Deals trends and outlook for the Middle East
Welcome to our first edition of TransAct ME. Our updates will provide insights into the deal market and specific sectors from across the region. We will look at what’s driving transactions and provide some practical steps that investors or companies can think about when they are next considering either buying or selling a business.
The evolution of a “new normal” market with transformational reform taking place across the region makes it an interesting and exciting time to do business in the Middle East. With that said, achieving organic growth and bridging the valuation gap (in some sectors) are just some of the challenges that investors and owners continue to face.
But the region's underlying demographics and value drivers means that traditional sectors such as healthcare and education continue to remain of interest but newer (or more nascent) sectors are coming to the forefront. The digitisation of businesses and processes across all sectors is also driving some great opportunities.
Positively, in our recent 2018 Middle East CEO survey, 56% of CEOs are looking to strategic alliances or joint ventures in the next 12 months to drive corporate growth and profitability.
Looking at Deals with a real “value creation” lens and careful planning should be a priority well in advance of a deal process being started by a seller or being completed by a buyer.
I hope you enjoy reading our first edition and please feel free to reach out to me or any of my colleagues should you wish to discuss any of the topics in this publication further.
Deals – Markets Leader and Regional Valuations Leader
The Middle East and Egypt remain exciting regions in which to invest. Whilst macro-economic and geo-political headwinds persist, the ongoing transformation agendas of regional Governments and the planned diversification of economies, away from carbon fuels, is opening up interesting opportunities in newer sectors, particularly those connected with or influenced by technology and digitisation.
Certain traditional sectors such as education and healthcare still remain popular but investors have been rethinking their growth expectations and valuations against the backdrop of rising multiples in these sectors. Across the board, there is a new focus on actively managing assets to unlock value, and a more cautious and critical approach to deal making. During the oil boom years, there was little need to actively manage portfolios, as valuation multiples tended to rise on their own. Now there is a need to drive value creation in different ways including cost management, capital optimisations and exit planning.
Given where we are in the economic cycle, current trading performance and expected valuations may make it difficult for investors who are divesting assets acquired over 3 years ago to achieve their target returns. This is one of the reasons why closing deals can prove to be a long and protracted process but we expect this to get better as buyers and sellers begin to embrace the “new normal” and early signs of this are already evident.
Whilst 67% of regional CEOs tell us that they are more focused on driving growth via organic means, a lack of organic growth opportunities in certain sectors may result in an increase in alliances and potentially joint ventures. Over half of Middle East CEOs who responded to our recent PwC survey said they were looking at a “strategic alliance or joint venture”. We therefore see corporate investors and family businesses becoming increasingly more active in the M&A market. The recent Al Islami - Mitsubishi Corp transaction is evidence of a family business partnering with a foreign multinational to drive growth.
As 2018 progresses and beyond, deal flow will likely remain below the more buoyant levels seen in 2013 – 15, but a combination of easing austerity measures, return of GDP growth and availability of dry powder with certain financial investors is likely to lead to an increase in investment activity. The enabling environment for investment will continue to improve throughout the region including the regulatory changes which are being implemented and should help increase foreign direct investment, particularly in UAE and KSA.
When we look at the geographical markets that Middle East CEOs are turning to for growth, KSA takes the lead followed by China and India. This is not surprising given the ongoing transformation of the economy in KSA; China is a major buyer of regional commodities; and India remains a close trading partner and ready supplier of both talent and labour to the Middle East.
Source: PwC Middle East CEO Survey 2018 – Adjusting to the new normal
Source: Merger Market, Thomson Reuters, Capital IQ and PwC Middle East analysis
The secular investment shift towards new economic sectors was evident in 2017 and is likely to continue in the years ahead. Old stalwarts, such as retail, real estate, construction and energy have seen a decline in deals completed. Interestingly, where deals have taken place in traditional sectors (e.g. energy and infrastructure), these have been of a larger size – the appetite is there but we expect investors to continue to be more selective in these sectors.
Up-and-coming sectors for M&A include newer ones, such as technology, and not-so-new ones, such as industrial manufacturing, where opportunities, perhaps overlooked in the past, are being re-evaluated. There is a strong interest in companies with expertise in the digitisation of business processes, from banking and telecommunications to automotive and retail, where – following Amazon’s acquisition of Souq.com in 2017 – almost every player is considering their online strategy and the distribution logistics that go with it.
Source: Mergermarket, Thomson Reuters
Deals in sectors such as technology however have tended to be of a smaller size and the number of assets available in the region may continue to present a challenge. Overseas opportunities may be a good way of bringing in technology that has been tested or developed in other markets.
Recently announced Gulf Finance House's acquisition of a majority stake in The Entertainer is a good example of how investors in the region are exploring newer sectors.
Education and healthcare, meanwhile, continue to provide opportunities for long-term investors, particularly in KSA, as the market remains largely untapped.
2017 was a landmark year for M&A in the financial sector, with the $14.8 billion merger of First Gulf Bank and National Bank of Abu Dhabi that created the largest bank in the UAE and one of the largest in the region. Elsewhere, Kingdom Holding Company, an investment firm owned by Saudi Prince Alwaleed bin Talal, took a $1.5 billion stake in Banque Saudi Fransi, while a group of MENA investors acquired a 20 per cent stake in Amman-based Arab Bank Plc for $1.1 billion.
This year we have recently seen the merger of Saudi British Bank (SABB) and Alawwal Bank coming together to create KSA's third-biggest lender in a reported $5 billion deal. The next few years are likely to see further consolidation opportunities in the various financial services subsectors but perhaps not always of the magnitude of deals as mentioned above as there is less urgency for it. Given the number of players in each of the financial services subsectors though, consolidation opportunities will continue to be a feature in the region.
Within the financial services industry there could be opportunities for private equity investment and M&A, particularly in the digitisation of banking processes such as payments processing, in technology-enabled regulation and compliance functions, and in asset management. Waha Capital's recent acquisition of a significant minority stake in Channel VAS, a financial technology company providing micro finance lending solutions being a good example. We also believe that regional telcos will be acquisitive in data heavy, customer-centric fin-tech opportunities. The insurance sector in KSA, meanwhile, is set to be boosted when women begin driving in KSA later this year – just one example of how the transformational agenda of regional governments is opening up new business opportunities for investors.
Source: Mergermarket, Thomson Reuters
Vision 2030, the transformation agenda in KSA, is creating much excitement in the region, with the reforms gathering pace in 2018. The Kingdom is embarking on an intensive drive to overhaul and diversify its economy as it seeks to create an investor-friendly climate for privatisation, including a listing for Saudi Aramco.
The Kingdom is updating some existing laws and introducing new ones such as bankruptcy regulations, which will make it easier for struggling companies to restructure debt and attract new investors. Nomu – a new market for small caps launched in 2017 was intended to tap unfulfilled demand and triggered a record number of listings in the Kingdom last year. New rules allowing foreigners to trade shares directly may deepen this market's liquidity in the years ahead. Opportunities are also opening up in the hospitality and leisure sectors as the Kingdom seeks to become a destination for religious tourism. And as Vision 2030 advances with the modernisation of society – for example, by granting women the right to drive (3 million new women drivers estimated to enter the market by 20201) – investors should see new opportunities arising in sectors such as insurance and automotive and indirectly in leisure and retail.
UAE continues to be the principal destination of interest for investors and transactions. The M&A environment has remained resilient despite the relatively difficult economic climate with 89 deals* closed in 2017. The year was dominated by the $14.8 billion merger between First Gulf Bank and the National Bank of Abu Dhabi. In addition, there were notable deals in e-commerce (with Amazon’s takeover of Souq.com) and in energy and infrastructure, including Engie of France’s $775m investment in Tabreed, a supplier of sustainable cooling for business districts. In the oil and gas sector, Abu Dhabi National Oil Company (ADNOC) has entered into a partnership with China’s National Petroleum Corporation to further its expertise in offshore exploration. Increasingly, national energy groups are selecting partners – not only for their operational and financial credibility, but also based on what outsiders can bring in terms of smart technology and energy utilisation.
The government’s digitisation agenda for 2021 is likely to create M&A opportunities across a range of sectors including financial services, transportation and logistics, and retail, among others, since existing players will seek to acquire these capabilities and integrate technology and innovation within their growth plans.
Investors are looking at Egypt with renewed interest now that currency issues seem to have subsided. While deal activity in 2017 was at its lowest level in five years, Egypt’s favourable demographics, coupled with new, greenfield investments in energy and infrastructure, have heightened the country’s potential and appeal. High inflation and elections later this year, however, mean that deal flow is more likely to grow over the medium term rather than in 2018.
* Source: Merger Market and Thomson Reuters
1 – PwC Middle East - Women driving the transformation of the KSA automotive market
There have been a number of recent tax legislative changes which are relevant to M&A transactions. These include changes to how the tax/zakat profile of a KSA company is determined and the tax treatment applicable to intra-group reorganisation transactions. Both buyers and sellers should take these into consideration as part of M&A planning and whilst working on deals.
In the context of deals, compliance with VAT obligations (e.g. VAT registration, issuance of valid tax invoices, application of the appropriate treatment on supplies, filing and payment of returns on time) and VAT control processes are new critical items for risk assessment purposes for businesses. The risks associated with non- VAT compliance are not only financial, with the application of tax penalties and analysis of incomplete financial data, but also reputational.
VAT must also be added to critical items being considered while structuring deals. This is because the amount of deal-related expenses can be significant and the VAT applicable on these expenses could become an additional cost if not anticipated and structured in an efficient way.
We have seen a key trend over the last 12 months in the increase of availability and use of warranty and indemnity ("W&I") insurance.
Designed to cover unforeseen risks associated with claims for warranty breaches, standard W&I provides buyers with the opportunity to plug gaps in warranty cover and has been commonly employed in the region in deals involving financial or institutional sellers. Other circumstances where W&I may provide mitigation of deal risk is where an ongoing management team make up some or all of the sellers or in an auction process where sellers may have increased leverage in relation to certain key terms of the deal.
The costs associated with W&I in the Middle East are beginning to reflect the costs of such policies in more mature markets, particularly where insurers are brought into a deal sufficiently early in the process and have access to relevant information, reports and key transaction documents. Another welcome move is that insurers are beginning to offer Shariah compliant W&I policies in the Middle East.
Whilst, W&I is not and should not act as a replacement for the usual forms of mitigating risks (particularly comprehensive due diligence to identify key risks), we do see it playing an increasingly relevant role in mitigating some of the risks of M&A activity in the Middle East.
Both family-owned businesses and conglomerates are looking to diversify their holdings away from oil, real estate and retail. Fintech, e-commerce joint ventures and technology for the modernisation of industry and manufacturing are all gathering interest, although – as with much of the tech sector – assessment of the deal potential and valuation remains a challenge and sectors such as technology remain relatively small. We expect value creation and exit planning to remain high on the agenda. Family groups are now more willing to divest as they are recognising the value creation opportunity from exiting ex-growth or non-core businesses.
Accurately assessing tax considerations is increasingly an important component of deal value. The region has seen many recent tax developments aimed at moving tax systems towards international best practices, such as the introduction of VAT in some countries and alignment with the OECD’s Base Erosion and Profit Shifting Project, which aims to create a coherent set of international tax rules. In this environment, the tax policies of companies can create both risks and opportunities for value creation in deals.
Looking ahead to late 2018 / early 2019, deal flow should improve as restrictions on foreign ownership are eased further, and regional governments advance with their transformation agendas. The learning curve around the transformation and privatisation agenda in KSA will continue. Across the region the regulatory framework for M&A is expected to be more supportive and should therefore contribute to an improvement in deal activity.
In the current environment, Companies can no longer afford to be reactive when it comes to exit planning. Businesses and sponsors will have to start early and plan carefully to ensure that the business is well prepared for demands of an exit process, the growth story is properly articulated and any potential deal breakers are identified and dealt with early on in the process.
With exit conditions likely to be less favourable than those at entry across a number of sectors, a holistic approach to value creation will be key to unlocking value. This would entail developing a full strategic blueprint for the business which provides a road map for creating value across all aspects - and not limited to cost optimisation measures only.
Corporates and family businesses looking at M&A to drive future growth need to have a clear acquisition strategy in place regarding what they are planning to achieve through M&A (synergies, diversification etc). Having clear visibility on how any potential targets fits with the Company's longer term strategic plan is an imperative. Careful consideration also needs to be given to the best form of M&A to achieve the desired objectives (e.g. merger, alliances, acquisition etc.)
Middle East Valuations Leader and Regional Deals Markets Leader, PwC Middle East
Partner, M&A, PwC Middle East
Tel: +971 4 304 3211
Transaction Services Partner, PwC Middle East
Tel: +971 566 829 961
Middle East International Tax Leader, PwC Middle East
Tel: +971 4 304 3445
Legal Services Leader, PwC Legal Middle East
Tel: +971 (0)56 418 9768