined performance targets.

The interests of the employees and shareholders are aligned using employee stock option plans and other forms of performance based compensation.

One of the major opportunities available to local companies is the potential to grow into regional players, operating in multiple markets across the Middle East, either through organic growth or mergers and acquisitions.

Regional Private Equity companies have specialised expertise in identifying and analysing strategic targets for add-on acquisitions, as well as generating synergies with existing portfolio companies, helping companies expand regionally and rapidly establish an operational presence in the various target markets. The PE company can also open new doors across the region by utilising its network and the network of its LPs.

Traditionally, the top Private Equity companies have been valuable strategic partners to corporations, collaborating closely with management to transform companies through aggressive value generating initiatives into lean and efficient operations. Private Equity-backed businesses have achieved superior growth and profitability levels compared to the market and thus allowed these companies to capture maximum value through an IPO.

The writer is a vice-president with Abraaj Capital.