European private equity investment is going from strength to strength. A recent study by Invest Europe, the association that acts on behalf of Europe’s private equity and venture capital firms, revealed that last year fundraising jumped to nearly €92 billion, a rise of 12% year-on-year. The study also showed that almost €72 billion was deployed across the continent. This is the decade’s highest level and represents nearly a 30% increase on the year before. More than that, it is good news for the 7,000 European companies that befitted from this investment. While investment from Asia reached a record high, Europe continues to attract most of its external capital from North America.
Encouraging signs for the developed market, then. And the world’s emerging markets are hot on their tails: just look at the Abraaj Group, which was, at one stage, the largest private equity firm in the world operating in emerging markets.
But the Abraaj Group also shows how the emerging-market private equity industry is going to undergo natural growing pains as it matures. In recent months, stories have emerged of financial difficulties that have threatened to overshadow its meteoric rise and historic successes. Having presided over uniquely high-yield funds across Africa, Asia, Latin America, the Middle East, and Turkey, including a landmark health fund backed by the Gates Foundation, the group’s veteran founder Arif Naqvi was on the verge of consolidating his lifetime’s work into a global behemoth when local conditions in unstable markets shook investor confidence. The group is now in the hands of Deloitte and PricewaterhouseCoopers, tasked with restructuring the two arms of the firm: the fund management business and Abraaj Holdings. Naqvi himself continues to assist the two JPLs, which in time, will likely prove to be beneficial to the developing countries in which the fund has so heavily invested.
Bold Ambitions: The Origins of Abraaj
Abraaj is unique insofar far as private equity firms are concerned. In early 2017, the success of the group’s early investments, beginning in 2002, enabled it to go about raising its first global fund, APEF VI as it was known. At $6bn this was a landmark fund, the largest ever raised in emerging markets, which elevated Abraaj into the big leagues to compete as one of the largest private equity outfits in the world.
Naqvi last year spent 320 out of 365 days on the global fundraising trail to bring it to life. His ambition had been to unify the separate funds into a single global fund, led by an international team; to consolidate and become a truly global brand with local presence and global institutional capability. In August 2017 a global investment bank valued Abraaj in preparation for a potential IPO, reporting that once Fund VI was completed, scheduled for mid-2018, the group would be worth $3 billion of equity value, an extraordinary valuation for any private equity firm, let alone one operating across emerging markets.
However, reality often has a way of not following pre-determined plans. In late 2017, the political and cultural problems that are invariably present across all emerging markets inevitably began to act as obstacles to the fulfilment of Abraaj’s ambitious long-term investment strategy. It entered a cash crunch situation that tied up $1 billion of receivables on its balance sheet. This included one of its most crucial assets, K-Electric, a formerly dysfunctional power provider in Karachi that was riddled with corruption and was haemorrhaging money. In a few short years, Abraaj had turned the company around, but just as it sought to discharge the straightforward task of selling the rejuvenated outfit to a suitable buyer (that would strengthen political ties between China and Pakistan in light of the former’s commitment of up to $60 billion into the country’s infrastructure investment), political conditions on the ground in Pakistan seemingly halted progress. This stalled venture by itself tied up nearly half of the receivables value on Abraaj’s consolidated balance sheet.
At the same time, Abraaj’s prized health fund was experiencing similar problems in the temperamental markets in which it operated. Two elections in Kenya held up approval for its work in revitalising eight hospitals across the country. A process that should have taken 45 days took 10 months. This made it increasingly difficult to deploy the capital that had already been drawn from investors which it had both promised and expected to do in a much shorter timescale.
In the steadfast pursuit of its high-growth trajectory to this point, the group had naturally been operating at a loss in exchange for growth, as many high-growth businesses across the world do. Abraaj’s fund management fees had never covered its costs, as it was building for future growth and earnings. To keep operations afloat and ensure revenues continued, Abraaj made sure to cover its operating costs, run by an arm known as AIML, the fund management business, by utilizing surplus capital lodged in Abraaj Holdings of $1.5 billion alongside credit lines. Though the company ran an expenses deficit, its successful investment exits and revaluations of its own investment portfolio (which included substantial positions in its own funds) meant that it virtually always posted a profit. Indeed, utilising surplus capital and borrowing where necessary in order to maintain this momentum was the status quo. However, it soon became clear in 2018, after news reports broke of disagreements with certain investors in the health fund, that investors expected the kind of structure typical to funds operating in developed markets.
Abraaj’s Restructuring Plan
In order to return the shortfall due to creditors at the parent, two JPLs were brought in to restructure the firm, filing their most recent submissions in the Cayman Court last week. Naqvi himself has also put forward a bold restructuring plan designed to separate the overlap previously perceived to have threatened the integrity of the business. The first priority will be to amalgamate both Abraaj Holdings and AIML, thereby aligning their incentives, to bring about a single platform solution to the restructuring through which to ensure maximum recoveries for creditors, alongside enabling investors in its funds (limited partners) to choose a new fund manager and separate the investment platform from the holding company in an organized manner.
The newly restructured group will naturally seek to agree upon an orderly time-scale in which it can monetize its assets – which include principal LP stakes in each of their underlying funds – so as to ensure full repayment of its principal liabilities. The most pertinent aspects of the plan are the agreed-upon sale of Karachi Electric, perhaps the group’s most valuable long-term asset, together with the fact that Mr Naqvi is personally ensuring a release of a large portion of liability held by the fund management business through personal contributions. As had been previously been agreed, he will be stepping aside from all operational involvement in the group, with the appointment of a Chief Restructuring Officer across both estates to ensure the implementation of a well-defined plan.
Despite the current situation, it is difficult not to admire Mr Naqvi’s crusading tenacity. The faith he showed in the potential of emerging markets over the course of several decades steadily became infectious to investors used to the safer shores and reliable returns often found in Europe and the other developed markets of the West. That his global ambitions met with diminishing returns much sooner than they expected should not have been a surprise to anyone. Having now taken personal responsibility for this collective disappointment, the approval of his restructuring plan can only be a positive thing for the fragile markets in which Abraaj is so deeply embedded. So long as investors are willing to place the same faith in emerging markets in the next five years that Mr Naqvi has in the last twenty, companies, citizens, and consumers might have a chance of seeing the returns which they surely deserve.