Gulf states: Less noise from leveraged wealth funds

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By:
Dominic O’Neill
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The credit crisis could leave in its wake rich pickings for Middle East sovereign wealth funds. But what about private-equity-style government groups that rely more on leverage to fund their investments?

Some observers now expect substantially less noise in the international markets from such operations as Istithmar, which is part of state-owned conglomerate Dubai World; and Dubai International Capital (DIC), which is part of another conglomerate, Dubai Holding. Even Qatar Investment Authority, a more conventional sovereign wealth fund, will be slightly more subdued, according to some analysts, as its investment model includes leveraged buyouts.

"The model of some so-called sovereign wealth funds of borrowing and then investing in high-profile assets is perhaps at an end," says Mushtaq Khan, Middle East analyst at Citi.

Dubai, Khan reckons, does not even have a sovereign wealth fund. "Dubai has investment companies that borrow and invest. A sovereign wealth fund, in my view, is an accumulation of capital surplus, not a leveraged company," he says.

DIC and Istithmar have indeed invested in high-profile assets around the globe. They are an integral part of the extremely complex state-owned corporate structure informally called Dubai Inc. DIC and Istithmar are thought to have little treasury-type investment; instead their focus has been on real estate and equity stakes in companies.

David Jackson, Istithmar: still digesting and analyzing

David Jackson, Istithmar: still digesting and analyzing

But according to David Jackson, chief executive of Istithmar, the overall opportunistic strategy of the fund has not changed because of the crisis, even if its emphasis has. Jackson tells Euromoney that Istithmar is looking at a handful of investments in financial institutions, both in developed and emerging markets, particularly in asset management, where he says valuations have become attractive. He says shares of financial institutions might have priced in the crisis earlier than other sectors.

He says: "We are still in the analytical and digestive mode. I don’t have a crystal ball, but it might be another two or three months before we go to the market and acquire." According to Jackson, for the relatively small, $1 billion to $2 billion buyouts that Istithmar does, leverage is still available – and he says Istithmar can still tap the resources of other companies in the Dubai-World arm of Dubai Inc.

"We are not a short-term, flip-orientated institution," says Jackson, when asked how falling values might affect Istithmar’s exit strategy on existing investments.

As for DIC, a source close to the fund says it will continue to focus more on emerging markets, particularly in Asia. In February, the fund announced plans to invest about $5 billion in India, China and Japan over the next three to four years, typically in undervalued large-cap companies. Last year, DIC announced that it had taken "a significant stake" in Sony.

Health concerns

Still, the fund is vulnerable to the global crisis, as demonstrated by its decision to cut 10% of its workforce last month. There is also growing concern about Dubai’s financial health and it is still far from clear what impact a crisis in the emirate could have on its state funds.

In October, Moody’s warned in a report that the liabilities of the entirety of Dubai’s government and government-owned companies (excluding banks) had tipped the balance, at least, of the 2006 GDP, the latest growth figure available for the individual emirate.

"Moody’s has conservatively identified in excess of $47 billion in liabilities at various government-related companies, which represents more than 100% of Dubai’s 2006 gross domestic product," says Philipp Lotter, co-author of the Moody’s report.

The agency says leverage in Dubai will grow faster than its GDP for the next five years. It says support from the biggest and richest emirate in the United Arab Emirates, Abu Dhabi, is now more important than ever.

Qatar Investment Authority is also focusing on Asia and has publicized joint ventures with government groups in the region. As the international investment arm of a tiny state with huge oil and gas reserves, the fund can have a higher proportion of income from hydrocarbon exports redirected towards it. In the second quarter of this year, the fund made six known acquisitions with a combined total of $8.2 billion, according to US-based consultancy the Monitor Group.

QIA continues to be aggressive in its investment strategy towards beleaguered financial institutions in the West. Last month it increased its stake in Credit Suisse to become the Swiss bank’s biggest shareholder. QIA is also rumoured to be the investor that coughed up £1 billion for Barclays as part of the UK bank’s plans to raise £6.6 billion from third-party sources over the next six months.

Even so, compared with Kuwait and Abu Dhabi’s sovereign wealth funds, the Qatar Investment Authority is small and young. It is known to have used syndicated loans to acquire assets – potentially meaning a slightly more constrained ability in the future to acquire in an ever more gloomy global credit environment.

"The only true Gulf sovereign wealth funds are the Kuwait and Abu Dhabi Investment Authorities. The others are more like leveraged private-equity groups, not much different from Blackstone or KKR," says a senior investment banker active in the Middle East.

Another issue is that problems in local capital and real-estate markets are already forcing some Gulf funds to invest more at home. As oil and gas prices fall, hydrocarbon-exporting governments will have less and less revenue to spare. This will further impede their ability to acquire.