Introduction
The MENA (Middle East & North Africa) region is often seen as an attractive location for international investments, particularly in relation to establishing manufacturing facilities or general real estate developments. Whilst the financial rewards can be significant, there are numerous pitfalls for the unwary. This article highlights 7 of the most important issues any potential investor should consider before entering into any MENA investment.
Rule of Law
Generally, the MENA region operates a Sharia Law based legal system, with many jurisdictions adopting their own Civil Code, which covers specific aspects of the investment and development process. Some markets have Free Trade Zones, which often operate in isolation using the United Kingdom or other international legal systems (high profile examples include Jebel Ali Free Trade Zone, Qatar Financial Centre and Dubai International Financial Centre), but it is important to note that in most cases when operating under these zones’ rules can come with other restrictions related to project locations, permitted activities, and investment limits.
Irrespective of the above exceptions it is vital investors clearly understand the laws under which their proposed investment will be governed, especially if these rules are markedly different to those in their home country. Many investors have be caught out by failing to understand that they do not have the same legal protection in the MENA region that they would expect at home.
Linked in part to this point, is the language of the agreements being entered into for the investment. In the MENA region, virtually all agreements have to be produced in Arabic for local statutory purposes. Whilst a bi-lingual version of the agreement may be present, it is generally the rule that the Arabic version will take precedence, therefore ensuring the translations are correctly prepared is vital.
Ownership
Many countries in the Gulf have very rigid regulations about the proportion of a development or company an offshore entity can own. Whilst it is usually advisable for any new investor to identify and work with a local partner, it is critical that the ownership split is understood. It is frequently the case that an offshore entity is limited to a 49% ownership share in any investment or business. This means that the controlling interest is held by the local partner / entity. Although this may not be considered a problem at the outset, in the event of a dispute it can result in decisions being made outside the control of the offshore party.
This particular issue is of major significance if the proportion of investment from the offshore entity is greater than the ultimate shareholdings in the venture. Similarly, where the local entity provides “equity in kind” (through the provision of land) the true valuation of the overall investment can become rather vague.
Sponsors / Partners / Conflicts of Interest
As noted above, most MENA investments will require some form of local partner to be involved. Certain countries, Qatar, Kingdom of Saudi Arabia, and Kuwait for example also require a local sponsor in order that any offshore company can legally operate in the local market. When deciding on a potential partner / sponsor it is important to consider carefully the following types of business arrangement available, before selecting the desired approach:
- Active Participant
These local businesses are usually experienced in the field being considered for investment and can be highly beneficial to the new investor. Usually they are looking to expand or enhance their existing position in the marketplace and therefore the new investment is usually complementary the established portfolio. These partners are usually experienced in working with offshore entities and can quickly identify potential mutually beneficial market opportunities.
Offshore firms should however, be wary of local organisations who are primarily agency outlets, and are simply looking to add another brand to their existing catalogue. In these cases, the level of ongoing interest might reduce once the deal is concluded.
- Silent Partner
Many offshore firms like the idea of a local firm simply acting as a registration medium, to ensure local legal compliance, and nothing more. Whilst this may seem attractive and appear to provide greater autonomy, it is important that under these arrangements the partner involved have the local credibility to support the offshore firm in the event of an issue. If this is not the case, then in event of a dispute or regulatory matter, the offshore firm will be left to resolve the problem themselves.
Linked with this category are those entities (such as service office providers) who offer company registration services. These are attractive avenues for consultants and businesses planning a limited entry to a new market, but often the level of commercial registration possible through these entities can severely restrict any future expansion of activities, resulting in additional expenses and delays being incurred.
- Influential Advocate
One of the most common target partners is what is often defined as being an “influential advocate”. These advocates are usually, members of the local Ruling Family, local elite, or prominent individuals. There is no doubt that influence and credibility in the local market can be enhanced through linkage with these categories of individual. However, since the Arab Spring, most MENA countries have cracked down on corruption and influence peddling. This means that today, bypassing the statutory processes or procedures is less common and certainly a high-risk business strategy. Therefore, apart from the passive credibility there is now limited benefit of seeking out influential advocates as a sole market entry strategy.
Despite the above, having a partner who is well connected in the local market is a powerful tool for opening doors and making introductions to enhance business opportunities. This strategy is still by far the most successful in the MENA region where relationships are the keys to successful business development.
In all cases, offshore investors must be wary of partners who also have a wide range of other businesses. Often these partners want / insist on their associate companies being involved in the design, delivery, or construction of the investment. This can result in a conflict of interest as well as loss of control of where the investment monies are being spent.
Ability to Exit Position
Irrespective of the duration of any investment horizon, it is important that the market exit strategy is clearly understood at the outset. Many MENA markets make investing relatively easy, but are much more restrictive on how investors can remove their money or sell assets. In the Gulf States for example, whilst they all have active real estate markets, the secondary property market is still in its infancy. This is partly driven by the constant stream of new developments being launched and partly due to the restrictions on securing mortgages for pre-owned properties. The result is that whilst a property may have an attractive initial valuation, the asset often cannot command the same value on resale.
Similar issues arise for manufacturing plants and equipment, where the second hand market has yet to fully evolve and therefore finding buyers will often be hard. A common strategy is to seek out competitors who are looking to consolidate or upgrade existing facilities and use this as a mechanism to off load unwanted assets (provided they are of a suitable standard).
Money Matters – Taxation / Currency / Duties
Securing regular expert tax advice is critical, because the rules are constantly changing across different markets and with the increased globalisation of trade, many dual and free trade agreements are being implemented. Generally, the main taxation and duty categories encountered will include VAT, Withholding Tax, GST, Customs Duty, and Agency Fees. It should be remembered that although many MENA markets claim to be “tax free” this usually only applies to certain industries or categories of individual / business.
In terms of currencies, most of the MENA region countries have freely exchangeable currencies, permitting the transfer of funds around the world. The key exception is Lebanon where local currency transactions are subject to significant limitations (which is why most businesses operate using US Dollars). Currently the GCC (with the exception of Kuwait) have US Dollar pegged currencies making them more stable from an investor’s point of view.
Economic Viability – Realistic Business Models
Many offshore investments fail because of unrealistic business models prepared using inaccurate local market information. Whilst local knowledge is critical to the preparation of any business plan, this knowledge has to be tempered with realistic expectations. In many cases, inflated assessments are prepared due to over optimistic views of how a market will perform or demand volumes.
In general, it is important to understand the overall track record of the market sector being considered. Gaining knowledge as to why the market is structured and sized the way it is, will give a good indication as to whether the proposed venture will succeed. Often the reason why a market sector has limited participants is due to the high barriers to entry. Furthermore, the historic growth in a particular area is still a good indicator future performance. Historically, it has been rare for the market fundamentals in a particular area, to change significantly in a short time period.
The manufacturing sector is one area where many offshore entities see great potential in the MENA region, and there are certainly great benefits (from a price perspective) by manufacturing close to the end market. However, the MENA markets also place a significant level of importance on the place of manufacture (as a measure of quality), therefore local manufacturing plants, whilst better from a price point of view, might be viewed as offering an inferior product to the same item produced in Europe or the USA. This perception is gradually changing but can currently be an influencing factor in the decision making process of potential buyers. Equally, many internationally backed local manufacturing ventures suffer quality control issues, which too damages brand perceptions.
Price is always a key decision driver and therefore ensuring any proposed product or service is competitive in the local market is key. Despite the opinion that an offshore delivered service or product is superior, the local market will generally not pay a premium for it unless it is unique or unequalled in similar regional alternatives. This situation is in part driven by the fact that many international services or products have historically not lived up to the expectations of the local clients (due to the practical difficulties international firms experience when operating in the MENA marketplace).
Mapping Local Competition / Market Landscape
As part of preparing the business plan, it is important to understand clearly, who the local competitors are. Most MENA markets have local regulations promoting local businesses and products to the extent that they will be given preference in a competitive situation. This is critical for manufacturing businesses since the pricing model may be very similar to the local competition but market share will be impacted due to local preference requirements.
In the GCC markets in particular, the differentiation between State entities and private sector businesses is also less clear. This means that in some cases competition in certain market sectors may be dominated by a few State backed players, reducing the ability for new entrants to take a significant market share.
A final consideration is that in some markets the government specifically reserve certain tenders and investment opportunities solely to local entities. Therefore, whilst the opportunity landscape may seem plentiful, when these restricted areas are removed from the calculation there might be significantly less opportunities available for an offshore entity.
Conclusions
All of the above points are just a sample of the wider considerations any potential MENA investor has to understand before moving into a new country. In all cases, it is essential that detailed local market research be carried out in advance, so that expectations can be set at the correct level from the start. This is not only in relation to the potential market size, investment return, but also in relation to the investment window to be considered. Many organisations have looked to the MENA region as being a “quick” win opportunity, this is not the case, and these firms have long since left the market. Preparation and planning are the key success strategies adopted by those who have developed sustainable business models for the MENA region.
Plateau Group 