by Tom Stein
September 9, 2015

PE’s Growing Acceptance in Saudi Arabia

As investment restrictions thaw, Huda Al Lawati of The Abraaj Group says Saudi Arabia poses a fertile market for private equity firms.

Saudi Arabia, long cloaked in strictures on outsider investments, is opening up. In June, it allowed foreign investors direct access to its stock market for the first time. And the country is now seeking to join MSCI’s emerging markets index.

In the meantime, Saudis are learning the advantages of private equity investments. In 2014, the MENA Private Equity Association, an entity aimed at supporting and developing the PE and venture capital industry in the Middle East and North Africa, recorded seven PE deals in the country worth more than $300M—21 percent of the $1.5B invested in MENA.

Huda Al Lawati, The Abraaj Group

“Every year we’re seeing greater activity and familiarity with private equity in the Saudi market, driven by regional and international interest,” says Huda Al Lawati, partner and chief investment officer for the Middle East and North Africa at the Abraaj Group.

She says acceptance of private equity as a funding source in Saudi Arabia is growing, and in most of her recent meetings, she hasn’t had to explain what private equity is, which wasn’t the case just a few years ago. In April, her firm closed a joint deal with TPG Capital on Kudu, a fast-food chain that’s expanding quickly, propelled by a rise in disposable income and increasing freedom among young people, who now spend less time at home.

More international PE firms like TPG are looking at Saudi Arabia, with deal sizes increasing and market clarity resolving with maturing government regulation. Other positive factors for PE are the stable riyal and the diversification of the economy as it moves away from oil.

“Saudi Arabia, from a MENA perspective, is one of the largest and deepest economies in the region,” Al Lawati says. “It has a big population base, a strong industrial base, and huge consumption on the back of its young and growing population. Entrepreneurship is growing, and business owners want to grow. They want to look at all their options.”

In contrast to business owners in other nations of the region, who tend toward satisfaction with what they’ve already achieved, Saudi business owners are very ambitious, she says.

Investors are naturally concerned about plummeting oil prices, because oil powers government expenditures, and the government is the nation’s largest employer and biggest spender. But there are other market factors driving PE interest here, including population growth and increased consumer spending.

“There are certain sectors where, in the medium and long term, you will see growth pan out, driven by population and consumption trends regardless of the oil situation, assuming [that oil] does not settle for the long term at a sub-$40 level,” says Al Lawati.

As an example of consumption’s capacity to drive growth despite headwinds in the MENA region, she cites her firm’s 2007 investment in an Egyptian company called Integrated Diagnostics Holdings, which provides medical diagnostics services to patients and laboratories. Despite the 2011 Arab Spring uprising and widespread uncertainty since, Integrated Diagnostics has realized double-digit growth every year and went public on the London Stock Exchange in May 2015.

Al Lawati further points out that volatility has upsides. “A level of uncertainty in a market can stimulate deal flow, because people have to prioritize their capital to core sectors and think about divesting some of their non-core holdings,” she says. “It can also help lower valuations. However, deal consummation will ultimately depend on the prospects of the underlying businesses”

The PE picture for Saudi Arabia today is among the most attractive in the MENA region. It’s one of the largest markets, with a GDP over $700B and depth in manufacturing and private consumption. It benefits from its currency peg. And it’s less homogenous than other regions in the area and has vast reserves of local capital.

But these upsides challenge PE firms to bring their A game to the nation. This is no place for wildcat dealmaking. “Due to the presence of large pools of liquidity locally, it’s a country where your ability to add value as a PE investor—not just add money—is really called into question,” says Al Lawati. “You have to demonstrate your value-add to win deals here.”