Private equity fails to make a mark in Pakistan

Only three dedicated firms registered with SECP, all of which are dormant.


Kazim Alam March 12, 2013
Photo: FILE

KARACHI:


‘Dormant’,  is how the Securities and Exchange Commission of Pakistan (SECP) described the status of private equity in Pakistan in one of its recent reports. Once you begin probing this industry, there is no wonder why.


Private equity firms buy sick companies and then try to turn them around before reselling them to other companies or cashing out via a public listing.

Although the regulatory framework for private equity was first introduced in Pakistan in 1995 – which has been revised twice in 2001 and 2008 since then – only three private equity firms are currently registered with the SECP. They have been practically inoperative for quite some time now, with negligible assets to their name. None of the three companies even maintains a website.

“We set up a dedicated private equity company in 2006 and planned to raise $100 million to $300 million from both international and local investors. But the global recession of 2008 scared investors away,” Pakistan Private Equity Management’s Vice Chairman Nasim Beg recently told The Express Tribune in an interview. “Since then, our conglomerate has put its private equity business on the backburner,” he added. He was referring to the Arif Habib Group, which owns Pakistan Private Equity Management, besides its brokerage, asset management, fertiliser, cement, real estate, steel, banking and energy businesses.

There are many other examples of large business houses – such as the UAE-based Abraaj Group, which bought Karachi Electric Supply Company in 2008 – acquiring troubled companies using borrowed money, transferring high interest costs to their income statements in order to save taxes, and then eventually turning their acquisitions profitable before cashing them out.

But only a handful of Pakistani firms have ever been set up specifically to carry out such transactions.

As per SECP regulations, private equity firms operate on a two-tiered business model, comprising a management company and a fund structured along the lines of a trust. Private equity firms do not raise money per se, according to Beg. Rather, they secure ‘commitments’ from institutional investors and high net worth individuals for high-risk, long-term investments.

“You draw down investors’ money in the first three years, as you look for different viable companies to invest in. Then you exit these businesses in seven to eight years, after making them profitable,” he explained.

Major impediments

One of the major impediments in the development of private equity in Pakistan is a rather difficult exit process, which discourages investors from pledging long-term investments in the first place.

“I have proposed that private equity firms’ exit should be encouraged without listing,” he said. Elaborating his point, Beg said capital gains on the sale of a private company are taxed heavily. On the contrary, capital gains are not taxed beyond one year in case of publicly-listed companies.

Similarly, the minimum capital requirement for a fund management company (FMC) is currently Rs30 million. The SECP has recently recommended that it be brought down to Rs20 million. As a typical FMC consists of a small group of professionals, Beg believes that asking it to raise enough capital to sustain itself for the first two years should be more than enough. “I think that even Rs20 million is too high for the minimum capital requirement. It should be brought down further.”

Moreover, under the prevailing regulatory framework, the minimum fund size that a private equity firm is required to maintain is Rs250 million. The requirement makes little sense, said Beg. “On what basis did the regulator determine that Rs250 million is the magic number? If I can get three investors, each pledging Rs50 million, why should I not be allowed to work?” he countered.

Published in The Express Tribune, March 13th, 2013.

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