Chapter 19

Swicorp: Private equity in the MENA region 2009a

Rilwan Meeran sat in his office high above Dubai and gazed out at The World, the iconic mega-project that replicated a map of the world with man-made islands. It was January 2009 and he was thinking about his ongoing deal in Jordan. Going over the main points once again, he knew he would have to bring it to Swicorp’s Investment Committee soon. As he mentally enumerated the various risks of the venture, a well-established aircraft leasing business in Amman, and the mitigations his team had comprehensively detailed, Meeran realized that he was actually asking himself whether the deal ought to go ahead given the revised performance in other recent investments brought about by the economic downturn.

Looking out to the island that represented the northeastern United States, Meeran thought back to his decision, in the spring of 2006, to leave his senior position at Finstar Global Partners in New York and move halfway round the world. At the time Swicorp had made Meeran a tempting offer and he thought back to the reasons why he had decided to relocate, first, to Tunis to gain an understanding of Swicorp’s culture, spending an intensive 2 months in the Swicorp office there, and, then, to Dubai to join the Intaj private equity team. He had liked the fact that Swicorp was an international company with a regional focus already 20 years old, had an established brand, and a good mix of international and local talent. With its current team he could see himself remaining with the firm for the foreseeable future.

SWICORP—A SHORT HISTORY

Founded in 1986 by Kamel Lazaar as a corporate advisory firm, Swicorp was initially based in Geneva. The founding brought together a number of European-educated francophone business partners. Before setting up the company Lazaar had held the position of Vice President with Citibank in North Africa and Europe and was on the Citibank team that set up Samba, the Saudi-American Bank in Saudi Arabia.

The initial activities of Swicorp concentrated on merger and acquisition and strategic advisory services to several large family-owned business groups. These groups, effectively family conglomerates, were common in the Middle East, and particularly Gulf countries such as Saudi Arabia. Swicorp made use of its relationships, in the Middle East and North Africa in particular, through business contacts established in Saudi Arabia.

The move into private equity

In 2003, Swicorp was engaged to advise a consumer products group on potential investment opportunities in the Saudi market. This group considered involvement in the bottling sector in the MENA region and, jointly with Swicorp, they set up a fund targeting potential acquisitions such as bottling plants and retail operations. The venture, however, did not proceed as planned and was ultimately abandoned. But the experience had provided a steep learning curve for Swicorp which resulted in the creation of an equity fund in 2004. A private equity group was set up under the leadership of Nabil Triki. Triki recognized the importance of finding a good team to kick off the fundraising. The fund was to concentrate on investment opportunities in the Middle East region tied to the large and growing consumer market, a market dominated by a young population.

At this time Swicorp undertook a group restructuring to reflect new business lines, relocated its head office from Geneva to the Saudi Arabian capital Riyadh to be closer to its main contacts and clients. The restructuring clearly split the company’s banking and equity activities, with the Geneva office continuing to provide corporate advisory services. Over the following years, additional regional offices were opened in Tunis, Algiers, Jeddah, and Dubai. The Tunis office contained the research and other support services, where well-educated and relatively low-cost talent was at ample supply. By the end of 2008 Swicorp had 120 staff with the majority in the Riyadh and Tunis offices. Staff working on the consumer sector fund were concentrated in Dubai and Saudi Arabia.

The Swicorp private equity funds

In addition to its concentration on consumer-driven markets, Swicorp worked with the Saudi Arabian Government Investment Authority to set up a fund targeting energy and energy-intensive industries. The two resulting funds were “Intaj” for the consumer sector and “Joussour” in energy. In addition, a further fund was created, “Emerge Invest”, an open-ended fund focused on greenfield and early stage projects. By 2006 the Joussour fund reached USD1bn in committed capital, while Intaj gained commitments of around USD250mn. The funds shared services, pooling research, finance, and other functions. Limited partners in funds (LPs) and co-investors had generally been corporate banking clients.

The Intaj fund

The Swicorp Equity team members believed themselves to be in a unique position in the regional private equity investment market, with a number of attributes that differentiated the team from other operations in the MENA market. A local presence with good access and long-standing relationships built on the advisory side with the business community was evident, and the makeup of the team, in terms of backgrounds and nationalities, provided a high level of understanding of the regional landscape.

The Intaj Capital I fund succeeded in raising USD250mn, as part of a total of USD1.4bn raised for all funds, from 50 MENA region investors including a concentration from the Gulf Cooperation Council (GCC) countries.1 Key investors included a number of large, private investment groups from North Africa and the GCC, as well as a number of high-net-worth individuals. Efforts were made to attract institutional investors from outside the MENA region. One such investor, a European financial development institution that specialized in providing private investment in developing countries, committed the relatively small sum of USD15mn as an initial “tryout” with Intaj.

Swicorp saw the importance of attracting institutional investors from Western countries and prepared itself to go through an extensive and arduous due diligence process that Western institutional investors require. Exhibits 19.1–19.3 display information on Intaj investments.

EXHIBIT 19.1 INTAJ FUND I—INVESTMENTS

EXHIBIT 19.3 INTAJ DEALS—EXAMPLES

THE MENA REGION

Spanning from Morocco to the Levant and the Gulf states, the MENA region covers over 20 countries. As a standalone economy it was the world’s fifth largest with GDP growing at 4.5–6% per annum from 2000 to 2007 (see Exhibit 19.4 for GDP data). Whilst not the fastest growing region in the world, its growth rate had increased incomparably since the early to mid-1990s. Job creation had increased and unemployment had declined during that period. With a rise in foreign direct investment the private sector had grown, although not evenly across all countries. In terms of private equity investment, with billions of dollars of petroleum earnings and liberalizing economies, money had flowed freely into private equity firms over the 4 to 5 years to 2008. Following the worldwide financial crisis triggered in summer 2007 the availability of cash was significantly reduced, although some was still flowing. The Financial Times noted that “[In 2007] Middle East private equity funds raised USD5bn but in the first half of 2008 only USD1.1bn was committed.”2

EXHIBIT 19.4 REAL GDP GROWTH 1996-2007 (PERCENTAGE PER YEAR)

Within the region, countries shared a cultural affinity and comparable consumption trends and habits existed. There were two types of legal and institutional frameworks within the region, however. The North African region of the Maghreb (Morocco, Tunisia, Algeria) had a legal and institutional civil law framework aligned with French law. In the Levant, Syria was transitioning from French-influenced systems to follow more closely the Gulf countries as Gulf wealth funds and family conglomerates invested in the slowly liberalizing Syrian economy. The Gulf countries generally followed common law principles and British institutional frameworks, as did Jordan.3 To undertake business in the MENA region as a whole, therefore, companies with cultural affinity to both systems had tremendous advantages.

Turkey is often included when considering MENA, although to a large extent it may be argued that Turkey is more aligned with Europe than the neighboring MENA countries of Iraq and Syria or the wider Middle East and Gulf region. To the east of MENA, Pakistan is also considered, by some, an extension of the region, particularly as a result of the proximity of Pakistan’s commercial centre, Karachi, to the Gulf states.

As one professional commented:

“Despite diversity in frameworks, MENA countries display a certain uniformity, which from a private equity perspective offers a number of advantages, such as critical mass for a diversified private equity portfolio and transferable value creation strategies.”

In terms of language, for countries in the Maghreb French was the language of regulation and governance and was required to undertake business. English was the main business language, alongside Arabic, in the Gulf.4 English or standard Arabic was generally used for communicating in business in this part of the region. Swicorp, with its background and cultural mix, was able to operate in both frameworks.

Demographics

The population of the MENA region in 2008 was approximately 360 million. If Turkey was included then the total population was 430 million at that time. The projected MENA population for 2010 was 376 million, and growth of around 2% was expected per annum until 2010, and 1.7% thereafter (see Exhibits 19.5 and 19.6).

The MENA population was dominated by the younger age groups. In Saudi Arabia, the median age was 21.5 years, and was 24.5 years in Egypt. Median age in France and Sweden, by comparison, was around 40 years.5

EXHIBIT 19.5 FDI AND POPULATION DATA FOR MENA

Despite a significant GDP growth in the past few years which persisted even during the financial downturn of 2008, and despite gradually improving incomes, many issues faced the population of the MENA countries. Even with increasing growth, the level of unemployment was high in North Africa. The MENA region had a sound educational establishment, but to enable high growth, particularly in the Gulf states, many highly trained professionals had to be from other Arabic countries, such as Egypt and Lebanon, or had to be expatriate professionals from outside the region.

THE MENA PRIVATE EQUITY LANDSCAPE

Private equity activities had grown to significant levels in the last few years pre the global credit crunch. Since 2005, average fund size had increased from approximately USD100mn to about USD300mn in 2008. The number of firms prior to 2006 was 29, rising to 44 at the beginning of 2008. The financial crisis had shaken activities in the region, but most firms were still in existence, weathering the financial storm (see Exhibits 19.7 and 19.8).

EXHIBIT 19.7 MENA PRIVATE EQUITY FUNDS COMPARISON 2004-2008 (USD MILLION)

Middle East private equity firms were made up of local, regional, and global players (see Exhibits 19.9 and 19.10). Local and regional firms had been established with headquarters in most of the Gulf capitals—Abu Dhabi, Kuwait City, Manama, Doha, and Riyadh. Most of the firms also had a presence in Dubai, as Dubai served as an important business and financial hub for the region. The presence may have been for operational reasons, such as fundraising, or may have been for representation purposes. In addition to private equity firms, sovereign wealth funds from the Gulf also made significant investments in the region.

EXHIBIT 19.9 MAJOR PRIVATE EQUITY FIRMS IN THE MENA REGION

In terms of investors, high-net-worth individuals (HNWIs) comprised a notable portion of equity investment. It was difficult to gauge the exact proportion of equity investment by HNWIs, as their investments were often channeled through family businesses or private investment houses, but 20–30% was not unrealistic. Private investment firms pooled individual wealth, and business conglomerates also invested. Institutional investors from outside the region, such as Europe and the U.S., were also beginning to invest—partly because they were reassured by increasing transparency and local firms’ improving ability to undertake meaningful due diligence, and partly because the region was still growing, despite the financial crisis of 2008, unlike most other regions of the globe.

THE ROLE OF SOVEREIGN WEALTH FUNDS (SWFS)

Sovereign wealth funds were found mainly in the Gulf states and were significant investors in companies and commercial developments in the region. Some funds in the region were relatively new, although a small number had been established for several decades. All had enormous financial weight, created predominantly from oil wealth. The strategies of the SWFs differed from country to country (and emirate to emirate in the U.A.E.).

Two main strategies are worthy of remark—one was an opportunistic approach to investment based on maximizing returns. The second was investing with a view to gain technical knowhow and knowledge to improve the skills base of the local populations concerned. The Abu Dhabi–owned Mubadala had a portfolio of investments and joint ventures in conventional and green energy, healthcare, engineering/manufacturing, and infrastructure projects, following the second model. Both strategies attempted to cushion the effects of reduced oil revenues anticipated in the future—either through returns generated by financial diversification or through gradually improving the intellectual capital of the country’s nationals (Exhibit 19.11).

EXHIBIT 19.11

SWFs were gradually coming under pressure by regulators to become more transparent; those based in the Gulf were no different.6 Adia had issued a Code of Conduct to reduce concerns over lack of transparency. Transparency had become an issue for governments of the home countries of companies in which the SWFs had acquired stakes, such as Adia’s and Kuwait Investment Authority’s investments in Citigroup and Morgan Stanley, as a result of the “unknown” nature of the funds. A major political storm was created in the U.S. in 2007 when SWF Dubai World subsidiary DP World purchased the ports of P&O. The U.S. government intervened and refused to allow the control of P&O’s U.S. ports to be ceded to DP World. In the case of the acquisition of stakes in Citigroup and Morgan Stanley, the SWFs aimed to be good global citizens by helping to stabilize the U.S. banking system, as well as anticipating financial gain. At the beginning of 2009, many of the SWFs experienced the impact of their first major global financial downturn.

SWICORP’S INTAJ INVESTMENT STRATEGY

Buy and build

Like any other private equity firm, Swicorp aimed to create value through the means of multiple arbitrage, financial leverage, and operational growth (see Exhibit 19.12). Although optimization of capital structure was carried out, this was not the predominant method of wealth creation, nor was multiple arbitrage. Swicorp preferred its “buy and build” strategy, including regional or international expansion, and vertical or horizontal integration, improved operations, and enhanced corporate governance. In addition, Swicorp believed in building value through synergies with other portfolio companies, cooperation with strategic investors and through long-term partnerships with other firms. Swicorp prided itself on its distinctive and consistent investment strategy: proprietary deals requiring hands-on value creation with international standards of governance and operations. Potential acquisitions, often already local leaders in their market with high growth potential, were targeted for development into acquisition targets for global players (attractive through their strength or their potential to compete). Swicorp provided the financial resources and management reinforcement to unlock that growth potential of purchased firms, connected the acquired firm to its MENA network, raised debt, assisted with recruitment and talent retention, and worked to optimize the value chain.

Private equity firms in the Middle East had faced several challenges including scarcity of debt (even before the worldwide economic downturn) and inflated acquisitions prices since around 2005. In an attempt to fight the latter challenge, Swicorp largely avoided auctions. Limited leverage was employed in Swicorp deals. More than 40% of the money invested was internal or co-investors’ money.

While Swicorp focused exclusively on the MENA region for acquisitions, it looked to Europe for possible exits. Swicorp believed its competitive advantage in MENA to be a thorough understanding of the cultures of both the GCC region and North Africa. In addition to many other nationalities, Swicorp employed among its staff a number of professionals of North African descent, fluent in both French and English, who had an innate understanding of the French–Arabic culture. Their understanding of the cultures of the people they were doing business with was both natural and profoundly deep. Few other firms could operate in North Africa west of Egypt; as one Swicorp professional remarked, “you can’t [easily] do business in Tunisia, Algeria or Morocco without French language and culture” and Swicorp’s “French connection” made it arguably the only player operating in the entire MENA region.

A major obstacle in the region was the imbalance between the supply and demand of capital. With limited mid-size deals, there weren’t enough targets of that size in the GCC for the number of private equity firms operating there. As commented by a seasoned professional, with long experience of fundraising in the region: “The Gulf states have a limited capacity to absorb capital.”7 But while there was global interest in the region, there was low private equity penetration. This fact, coupled with favorable trends that included liberalization, privatization, family successions, and a growing internationally competitive talent pool, made the region an attractive place to do business.

Typically Swicorp restricted investment to no more than 25% of target commitments in a single country, or a single sector, providing diversification in both geography and industry. Deals were periodically reanalyzed as macroeconomic conditions changed and as appropriate deals were restructured.

The deep dive

An important aspect of Swicorp’s corporate strategy was the concept of the “deep dive” in which one sector was analyzed right across the MENA region looking for gaps between MENA and Europe. When Swicorp analyzed flexible packaging they discovered one such gap. They bought the market leader in Tunisia, a small company with low margins that could be substantially improved through economies of scale, together with a packaging manufacturing facility in Europe. Swicorp shipped partially manufactured flexible packaging products from Tunisia to their plant in France where the manufacturing process was completed. The Tunisian plant was scaled up to meet the European demand; products completing manufacture in France allowed greatly enhanced margins. Reanalysis, in light of falling energy prices, revealed an ever improving bottom line. The final benefit of this scheme was that the combined flexible packaging manufacturer, having gained a not insubstantial market share, quickly became an acquisition target for its larger competitors in Europe.

The flexible packaging acquisition epitomized Swicorp’s “model”, one that included proximity of market, a diversified investor base, and diversification across the region. Proprietary deals were sourced by capitalizing on Swicorp’s regional networks through their local offices and their multinational team. To vary from the model would always cause great concern to the investment committee of any private equity firm expecting difficulties in the implementation strategy post acquisition as well as risking to be perceived by investors as lacking focus.

Deal makeup

Co-investors figured most prominently in the Middle East. Because of the scarcity of debt, co-investors’ funds were used in lieu of leverage, silent money that was brought in deal by deal—this was direct investment often provided by selected LPs, invited to co-invest in addition to their LP stake. Co-investors included institutional investors, high-net-worth individuals, and other funds. Their prime interest was in growing the company value and reinforcing Swicorp’s essential buy-and-build value creation strategy.

Swicorp allocated considerable time to agreeing valuations with the seller—this was often the most protracted portion of an acquisition negotiation—as certain key concepts, such as EBITDA, were not well understood. Multiples, comparables, and discounted cash flow methods were all used to establish a range from which the final valuation could be negotiated. Target firms were gradually coming to understand these concepts in the MENA region.

DEAL SELECTION PROCESS

Once preliminary research had been commenced on a potential deal, research was carried out by the extensive back office in Tunis. Swicorp’s private equity teams in the various branches had weekly conference calls to discuss their ongoing pipelines, with each team generating in advance a deal entry form so to ensure a well-informed and challenging discussion. Output from these discussions resulted in a short memo for a further peer review and for comments from the Head of Private Equity, Nabil Triki. Assuming a green light to continue, a detailed financial model was built and the actual negotiation and deal terms would be finalized. Finally, an investment memorandum, a comprehensive analysis of the target and a detailed description of the proposed deal structure, was produced for the benefit of detailed review and subsequent discussion by the Investment Committee.

The Investment Committee comprised five to six members and included Swicorp’s Chairman, Kamel Lazaar, the Head of Private Equity, Nabil Triki, representatives from the fund’s LPs and on occasion peer professionals not employed by Swicorp. Meetings were held on an ad hoc basis, usually by conference call, and it was unusual for there to be a formal presentation. Committee members were expected to have carefully studied the investment memoranda prepared for that meeting. Typically, the deal would be discussed for 15 to 45 minutes followed by a vote to determine whether to proceed with the deal.

STEP CARPET GROUP

In July 2008 Swicorp closed a deal with a Turkish company, Step Carpet Group, to acquire in stages a majority of each of Taftel, the manufacturing arm, and Step/Stepevi, the retailing arm. From a third-generation Istanbul-based family business dating from 1919, the Step Group was restructured in 1998 with the objective of redefining the traditional carpet industry in Turkey. Carpets targeted style-conscious middle and upper-middle class customers through contemporary designs, vibrant colors, and differentiated fabrics. By 2008, the Turkish carpet group had already established an international brand and held a significant share of the quality carpet and rug market, as a result of aggressive marketing and steady expansion, and had a strong reputation as a provider of quality carpets and associated accessories. With over 60 shops and “sales corners” located in department stores across Europe, the Middle East, and South Africa, both wholly owned and franchised, Step had achieved an impressive penetration within a short time for global market share in various carpet categories (see Exhibit 19.13). In addition, Step Group had a special projects division that designed and provided carpets for high-end residential complexes, hotels, yachts, offices, airport lounges, and quality stores.

EXHIBIT 19.13 GLOBAL MARKET SHARE OF STEP (MAIN CARPET PRODUCT CATEGORIES)

Mass customization

Step’s unique concept of “mass customization” was based upon its revolutionary robotic hand-tufting manufacturing technology that was linked to proprietary CAD/CAM systems. This technology, developed in house, permitted Step to achieve high precision in mass production with a significantly lower cost structure than its competitors. It permitted production runs ranging from one to infinity. Step’s delivery time of 3–4 weeks was significantly lower than its competitors (hand-made designer carpets were typically delivered in 10–14 weeks). This enabled a much faster combined delivery, which tied up well with high-end furniture stores such as Natuzzi, Selfridges, and Roche Bobois, stores that would themselves normally require 3–4 weeks to deliver furniture. The customer, having selected complementary furniture, carpets, and accessories, could expect a single delivery of their new household.

Entering Turkey

The acquisition of Step Carpet Group represented Swicorp’s first foray into the Turkish market. Meeran recalled that when he joined the company it seemed that each team leader had staked out a target country, but that no one was yet operating in Turkey. He started to build his contacts in Istanbul through an old contact from New York, now relocated to Turkey. It was through this friend that Meeran made contact with the Turkish investment banker acting as Step’s sell-side adviser. The adviser was impressed by both Meeran and the Swicorp approach and endorsed the firm in discussions with Step. The main shareholder and founder as well as Chairman of the Board and General Manager of the Step Group, Mr. Cem , had been exploring ways of injecting capital into the group. Step was already speaking to a number of private equity firms when Meeran, representing Swicorp, was introduced by the adviser. Step Group comprised two companies that were each controlled by the family. The Group’s ownership structure at the time of the transaction is shown in Exhibit 19.14.

EXHIBIT 19.14 OWNERSHIP STRUCTURE AT STEP GROUP

Step’s intention was for IS Venture Capital to cash out entirely, in accordance with IS’s exit strategy, while the other shareholders’ stakes were to be substantially reduced. Step wanted to set up an auction and sell to the highest bidder. After early stage negotiations Meeran convinced Step to go with Swicorp and the full auction was circumvented.

An attractive alliance

There were a number of reasons for the Step/Swicorp alliance to be attractive to both parties. Step wanted to move into the U.S. and Middle East markets and, although Swicorp had no office in Turkey, Step appreciated their network of branches and consequent strong presence across the MENA region. Swicorp’s willingness to cross borders and the fact that it was supported by Step’s sell-side adviser were also determining factors. For Swicorp, Meeran thought Step to be an attractive investment opportunity due to solid fundamentals, aggressive growth strategy, quality products, and clean books, the latter a consequence of IS Venture Capital’s involvement. Traditionally, bookkeeping in Turkish firms, particularly as the vast majority were family companies, was more art than science; Step was in the first wave of companies moving, partly due to Turkey’s gravitation towards the European Union and the accompanying regulatory requirements, to GAAP compliance. Step was not typical of Turkish firms at that time as it did not entertain black market sales and had an efficient reporting system. In particular, Swicorp liked Step’s fast growth, strong local market position, successful export strategy, clear competitive advantages, brand name, retail network, and the sound management team.

The share acquisition deal was closed formally on July 21, 2008. The enterprise value of the Step Group was agreed at 8× the estimated 2008 EBITDA of Step and Taftel consolidated, of which equity comprised just over USD44mn.8 The initial intention was to execute three ratcheted tranches with Swicorp acquiring 40% of each company in Tranche 1 and, altogether, could obtain up to 75% of each company. Performance ratchets were commonly employed in Swicorp deals. Meeran explained that the ratchet worked well to align the target owners’ interests with Swicorp’s. Details of the transaction structure are found in Exhibit 19.15. Within a few weeks of Tranche 1 of the transaction for Step (but not yet for Taftel), in the wake of the continuing worldwide economic downturn, Swicorp renegotiated the structure such that its stake would grow to 46% of each company. No additional capital was injected as the company was revalued—the entrance multiple was reduced from 8× to 6.3× of the estimated 2008 EBITDA and the value of equity adjusted accordingly. In return, the renegotiation eliminated the ratchet thresholds imposed upon Step. In fact, equity ratchets were offered to management based on annual earning thresholds. Although the Swicorp 46% equity was a minority position, it came with substantial blocking powers. As Meeran remarked, it is best to close in a bull market, then restructure in a bear market. Details of the renegotiated deal are found in Exhibit 19.16. Selected financial data and forecasts for the Step Group are found in Exhibit 19.17.

EXHIBIT 19.15 ORIGINAL SHAREHOLDING STRUCTURE OF STEP ACQUISITION

EXHIBIT 19.16 STEP SHAREHOLDING STRUCTURE FOLLOWING RENEGOTIATION

EXHIBIT 19.17 STEP GROUP SELECTED FINANCIAL DATA IN EARLY 2008 (ACTUAL AND FORECAST)

Buy and build in practice

The acquisition of Step represented a typical example of buy and build for Swicorp. Within the first 6 months Swicorp had helped Step to reduce cash burn by 20%, had introduced Step to a large retail chain in the Middle East, representing a significant increase in the volume of business through channel partners, and had assisted Step to increase production by 30% without increasing manpower.

Risks

Prior to entry, Swicorp’s Investment Committee had been concerned about a number of risks, particularly keyman risk and the dependence upon the yarn supplier, Ipliksan. The Committee had reasoned, however, that with Step becoming a global brand the founder was less critical to the operation; in effect, any talented and dedicated executive could run the companies effectively. The concern regarding the concentration of supply from one yarn supplier was eased because Ipliksan itself was in good shape through sales of high-end yarns. Ipliksan had reduced costs by outsourcing much of its production to Croatia, a country with cheaper labor costs than Turkey; and, with Ipliksan retaining a large portion of Taftel’s shares, its interests were more aligned with those of Step and Swicorp. Ipliksan, as a yarn manufacturer, was not dependent upon Taftel—it was the largest hand-knitting yarn manufacturer in Europe with 40,000 m2 of covered facilities and an annual output of 5,000 tonnes; Taftel’s custom represented only a tiny proportion of Ipliksan’s total sales.

One risk that was not given much weight at entry was currency risk, as the days of wild currency fluctuation were considered to be long gone. Unfortunately, this confident prediction was not borne out and the Turkish lira lost 30% of its value against the U.S. dollar in the fourth quarter of 2008. The decision to outsource production to Croatia for both domestic and international sales turned out to be quite detrimental.

Despite the global economic downturn in market demand Step was projected to achieve net sales of approximately USD30mn and 19% EBITDA for 2008, representing a year-on-year growth of 25% in net sales and 22% in EBITDA. Meeran pointed to Step’s solid performance through aggressive sales promotion and significant cost reductions that had driven sales volume growth of 16% in the domestic market and 27% in the international market.

Swicorp’s hope was to exit the Step Group in 2012, based upon 2011 financials, through either a trade sale or an IPO, on the basis of having taken the company from being a regional to an international player.

JORDAN AVIATION LLC

The next deal being considered was for an aviation leasing business in Jordan. The main added value considered was to use Swicorp’s Saudi contacts to grow the business by sourcing new revenue streams.

Relationships in Jordan

Hoping to sell 20–25% of the company, the owners of Jordan Aviation LLC (JATE), Hazem Al Raekh and Captain Mohammed Al Khashman, came to Dubai to meet potential investors in August 2008. As a private investor and the second largest shareholder, Al Raekh decided to bring an adviser with him to the investor meetings. Meeran, through other business dealings in Jordan, knew Al Raekh’s adviser and was able to initiate discussions directly and openly with him. These discussions concentrated on the purchase of Al Raekh’s stake and the talks progressed well. As the discussions continued other shareholders learnt of the plan and they also expressed interest to take part in the sale transaction.

Meeran flew to Jordan and talked through a proposed term sheet for the purchase of a portion of each shareholder’s stake. Over two long days, Meeran convinced the shareholders that Swicorp was a good fit with JATE and would be a reliable and useful partner. The deal structure was tentatively agreed late on the second day with a handshake, after running through the term sheet many times.

The deal

Al Raekh and Captain Al Khashman owned 91% of the company between them but were looking to purchase additional aircraft to allow expansion. One potential growth area they had studied was the increasing number of passengers, bound for Mecca, undertaking the Hajj pilgrimage—these passengers were fueling a demand for charter flights. Meeran had spent time with JATE’s owners showing the potential valuations that could be achieved based on comparables from similar deals. He argued that Swicorp was ideally placed to offer significant business contacts to JATE through its Saudi connections; Swicorp also had excellent relations with JATE’s banks in Jordan.

Jordan Aviation was incorporated in 1998 and commenced operations in the aviation leasing sector in October 2000. By the end of 2007 JATE’s fleet consisted of eight aircraft and it had a workforce of over 300 employees involved in various business segments. In early September 2008, JATE added two new planes to its fleet assigning them to the wet-lease subsector (see Exhibit 19.18 for JATE financials).

EXHIBIT 19.18 JATE FINANCIALS—ACTUAL AND FEASIBLE AT TIME OF ORIGINAL DEAL (USD MILLION)

Comparing JATE with other deals

It was difficult to find similar MENA companies that were comparable with JATE. Swicorp’s analysts used comparables from other emerging markets, as well as from the U.S. and Europe, “normalized” to cater for differences in growth, margins, and returns.

Genesis Lease Ltd. was considered to be a similar deal—a global commercial aircraft leasing company, incorporated in Bermuda and headquartered in Ireland, the company acquired and leased commercial jets to passenger and cargo airlines around the world. Genesis went public on NYSE in December 2006 raising USD720mn in one of the largest IPOs ever for an aircraft-leasing company. It also issued USD810mn in floating rate notes backed by aircraft leases. The transactions helped Genesis to pay for 41 large passenger aircraft, acquired from other leasing companies. Genesis’ sales grew by 30% in 2006 to USD153mn.

The aviation leasing market

The aircraft-leasing sector underpinned commercial aviation and was the fastest growing sector in the aerospace industry. The most significant trend was the anticipated growth of the aircraft-leasing market. The total worldwide market in 2008 was worth USD129bn, generated through 5,000 leased aircraft worldwide, and with an anticipated market growth of approximately 6% per annum; leased aircraft numbers were expected to reach 7,200 by 2011. As of September 2008, over 30% of the global commercial aircraft fleet was leased, compared with just 5% in 1990 and 3% in 1980. It was thought that aircraft leasing was set to mushroom over the next decade as airlines scrambled to serve the fast-growing economies of the Middle East, Asia, Latin America, and Eastern Europe.

Subsectors served

JATE served a number of subsectors, namely passenger and cargo charters, dry and wet leases. Under a dry lease, aircraft-financing entities provide aircraft without insurance, crew, ground staff, supporting equipment, and maintenance. Wet leases involve the lease of an aircraft, complete crew, maintenance, insurance, fuel, and airport fees paid by hours operated. A wet lease is typically utilized during peak traffic seasons, annual heavy-maintenance checks, or to initiate new routes. A wet lease typically generates a net revenue of USD4,000 to USD6,000 per hour per plane. The charter areas covered were:

• U.N. charters—54% of JATE’s revenues in 2006 were generated by contracts with the U.N. and two of JATE’s aircraft were dedicated for this purpose. JATE had been the largest vendor for the U.N. for the past 4 years. These contracts were made on a monthly basis and had no long-term legally binding commitment. The U.N. charter business was considered to be a non-cyclical year-round business.
• U.N. cargo—the U.N. cargo charters subsector was similar to the U.N. charters segment with regard to getting contracts and revenue generation.
• Air taxi—this subsector was similar to a private on-demand jet service.
• Program charters and tours—program charters concern the operation of charter flights, similar to those operated by a scheduled airline. This subsector catered for tours to Mecca for the Hajj and Umrah seasons. The tours and air taxi services were booked on an ad hoc basis and, therefore, were difficult to forecast. JATE was in discussions with a third-party airline and planned to focus future aircraft utilization on Saudi Arabia by opening more routes to Mecca.

Structure of the proposed deal

A special purpose vehicle (SPV), Intaj JATE Invest Holding, was formed as a leveraged investment vehicle for the JATE transaction. Intaj put USD30mn for a 30% stake in the SPV and invited three investors from the Swicorp network to be co-investors. Consequently, family offices from North Africa and the Gulf invested around 20%. An additional sum of around 10% was provided by another PE firm (a non-fund based equity) and an individual investor made up the remaining amount of the planned 65% Swicorp share of the investment. JATE’s owners agreed to provide the remaining 35%. With USD100mn equity and an additional planned debt of nearly USD90mn also at the SPV level, this would be the biggest private equity deal in 2008 in the MENA region.

Al Raekh and Captain Al Khashman’s direct ownership of JATE was to be reduced from 91% to around 42% in the original transaction in September 2008. The Swicorp controlling stake through its SPV was to be gained through two purchases:

• 12 million of JATE’s 40 million existing shares from Al Raekh and Al Khashman for USD73mn
• 17 million new shares issued by the company for USD115mn.

Meeran turned his mind to reviewing the Swicorp deals completed to date. It looked like JATE, with its business based on U.N. charters and Hajj pilgrimage, should be safe in the downturn even if new business streams were slow to take off. More pressing issues were coming to the fore in Turkey where it was clear Step was starting to experience problems meeting its revenue targets. Meeran knew he would need to take action on Step and started to plan how he could safeguard Swicorp’s investment and keep the Step management motivated and on-side. As he sat back looking out of the office at The World islands once more, he wondered what the main issues with Step should be in an upcoming meeting on the way forward. He also knew Swicorp would need to exit some deals as planned in order to build credibility with new investors once the pressure of the downturn had subsided. With the downturn, was the oil-rich MENA region really the best place to be?

a The case was co-authored with Richard Harvey and Geoff Leffek (LBS Dubai London Executive MBA 2009).

1. The Gulf Cooperation Council is a unified economic community of Gulf states comprising Saudi Arabia, Bahrain, Kuwait, Oman, Qatar, and the U.A.E. The U.A.E. consists of Abu Dhabi, Dubai, Sharjah, and four other emirates.

2. “Private Equity: Credit Crunch Deflects Upward Trajectory,” Financial Times, November 24, 2008, Robin Wrigglesworth.

3. British common law is also more similar to Islamic law. In fact, it is widely suggested by scholars that fundamental English common principles were derived from similar legal institutions in Islamic law and introduced to England by the Normans.

4. Arabic dialects differ between countries, so it may be that Arabic is not the easiest language of communication between nationals of geographically disparate nations; Moroccan and Gulf nationals, for example. In these cases English may be used by two native Arabic speakers, or discussion is facilitated if both know modern standard Arabic. English and French nevertheless provide many of the technical words needed to conduct modern business.

5. Source: U.S. government surveys.

6. “Sovereign Funds Sign Up to Code of Conduct,” Financial Times, September 4, 2008, Krishna Guha.

7. Mounir Guen, founder of globally leading private equity placement agency MVision, quoted in Private Equity International, July/August 2003.

8. All valuation figures and ownership percentages hereinafter are indicative approximations.