When members and guests of the Institute of Chartered Accountants in England and Wales (ICAEW) met in Dubai recently, a range of issues came up for discussion. What inevitably hogged the limelight though was the impact of oil price correction on capital markets in the Gulf Cooperation Council (GCC) region.
It was argued that the situation isn’t likely to remain uncertain over the longer term because of continued high government spending and underlying investments in the oil sector. Yet, the panel also agreed that certain initial public offerings (IPOs) may be delayed in the short term as liquidity in the market is tight and investors are hesitant. The obvious rider was that this will improve with market sentiment and as the oil sector recovers.
This situation has been in the making for several months now. If 2014 was the busiest year for the GCC equity capital markets since the global financial crisis the new year has begun with a roller-coaster ride. A sharp slump in oil prices exposed the classic fault lines related to the balance between oil and non-oil sectors.
Lord Mayor of the City of London, Alderman Alan Yarrow, who visited the region and attended the ICAEW event, jumped right into the debate. “The GCC states are fully aware they need to reduce their reliance on hydrocarbons, with the topic in the spotlight over the volatility of oil prices. That is why they have put in place bold and ambitious infrastructure plans that will look to diversify their economies into a wide number of sectors,” he said.
Basically for investors it is not just about oil prices but also the ability and willingness of governments in the region to spend in non-oil sectors. Government spending is already high, at least for the medium term, and there is no dearth of reserves to support spending plans, if needed. Yet, there is little doubt that capital markets have been hit by oil price correction. Most observers believe that this should be short-lived as underlying investment in the sector has continued and non-oil businesses remain attractive investment targets.
“There may be a vested interest for GCC oil producers if oil prices trend down even further – this is resulting in shut downs and other commercial inefficiencies in those parts of the world where production costs are much higher, say over USD 100 per barrel,” said David Petrie, the head of corporate finance faculty at ICAEW.
Moreover, oil price correction has provided investment opportunities in other sectors such as petrochemicals, trading, light manufacturing, aviation, logistics, and renewable energy. Those attending the ICAEW event agreed that the oil price could go down to USD 35 per barrel by July 2015 but rise again to its normal price of around USD 65-75 per barrel.
No looking back
The discomfort over oil price, and its impact on capital markets, is obvious considering the smooth sail that lasted all of last year. According to an EY report, MENA companies raised USD 11.5 billion in 2014 through 27 IPOs, almost four times more than the USD 3 billion raised in 2013 through 25 IPOs. The report said 2014 registered the highest amount of capital since 2008. In the UAE, for instance, among the successful IPOs was Emaar Malls Group, which raised USD 1.57 billion, and was oversubscribed over 30 times.
“2014 was a good year for MENA IPO markets, moving closer to the pre-crisis capital raised in 2008 of USD 13.2 billion,” says Phil Gandier, MENA transaction advisory services leader at EY. Saudi Arabia and UAE were the two most active IPO markets in the MENA region last year, he said, adding that both markets collectively raised close to USD 10 billion in IPOs. Industrial manufacturing was the most active sector in 2014 with five IPOs, followed by three IPOs each in food and beverages, oil and gas and real estate sectors.
However, many firms still chose to delay or abort their IPO plans in Q4. “Although there is a healthy pipeline of IPOs for 2015, companies are adopting a ‘wait-and-see’ approach until markets have settled. The interest is still there, but companies are watching the markets closely, waiting for the right window of opportunity to float,” Gandier says.
Basically, decline in oil prices has left regional and international investors concerned about the curtailment of future government spending on infrastructure, education and healthcare. According to EY, this would have an impact on companies operating in these sectors in the short run, and investors would be cautious to raise money through IPO in Q1 2015.
“The strong Q4 performance closed 2014 on a positive note, as investor confidence in the region remains high despite the backdrop of volatile equity markets and falling oil prices,” says Mayur Pau, MENA IPO Leader at EY. Pau says that the impact of this has been felt in stock exchanges in Dubai, Kuwait, Saudi Arabia, Qatar and Bahrain, which have tumbled over the past few months.
“Investors are becoming more cautious despite other market fundamentals remaining largely unchanged. Amid all the positive signs that indicate IPO market growth, uncertainty still exists in the market,” Pau says.
“MENA investors will continue to be guarded if the price of oil hasn’t stabilized,” EY’s Gandier makes the most definitive projection. “Regional companies will be analyzing the markets, waiting for oil price volatility to settle down before they can launch their IPOs,” he says.
According to him, market fundamentals remain positive and developments in regulatory reforms are still expected to drive IPO growth in Q1 2015, drawing new liquidity to the region. “An increasing number of regional governments are looking to diversify their economies which will encourage companies in the non-oil sector to expand through the IPO route,” he says.
Interestingly, for a range of sectors the possibility of an IPO is detached from the oil price debate. Saudi Arabia’s Kingdom Holding Co, for instance, is reported to be planning to sell shares in a ‘significant’ number of assets. A Bloomberg report said that the investment company owned by Saudi billionaire Prince Alwaleed is considering offerings on the Saudi stock exchange and internationally.
Flynas, the Saudi budget airline, in which Kingdom Holding holds a 34 percent stake, is among companies planning share sales. The investment firm has minority stakes in companies such as Citigroup, News Corp and Twitter.
Signals have been varied on what to expect going forward. Improved market performance and macroeconomic fundamentals as well as conducive regulatory environment were all contributing factors to positive market sentiment and investor appetite, PwC’s Capital Markets team found.
According to them, this encouraged issuers to execute their IPO plans. The fourth quarter of 2014 witnessed a total of five IPOs in the GCC, raising USD 7.3 billion – leading to a considerable increase as compared to the same quarter last year, which saw a total of three IPOs raising USD179 million.
IPO performance during the last quarter of 2014 was stronger than the previous quarter, which saw a total of two IPOs raise USD 1.6 billion. The most tricky judgment call, under these uncertain circumstances, is trying to understand investor sentiment.
Steven Drake, head of PwC’s Capital Markets team in the Middle East, says with oil prices at relatively low levels and a number of regional market indices lower than witnessed recently, the real challenge is whether or not investor appetite will remain. “We should soon know the answer to this question as scheduled Q1 2015 IPOs look to come to market,” he says. The haze is likely to clear alongside the brief winter spell across the Gulf region.