MENA Mergers & Acquisitions - August 2008 Activity Update

16/09/2008

Country Focus: Saudi Arabia

•Non-Oil real GDP is expected to grow by about 6% during 2008, supported by prudent macroeconomic management of the oil boom and the ongoing structural reforms. In 2007, it grew by about 5% in real terms, driven by the construction, transportation, and communication services.

  • A massive investment program of about US$492 bn (130% of 2007 GDP) for 2008-12 is being implemented to address critical infrastructure needs, including new cities, ports, and expansion of oil production capacity.
  • Inward foreign direct investment (FDI) continues to increase, reaching US$18 billion in 2007 as compared to less than US$2 billion in 2004.
  • As per the World Bank Doing Business 2009 report, Saudi Arabia was the best performer in the Middle East, moving up to the 16th spot from 24, ahead of Bahrain, United Arab Emirates and Kuwait. Source: IIF Key growth sectors have been as follows (2007 performance):
  • Highest growth sectors were the manufacturing and the construction sectors, which grew by 6.5% and 7.1% in real terms respectively.
  • The wholesale and retail sectors have performed better than the previous year due to a rise in consumer confidence. Growth in the electricity, gas, and water sector slowed to 5.0%, while new power and water projects are being developed; and expected to come on stream by 2009. Electric generation capacity is set to more than double to 60 gigawatts (GW) - roughly equivalent to the current capacity of South Korea at a cost of an estimated US$120 bn1.

 (As of 2007, the capacity has reached 35.9 MW)2. An investment plan has been announced to launch ten Independent Water and Power Projects (IWPPs) by 2016, at a total cost of around US$16 billion. The combined production capacity of the original four projects, which are in the bidding phase, are expected to derive capacity of more than 7,000 MW of power and 600 mn gallons of water daily. In addition, there are independent power projects (IPPs), which are not integrated with desalinization facilities, also being tendered by the SEC. About 8,000 MW of new capacity is currently under construction, 5,200 MW of which are IPPs2. 1 - Saudi Arabia's Water and Electricity Ministry (WEC) 2 - Saudi Electricity Company (SEC) Private consumption and investment were the main sources of growth. Large scale investment was primarily in the construction, petrochemicals, oil refining, and gas exploration sectors. Source: Economic Intelligence Unit 2008

  • Continued large fiscal surpluses have enhanced long-term fiscal sustainability. Significant portions of the fiscal surplus were used to retire domestic debt, thus contributing to reduced interest costs, which fell to 1.4% of GDP in 2007 as compared with 4.6% in 2001. This, together with higher investment income from SAMA’s foreign assets, will help sustain the higher spending on social and infrastructure programs over the medium term.
  • Indirect FDI in Saudi Arabia’s stock exchange through swap agreements is a step toward opening the market to direct foreign investment in the Tadawul. Investors in the swap contract will receive the economic benefits of owning the stock, such as dividends and stock splits, but will not hold voting rights. Earlier, foreign ownership was allowed only through investment funds. Due to the market’s upside potential, large pipeline of mega-projects and increasing public sector expenditure has been planned, some of the key projects are as follows: Source: IIF Some of the key structural reforms are as follows: The Supreme Economic Council has earmarked 20 sectors for privatization, of which the major ones are power, desalination, water and sewage, telecommunications, railways, and the transportation sector. •In 2002, the Supreme Economic Council passed a resolution setting out a framework for private sector involvement in developing mega-scale integrated Independent Water and Power Projects (IWPPs. This aims to attract private sector investment for up to 60% equity in IWPP projects, with the remainder split between Public Investment Fund (PIF) and the Saudi Electricity Company (SEC).
  • Private non-oil investment growth has accelerated, supported by a broader range of business opportunities and an enhanced business climate. The authorities are increasingly relying on public sector and public-private partnerships (PPP) to alleviate bottlenecks in the economy. For e.g. as part of the reform process and privatization policy, the SEC has licensed the National Water Company (NWC) which is 100% owned by the Government through the Public Investment Fund, to oversee the privatization process within the water sector. The initiative is specifically implemented in the form of BOT or PPP type projects, under two separate schemes of which the first will involve private companies taking over the operation and maintenance of water and wastewater networks and the second component of the plan involves the privatization of wastewater treatment plants. Banking
  • Driven by the inflow of liquidity and liberalization of the banking sector, the private sector credit to non-oil GDP has risen to 90% in 2007. Banking concentration is moderate with the largest four banks accounting for 60% of the total assets. Nine new foreign banks and two domestic banks have been licensed since 2004, doubling the number of licensed banks to 22 in 2007.
  • The banking sector remains profitable with an ROE of around 22% in 2007. Islamic banking activity continues to increase as evident from the relatively high ratio of demand deposits in total deposits, which increased from 41% in 2006 to about 45% in May 2008.
  • The projected large financing needs associated with the ongoing investment programs will provide ample opportunities for the banks to maintain their current rapid expansion and financial innovation for the coming few years. Services
  • Nonbank financial activities have also expanded. The establishment of the Capital Market Authority (CMA) in 2003 and the passing of the insurance law in 2005 have opened new opportunities for regulating and expanding the role of nonbank financial institutions. As of June 2008, about 90 investment banking and brokerage institutions were licensed. The licensing of advisory, brokerage, and other capital market-related financial intermediaries was initiated in 2006.
  • The insurance sector's growth was boosted as the Saudi government introduced new regulations which made vehicles insurance mandatory. Health insurance being made obligatory for all expatriates has also been a driving factor.
  • A real estate ownership law allowed foreigners to own real estate except in the two holy cities (2001). Draft proposals are being considered by the Consultative Council on a regulatory framework governing the provision of housing finance, expected to be formalized by the end of the year. The four components of the law are: real estate financing system, system to monitor financing companies, lease financing system and real estate mortgage system. The state-owned Public Investment Fund, General Organisation for Social Investment, the Public Pension Agency and the World Bank's International Finance Corporation signed a MOU for a US$400m housing finance facility, to provide long-term funding to banks and housing finance firms in providing affordable financing to lower and middle-income households.
  • In terms of the telecom sector, a strong economy is providing an environment fit for inward investment, and the ingredients for growth in both the fixed-line and mobile markets. Since 2007, CITC3 introduced regulatory reforms to increase investment and foreign participation in facilities based ICT infrastructure; for e.g. introduced the technology neutral and service specific regulatory framework as a first step towards a unified licensing regime, additional services licenses, de-regulation and full competition. The foreign-equity limit in telecommunications companies was set at 49% following the country’s accession to the World Trade Organization in late 2005, which rose to 51% in early 2008 and is expected to rise to 60% in 2011. The incumbent operator Saudi Telecommunications Company (STC) now competes for market share with Mobily and Zain. STC is one of four operators in Saudi Arabia's fixed-line market with consortia headed by Verizon, PCCW and Batelco all winning concessions to operate fixed-line networks from 2008. 3 - Communications & Information Technology Commission (CITC) Country Risks
  • Meeting the targets for the investment programme can pose to be a risk in the medium term.
  • Turmoil in international economies and capital markets.
  • Reduction in demand for oil and gas, with rising competition and relatively untapped potential from Russia, West Africa, Latin America, and Canada.
  • Geo-political risks including a potential war in the region.
  • Health of the present monarchy. M&A Activity (Year to date)
  • The Saudi banking and insurance sectors have been active in both crossborder and cross-sector acquisitions and expansions. Some of the key transactions have been as follows:
  • UAE based Al Khazna Insurance Company acquired a 15% stake in Saudi Arabia's Sanad for Co-operative Insurance and Reinsurance, with the transaction involving 3.0 mn shares with a value of US$25.8 million.
  • Crédit Agricole Asset Management (CAAM) entered into a JV with Banque Saudi Fransi (BSF) and formed CAAM Saudi Fransi; in which 60% is held by BSF and 40% by CAAM.
  • The telecom sector witnessed M&A activity with STC’s first acquisition of 25% of Malaysia-based Maxis Group in September 2007 for USD3.04 bn. The deal also included a 51% stake in Maxis' Indonesian subsidiary PT Natrindo Telepon Seluler, which has a license to operate a third generation mobile network. STC also acquired a 26% stake in Kuwait's third mobile network operator, with a value of US$900 mn for the licence. It is expected that STC will continue to grow through M&A deals in the future as well.
  • M&A transactions have primarily occurred in the industrial / manufacturing, services, food & beverage (F&B), services, O&G, real estate/construction, and investment services sectors. Please refer to Annexure II, for details on M&A originated with respect to Saudi Arabia, for the period July 2007 to August 2008. Brief Outlook – Saudi Arabia
  • Planned energy investments estimated over the next few years, are amounting to:
  • US$90 billion in petrochemical projects
  • US$90 billion in power generation
  • US$88 billion in water desalination plants
  • US$50 billion in natural gas related projects. Source: Arab Oil and Gas Directory forecasts To achieve this target the authorities would have to present several joint projects to the private sector, local and foreign, in order to increase power generation capacity. The petrochemicals sector is driven by either proximity-to-market or large-scale projects, which take advantage of low-cost, secure oil and gas supplies. These factors, in turn, have, made the country one of the world’s strategic hubs for petrochemicals. These competitive advantages are now likely to be joined by a number of highly integrated refining and petrochemical investments, which will develop and strengthen the industry. However, it is speculated that the capacities after 2008 based on current planned projects, may not be met due to the restriction on inputs supply unless the gas production capacity is substantially increased. The fiscal surpluses are projected to decline from 12.4% of GDP in 2007 to 6.9% of GDP in 2012 as spending continues to increase rapidly. (Source: EIU)
  • Currently, 50% of the domestic demand for potable water is met with desalinated water. Given the demand, there is a clear need for additional generation/desalination, transmission and distribution capacity and improving investment and regulatory environment for private investors.
  • In addition, the expanding population, coupled with increasing incomes, will continue to feed demand for infrastructure and utility services, particularly energy, water, transportation and other infrastructure services, housing, health and education. The Saudi Arabian General Investment Authority (SAGIA) took the lead in promoting the feasibility of education initiatives. This was attained by a combination of private sector financial contributions and proper incentive packages.
  • Demand for the F&B, telecommunications, especially mobile telephony and internet services should remain robust, giving rise to investment opportunities in these sectors.
  • As one of the region's largest consumer markets and its rapidly growing population will remain highly dependent on imports of food and beverages. Total consumer expenditure on food, beverages and tobacco is increasing, and reached an estimated US$24.4bn in 2007 (the equivalent of 24% of household spending) and is estimated to increase to US$35.6 bn in 2010.
  • Retail trade has been opened up to FDI, following a decision by the Supreme Economic Council in May 2007, drawing the possibility of investment activity into the sector. Annexure II: M&A Announcements (Saudi Arabia): July 2007 - August 2008 Source: Bloomberg

About Kuwait Financial Centre "Markaz" Kuwait Financial Centre S.A.K. 'Markaz', with total assets under management of over KD 1.4 (USD 5.32 billion) as of June 30, 2008, was established in 1974 has become one of the leading asset management and investment banking institutions in the Arabian Gulf Region. Markaz was listed on the Kuwait Stock Exchange (KSE) in 1997; and has been awarded a BBB+ corporate rating by Capital Intelligence Ltd.