IFR Mid East 2006 - Seeking a home abroad
With Dubai International Capital snapping up yet another string of high-yielding assets, Barry Marshall investigates the routes GCC capital takes abroad, the gains to be made and the risks it carries.
High global oil prices are driving rapid economic growth in the wealthiest countries in the Middle East that make up the Gulf Co-operation Council (Saudi Arabia, UAE, Kuwait, Oman, Qatar and Bahrain), yielding substantial external surpluses and stimulating an investment boom. GCC private equity has never been more bullish and the region is awash with such liquidity, with plenty of it seeking a profitable, and in some cases lucrative, home abroad.
Gulf countries' economies
The region has been expanding massively in recent years, as everyone knows, and rising national current account surpluses have allowed these countries to substantially increase their already large holdings of private and official foreign assets. Capital account data is opaque, but using the current account surplus as a proxy, the implication is that GCC countries accumulated foreign assets worth US$167bn in 2005, lifting the total for the last six years to more than US$400bn. On the same basis, foreign investment flows from the GCC will amount to at least US$450bn during 2006 and 2007.
The money has, of course, come mostly from oil. In 2005, the GCC accounted for 22% of global oil production, around 40% of exports and a similar proportion of proved reserves. The oil windfall has supported increased government spending and lifted domestic confidence, resulting in an investment boom. Projects worth more than US$1trn, mostly in infrastructure, are either under way or planned that aim to diversify the economic base and generate greater value added from hydrocarbons.
Domestic growth is again gargantuan. The region's 2006 nominal GDP growth is almost 19%, leading to a collective GDP of US$725bn. GDP has expanded cumulatively by 74% over the last three years, with per capita GDP up US$6,000 to US$17,000, from a previous US$11,000. A moderation in growth to 9.4% is projected for 2007. Given current high oil prices, current account surpluses of almost US$230bn this year will be registered, following surpluses of US$167bn in 2005 and US$90bn in 2004.
A new report from the Institute for International Finance (IIF), a Washington-based research organisation, examines the current state of the economic fortunes of the GCC. It recommends that the strategy of acquiring foreign assets is the key to diversifying away from oil and infrastructure and avoiding potentially crippling inflation that is often the price to pay for untrammelled growth. To avoid the risk of the domestic economy seriously over-heating and economic production getting carried away, buying foreign assets is an effective way of removing some of the heat.
Middle East investments abroad are nothing new. During the last oil boom in the 1970s and early 1980s, billions of petrodollars went into buying US Treasuries, which were then lent to Latin American countries that by the mid-1990s couldn't pay up, triggering a massive debt crisis. This time around, however, investors are being savvier and hunting for assets that represent a more solid investment.
There have been plenty of high-profile big-money deals. In the biggest Middle East deal of all, Egyptian cellular operator Orascom Telecom Holding formed a consortium to buy Wind, a top Italian mobile network, for US$13bn. Colony Capital LLC recently partnered with Saudi Prince Alwaleed bin Talal to buy the Toronto-based Fairmont Hotels & Resorts for US$3.9bn.
The United Arab Emirates have the most clearly co-ordinated strategy at work, where the governments of Abu Dhabi and Dubai in particular are actively on the prowl for key assets with high-growth prospects. Dubai is distinguished from other GCC countries and Emirates within the UAE because oil revenues account for only 6% of its total GDP. The bulk of its income is derived from tourism and its free port status. Yet this does not deter it from partaking in some prominent mega-deals. The Emirate is striving to create as much revenue as it can from the travel and tourism sectors as it cannot rely, unlike its bigger brother Abu Dhabi, on oil revenues alone.
Because of the Emirate's specialisation in the tourism and trade fields, then, it is not surprising that its most highly visible acquisitions have been in that sector. Over the past year Dubai has invested in the Travelodge hotel chain, Madam Tussauds, DaimlerChrysler and, most controversially, P&O.
The Travelodge deal is the most recent European acquisition for Dubai International Capital, part of Dubai Holdings, the government's oil money coffer. Following the normal practice, the deal was a leveraged buyout (LBO) in the magnitude of £675m from owner Permira, which itself bought the chain from the Forte group in the 1990s.
Though the deal will not be complete until September, DIC see it as a major diversification of its assets. The chain consists of nearly 300 hotels in the UK, with nine in Ireland and three in Spain. DIC is hoping it can pursue an aggressive growth strategy in the UK and add 32,000 rooms. With the London Olympics due in six years, Travelodge will be well positioned, it reckons, to take advantage of a tourist boom by providing 7,000 budget beds. The chain is in a very strong growth position, a fact reinforced by the competition it managed to beat: Cinven, BC Partners and Starwood Capital.
Still in the leisure and tourism sector, last year saw the £800m acquisition of the Tussauds Group, owners of the famous London waxworks museum as well as some of the UK's most popular attractions, including Alton Towers and the hugely popular London Eye. The group also holds assets in several other major cities across the world.
A little later on, in March this year, DIC teamed up with HSBC to launch a new US$500m fund to further diversify its portfolio. Special focus was given here to the Middle East and North Africa, but the group had a very wide definition of what constitutes infrastructure by eyeing up IPPs and downstream oil and gas assets.
Also in the bag for DIC with a US$1bn price tag was a stake in DaimlerChrysler, the US auto giant. Dubai is now the third largest shareholder after Deutsche Bank and the Kuwaiti government. In this scenario, Dubai could use its stake to influence the company to move production to its jurisdiction and reinforce the home economy.
In May, the company completed a US$1.3bn deal to acquire Doncaster, a US-based engineering company that makes parts for aircraft and military vehicles. Previously owned by Royal Bank of Scotland Equity Finance, the company makes parts for the US$256bn F35 joint strike fighter project and the M-1 Abrams Tank. The deal was passed by US lawmakers, but did attract plenty of criticism. In fact, DIC is the second company to be evaluated by the US authorities for potential security risks. The other company, of course, was Dubai Ports World.
Dubai Ports buys P&O
The most controversial of all the recent GCC-linked infrastructure deals involved the purchase of the world's fourth-largest ports company, P&O, in a transaction totalling almost US$7bn. Dubai Ports World is a relatively new venture launched by the government of Dubai in 1999. It operates port facilities from Australia to China, Korea and Malaysia to India, Germany and Venezuela. Dubai Ports World also took over the company's massive pension obligations, which ran to almost £200m. But the Dubai giant was attracted by the massive potential for growth. P&O is tipped to be on the verge of clinching planning permission for a huge £1.5bn ports development in the Thames Gateway.
Since the late 1990s, Dubai Ports World has been aggressively buying up assets, including CSX Corp. It claims to have expanded by 20% per year since 2001, though as a private company it does not have to disclose its income. Across the world, ports are reaping the benefits of a boom in world trade as goods from Asia and the sub-continent are shipped to Europe and the US. The World Bank estimates that the next year will see shipping volumes increase by 7.6 per cent.
There is plenty of liquidity, and cheap capital at that, to finance these mega-deals. The P&O acquisition financing facility itself broke down into a US$6.8bn five-year loan initially priced at 100bp, but decreased by 25bp, and a revolver tranche that was upped by US$200m to US$500m. Fees came in at 40bp for US$400m and 30bp for US$200m. The deal was hugely oversubscribed, with Barclays Capital and Deutsche the lead arrangers.
The extremely low pricing on the international deal belies the hugely controversial nature of the transaction. P&O owned 10 ports in the US and domestic politicians were quick to raise the spectre of 'security'. It was outrageous, some said, that the moment that the US was at its most vulnerable it should be handing over key ports to powerful Middle Eastern interests. Continental Stevedoring & Terminals Inc went to court to try to challenge the deal on security grounds, but neither the regulators nor the Department of Homeland Security saw problems with it. In fact, Dubai Ports has a number of Americans well known in the shipping industry counted among its senior leadership.
In any case, 80% of US ports are foreign-owned, but in the end President Bush vowed to veto any moves by Congress to forestall the acquisition. As a token of goodwill, Dubai Ports offered to sell-off the US interests to a separate bidder. No-one has thus far come forward, which is all the better for Dubai Ports because, to take one example, P&O had not too long ago signed a 30-year concession with New York State to continue its operations there.
Investing in America
The political climate has reinforced a mood, though, and GCC investors are definitely being put off putting too much America's way, particularly in the wake of 9/11, Afghanistan, Iraq and now Israel-Lebanon. However, the US needs foreign capital badly. Its near-US$800bn deficit is in the long term unsustainable unless overseas cash finds its way faster into the country. Companies such as Bahrain-based Arcapita specialise in Middle East investments into the US and have to date completed more than 50 transactions totalling US$10bn.
Bahrain is an interesting case in point as it is the only country that publishes figures on the total value of foreign assets. Last year, more than US$120bn was held abroad, up from US$105bn in 2004. Most of this was outside the US. The trend seems to show that Middle East states are happier putting their money in closer countries. The single biggest local investment was the purchase of a 55% stake in Turk Telecom by Saudi Oger for US$6.5bn.
And investment into the US needs to be ramped up to astronomical levels to sustain its balance of payments. To cut the deficit within one year would require up to US$20bn of investment per week. To put it another way, it would have to sell the equivalent of three P&Os per week, an impossibility.
Sending money outside the region is inherently risky, more so Stateside. If, say, a Gulf fund or asset is part-owned by Syrian interests and diplomatic tension between the US and Syria reaches a critical point, what happens if America freezes Syrian assets? The answer to the question is too much up in the air and too risky for Middle East investors, who at the moment have plenty of other less risky options. According to the IIF report, though, Gulf investors could be ploughing money into the US through intermediaries because of the risks of asset sequestration.
The problem in any case may not be so clearly political. To Arab investors, US assets may simply be seen as overpriced compared with the cheaper bonanza on offer in Asia. India is hotting up as the key place to invest, more so than China, where foreign investments are always co-ordinated through the central party bureaucracy. It is also more important to recognise that an increasing amount of cash will stay closer to home as the economy grows and develops.
Indeed, equity markets in the Gulf region have seen the total raised through local share issues soar by 456% cent to US$14.69bn in the past 12 months. This compared with US$2.64bn in the whole of the previous year (July 2004 to June 2005).
According to Trowers' Middle East finance expert Andrew Rae, issuers of securities in the Gulf continue to benefit from the high level of oil prices, as more and more investors look to re-invest their petrodollars in local public equity markets because more opportunities are opening up.
Rae said: "Companies are increasingly using the cash raised not only to grow organically by funding their own investment projects but also to fuel M&A activity both at home and across borders with other Gulf states." For example, a subsidiary of Saudi-based Savola Group acquired a 70% stake in Egyptian plastics company New Marina Plast in May. Savola Group undertook a rights issue in January.
But if it is a significant increase in relative terms, absolutely the figures are more modest: the past year has seen growth of US$12bn in domestic rights issues. What it points to is the growing power, sophistication and diversification of the Middle East economy, and while cash from oil is being used to pump up infrastructure at home, it is also seeking a lucrative mooring abroad.