Back to basics (Interview with the CEO of FEP Capital)

omar-el-maghawryOmar El Maghawry, the CEO of FEP Capital, discusses the Egyptian oil and gas market’s biggest areas for growth, the challenges faced by foreign investors and how the government can work to improve the ease of doing business for international companies operating in Egypt. FEP Capital is a financial services company that offers turnaround services and provides private equity to small and medium-sized enterprises (SMEs) working in a host of sectors in Egypt.

What factors are driving demand in Egypt?

The fundamentals of Egypt never go away. Egypt has huge domestic demand, and the economy is all demand-driven. It’s not a production economy per se, but GDP is all demand-driven. We’ve had consistent growth, even during the revolution years. Now, it’s moving even better, and there’s more visibility. The fundamentals can be seen more clearly as things are settling down on the political side.

The economy itself is still challenging, but domestic consumption is growing tremendously. However, domestic consumption cannot always be seen because a lot of it comes from the parallel economy that’s not recorded in the economic data. You have to be on the ground to really understand where the dynamics of Egypt are going.

When we bet on building steel factories in such troubled times, we were betting on the country and on our partner that has the technical knowledge. This is quite important for us, and that equation has paid us well.

The banks came into play, as the group is nicely leveraged. Most Egyptian banks have decided to lend to the group for project finance, expansion and growth. Now, we have two factories operating, a third factory coming into play soon and a fourth factory opening next year.

In Egypt’s oil and gas value chain, where do you see the most area for growth?

As an outsider, I would only be interested in storage for crude oil as an investment. I’m coming at it from an investor’s point of view, not an industry expert, so I’m only money-oriented. If I could throw some money into a fund today, I would only give money to build more tankers, more storage capacity and buy physical stock. I would not trade over a Bloomberg screen.

We have been monitoring oil and gas out of interest, and out of a couple of services companies that we have reviewed we saw a very interesting angle on the physical supply and demand side. You have excess demand on almost a daily basis in terms of global production, and this has been happening for the past three years. This excess, this designed excess supply, is always on average around 2 million bopd, give or take.

This 2 million bopd is now nearly 4 million bopd of excess daily demand. This has increased 100% over the past year and a half. This is not by design, it’s due to lack of demand. That has caused an interesting storage issue on the ground. So, I would invest in storage, if I could.

I would invest in it for maybe a year and a half, sell down and exit. We are probably looking at something that is beyond a 120-150% return in such a short period of time.

When is the best time for a company to get into the Egyptian market?

It works like a cycle, basically. Most firms invested in Egypt in the good days back in 2006-2008. We saw a lot of fundraising and capital deploying into Egypt. As a result, we are seeing some of these firms stuck with assets that they need to exit because the funds are due, and unfortunately these exits have to happen around this time. Right now, it’s really a buyer’s market, not a seller’s market in private equity terms.

For us, we started investing in 2011, in the worst years. We were fortunate that we invested during the downturn. We are still investing as our overall portfolio is net buying. We still see a window of good buying opportunities for another two years to come. So, for private equity firms that are on the buying side, this is the best time to invest.

You’ve got companies with decent evaluations, decent entry levels and if you can invest and be patient for a five-to-seven-year cycle, which is our typical cycle, you should be exiting at hopefully the economic rebound days. That’s typically the right timing. Private equities come in during economic turbulence, are patient, grow their investments and exit during the good economic days.

For other firms, you will hear different answers. They either need to exit, raise more funds or convince their investors to be more patient and wait for another four years to do a proper exit. This means that investors will have been waiting for nearly 10 years to see their money. So, it depends where you ask the question. Currently, we are buying, so these are beautiful days for us.

What would you say are the disadvantages or challenges of the Egyptian market for private equity firms?

Egypt has challenges in every aspect of finance that you can think of. Forex is one issue, as well as rules and regulations, the way of doing business, selling a company, getting licences, acquiring land and establishing factories. We’ve got issues everywhere. We are positioning forex today as the biggest issue because it’s the most painful. However, if you solve the forex issue, will investments come in, raining down money and dollars? No.

Look at the World Bank World Competitiveness Report released in January 2016. You’ll see something very interesting. Egypt is among the top 20 to 25 countries in terms of market attractiveness globally. So, we are one of the most important 25 markets in terms of attractiveness, which is measured by size, domestic demand and domestic purchasing power. Despite the fact that around 26% of the population is ranked as poor or below the poverty line, the remainder have tremendous consumption power.

You also have to take into account the parallel economy. You can’t only take the bankable society. You have so much cash, and we’ve seen so many examples of billions coming out of the parallel economy and going into banks when they are raising funds. For example, for the Suez Canal, it was 12%. We saw nearly EGP 30 million (USD 3.38 million) coming into the banking sector for the first time within an eight-day period. So, Egyptian society is very cash rich, but the Egyptian government is poor. That’s a bit like the Greece model.

You’ve got a market that’s among the most important 25 markets globally in terms of attractiveness. Yes, it’s that attractive. However, when you look at it for everything else, such as ease of doing business, setting up a company, getting licences, paying taxes, understanding the tax system, dealing with government officials and so on, we are looking at a very low rating.

When you look at everything else, we’re failing because the rating is out of 180 countries. The report gives you a percentage mark out of 100, just like in school, and on everything else we have not even scored 50%. It’s a big failure.

Whatever the government has done to attract investors has failed. That’s the dynamics of everything, and actually it’s the reason why people don’t want to go into the official economy. The big attraction point is this parallel economy, where people have purchasing power and excess cash. They are throwing it into real estate, cars, consumption, dining and going out.

You have that much attractiveness in the economy and that much failure in government. Every single aspect of doing business is an F. The country has not even scored above 50% in one aspect. When you see that, it’s not only forex. It’s every single aspect put together. Forex is a taxation issue, repatriation of your capital, dividends and work permits, surprisingly, are an issue. We have so much to work on.

What effects does this situation have on international companies on the ground?

If you are an expat and you’re sitting on a board of your own company, you have to go through legal and security checks that are renewed every six months. It’s a pain for you to sit on your own board, and you have to renew so many things constantly. You cannot own or register the land. As a result, leveraging it with the banks is a big issue. We have so many things that we have to work on.

Some recent announcements from the governor of the Central Bank, Tarek Amer, almost sound as if they want to pick a fight. You are a foreign direct investor working in Egypt and you complain that you cannot distribute your dividends or because the banks cannot supply you with working capital. If you are not happy enough to work in Egypt, pick up and leave. That’s the kind of language coming from the government now.

The Central Bank is out of its element in this fight. They are running on USD 14 billion-15 billion in reserves. With all due respect, FEP Capital is managing a USD 4 billion portfolio. We are one-quarter of their reserve, and that’s just one single private equity firm. So, let’s put things into perspective.

Some of the companies you are picking a fight with have cash in their balance sheets that’s bigger than your reserves. So, what are you going to do? Pick a fight with the companies because they are complaining that the banks cannot supply them with enough letters of credit to manufacture in Egypt and keep their employees? You don’t understand what’s behind this. Are we moving into socialism? Do we have treasure we don’t know about? Did we find USD 100 billion?

Do you think all of this is a hangover from the Nasser era?

We have a new struggle. We are now struggling to redefine what kind of market are we in. Are we in a truly mixed economy between capitalism and socialism, or are we more moving more towards a socialist system that favours capitalism?

When the Ministry of Supply shifts to building state-owned retail shops from making sure that food subsidies go to people in need rather than merchants that resell at a higher price, that’s a bit of socialism. There’s no competition as they are the regulator determining prices.

We should go back to basics. Let’s not reinvent the wheel with a new system. There is socialism, there is capitalism, there are countries that have both. However, let’s not do our own thing because we can’t afford innovations and the process of trial and error right now. You have companies that can survive and still do business, you have investors that still enjoy the returns that the country is giving. At least don’t scare them away. Just keep it floating.

Do you think the Central Bank will float the currency?

No, that’s a bit too much to ask for because it becomes a political decision. You cannot float because people will compare this president to that president despite the fact that most of the developed economies globally and the world’s largest economy, China, have decreased theirs. If we keep bringing up names, look at China and look at countries such as Egypt, Turkey, South Africa and countries in Latin America.

Last year specifically, you have an average devaluation of currencies that in some cases was as extreme as more than 30%. These are powerful economies, they are producing, exporting economies, and they still do that to be competitive. It’s not a bad thing to do. It’s not necessarily a failure of a certain regime. However, let’s assume this is not an option on the table as Central Bank Governor Amer said, ‘There’s no floating.’

OK, there’s no floating. Then what else do you have to offer? You can’t just say I’m not going to do this, if you don’t like it you can pick up and leave, I don’t need you, I don’t care about you. In reality, you need to go back to basics and put a system back in place.

What should the government do to encourage more foreign investment?

First of all, we need to lift the deposit ceiling. The banks cannot fulfil all the demands of manufacturing companies for opening letters of credit to bring in raw materials to keep producing. We all know there is ample liquidity of dollars in the market in the parallel economy. I can go and buy USD 30 million today if I want, but then I don’t know how to deposit them in the bank because there is a deposit ceiling.

First thing, lift the ceiling. There would be a hike because there would be strong demand on the dollars, so the price will increase. You don’t want to increase the official price in the Central Bank, so basically you are saying to buy your dollars and bear the losses on your balance sheets as companies, I’m not going to float it in the Central Bank. So, if you buy the dollars even at EGP 10 (USD 1.13), you will have to register them officially as EGP 7.8 (USD 0.88) and the difference is a loss on your balance sheet as companies.

Some companies, especially producers and manufacturers, are saying they can bear that, because it’s more expensive not to open the letters of credit and stop the factories.

We have a saying in Egyptian, “Hit me with one big thing once instead of hitting me every day.” So, let’s take the hit once and move on. People will price it in if you don’t want to float it. What is the alternative?

If you don’t want to lift the deposit ceiling, we have proposed a suggestion. As was done for the Suez Canal, just put a structure that throws 20% on the Egyptian Pound and when new clients come in carrying bags of Egyptian Pounds, don’t ask them where they got the cash. Let’s do that for the dollar without calling it what it is.

Give people a bond that gives 7% on the dollar, which is already our sovereign rate, and bring the dollars that are on the street into the banks. You can easily raise USD 3 billion-4 billion locally, but then you will also have to not ask people where they bring these dollars from as it moves into a bank.

The dollars have to end up in the bank for the country to keep growing, for the companies to keep producing, for everything to keep happening. We are always stuck, what’s going on in the mentalities of officials? We don’t know.

Since we’ve been talking so much about Egyptian steel, how do you think the country can become an engineering and manufacturing centre in the coming years?

It’s not going to come from the large-caps. It can only happen through the SMEs. The smaller manufacturers will probably do this work because steel manufacturing will only service the domestic market. You cannot export steel, there’s already a shortage.

In cement, there’s only a handful of people that can go in to cements investments, again because there’s a big capex gap. You can export cement, and we are exporting cement to some countries in Africa, such as Sudan. Cement is the opposite of steel here. Egypt has excess supply, so we are exporting.

The government has always talked about how strategic and important Egypt’s location is. They’re always saying it’s on the edge of something. In reality, nothing has ever happened because we have never explored what the African market needs.

We keep talking about the African market as having big potential, and then when you look at it, you find out that they have so many Chinese manufacturing firms operating there already, dominating the market. So, Chinese companies that are not selling raw materials have actually set up manufacturing platforms.

For example, when you are looking at the smaller companies that produce orange juice concentrate on the SME side, they probably have a better chance to export as it’s less expensive for finished goods. The worst thing you can do is export raw material. That’s what we’ve been doing since the beginning of history of Egypt. We export raw material, it gets manufactured and then we import the finished good. We are very talented at doing this.

What we need to do is build on smaller value-added processing and value-added manufacturing in agriculture, raw materials and building materials. Then you have the finished goods and can try to export it to Africa. This means you have to go open up channels with the African markets, which you don’t have at the moment. They have their own requirements and sometimes you might find that you’ve got certain things that are very suitable.

(Source: The Oil & Gas Year)

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