Middle East equity research poll 2009
Most convincing and coherent strategy
IT HAS BEEN a difficult year for leading Middle Eastern financial institutions. Following the collapse of the housing and credit markets, as well as the steep decline in the oil price, some prominent investment banks in the Gulf Cooperation Council countries have found themselves struggling to meet their debt obligations. In light of these difficulties, it is likely that these broader problems are affecting the functioning and profitability of their core businesses.
As many of these Gulf firms are facing severe financial strain – and, in some cases, fighting to survive – it is interesting to examine what effect these circumstances have had on their analytical capabilities, as well as on their international reputations as equity research houses.
Global Investment House and Shuaa Capital are two big names in the regional financial industry that are coping with an especially rough year. After the tightening of credit conditions in the wake of the international financial crisis, Global Investment House, Kuwait’s largest investment bank, announced in January that it had defaulted on $200 million in loans. Despite the default, Global claims that it has continued to pay interest on subsequent outstanding debt. The company is now improving its balance sheet, offloading unprofitable assets and restructuring to emerge as a more streamlined, fee-driven business.
Similarly, Shuaa Capital, a leading investment bank in Dubai, has spent the greater part of a year negotiating new terms for a convertible bond held by Dubai Banking Group (DBG), which is 70% owned by state-backed Dubai Holding. The controversial and highly publicized debate began when Shuaa’s stock price fell below the original conditions of the conversion of DBG’s senior debt into equity, leaving Shuaa unable to meet its initial commitments. Ultimately, in late June, the two firms reached an agreement whereby DBG became Shuaa’s largest shareholder, with a 48.4% stake of Shuaa’s post-conversion share capital.
In response to such local financial uncertainty, international investors in the Middle East have shown mixed reactions. Some believe the financial troubles of local firms have adversely affected their research capabilities and reputations. Other investors maintain that this financial instability has not hindered the local banks’ abilities to produce equity research on a par with that of global investment banks. In fact, when trading in Middle Eastern equity markets, these investors continue look to the regional equity research houses just as much, if not more so, than their international counterparts.
Frank Dewotor, a portfolio manager at UBA Capital, believes he has every good reason to continue to trust his local analysts. "The financial difficulties in the Gulf region have not stunted the quality of the research that I have been receiving for a number of years," he says. "I have confidence in their rigorous and consistent equity valuations and recommendations, and I see a distinct difference in their local specialization."
Another big investor in the region also continues to value local equity research, confident that the banks that got into trouble did so at a corporate level, which in turn has had little impact on their research departments.
Rebuilding the model
In contrast, other investors argue that international perceptions of these local firms have changed as a result of their financial challenges. Anatoly Romanovsky, a fund manager at Hermitage Capital Management, asserts: "The problems that these banks [Shuaa and Global] are now facing stem from the questionable strategic choices they made during the bull-market era. They opted for a leveraged hedge fund model to benefit from gains on proprietary positions while paying much less attention to the fee-driven business lines. With the market downturn, accompanied by the credit crunch, that model collapsed... at some point, many investors were scared away by the uncertainty surrounding these troubled institutions. These banks need to restore investors’ confidence as soon as possible to get back their share of business."
According to Romanovsky and many other like-minded investors, now is the time for the Middle Eastern financially distressed institutions "to rebuild themselves as proper investment banking and brokerage businesses with a much greater focus on customer needs".
He stresses: "Research is mainly about personalities; any departure of a leading analyst dents into a firm’s ability to ensure proper client coverage. Some meaningful departures have happened [from the local houses], but many leading analysts are still there and it’s up to the owners and management to make sure the best talent is retained or recruited, if necessary."
In fact, rather than pitting local against international research houses, many investors usually focus on the knowledge and diligence of the individual analyst.
Romanovsky is not alone in saying that he tends to value particular analysts rather than investment houses. Like many other international investors in Middle East equities, Romanovsky uses both Gulf-based and international research, claiming: "In order to be ahead of the curve, one has to know how this curve gets shaped." After some of his own analysis on a particular stock, he often trusts local equity researchers for "insight into a company’s history, ownership and management issues, clients, suppliers, and competition... as well as subtle details not captured by any discounted cashflow model".
Investors often look to Middle Eastern research teams for a wider range of companies in the area, as these analysts do not usually narrow their coverage to only blue-chip stocks. At the same time, Romanovsky also looks to research reports published by international banks, which are generally "much more useful in cross-checking [my own] view on the global trends and the ranking of an individual stock on the wish-list or hate-list of mainstream international investors".
He adds: "Some analysts working for global houses over the past couple of years are able to generate high-quality, broad-picture analysis that their local colleagues fail to match."
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| Local and foreign investors "tend to prefer research teams that are located on the ground and close to the action" Mahdi Mattar, Shuaa Capital |
Mahdi Mattar, head of research and chief economist at Shuaa Capital, says that both local and foreign investors "tend to prefer research teams that are located on the ground and close to the action, irrespective of whether the research institution is a local name or an international name". In general, equity investors in the Gulf region are looking "to better understand the local market, the local economy, as well as the dynamics of the various companies".
Will Manuel, head of CEEMEA equity research at HSBC, also stresses the value of his firm’s strong regional presence, with analysts across the Middle East in Cairo, Riyadh and Dubai. HSBC prides itself on its ability to provide its clients with what Manuel calls the "local feel and flavour" of the Middle East, as well as a general understanding of quantifiable and effective equity research, believing that a balance of the two is crucial for its credibility as a Middle East equity research institution.
The value of research
Equity research is particularly highly valued during times of economic downturn. In the Middle East, where retail investors dominate turnover and where research coverage is relatively scarce and stock prices can move on the whim of a rumour, both foreign and local investors appreciate the more considered view of institutional reports. "It is the role of equity research teams to identify investment ideas, analyse the dynamics of the corresponding industry and provide the economic framework by identifying and examining key drivers," says Mattar.
During bear markets, when investors’ risk aversion increases, the importance of clean and timely data becomes essential, and in many cases equity research houses become the primary provider of this information in the Gulf.
Despite the recent setbacks in the region’s financial sector, Mattar still believes in the growth opportunities that the Middle East presents, "with valuation at discount, especially after the severe sell-off of last year, and the regional equity markets offering some highly attractive value plays".
Gulf promise
Manuel of HSBC also continues to see promise in the area. He says that the region’s prospects are good, as equities in the GCC and Egypt become a large bloc of the global emerging market benchmark indices, such as the MSCI Emerging Markets Index. As more Middle Eastern stocks move into the emerging market benchmarks, increased trading volume in the Gulf region is bound to follow, particularly among institutional investors.
As businesses in the Middle East continue to move away from the family owned and operated model and place greater portions of their companies in the hands of public shareholders, a higher level of corporate transparency, scrutiny and research will be required. With increased coverage from both local and global firms, Middle Eastern equity markets will become deeper and more liquid as time goes on.
Indeed in a region where information and data dissemination is still relatively weak – both at corporate and state level – equity research plays an increasingly important role as the financial markets grow. In an area where the availability of statistics, disclosure of information and quality of data do not yet meet the required international standards, the job of both local and global equity researchers is harder, yet more essential to international investors.