By Dorina Barna and Jakob René
The Abraaj Group, a Dubai-based private equity firm, is a narrative of success turned dark comedy. Founded by Arif Naqvi, Abraaj became one of the most influential emerging-market buy-out firms after 16 years of operations with more than $14 billion in AUM. In 2018, with its reputation tattered, the firm’s promising equity story collapsed in just 4 months.
In April 2019 Naqvi and then-executive Mustafa Abdel-Wadood were arrested on U.S charges of defrauding investors. U.S prosecutors claimed that the management had been lying about the firm’s performance since 2014 thereby inflating Abraaj’s value by more than half a billion dollars. The charges also pinned the executives with the misappropriation of millions of dollars of investor’s funds in Madoff-esque fashion. Also, there is an ongoing investigation as to whether or not the dynamic duo bribed Pakistani politicians. In June, Mustafa Abdel-Wadood admitted in court that he deceived investors in an attempt to hide losses and raise further capital.
What was the Abraaj Group?
Abraaj was founded in 2002 by Arif Naqvi, a Pakistani businessman who remained chief executive throughout the years. The supporting character is Mustafa Abdel-Wadood, who joined Abraaj in 2006 and became managing partner. After foundation, the company dazzled with an impressive 17% annual return; in the years 2014 and 2015 it realized $450 million on 13 exits. An exemplary investment was Integrated Diagnostics, which Abraaj listed on the London Stock Exchange in 2015 at a valuation of $668 million. At its zenith, the fund oversaw operations in six continents and held local offices in 25 countries from Kenya to Kazakhstan. The company was an investor in global growth markets and made over 200 investments in a variety of sectors. Abraaj kick-started the private equity industry in the Middle East and was the self-proclaimed pioneer of “impact investing” by investing in hospitals and education in developing countries that promoted social progress.
When did the trouble begin?
Despite its glamorous inception, the company began to struggle as year-after-year its P&L displayed multimillion-dollar operating losses. The revenues that made up the management and performance fees were outweighed by bloated costs; to plug the gap, the group borrowed. By 2018, financing costs came to $41 million. Two years prior, Abraaj attempted to divest assets, including a $1.8 billion stake in a Pakistani utility firm, in an effort to avoid a cash crunch. However, these deals were repeatedly delayed.
Last February some investors including the Bill and Melinda Gates Foundation and the World Bank’s private-sector arm, who instated their savings in a $1bn healthcare fund, hired consultants to investigate the firm on the suspicion of fund mismanagement. When news of racketeering broke in February 2018, creditors turned off the taps and sought to have the firm wound up.
Naqvi and Abraaj denied any wrongdoing and blamed unforeseen political and regulatory hurdles for the delay in deploying capital. After Abraaj defaulted on its loans, Kuwait’s Public Institution for Social Security alongside a fund linked to Sharjah-based Crescent Group’s Hamid Jafar moved to force the company into a court-supervised restructuring.
PricewaterhouseCoopers, helping to oversee Abraaj’s restructuring, stated the group’s primary revenues, fees earned from managing investments, hadn’t covered operating expenses for years. Abraaj had borrowed to bridge these gaps in order to fund asset purchases – a bet which placed it in a $1 billion hole.
What can be learned from the scandal?
What happened to Abraaj can be seen as a “wake-up call” according to Ludovic Phalippou, a finance professor at the University of Oxford’s Saïd Business School, who says that people should not be naive about the relationship between the contract’s auditors and private equity managers. The Abraaj case shows how much freedom there is for investors to be proactive. He says conflicts of interest between auditors and the private equity groups that employ them are an “eternal problem” in the sector.
Private equity valuation has always faced a motley of challenges arising from the lack of transparency in the market regarding information. Such issues include sourcing suitable comparable companies and calibrating relevant liquidity and marketability discounts/premiums. Further challenges have emerged over the past few years as a result of increased regulatory oversight and investor pressure for added transparency, particularly in the area of valuation.
A tactic employed by private equity firms has caught investors’ attention with the collapse of Abraaj. The method is to use the fund’s committed capital as collateral for short-term bank loans (or bridge loans). This enables private equity companies to increase the rate of return of the fund – a necessity in a competitive market climate. Experts estimate that such loans amount to $400 billion globally. However, once the committed capital is used as collateral, the limited partners will be asked to pay if the fund defaults, as in Abraaj’s case.
These loans taken out by managers coupled with the asymmetry of information increases the limited partners’ demand for reassurance when investing. The simplest way to achieve comfort is to implement stacks of reporting and paperwork. Increased paperwork is preceded by higher legal and compliance costs which is no problem for minted large firms such as Blackstone. However, for new funds, these requirements can serve as a market-entry deterrent. Therefore, the incumbents float atop increased documentation and regulation since they can foot the bill while newly funded firms will struggle. With limited partners’ demand for tighter regulations and increased documentation, a lasting impact on the industry from the Abraaj scandal can be a decrease in competition and higher barriers to entry.
The Abraaj scandal might also have another lasting implication on the private equity industry. With fierce competition in established markets, mainly Europe and the US, funds have turned to emerging markets which tend to produce higher returns tied to higher risk. Abraaj, an established actor in the emerging markets, attracted a broad base of investors with its previous track record. With the fallout, several investors may begin to question investment in emerging markets. Although there has been a recent recovery, funds in the Middle East and Africa only raised a third of their previous annual average after the Abraaj scandal became public. The wake of the scandal can deeply impact the region as well as create skepticism regarding emerging markets as a whole. Institutional investor confidence in the Gulf is all but gone, stemming from the lackadaisical response by the Dubai Financial Services Authority to the scandal. Bloomberg reports that investments involving Gulf firms have fallen to a 10-year low.
What happens to Abraaj now?
Liquidation and reparation. Of course, the collapse of Abraaj created a highway for competitors in the industry to expand into new markets. Actis Capital, one of the largest rivals of Abraaj, immediately took advantage of the chaos purchasing two of its funds. This transaction led Actis to acquire a portfolio of 14 companies valued at $1.6 billion with a focus on Africa and the Middle East. In some of its latest deals, Actis also took control of companies across North Africa, including Cleopatra Hospitals – Egypt’s largest hospital chain – and Southeast Asia, in countries such as Singapore, Malaysia and Indonesia. US-based Colony Capital took over Abraaj’s Latin American operations while TPG plucked the healthcare platform, Evercare.
Consultancy firms PwC and Deloitte who were appointed by a Cayman court to oversee the restructuring of Abraaj, are evaluating bids from companies to operate other funds. Deloitte decided to sell some of its fund management business to pay off the $1 billion debt.
Protagonists Naqvi and Mustafa Abdel-Wadood face prison time. Naqvi, maintaining innocence, is under house arrest in London. He was sentenced in absentia to three years in prison by a court in the United Arab Emirates for a case involving carrier Air Arabia PJSC. Redemption for Mustafa Abdel-Wadood’s change-of-heart could cost him up to 125 years in prison.
Editor: Eric Peghini
Authors: Jakob René, Dorina Barna