by James Crombie

A rising tide of Middle Eastern money is starting to wash up on LatAm shores. After the oil price spike, investors from that region seek high yielding but conservative investments to place increasingly ample funds. LatAm is ideally positioned to capitalize on Sharia-compliant private equity’s (PE) strict anti-leverage requirement.

The Islamic finance industry is valued at over $800 billion by Crescent Asset Management, which is seeding a dedicated LatAm PE fund it hopes to grow to $500 million by the end of 2008. Crescent also has a $1 billion global co-investment fund targeting LatAm institutional investors for ventures in infrastructure, energy, biofuels, distribution, commodities including mining, exporters among other industries.

“We are catching a wave of interest from the Middle East,” Crescent Group CEO and principal Paul Homsy tells LatinFinance. “There is just a tsunami of money flowing into the Gulf.” More than $2 trillion is estimated to have accumulated in Gulf states, but Homsy estimates that private sector funds could easily double the total liquidity.

Crescent may be just the tip of the iceberg as Middle East accounts wake up to the fact that Latin America – with its huge infrastructure needs – is ideally suited to portfolio requirements. “We have access to some great private equity opportunities,” says Homsy. “Most of it is in basic industries: distribution, some telecommunications, natural-resource based industries.”

Besides complying with Islamic law – which prohibits investment in conventional banks, insurance companies, alcohol, tobacco, firearms or entertainment – these LatAm projects deploy low leverage. The most common Sharia anti-leverage requirement constrains the conventional debt to enterprise value of a portfolio company to 30%-33%, according to Crescent.

“There’s a fundamental compatibility between the rules that govern Islamic finance and venture capital and private equity investment in Latin America,” says Cate Ambrose, executive director at the Latin American Venture Capital Association (LAVCA). “Islamic finance targets value creation and growth capital as opposed to generating returns through leverage or financial engineering.”

Upward Spiral
Crescent claims to be the first to bring Middle East capital to LatAm, whose protracted run of expansion and calm has enticed investor interest from across the globe. Dubai’s Nakheel is heard looking at the opportunity, while Abu Dhabi Investment Authority (ADIA), a sovereign wealth fund owned by Abu Dhabi, is a ubiquitous limited partner with significant dedicated money in LatAm.

“Some of the sovereigns have always been investing [in LatAm]. They have so much capital, they have certain allocations for different parts of the world,” says Homsy.

Competing with Crescent is Bahrain-based Ithmaar Development, part of Kuwait-based Al Safat Investment. With Arabian Ventures, also Bahrain-based, it has launched a $500 million Sharia-compliant real estate fund targeting LatAm real estate. The closed-end vehicle will have an initial term of five years and invest with local currency. It is focused on Brazil, Argentina, Colombia, Mexico, Ecuador, Venezuela, Chile and Costa Rica.

“In the last few years economic stability has started to take hold in Central and Latin America, which has resulted in unprecedented growth in the region’s real estate sector,” says Ithmaar Bank’s chairman Khalid Abdulla-Janahi. “The robust development of capital markets in Mexico, Brazil, Argentina and Costa Rica has increased liquidity, a clear indicator of positive, economic progress.”

“Growth has direct co-relation to the upward spiral in the real estate sector in the region,” adds Waleed Ahmad Al Sharhan, chairman of Al Safat. “Real estate development activity is gaining traction, although demand outstrips the supply.”

Middle East investors have typically focused on their own region, as well as North Africa and adjacent South Asian states. But there is only limited capacity to absorb excess cash.

Homsy says Crescent has had some very strong indications from investors and expects to hit the $500 million target for Sharia compliant fundraising this year. “We’re working with a couple of major sponsors so it’s coming along pretty well,” says the fund manager. Crescent generates investment from Abu Dhabi and other UAE countries, together with Saudi Arabia, and invests through a network of co-managed funds.

Crescent seeks returns above 20% a year with a lock up of 5-7 years. The focus is Brazil, Chile, Colombia, Peru and Central America – mainly Panama, Honduras, Guatemala and El Salvador.

Middle East investors tend to have a shorter time horizon than typical PE, which can be 10 years with 1-2 year extensions. “The max you could see doing private equity out of the Middle East is six or seven years,” says Homsy. Crescent aims for a significant minority or a majority ownership stake.

“Is it realistic? With the right manager, sure,” says Ambrose, speaking of Crescent’s targeted returns. “It depends on the quality of the manager and the macro environment. If the macro environment changes dramatically then the lock up period may become an issue,” adds Ambrose.

But resilient and evolving local markets may make it easier to exit sooner, fund managers hope. “As the capital markets mature, there’s going to be a lot more viable exits through local capital markets,” says Homsy. “As more and more private equity firms go into Latin America I think there’s going to be pressure on valuations, and as you pay more the exit is going to become much more strategic.”

Field Wide Open
Crescent is excited about the opportunity and present lack of competition. But it is making a substantial long term commitment and looking for partners on the ground willing to share some of the risk.

“It’s not too crowded yet. The PE firms haven’t yet piled in and when that happens, competition for deals is really going to get intense,” says Homsy. “We look for these special opportunities and we’re a little bit ahead of the pack.”

For its $1 billion global co-investment fund, Crescent seeks partnerships with local pension funds to invest in alternative assets, focused on Peru and Colombia. Each co-manager has primary responsibility to originate deals and must be prepared to cover at least 10% of each transaction with its own capital. The Crescent Opportunity fund targets a $1 billion raise by year-end and has a dynamic allocation model, with no specific minimum allocation for LatAm.

“We don’t invest in any country unless we have one of the best local partners with an excellent reputation, track record and large deal flow,” says Alejandro Vargas, president of Crescent Asset Management Latin America.

Vargas looks to co-invest with other strong local partners and raise substantial co-investment money locally. These include large institutions, economic groups or operating companies rather than PE managers, which are still quite inexperienced in LatAm. Among existing local partners is Chile’s Moneda Asset Management, with approximately $2 billion in assets under management and presence in mutual fund distribution.

Crescent is also working with major financial institutions in Colombia and Peru. It has infrastructure deals on the go in Colombia, Peru and a partnership with a major banking institution in Central America for PE deals, but Vargas declines to comment on specifics. Crescent is also doing ethanol, energy and infrastructure deals in Brazil.

Crescent does not seek to allocate more than 20% of its $500 million Sharia fund to any single deal, although there may be some exceptions. Participation in some of the region’s larger infrastructure projects could warrant much higher exposure. It would also help mitigate the constraints of deploying such ample fresh funds in LatAm.

“Diversification is very important – that’s where you have the best returns and the lowest risk,” says Vargas, former international chief legal officer of Entel Chile, and a board member of Entel’s affiliates in North, Central and South America and Europe.

“Prices are still very convenient to invest and get high returns,” adds Vargas. The Chilean native underscores his long term commitment to the region by describing recent work with Peru and Colombia pension regulators on freeing up local funds for PE investment.

Given this affinity, Crescent and Ithmaar may well be the thin end of the wedge in terms of the new Middle East buyer base. “You are talking about sophisticated investors who understand global markets,” says Homsy. “There’s plenty of room for expansion.”

“There definitely will be more money moving in that direction, the question is will there be managers there who they can allocate to,” says LAVCA’s Ambrose. “[Middle East investors] could be an important investor in the global universe of investors active in Latin America,” she concludes. LF