Thanks to its large population, a renowned hydrocarbons industry and an increasingly diverse non-oil sector, Saudi Arabia is one of the world’s wealthiest nations and a member of the G20 group of major economies. IMF data shows its GDP to be larger than that of advanced economies such as Sweden, Norway and Austria, as well as those of Middle East and African giants such as Egypt and Nigeria.
Within the GCC, it is home to the largest single slice of private wealth, accounting for around 44% of regional capital controlled by affluent citizens, according to a recent study by Strategy& (formerly Booz & Company), comfortably ahead of the neighbouring UAE, which is home to 30% of the total. The Kingdom’s high-net-worth individuals are cash-rich and sophisticated investors, accustomed to deploying their wealth in markets across the globe and therefore familiar with the full range of asset classes and investment instruments.
At home, the Saudi Stock Exchange has proved a useful source of yield since it began to recover from the effects of the 2008 global economic crisis, with its Tadawul All Shares Index growing by more than 50% since January 2012, and yielding a compound annual growth rate of around 13% from 2010 to 2014. Saudi equities remain in the spotlight in 2015 as the nation’s exchange opened its doors for the first time to direct investment by foreign investors, a development expected to not only boost liquidity over the coming years but also to bring about institutional enhancements in areas such as analytical coverage, transparency and market processes (see Capital Markets chapter). The nation’s fund industry has responded to this positive trajectory and is establishing new instruments to target growth areas such as initial public offerings (IPOs), which have staged a welcome recovery over the past two years.
These innovations are expected to attract significant amounts of capital in the short to medium term, but Saudi Arabia’s investors are also looking at alternative routes to generate investment income. The government has played the leading role in encouraging entrepreneurship and supporting the development of small businesses in the country, but a number of corporate and private investors have started to deploy their assets in venture capital (VC) and seed investment initiatives that aim to capitalise on the pool of domestic talent. This development heralds the beginning of an interesting phase in the economic evolution of Saudi Arabia, and one which will offer an even greater array of investment opportunities to the Kingdom’s investment community.
The Saudi Arabian market was the first in the GCC to play host to a mutual fund. In 1979 the National Commercial Bank established the Al Ahli Short Term Dollar Fund, an innovation in the region which created an appetite for similar instruments in markets around the Gulf. However, it was to be nearly two decades before the mutual fund concept had established itself as a ubiquitous component of the MENA financial landscape. After Kuwait’s successful trial of a fund in 1985, Egypt, Bahrain and Oman did not follow suit until 1994, while Lebanon and Jordan did not introduce mutual funds until 1996 and 1997, respectively. Saudi Arabia, meanwhile, had been working to formalise its growing fund segment, and in 1993 it established the first rules governing mutual fund activity in the Kingdom. The country’s head start in fund development, both in terms of creation and regulation, helps to explain its dominant position in the regional fund market today.
Saudi Arabia is the largest fund domicile in the MENA region. The country accounted for $27.7bn of the $62.7bn MENA fund industry at the end of 2014, according to figures from Zawya. Only Morocco comes close in terms of assets under management (AUM), with $16.3bn, followed at some distance by Egypt, with $7.54bn of the region’s AUM controlled by funds domiciled within its jurisdiction.
Over the years Saudi Arabian banks and asset management companies have broadened their offering from an initial focus on equity funds to establish the most diverse fund pool in the region. At the close of 2014, a total of 263 public funds were registered in the country, according to the Capital Market Authority (CMA), between them offering the investment community exposure to Saudi shares, regional and international stocks, money markets, bonds, real estate, trade finance and IPOs.
A total of 315 private funds, meanwhile, offered access to similar asset classes as well as alternative investment instruments such as hedge and financial derivative funds. The latter segment has shown particularly strong growth in recent years, rising from just nine funds in the first half of 2013 to 26 during the second half of 2014. Saudi-domiciled funds have also provided a useful investment channel for foreign entities wishing to gain access to the local market: for many years investment in mutual funds was the only means by which non-resident foreign investors could participate in the Kingdom’s exchange, until a 2008 regulatory decision allowed foreigners to enter the market via swap contracts.
Individually, Saudi Arabia’s fund management entities are also the largest in the region. At the close of 2014 four of the top five MENA fund managers in terms of AUM were based in the Kingdom. Of these, NCB Capital, the investment arm of National Commercial Bank, was the largest, with around $8.6bn under management, followed by Riyad Capital ($4.6bn), SambaCapital ($3.1bn) and Al Rahji Bank ($2.8bn). Each of these large players offers more than 30 funds covering the full investment spectrum, from high-risk and high-growth portfolios to medium-growth instruments and income equity and small-cap equity funds.
As well as the local names, a number of prominent international institutions have secured licences to offer investment services in the country, including Blominvest of Lebanon, Egypt’s EFG-Hermes, Morgan Stanley and HSBC. A significant market entrance came in 2014 in the form of Ashmore Investment Saudi Arabia, the new local subsidiary of the UK-based emerging market asset management specialist.
The company was already a long-term investor in Saudi Arabia through its range of emerging markets debt, equity, special situation and private equity (PE) funds, but the addition of a Riyadh office to its network represents a significant scaling up of its local activities and a vote of confidence in the Kingdom as an investment destination.
“Opening this subsidiary is part of Ashmore’s strategy to build local businesses in key emerging markets. Establishing our first office in the Middle East in Riyadh clearly demonstrates our confidence that the country’s young but significant asset management market will continue to grow at an impressive rate,” Mark Coombs, CEO of the Ashmore Group, told the local press in October 2014.
Both Ashmore and Blominvest secured permission from the regulator to launch IPO funds in early 2015. The new products join existing IPO funds from local players such as KSB Capital, and their growing number demonstrates the renewed interest in public offerings in the Kingdom driven by the opening up of the exchange to qualified foreign investors in June 2015 (see Capital Markets chapter) and the country’s strong macroeconomic fundamentals.
Relative to Saudi Arabia’s vibrant fund market, PE activity in the Kingdom remains at any early stage of development. For international and local PE firms alike, the Saudi market is made challenging by a unique business culture which, notwithstanding a ranking 49th out of 189 countries in the World Bank’s 2015 “Doing Business” survey, limits the scope for PE initiatives.
The fact that around 95% of the corporate economy is made up of family-owned businesses, which have historically been reluctant to cede control to outside interests, is a principal hurdle. Family businesses in Saudi Arabia have also shown a tendency in the past to over-value their assets when interacting with PE operators, a legacy of the overheated investment environment in the run-up to the 2007-08 global economic crisis. The valuation gap in pricing has been exacerbated by PE firms re-assessing their risk appetite in the wake of the economic crisis, particularly where their portfolios have been negatively impacted and they have been compelled to hold on to interests longer than expected.
Another problematic area is the absence of a codified legal system in the Kingdom, particularly with regards to bankruptcy laws required by PE investors should portfolio companies fail. The current legal framework also places minority investors at a disadvantage, as regulations governing preferred shares are absent and governance of takeovers and squeeze-outs is unclear. Finally, PE firms face a lack of exit opportunities. IPO exits and secondary buy-outs are relatively rare, leaving trade sales (a stake sale to other corporate entities) as the only viable exit from PE transactions in most cases.
However, there are signs that the nation’s PE arena is beginning to gather momentum. One of the traditional challenges, the high degree of family ownership, is being transformed into an opportunity as businesses established during the boom of the 1970s and 1980s reach a new level of maturity. “These companies are being passed to heirs, the second or third generation, and in some cases they are not ready to take them on. The founding shareholders therefore attempt to restructure, to improve corporate governance by inviting in strategic shareholders with a view to taking the company public to protect it from any disturbance from the death of the founder,” Khalid Nasser Al Muammar, CEO for Saudi Hollandi Capital, told OBG.
PE deals as a stepping stone to an IPO are therefore becoming more common in the market. The increasing appetite for PE transactions in the Kingdom means that the fledgling industry is beginning to capitalise on the many compelling advantages that the domestic economic landscape offers, such as a stable and resilient economy, political stability (reinforced by the recent royal succession), a young population which grew at an annual average rate of 3.2% between 2004 and 2013, and a government commitment to infrastructure development that has resulted in a pipeline of more than 80 mega-projects, each valued at $1bn or over, in the planning or development stage (see Construction and Real Estate chapters).
Added to this is the risk-averse stance of the banking sector, which has resulted in just 2% of the aggregate Saudi Arabian loan book being directed to lending to small and medium-sized enterprises (SMEs), thereby establishing a significant funding gap that PE is ideally suited to address.
The investment arms of Saudi banks and standalone investment banks are gearing themselves up to address the market opportunities that these factors present. “The PE market is underserved in Saudi Arabia. We are investing greatly in it, as we feel there are significant opportunities in the PE space. The challenge is choosing the right partner and sector, and in having a mutual interest in developing the business,” Fahad Al Turki, chief economist and head of research at Jadwa Investment, told OBG.
Foreign PE firms, too, are playing their part in driving activity. They have succeeded in overcoming the challenge of limited exit options, most notably in the case of the Carlyle Group’s successful sale of its 30% stake in the General Lighting Company to Philips and the National Bank of Kuwait’s sale of its 38% interest in Nayifat Instalment Company to FALCOM Financial Services. Significant activity from US and Asian entities in early 2015 has reinforced the proposition of Saudi Arabia as a growing market for PE in the region (see analysis).
VC is another expanding financial segment in Saudi Arabia, although its development has followed a different pattern from some other markets in that the government has played the central role in its growth from the outset – and continues to do so to this day. When the King Abdulaziz City for Science and Technology (KACST) established its Badir Technology Incubator Programme in 2007, there were no angel investors, seed investment vehicles or VC programmes in the country.
The Badir programme was designed to address this gap and in doing so incorporates two streams of activity which are open to all technology entrepreneurs from Saudi Arabia that have an early-stage technology-based prototype or concept.
First, Badir’s incubators provide a mix of services, such as business consultancy services, office and lab space, secretarial and administrative support, and assistance with preparing business plans, financial modelling and pitching. Badir’s second function is to help its clients find funding for further development, which it does by building relationships with existing funding channels as well as creating new ones.
Some of Badir’s graduates have gone on to secure additional funding from another government initiative, TAQNIA, which was founded in 2011. The organisation has established a VC fund and partnered with Riyad Capital to help it raise its target of SR500m ($133.3m). The fund is the first in Saudi Arabia to include commitments from both public and private investors, and as of early 2015 it had secured SR250m ($66.6m) from government institutions such as the Public Investment Fund, the Saudi Credit and Savings Bank, and the Human Resources Development Fund.
As the fund grows and it becomes more active, it is hoped that it will help to address one of the main weaknesses of the entrepreneurial scene in Saudi Arabia right now. “One of the problems in the entrepreneurship ecosystem right now is that there are no exits. We are hoping that VC will help grow a start-up to a corporation so that they can either exit or become sustainable in the long term,” Fahad Al Hussain, president of TAQNIA, told OBG.
Linking With Higher Education
The government is also using the Kingdom’s university network to boost VC activity in country, and in 2010 established VC investment arms at the King Abdullah University of Science and Technology, King Abdulaziz University in Jeddah, King Fahd University of Petroleum and Minerals in Dhahran, and Riyadh’s King Saud University. Of these, the last is at the most advanced stage. Riyadh Valley Company started life with an initial fund of SR100m ($26.65m), and also owns 480,000 sq metres of land valued at more than $800m, parts of which it has begun to deploy for deriving liquidity to be used in its VC investments.
Riyadh Valley Company seeks investment opportunities in areas such as health and life sciences, information and telecommunications technology, renewables and water resources technology, and in its first few years of operation it has built a portfolio of companies specialising in areas as diverse as water pump monitoring technology and electronic calling systems. The work of state-backed VC investment vehicles such as Riyadh Valley Company and TAQNIA is essential to the growth of the VC industry in Saudi Arabia going forward. “The Saudi government has launched initiatives like Riyadh Valley Company to build a solid foundation for venture capital investments in the kingdom. For private money to come into VC there needs to be confidence in this sector; therefore, we need some success stories, some start-ups to go big,” Abdelhakim Hammach, managing director of investment at Riyadh Valley Company, told OBG.
There are now some signs, however, that elusive private sector capital is starting to move towards the VC arena. At the angel and seed investment level the private sector has assumed a leading position thanks to the activities of a small number of Riyadh-based high-net-worth individuals who, after starting out as an ad-hoc gathering of investors, have since formalised things and become the angel investor group Oqal.
After its founding in 2011, the company had by 2015 assessed more than 1000 opportunities, of which more than 120 were chosen as qualifying enterprises and around 20 were invested in – including Careem, a rival to smartphone car service Uber, and online food portal HungerStation. It has recently been joined in the market by Oasis500, the seed investment company that began life as a vehicle for information technology entrepreneurship in Jordan. In 2014 Oasis500 announced that it was joining forces with Badir to create the Badir-Oasis500 programme, by which it will take equity stakes in start-ups in return for seed funding and mentoring.
The government has not ceded the angel investment field entirely to the private sector though. Partly in response to the success of Oqal, Badir has helped to establish another angel investment platform on Saudi Arabia’s west coast: the Angel Investor Network, known as Sirb, was formally founded as an initiative of KACST in line with the university’s vision of transitioning to a knowledge-based economy.
The emergence of these companies in the Kingdom goes some way to answering the funding gap which characterises the current entrepreneurial environment, between the ideation stage and the Series A investment stage (see analysis).
Moving up the investment scale, more private VC has come to market thanks to some of the Kingdom’s largest corporates, one of the most prominent of which is STC Ventures – an independently managed VC fund whose anchor investor is the Saudi Telecom Company. Headquartered in Riyadh, the fund focuses on technology innovation in Saudi Arabia, the GCC, Levant, North Africa and Turkey. The fund is managed by Iris Capital Management, which since its foundation in Paris in 1986 has managed investments in excess of $1bn in more than 200 companies. In seeking funding for its graduates, Badir has established strong links with STC Ventures and the nascent corporate VC segment, which also includes: Mobily Ventures, the VC fund of Etihad Etisalat (Mobily) Saudi Arabia; MBC Ventures, an internal division of the MBC group which focuses on media and entertainment opportunities; SABIC Ventures, a wholly owned subsidiary of the Saudi petrochemicals giant; Saudi Aramco Energy Ventures, which concentrates on hydrocarbons, renewable energy and water efficiency initiatives; and the SME fund, the anchor investor of which is the Islamic Development Bank and which seeks investment opportunities across all sectors.
Saudi Arabia’s investment landscape is currently entering a transformative period. In the fund arena the growing draw of IPO-following instruments has been firmly established as a theme for 2015, while questions have arisen about the appeal of the hitherto popular real estate funds as a result of a newly proposed land tax.
The Kingdom’s investors have for some time had a wide range of mutual funds to choose from, and recent years have seen an increase in more exotic hedge and derivative funds which have boosted Saudi Arabia’s alternative investment sphere.
The PE arena, meanwhile, stands to benefit from the CMA’s recent decision to open the nation’s stock market to direct access by foreign institutional investors. The development promises to increase market depth and promote easier exits, as well as enhance market practices in areas from research methodology to management accountability.
Finally, the trend to watch in the VC industry is the increasing participation of the private sector, which is sometimes working with existing public sector VC institutions, as domestic and international companies continue to make further inroads into the Kingdom’s challenging but potentially lucrative market.
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