Reviving Mideast private equity market draws international interest

* Value of private equity funds in region growing

* Confidence returning after big losses due to global crisis

* But Gulf private equity remains in its infancy

* Western firms still demand risk premium for Mideast

* Some Gulf firms reluctant to yield control to outsiders

By David French

DUBAI, Nov 18 (Reuters) - The Middle East's private equity market is trying to put its Wild West days behind it, drawing big international players for the first time since investors lost heavily when the global financial crisis hit the region.

While most of the interest is focused on the stable Gulf Arab states, Western investors are still seeking risk premiums over markets closer to home due to the chaos and violence elsewhere in the Middle East.

Many Gulf firms are also reluctant to yield too much control to outsiders, and the value of completed deals remains modest. Nevertheless, interest in making direct investments in companies rather than via the region's stock markets is picking up.

The total value of private equity (PE) funds announced in the Middle East and North Africa so far in 2014 is $1.975 billion, up from $1.23 billion in the whole of 2013, according to data from Zawya, a Thomson Reuters unit.

Zawya data cover funds that invest more than 50 percent of their assets in the region and have a representative office there, so the activities of most big international players will come on top of these figures.

Despite significant personal wealth and massive sovereign wealth funds, PE in the Gulf is still in its infancy, representing a tiny fraction of the $3.5 trillion global market.

Traditionally, much Gulf cash has flowed out of the region, as investors diversified geographically and often regarded local markets as risky bets.

So far, PE activity is below levels reached during the boom before the global crisis erupted six years ago. PE funds raised in the Middle East soared from $3.91 billion in 2006 to $8.36 billion in 2008, according to Zawya data.

Many of these funds failed spectacularly though, largely due to a property market crash and diving stock markets, wrecking confidence in the regional PE sector for some time.

"Into and through the financial downturn, we had a huge mess in the private equity industry in this part of the world, which has now rationalised itself," said Paul Harter, head of law firm Gibson Dunn's Middle East PE practice.

NEW PHASE OF DEALMAKING

Many Gulf families continue to invest their wealth, but active Western-style PE houses have been reduced to a handful. Those remaining are using improved sentiment in the wider economy to pursue a new phase of dealmaking, selling long-held assets and using the cash for new investments.

While the amount of funds raised is growing, investments are being completed relatively slowly. So far in 2014, 38 deals worth $428 million have been closed. This compares with 71 last year and 101 in 2012, worth $1.01 billion and $917 million respectively, according to Zawya data.

International firms, whose Middle Eastern dealmaking was minimal in the past, are nevertheless becoming more active.

This year Warburg Pincus has taken a majority stake in Dubai-based aviation technology firm mercator from Emirates Group, while Blackstone Group teamed up with Bahraini sovereign fund Mumtalakat and local firm Fajr Capital to buy a stake in GEMS Education.

"The combination of non-oil sector growth, fast-growing population and government spending in most Gulf countries makes it a very attractive destination for international PE players," said Karim El Solh, chief executive of United Arab Emirates-based Gulf Capital.

Kuwait has seen the most prominent action. U.S.-based Hellman & Friedman had a $3.2 billion offer for pay-TV firm OSN rejected in August, and KKR & Co and CVC Capital Partners (Other OTC: PGPHF - news) are jointly bidding to buy a majority stake in Kuwait Food Co.

Faisal Sarkhou, chief executive of KIPCO Asset Management Co (KAMCO), believes Western investors set their sights too high in Kuwait before the crisis. They wanted minimum 30 percent stakes in firms operating internationally, and demanded board and management representation, severely limiting their options.

"Now (NYSE: DNOW - news) there are more such firms that are both international and are good businesses available," he said. "Buyers have also understandably reduced their ticket size expectations, so that's why you're seeing the interest you're seeing now."

RISK PREMIUM

One thing which hasn't changed is the risk premium which international investors want due to the war or political instability in a number of countries outside the Gulf.

While funds might target an internal rate of return of 20 percent in Europe or the United States, they would expect 25-30 percent in the Middle East, Hany Hussain, head of asset management at Saudi-based Itqan Capital, told a PE event in Dubai.

International PE investors also often lack local offices, which can hinder their activities in a region where face-to-face business dealings are vital, and where there is a wariness about Western firms taking over control.

This is especially common among older members of local business families, who may otherwise wish to sell assets as they plan for their retirements.

While CVC co-chairman Steve Koltes said last month that he was targeting deals of around $700 million, local PE players are mostly looking at purchases below that level.

In many cases, international firms are complementing local players by buying up the investments which Gulf houses have grown and are now looking to sell, said Gulf Capital's El Solh. (Additional reporting by Nadia Saleem; Editing by David Stamp)