Mezzanine funds are becoming increasingly attractive as a new source of financing for mid-market companies
MENA market demand for such funding is expected to grow significantly in the coming years
From the perspective of medium sized enterprises in the MENA region, one of the most daunting challenges is obtaining the financing needed to fund a variety of corporate goals, including growth capital expenditures, acquisitions and recapitalizations.
In the Middle East and North Africa region and Turkey the challenge in obtaining debt financing stems from a market that has traditionally been dominated by commercial banks which demand high levels of collateral and prefer lending to larger companies.
However, fast-growing mid-sized companies are now finding a new attractive tool to help secure the funding they require: mezzanine debt. In contrast to traditional lenders, mezzanine lenders look favourably on stable, profitable mid-market companies, especially those in service-based industries which, due to their lack of hard assets, require a cash-flow based lending approach.
NBK Capital, which operates in the region from offices in Kuwait, Dubai and Istanbul, together with GSC Group, a leading provider of mezzanine capital in Europe and a global investment manager of credit-based alternative assets, launched a joint venture to address this unmet mid-market customer demand. The venture, the first of its kind in the MENA and Turkey region, currently has $115 million available to fund mezzanine financing in the area, a sign that there is strong interest in this new financing concept.
NBK Capital’s Chief Executive for Investment and Merchant Banking, Amjad Ahmad, explains: “Mezzanine financing is an attractive option for small and medium enterprises seeking capital given the stringent lending practices in the region and the instrument’s flexibility.
“We are confident that mezzanine financing represents a strong growth opportunity in the Middle East and North Africa, for private equity sponsors and corporate clients.”
Mezzanine financing is a form of debt capital, a hybrid of debt and equity financing that is usually structured as a loan, note or other debt instrument that is contractually and/or structurally subordinated to senior bank debt.
Mezzanine financing often benefits from second ranking security interests and is always senior to the equity. Mezzanine securities generate a significant portion of their return on a current and contractual basis. In addition, mezzanine securities may have an equity “kicker,” usually in the form of warrants or common stock.
Part of the attraction for such financing is the fact that it can be arranged fairly quickly. Moreover, because mezzanine capital is subordinated to the senior bank financing on the borrower’s balance sheet, the company is able to optimize the amount of total leverage.
Financial observers in the region believe that the amount of demand for mezzanine financing during the next few years will increase significantly. This growth will be driven by many factors including the highly attractive regional investment environment that is fostered by continued strong economic growth and the average GDP increasing by 6.3%.
GDP growth rates are expected to stay at levels over 5% for the foreseeable future and with oil at over US$100 a barrel there will be large amounts of regional liquidity in the short to medium term.
Walid Cherif, who heads up the NBK Capital – GSC mezzanine team, said: “We believe mezzanine lending to mid-market companies offers attractive risk-adjusted returns, with current income, downside protection and equity upside.
“NBK Capital’s deep understanding of the target markets coupled with GSC Group’s expertise in structuring mezzanine instruments should enable us to benefit from the best opportunities in the market.”
NBK Capital and GSC Group believe that an attractive opportunity exists for the deployment of mezzanine capital in the MENA and Turkey region because of the tremendous growth in private equity, inflexible lending practices by regional banks and reluctance of family businesses to dilute their shareholdings.
But what ultimately makes mezzanine investing more attractive to investors than other asset classes?
Christine Vanden Beukel, Senior Managing Director at GSC Group responsible for corporate mezzanine lending, explains: “A mezzanine investment provides investors with an opportunity to generate an excellent return compared to the level of risk. The hybrid nature of mezzanine means that the debt component yields significant recurring income while equity components such as warrants and conversion options provide more opportunities to generate upside.”
Mezzanine Financing has a number of advantages for companies compared to the other traditional financing methods. These include:
Being less expensive than equity financing
It avoids dilution of equity: Shareholders continue to operate more independently than would be the case if additional investors had rights to the capital.
Cash flow based (as opposed to collateral based)
Ideal for smaller-size companies who have limited access to financing
Easy to implement and quick to execute which makes it attractive for the smaller-size companies
More flexibility than classic bank debt arrangements
Walid Cherif adds: “Mezzanine financing will bridge a large gap in a market that lacks alternative sources of second layer debt mechanisms such high yield debt. That is why the role of mezzanine financing is set to increase in our region.”
In general mezzanine funding can be arranged in one of the following cases:
Cash Flow Based Financing – bridging the gap between traditional capital and senior ranking debt.
Financing acquisitions, buy-outs or expansions - Helping to finance a possible acquisition, or provide the capital required to help the organization develop and execute its plans for growth.
Management Buy-Out - In the context of the succession arrangements or separating sections of the company where private resources for the management team are limited
Restructuring / Recapitalization - Where the owners of capital can liberalize the capital by leveraging their equity without having a negative impact on their ownership.
As the MENA market matures, the demands of investors and lenders are becoming ever more sophisticated for increasingly complex financing tools. The comprehensive offers of organisations such as NBK Capital ensure that the market is well positioned to handle such requirements from a regional client base.
© 2008 Al Bawaba (www.albawaba.com)
