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Dubai's Private Equity Dreams

Can Dubai International Capital become a global player in private equity?

It's a typically scorching Sunday morning in mid-October, and Sameer Al Ansari, executive chairman and CEO of Dubai International Capital, cracks open a bottle of mineral water as he expresses relief at the day’s big news. Earlier that morning the government of the United Arab Emirates, of which Dubai is a member, had declared that it would guarantee bank deposits and interbank lending and inject as much liquidity as necessary into the financial system to safeguard banks from any risk of default. To Al Ansari, who built DIC into an $11.5 billion-in-assets public and private equity investment firm in just four years, the announcement provided timely reassurance that the government was determined to maintain the free flow of capital — the lifeblood of Dubai’s financial ambitions — despite the worsening global credit crisis.

"Dubai is not immune to what happens in the rest of the world," Al Ansari tells Institutional Investor in his plushly carpeted, wood-paneled conference room in the company’s headquarters in the Dubai Financial Center. "If anything, we are more vulnerable now than we were a few years ago, because the emirate has used a lot of leverage to fuel its expansion — and there has been some obvious speculation, especially in real estate development. But I still believe than the fundamental growth drivers in Dubai remain very strong."

Al Ansari will have to work hard to sustain that optimism. The global financial turmoil has hit the Gulf region hard in recent months, and Dubai — which has based its bold development strategy on borrowed money rather than oil earnings — is particularly vulnerable. The decline in oil prices to less than $40 a barrel from a peak of $147 in July has also dented economic prospects across the region.

DIC is in no apparent danger; the company is wholly owned by Dubai’s visionary ruler, Sheikh Mohammed bin Rashid al Maktoum, and serves as his primary personal financial vehicle. But the crisis has hammered the value of many of the company’s investments and stalled its aggressive growth plans.

Modeled after U.S. giants like Blackstone Group and mandated to build an international private equity portfolio commensurate with Dubai’s global financial ambitions, DIC began investing at what turned out to be the peak of the buyout boom. By the end of 2007, the company had completed six leveraged buyouts in Europe — ranging from the U.K.’s Tussauds Group waxworks operator and hotel chain Travelodge to German industrial packaging producer Mauser — worth a total of €5.8 billion (about $8.6 billion at the time). The company also plowed heavily into public equities, investing $2.7 billion to buy sizable stakes in companies including such companies as U.S. hedge fund manager Och-Ziff Capital Management Group, U.K.-based banking group HSBC Holdings and the European Aeronautic Defence and Space Co. (EADS).

The global crisis has dealt a severe blow to Al Ansari’s strategy. DIC executives valued the firm’s public and private equity portfolio at about $11.5 billion at the end of 2008, down from $13 billion a year earlier, but local media reports have put the value as low as $10 billion. The company is nursing a nearly billion-dollar paper loss just on Och-Ziff, which has seen its share price plunge 87 percent since DIC paid $1.1 billion for a 9.9 percent stake in November 2007. In addition to hurting Sheikh Mohammed’s portfolio, the losses are likely to make it harder for DIC to attract third-party funds to manage, a key corporate goal. Chastened, Al Ansari and his team have called a halt to further stake-buying until equity markets show signs of a lasting recovery.

DIC has also been stymied in private equity. Although the company’s holdings have so far met or exceeded operating targets, the meltdown in equity markets and the seizing up of credit are preventing DIC from making new deals or exiting old ones. So Al Ansari and his team are hunkering down, determined to prove themselves to be capable managers rather than ambitious wheeler-dealers.

"I have no idea when normal business conditions will resume," admits Al Ansari, "so all we can do right now is focus very closely on strengthening our team, managing our portfolio and marshaling our resources so that we get the best results we can."

The challenge is daunting for Al Ansari and his team, many of whom joined the company only in the past 12 to 18 months. They are working closely with company managements to develop strategies to steer through the downturn and set the stage, Al Ansari hopes, for exits in four or five years’ time.

"DIC really needs to sell some of its holdings in order to provide evidence of a track record, take the business forward and perhaps even raise some external capital," notes a Dubai-based banker, who like many outsiders would speak only on condition of anonymity.

DIC is far from alone in throttling back. Dubai’s impressive growth has nearly doubled the emirate’s population since 2000, to 1.59 million, and has turned the desert sands into a glittering 21st-century cityscape boasting the world’s tallest building, the Burj Dubai. But that growth has slowed abruptly in recent months because of the global fallout from the September bankruptcy of Lehman Brothers Holdings and the subsequent credit market freeze. In December commercial property giant Nakheel announced that it would dismiss 15 percent of its workforce and was considering scaling back some projects. In November the government arranged for the merger of two leading mortgage lenders, Tamweel and Amlak Finance, after collapses in their share prices over the past year.

Unlike neighboring Abu Dhabi, which has vast oil reserves, Dubai has relied on leverage to fund its development. The state’s debt amounts to $10 billion, and affiliated companies owe an additional $70 billion, Mohamed Ali Alabbar, a member of Dubai’s executive council and chairman of developer Emaar, said recently. That makes the emirate’s total debt roughly equal to its $80 billion gross domestic product.

Credit default swap spreads on the Dubai government and local banks and corporations have widened significantly in recent months. Credit spreads for Dubai-based institutions ranged from 650 to 1,000 basis points in early November, compared with 250 to 400 basis points for their counterparts in Abu Dhabi, according to a research report by Cairo-based investment bank EFG-Hermes.

As a privately held company, DIC has no credit rating and does not disclose precise debt levels or operating results. The company says it does not use excessive leverage, though. A recently released private equity report, the first the company has ever issued, disclosed that DIC has invested €1.8 billion ($2.5 billion at current rates) in private equity deals valued at €5.8 billion, implying that it has relied on debt to finance 69 percent of the value of its deals. That is roughly in line with the norm for secondary buyouts, says Bob Long, CEO of U.S. buyout group Conversus Capital. In its public equity deals, the company has relied on debt for 20 percent to 80 percent of individual transactions.

DIC is one of seven subsidiaries of Dubai Holding, an entity founded in October 2004 to consolidate Sheikh Mohammed’s various infrastructure and investment projects and use them to develop Dubai’s economy and global brand. The holding company consists of two operating companies: Dubai Holding Commercial Operations Group, which owns technology and research company Tecom Investments, luxury hotel chain Jumeirah Group, residential real estate developer Dubai Properties, industrial conglomerate Tatweer and international real estate developer Sama Dubai; and Dubai Holding Investments Group, which owns DIC as well as 51 percent of Dubai Group, a financial services company.

"DIC adds to the emirate’s international profile and shimmer," explains Florence Eid, who oversees investment strategy in the Middle East and North Africa from the London office of San Francisco–based hedge fund firm Passport Capital. "Sheikh Mohammed promotes the growth of Dubai in everything he does, including in his private investments. So DIC has some of the same characteristics of a sovereign wealth fund, but in its investment style, it more closely resembles a large family office."

A Kuwaiti-born British national, Al Ansari, 46, is an accountant by training, not an asset manager. But in two decades working in Dubai, he has forged tight relationships with Sheikh Mohammed’s closest advisers and made himself a trusted member of the emirate’s inner circle of top financiers. (In recognition of that fact, the ruler granted him UAE citizenship in 2005.)

Al Ansari went to secondary school in London after his father, an entrepreneur and investor, moved his family from Kuwait to the U.K. when he was 14 years old. He later went to Loughborough University and earned an undergraduate degree in accounting and financial management in 1984. He took his first job that year as an accountant with BDO in London. In 1987 he jumped to global accounting giant Ernst & Young and moved to Dubai to work in the firm’s regional audit division.

As a native of the Gulf region, he was put in charge of most of Ernst & Young’s government-related work, and he developed relationships with Dubai officials, particularly Mohammed Al Gergawi, Sheikh Mohammed’s top economic adviser, who is now minister of government affairs and chairman of Dubai Holding, and Emaar’s Ali Alabbar.

In the early 1990s, Al Ansari led an Ernst & Young investigation into the corporate accounts of Dubai Aluminum Co., better known as Dubal, which was suffering from losses and allegations of fraud and corruption. His success in cleaning up accounting inconsistencies at the company prompted Ali Alabbar, then Dubal’s vice chairman, to appoint him Dubal’s chief financial officer in 1992. Over the next eight years, Al Ansari arranged financing for two expansions of Dubal’s smelter and developed a hedging system to manage the company’s financial risks. Dubal, once a small aluminum-smelting operation, is now a major enterprise that produces 950,000 metric tons of aluminum a year for clients in 46 countries.

Al Ansari left Dubal in 2000 and went on to co-found Amlak, the first mortgage provider in Dubai (and one of the first in the region). He also started a small, independent corporate finance advisory firm that began working with several key business leaders in Dubai, including Al Gergawi, who, in addition to his ministerial duties, was chairman of Sheikh Mohammed’s Executive Office, which oversees all of the sheikh’s financial interests. Al Gergawi asked Al Ansari to join the office in 2003; he came on board as CFO in September that year and over the next year helped reorganize the sheikh’s businesses under the umbrella of Dubai Holding, which was established in October 2004.

Aware of the potential to achieve higher returns by giving the ruler some exposure to private equity, Al Ansari urged the creation of a new international asset management business. The result was Dubai International Capital, also founded in October 2004, with Al Ansari as CEO. Al Ansari, in turn, recruited Sylvain Denis, a chartered financial analyst he had hired in 2003 as a finance director at the Executive Office, to help lead the effort; Denis is now chief executive of DIC’s private equity group.

Denis, 42, a Canadian national, was previously the chief operating officer of the Dubai-based Injazat Technology Fund, a $50 million venture capital fund focused on investments in media, technology and telecommunications. Before that he’d spent seven years at Dutch bank ABN Amro in Abu Dhabi overseeing relationships with large corporate clients in the region.

DIC was getting started in the midst of an unprecedented boom in private equity, in which global giants like Blackstone Group and Carlyle Group were raising record multibillion-dollar funds. Al Ansari and Denis decided to invest in some of the big funds to learn about the industry. DIC now has about $300 million invested with firms including Kohlberg Kravis Roberts & Co. and Carlyle.

As they became more comfortable with the business, the two executives began trying their hand at secondary buyouts, the acquisitions of portfolio companies from other private equity owners. Secondaries are not exactly sexy, but Al Ansari and Denis wanted to work with experienced management teams with tested growth strategies.

"We made a deliberate choice to be conservative," Denis explains. "We wanted to buy great companies with good cash flow and convincing growth stories in their own markets and then look for ways that we might be able to deliver new growth by adding international expansion programs in emerging markets like Asia, India and particularly the Middle East."

In May 2005, DIC made its first acquisition by buying Tussauds for £800 million (then worth $1.5 billion) from London-based private equity firm Charterhouse Capital Partners, which had purchased it in 1998 from Pearson Publishing Group for about £350 million. DIC continued to extend the Tussauds brand, opening museums in Europe and acquiring the London Eye, the giant Ferris wheel that is one of London’s top tourist attractions. In late 2005 the firm also waded into the public equity market and acquired a 2 percent stake in DaimlerChrysler, becoming the German automaker’s third-largest shareholder.

"We did worry at first that secondaries might be a bit dull," says Alan Hyslop, a Scottish private equity manager who joined DIC in January 2005 after spending seven years with British private equity firm 3i in Singapore. "But the more experience we gained with them, the more we felt we could benefit by working with them — especially if their management teams were already doing an excellent job."

In 2006, DIC struck two secondary deals, buying Doncasters, a leading British manufacturer of precision-engineered components, from London-based Royal Bank of Scotland Equity Finance for £700 million and Travelodge from London-based Permira for £675 million. DIC defends its secondary strategy by pointing to the portfolio companies’ performance. Earnings before interest, tax, depreciation and amortization are expected to be more than $800 million in 2008, executives say without providing details.

DIC had its busiest year in 2007. Al Ansari and Denis opened an office in London and made three secondary deals, buying German industrial-packaging company Mauser from the European division of New York–based One Equity Partners, a subsidiary of JPMorgan Chase & Co., for €850 million; British medical diagnostic imaging company Alliance Medical for £600 million from London-based Bridgepoint (which had bought it in a 2001 secondary buyout for £111 million from 3i and F&C Investments); and Frankfurt-based global specialist aluminum manufacturer Almatis for $1.22 billion from New York–based Rhone Capital and Toronto-based Teachers’ Private Capital, the private investment arm of the Ontario Teachers’ Pension Plan, which had bought Almatis (then Alcoa Specialty Chemicals) for $342 million from Alcoa Inc. in 2004.

DIC also realized its first and only private equity exit in 2007 when it sold Tussauds to one of Blackstone’s portfolio companies, Merlin Entertainments Group, for £1.03 billion in cash — netting a profit of £225 million. It retained a 17.5 percent stake in the combined company, which is the second-largest tourist attractions operator in the world, by visitor numbers, after Walt Disney Co. DIC also sold its 2 percent stake in DaimlerChrysler near the top of the market, having seen its share price rise from €30 to €70 during the two-year period DIC was invested.

The company’s other moves in public equities were less well timed. In 2007, DIC launched a $1.4 billion Global Strategic Equities Fund as part of its efforts to develop a third-party asset management business. Banks, Gulf-based institutional investors and wealthy individuals supplied just over half of the fund’s capital, and the remainder came from Sheikh Mohammed.

With share prices falling in late 2007, DIC began to make some sizable investments at what appeared to be bargain prices. It bought stakes of less than 3 percent in HSBC Holdings and less than 5 percent in Japan’s Sony Corp., snapped up 3.12 percent of EADS and purchased 2.87 percent of India’s ICICI Bank. The subsequent rout in global stock markets has pummeled the shares of those companies, however. HSBC’s share price fell by nearly 30 percent between January and early December last year, and EADS dropped by 46 percent, Sony by 63 percent and ICICI by 73 percent. Al Ansari insists that the firm has used derivatives to hedge its exposure, but DIC provides no details of its gains or losses on public equities. The Global Strategic Equities Fund has deployed just 35 percent of its capital; the rest is in cash or is committed but not called. Al Ansari does not anticipate investing more of it anytime soon.

"Only when I see stock markets stabilize because the forced selling has stopped will I feel that maybe we are hitting a bottom," he says. "But it will take a long time from that point to rebuild confidence and get liquidity back into the system."

Aguably the greatest disappointment in DIC’s portfolio has been its high-profile stake in New York–based Och-Ziff. In the summer of 2007, bankers at JPMorgan introduced Al Ansari to Daniel Och, the firm’s founder, chairman and CEO. At the time, buyout firms and hedge funds were scouring the Gulf and Asia in search of funds and potential deal flow, and Blackstone had secured a $3 billion investment from China Investment Corp. Och was looking for a strategic partner to invest in his company; Al Ansari saw the potential to use Och-Ziff’s analysts to uncover deals. Al Ansari persuaded Dubai’s ruler to let DIC buy 9.9 percent of the hedge fund firm’s class-A shares on completion of Och-Ziff’s IPO last year; it used funds from the Chairman’s Office, a separate, discretionary pool of capital, to finance the $1.1 billion investment. Och-Ziff went public on November 14, 2007, floating its stock at $32 a share; by late December of last year, the shares had lost 87 percent of their value and were trading at $4.06.

DIC remains committed to Och-Ziff despite the huge paper loss, insists Al Ansari. "The entire hedge fund industry would have to go bankrupt for us to suffer any more pain on that investment than we have already," he notes. "If I take a three-to-five-year view, I believe that Och-Ziff will emerge as one of the strongest hedge funds in the world. So yes, we have a marked-to-market paper loss, which is very painful, but we haven’t realized that loss, nor do we intend to." Al Ansari and his team are not looking to sell any of their other public equity holdings, either.

DIC’s private equity portfolio has performed well through the first nine months of 2008, but Denis is under no illusions about the portfolio companies’ vulnerability if a global recession takes hold. Over the past few months, he and his partners have been modeling worst-case scenarios to anticipate decreasing revenue and potential financing difficulties. The executives are working closely with the companies’ management teams to figure out how DIC can help them add value — such as striking strategic partnerships with other companies for distribution of their services or even adding bolt-on acquisitions to expand their reach.

"When a Wall Street issue becomes a Main Street issue — and our companies are in the business of selling products and services — then we know we are going to feel the impact eventually," says Denis. "We have always had contingency plans in place; now we have to put those plans into action."

One of DIC’s most visible portfolio companies in the U.K., Travelodge, has been pushing hard to grab additional market share in a weakening economy by expanding domestically.

The name Travelodge may elicit a certain horror among the well-heeled — "people think they’re going to end up sleeping in a broom cupboard," quips CEO Grant Hearn — but the budget hotel company, which separated from its U.S. namesake in 1973, has become the third-largest hotel operator in the U.K.; its business traveler numbers were up 45 percent for the year through November. Hearn plans a major expansion by acquisition and new construction. Travelodge currently has 25,000 rooms in 356 hotels in the U.K., Ireland and Spain; by 2020 he aims to have 70,000 rooms in 1,000 hotels, which would give the company a 10 percent share of the U.K. market.

DIC is intent on helping the ambitious CEO take his business model to India. Michel Gaudreau, who leads business development activities for DIC’s portfolio companies, has been studying the logistics of exporting the Travelodge model to a market that doesn’t have a standardized budget hotel chain offering a uniform level of service across a broad geographic region.

"When we look at potential expansion like this, we are prepared to do the legwork for it," says Gaudreau, "so we’ll build an entry strategy and a business plan, working side by side with the management team to do market research, work out the legal structure and tax implications and help them set up the business."

DIC is looking to expand more widely into emerging markets, although the global market slump may slow its activities here too. It has begun raising up to $1 billion for a new investment fund, Saudi Dubai Capital Fund, and expects to close on an initial $300 million-to-$500 million tranche within months. Al Ansari and his team see their relationships in the Middle East and North Africa region as a competitive advantage. DIC has already made three private equity buy-ins, taking significant minority equity stakes in Singapore-based fitness company True Group, Dubai-based retailer Rivoli Group and UAE-based precision-steel-casting company KEF Holdings. Terms of those transactions haven’t been disclosed.

Al Ansari recently hired Alykhan Nathoo, a Bain Capital veteran and one of the founders of Bain Capital Europe, to run the emerging-markets division as its new CEO. Nathoo, an ethnic Indian with an economics degree from Stanford University and an MBA from Harvard Business School, helped grow the firm’s European investment group from four people to 40 people and build up assets to $5 billion over the past eight years. The idea of joining DIC and focusing on emerging markets appealed to him.

"If you think about the balance of power in the world, economics and geopolitics are shifting quite rapidly toward emerging markets," Nathoo says. "Structurally, these markets are poised to enjoy significant growth over the next 20 years, especially in light of the incredible shake-up in the financial system in the West, because they’re less indebted."

DIC has also been quick to take advantage of the crisis by picking up private equity deal makers from retrenching investment banks, hoping to be ready to pounce when markets stabilize. In July, DIC hired David Smoot, an 11-year veteran of Morgan Stanley who helped the firm relaunch its private equity business in 2006. He has moved to Dubai and is working to identify future investment prospects in North America and beyond. In October, DIC brought on Eric Kump, a 16-year veteran of Merrill Lynch & Co. and former managing director with Merrill Lynch Global Private Equity, to head its London office. Overall, DIC now has 42 investment professionals — 16 in private equity, 15 in emerging markets, nine in global public equities and two in asset management — along with 66 support staff working in its headquarters in the Dubai Financial Center and in its London offices near St. John’s Square.

The great unknown in all of DIC’s strategic planning, however, is the fate of Dubai’s own economy. If the emirate’s creditworthiness deteriorates further, Sheikh Mohammed may be less inclined to bestow more billions on DIC — and without his continued support, DIC is unlikely to succeed in expanding its investment activities or winning fresh financing from international banks to conduct leveraged buyouts. But Denis is convinced DIC can handle the risks.

"We are confident enough to say that there are no issues with our financing or our capacity to service our own debt," he asserts. "We don’t foresee an issue with that even if the economy in Dubai takes a severe downturn, because we’ve run those worst-case scenarios."

The chaos in the financial markets hasn’t crushed DIC’s fundamental optimism. But Al Ansari and Denis will need time, and a recovery in markets, to prove their mettle and make DIC a global investment heavyweight.

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