Waiting in Wings In Mideast: VCs

Britt Erica Tunick (britt.tunick@thomsonmedia.com)

If past is prologue, as major companies such as Shell Oil Co. and McDonalds Corp. dip their toes into post-conflict areas like Iran, venture capitalists will begin to follow their lead into the volatile region.

No one is suggesting that VCs are ready to pile into an unresolved situation like Iraq anytime soon, but history suggests that the first VCs willing to gamble on a post-conflict region benefit the most, and that their entree is usually in a sector like consumer goods, in which the local competition is often nonexistent.

“This is the next area-doing business in post-conflict areas such as Israel and Palestine, Serbia, Bosnia and places like that,” says Lucy Marcus, managing director of U.K.-based Marcus Venture Consulting, a consultancy for both U.S. and European venture capitalists and startups. “When you look at what’s left and what’s interesting for people to invest in from a real venture perspective, these places have all the good hallmarks.”
She says many venture capitalists are now turning their attention to parts of the Middle East, Africa and Latin America as potential big growth areas, looking at past success stories of companies and funds that were early investors in places like Russia and Poland. Beyond the natural resources that are obvious attractions for many of these places, she says investors have also been drawn by cheap access to large labor pools-many with surprisingly sophisticated skill levels, favorable tax regimes and the promise of significant consumer growth.

Dr. Stefan Wolff, a U.K.-based expert in post-conflict reconstruction who has advised companies on investments in Northern Ireland and the Balkans and now the Middle East, says he is seeing growing interest from companies looking to invest in post-conflict areas.

“These post-conflict zones are basically the new emerging markets of the 21st century. If you want to stay ahead of the curve as an investment organization and be able to perform well in terms of your returns so you can attract more investors, then the important thing is to move early,” says Wolff. But he says investing in these areas is not for the faint of heart and that companies and VCs prepared to commit capital in such locations should be sure they understand all the risks and have plans in place for handling them.

Risks, rewards

“It’s not just good enough to see that there is this enormous amount of money that you can make, if you are not aware that there are potential risks that, if not managed properly, can jeopardize your whole investment,” says Wolff.
Among the risks are issues such as religious fundamentalism and anti-American sentiment. “You have to ask yourself how safe is it to invest in a country that doesn’t really have, by Western standards, a legal process?’” says Wolff.
Nonetheless, those risks have not been enough to deter early entrants into many of those areas. To wit:

In Egypt, Bechtel Group Inc. and Shell have joined with two local partners and committed $450 million to build the Middle East’s largest private power plant; Electricite de France has committed $900 million for a development project; and BP Plc, Repsol YPF S.A., British Gas, Apache Corp. and Tanganyika Oil Co. Ltd. have all formed joint ventures in the country, according to Wolff’s research.
In Serbia, Germany’s WAZ-MedienGruppe has invested E25 million in Politika Newspapers and Magazines; Hellenic Telecommunications Organization has purchased 20% of Serbian Telecom; and EFG Eurobank Ergasias SA bought 68% of Postbank AD.
In Croatia, a number of banks have formed partnerships, among them Banca Commerciale Italiana; Raiffeisen Bank Polska SA; Bayerische Vereinsbank AG and Credito Italiano.

Within the first three weeks of the end of the war in Iraq, Wolff says foreign companies had already committed more than $8 billion for reconstruction contracts in the country. But in areas like Iraq in which conflict is ongoing and political uncertainty remains so strong, industry observers say it is likely VCs and companies outside of oil and energy concerns are likely to keep their distance a while longer.

Bill Browder, manager of the Hermitage Fund, Russia’s largest equity investment fund, has been living in Russia and investing in public companies there since the fall of the Soviet Union. He says the country generated significant interest among VCs and private equity investors early on. But he says it is only recently that mainstream companies have been willing to step off the sidelines themselves and that it’s likely investments in Iraq will follow a similar pattern.

“Russia has a similar order of magnitude of [oil] reserves as Iraq, and it wasn’t until this spring that British Petroleum finally made the first huge cash investment into Russia,” says Browder. “Regardless of the natural resources of a country like Iraq, the chaos that’s currently occurring is so scary for investors that you’re not going to see any real investment flows for many years. All the predictions about people going in to invest lots of money in the oil industry are all misplaced, and it’s only going to happen when there’s pure political and economic structure, laws and rules governing the country.”

Golden Arches lure

Still, one area industry observers believe will generate significant interest among venture capitalists is consumer-oriented products and services, particularly in regions such as the Middle East where competition is virtually nonexistent.

“If you think back 10 or 15 years ago to the emerging markets, one of the things that really worked in East Germany was consumer goods and household electronics,” says Wolff, who lived in the country at the time. “We had never seen a video recorder in our life before, and I’m talking 1989-1990. And though it sounds banal, what grips the imagination of consumers in these areas are things like McDonalds.”

On top of the first-in benefit that venture capitalists hope to turn to their advantage in post-conflict areas, Wolff says many of these countries also have the added perk of free trade agreements that would give businesses instant exposure to millions of people.

Turkey, for example, is not yet a member of the European Union, but it has an extensive free trade agreement with the EU. “So investing in Turkey from the start opens you to a market of more than 300 million people, which is a natural export market,” Wolff says.

Conflict, Conflict and Post-Conflict Zones, Investment, Private Equity, Venture Capital