Bright spot for ECM sector
As equity capital markets around the world languish, the Middle East has proved an isolated bright spot since the start of the year with a steady flow of high-volume deals. By Christopher Vellacott.
Industry analysts predict that the good times will continue throughout 2009 and beyond, buoyed by fast developing markets, healthy local liquidity levels and capital reserves, as well as a safe haven status. A surge in buy-side investor demand focusing on markets in the Gulf Co-operation Council (GCC) has seen a rise in "frontier" investment funds alongside a scramble for market share among ECM bankers.
This is perhaps surprising given a sluggish performance by local equity markets. The MSCI index for GCC countries excluding Saudi Arabia has fallen by 11% over the past month and by 16% over the past three months. This has wiped out the strong gains seen in the last quarter of 2007 and the early part of this year, leaving a flat performance for the 12 months to-date.
But bankers point to heightened interest among local issuers wanting to raise capital through equity as well as efforts by local authorities to consolidate market infrastructure as sealing the region's prospects.
"Many US$1bn mandates are going to come out of the Middle East. A lot of local companies want to go to market, whether through a dual listing or a local listing, and there is a lot of liquidity there," says Emmanuel Gueroult, managing director of global capital markets at Morgan Stanley
Industry sectors tipped to account for the lion's share of issuance are those associated with a rapidly developing economy, such as financial services, telecommunications and infrastructure. Christopher Laing, head of MENA Equity Capital Markets at Deutsche Bank also points to medium-sized family-owned businesses in markets such as Dubai and Abu Dhabi, where a younger generation wishes to diversify ownership and raise capital. Other bankers point to real estate, though sentiment is starting to sour following sharp falls in property companies' share prices recently.
In response to the demand from local corporations to use equity issuance to raise capital as well as interest from international investors, GCC regulators have rushed to liberalise and attract business. A race has begun among markets to establish themselves as a regional hub, with financial authorities using the example of Hong Kong as an aspiration. The first such move came from Dubai, which founded the DIFX as an international exchange in September 2005.
Though the exchange has struggled to attract liquidity despite some high-profile listings, other markets such as Kuwait and Abu Dhabi have sought to emulate the move. Concerted efforts in various territories to scrap barriers on foreign ownership of national assets and the easing of capital gains tax regimes have pared Dubai's credentials as the region's uncontested financial centre.
One area of activity that has required legislative and regulatory concessions is the issue of global depository receipts (GDRs), certificates issued and listed in London that represent a set number of locally listed shares. The rationale behind GDR issuance by companies in emerging markets is to take advantage of access to investors and liquidity offered by the London connection.
Though Dubai-based companies have an established track record of GDR issuance, the facility remains a novelty elsewhere in the region. The first GDR from Kuwait was a US$1bn offering last May from Global Investment House, an asset manager. Bankers said the deal's rarity value, though throwing up a number of regulatory complications, helped drive demand, with investors eager for alternatives to more crowded markets nearby such as Dubai.
More recently, Kuwaiti Project Company (KIPCO), a services company, mandated Credit Suisse, Goldman Sachs, HSBC and Millennium Finance Corporation for a GDR listing. The company has not released further details on structure but the deal is expected to amount to around US$1bn and to be launched in the fourth quarter.
Some analysts suggest that the use of GDRs may be a short-lived phenomenon. As regional markets become more sophisticated and liquidity increases, it follows that there will be less need for a London listing. ECM bankers specialising in the region agree that it is too early to call the end of GDRs from GCC companies, however.
Lorcan O'Shea, director of ECM for the EMEA region at Merrill Lynch, says that as Gulf markets open, liquidity rises and transparency increases, there is less of a rationale for GDRs. However, he also highlights the use of GDRs and their association with London for adding value to equity transactions.
"There is still a prestige element attached to a GDR issue because the companies are seen to go through the associated corporate governance requirements," he says.
Evans Haji-Touma, head of CEEMEA equity capital markets at HSBC, agrees, saying: "GDR issuance will continue in the region for the time being, even though local markets are becoming more sophisticated, because some issuers want to be seen to obey the stringent regulatory issues associated with a London listing." He also highlights that a London listing still offers access to a wider pool of potential investors, thus facilitating successful equity issuance. "Companies also see GDRs as a convenient way to diversify the investor base," he notes.
But even if local markets do acquire the sophistication to render GDRs unnecessary, most bankers remain sceptical about the possibility that an uncontested hub will emerge.
"We are seeing the emergence of localised exchanges in the region and while I wouldn't be surprised to see links between GCC exchanges, it is unlikely that one market will distinguish itself as a hub. There is too much competition," Haji-Touma says.
The experience of attempts in Dubai to dominate the region's equity markets by setting up the DIFX international exchange sets an ominous precedent. The exchanged received an apparent shot in the arm last year when the UAE government opted for a single DIFX listing in the privatisation of ports operator DP World. The move was a concerted effort to boost liquidity and raise the profile of the exchange.
Indeed, the must-have status of DP World's IPO went some way to attracting considerable foreign investment to the exchange. But liquidity remains sluggish and the DIFX has yet to live up to the heady expectations of last year. This may yet change, however, with more trophy privatisations of state concerns expected during 2009, in particular a sale of the airline Emirates.
The attention of most ECM bankers based in the Middle East is now focused on the emergence of Saudi Arabia, which until recently was stifled by rigid regulation. Saudi Arabia, like other territories in the region, has made concerted strides towards liberalisation in recent months.
Moves towards deregulation of the market have coincided with a healthy pipeline of privatisations, the most recent example being the SR9.2bn (US$2.47bn) IPO of Ma'aden, a mining company. A recent move to allow limited access for foreigners to the Saudi market, hitherto strictly off-limits because of a prohibition on non-Saudi ownership of assets, was greeted with much excitement among investors. Under the new guidelines, foreigners are allowed exposure to Saudi equities through contractual Total Return Swaps.
"Saudi Arabia is taking a stance that will facilitate massively access to international investors and we expect to see massive inflows of capital into that market as a result because now investors can pick stocks individually," says HSBC's Haji-Touma.
Merrill Lynch's O'Shea agrees, adding Saudi Arabian corporates are likely to make greater use of equity issuance in coming years. "The Saudi market is a big opportunity, it is modernising quickly and a lot of banks are looking at it," he says. "There are some sectors in Saudi Arabia, such as financials, petrochemicals and telcos, that have a continued requirement for capital and the equity market can provide that."
Not all the region's bankers are as enthusiastic, however. Deutsche Bank's Laing says that Saudi Arabia was already highly competitive, even prior to the arrival of foreign banking institutions eager to carve out market share for themselves.
"Local banks in Saudi Arabia are very aggressive in defending their turf, which has had an impact on fees," he says. Laing also points out that Saudi banks have a greater ability to extend credit than some international banks, which allows them a competitive advantage in establishing relationships with potential issuers. "Saudi banks have a wealth of credit, so some international banks find it hard to compete with them in offering the kind of credit commitments attached to some deals," he says.
But many bankers with Saudi Arabia in their sights retort that the vast volumes characteristic of ECM deals in the Kingdom compensate for the competitiveness. Ostensibly, the record of deals completed in Saudi Arabia bear this argument out.
The IPO of industrial group Mohammad Al-Mojil amounted to SR6.59bn (US$1.76bn), while the sale of 20% of Mobily, a telecoms company, was worth SR5.5bn (US$1.5bn). Petro Rabigh, a joint venture between Saudi Aramco and Japan's Sumitomo, raised US$1.23bn in an IPO last January.
Nevertheless, Laing questions the benefits to lead banks working on similar sized Saudi deals in the future. "We will continue to see very high volumes out of Saudi but when you look at them in terms of fees, the deals may not be so attractive," he says.