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After the Spring - Middle East & North Africa (MENA)

Barriers to deal-making still exist across North Africa and the Middle East. But in the wake of the Arab Spring, opportunities are arising for those brave enough to take them

After the Spring - Middle East & North Africa (MENA)
The wave of popular uprisings that broke across the Arab world in 2011 is one of the most significant events of this young century.
While not all of the forces that the Arab Spring unleashed have been felt equally, or harnessed for growth, it is clear that societies and economies across the region are changing rapidly.
Prior to 2011, and despite a history of political strife, the Middle East & North Africa (MENA) has not traditionally been perceived by foreign investors as a region particularly prone to political risk.

In recent years, impressive strides have been made to remove impediments to investment. With massive infrastructure needs, attractive demographics and, in some areas, a surfeit of liquidity, MENA has emerged as an enticing region for investing.
“People were coming into the region on the positive side because of the growth,” says Phil Gandier, Head of Transaction Advisory Services at Ernst & Young MENA. “A lot of the mature markets were tapering off so, as a Western company, if you wanted to get additional growth you had to have some of your portfolio in a fast-growth market like China or the Middle East.”
This growth was exemplified by the rise in foreign direct investment (FDI) inflows in the region, which stood at US$92b in 2008, according to HSBC Q4 2011 Global Economic Forecast. The effect of instability in the region saw FDI fall to US$30b in 2011. The report forecast that FDI would fall by a further US$1b to US$29b in 2012.

Obstacles in the way

With this fall in FDI in mind, it would appear that events have impacted investor appetite. The relative lack of transparency and limited overseas shareholder control in certain areas further raises barriers to deal-making.

Egypt aside, regulatory regimes present obstacles to majority ownership. There are legal and practical impediments that prevent non-residents from holding positions higher than 51% in companies, and economies can be impacted by substantial subsidy regimes, which distort economic decision-making and place a major drag on budgets. International Monetary Fund (IMF) estimates show that price subsidies in MENA countries amounted to US$200b — equivalent to 7.8% of GDP in 2010, with 15% of this amount reflecting the cost of food subsidies.

Low job creation levels and sluggish economic growth are direct indicators of generally underperforming private sectors. Insufficient participation by private enterprise and businesses has precluded some MENA economies from undergoing an effective process of economic diversification.

According to a 2011 World Bank Multilateral Investment Guarantee Agency (MIGA) report, this has meant that MENA economies score poorly in measures such as export diversification or contribution of exports to economic growth.

This is reflected in the region’s weak export base. The most diversified economies in MENA export around 1,500 goods compared to nearly 4,000 in countries such as Poland, Malaysia and Turkey.

Another barrier to investment in the region comes from limited transparency, according to Gandier. “The regulations are a bit opaque,” he says. ”Governments could change laws quickly. You would have a broad kind of principle as a law, but detailed regulations weren’t there. It was up to the employees working at the applicable regulatory body at the time to decide how they wanted to implement or interpret that law.”

The Arab Spring

The heightened political risk brought about by the Arab Spring has added a new dimension to the decision-making process for those looking to invest in the MENA region. This is aggravated by investor concern about how businesses will be treated by the new elites that have risen to power in the region.

Inward FDI flows plummeted in the countries that were directly affected by last year’s political events. Greenfield investments in Egypt also declined by 80% in the first four months of 2011, compared with the same period in 2010.
A MIGA survey shows that the turmoil has had a significant impact on investment intentions.
More than 20% of respondents said their organization has placed investment plans on hold or was reconsidering investments. “A perfect storm has been created to stop a lot of investment,” says Gandier.

“We had a few months where there was real growth in M&A activity. We saw an upturn in business confidence, and then came the Arab Spring. At the same time, you started having a lot of nervousness about the US going into a double-dip recession, and the whole Eurozone crisis.”

Access to international markets has also deteriorated. According to the IMF MENA Economic Outlook, published in October 2011, international issuance of bonds, equity and loans from MENA-based companies declined by 40% during the first half of 2011. This compares with an increase of almost 17% for emerging markets companies as a whole.

Such financial market trends could further endanger political progress and erode investor confidence. Meanwhile, political violence — especially civil disturbance — ranks as the most concerning risk for foreign investors, according to MIGA’s 2011 World Investment and Political Risk report.

The close identification of Egypt’s business class with the regime of ousted President Hosni Mubarak further complicates the investment climate. Punitive measures were handed out to prominent Egyptian corporates such as Ezz Steel. This trend may also inhibit growth in Libya, where Saif Gaddafi, son of the late leader Muammar, directed the deposed regime’s reformist economic agenda.

The consequences are already being felt across the region. Hazem el-Beblawi, Egypt’s finance minister, warned last November that lawsuits against foreign businesses were shaking market confidence in the country. Legal challenges to foreign developers have been based on alleged profiteering and misappropriation of public funds under the Mubarak government.

Opportunities abound

Despite these barriers, the MENA region’s transformation also throws up opportunities. Infrastructure is especially crucial. According to Abdulla Mohammed Al Awar, CEO of the Dubai International Financial Centre Authority, infrastructure development is so vital because it is the foundation of overall economic growth. “There is a lot to be done to identify opportunities and manage investment risks in the region,” he told a seminar in January.

Gandier agrees that much of the growth that follows the Arab Spring will be around social infrastructure. “It is about improving the healthcare, education and housing facilities. A lot of these countries have big housing programs on the go, to build affordable houses for the population,” he says. “Then you are going to move into building up the power and water utilities capacity for these countries.”

For those companies looking to make investments or acquisitions in the region, there are four key areas to consider:

1. Appreciate the differences

Investors should not treat the region as one bloc. “In the very early days of the Arab Spring, people looked at the region and saw all sorts of trouble,” says Gandier. “Now we’re seeing people differentiating between countries. People may be wary of what is happening in countries such as Bahrain, Syria and Egypt, but much of the region has been barely affected by the Arab Spring. So they have to apportion the appropriate risk to the appropriate country.”

2. Understand the demographics

The region has a combined population of 450m people, 90m of whom are between the ages of 15 and 25. Over the medium- and longer-term, economic and demographic factors will continue to attract market-seeking foreign investors, especially if governance is improved and less cumbersome frameworks for doing business are implemented.

This huge pool of workers, consumers and entrepreneurs wants jobs and increased income to spend on themselves and their families.

“Anything that leverages the demographic factors such as consumer goods, healthcare, education, real estate and even tourism offers huge opportunities,” says Gandier.

A clear example of this is in the fast-moving consumer goods (FMCG) sector. In the largest FMCG deal in Middle Eastern history, Coca-Cola recently paid US$980m for a half-share of Saudi beverage company Aujan Group, in order to extend sales into Egypt and beyond.

Lundi 24 Septembre 2012