The biggest collapse in private-equity history will have a lasting impact
IN SEPTEMBER 2017 executives at Hamilton Lane, an asset manager, received an email. Entitled “Abraaj Fund VI warning”, it accused the Abraaj Group, a buy-out firm based in Dubai, of inflating the value of its investments to lure capital into its latest fund. The email was anonymous and littered with typos and grammatical errors, but its tone was sinister. “The governance is not what it appears but employees are afraid to speak,” it said. Hamilton Lane forwarded it to Abraaj, requesting documents disproving the claims. The evidence provided allayed its concerns, and the firm backed Fund VI with over $ 100m.
Similar emails went to other Abraaj clients. They had little effect: weeks later Fund VI had already attracted $ 3bn, half its $ 6bn target. But the firm’s problems were real. Its collapse last year consumed millions of dollars of investors’ money, the reputation of Dubai’s financial regulator and Abraaj itself. Even as rivals divide up the firm’s former empire, it threatens to cause yet more damage.
It had taken 16 years for Abraaj to become the best-known emerging-markets buy-out firm. With over 30 funds spanning Africa, Asia, Latin America and Turkey, it managed $ 14bn in assets. Its Pakistani boss, Arif Naqvi, was a Davos regular and arts patron. He presented a kinder, gentler face of private equity: Abraaj’s $ 1bn health fund, which closed in 2016, was backed by development banks and philanthropists.
Yet Abraaj faced a chronic problem: year after year of multi-million-dollar operating losses. According to sources with knowledge of its books, its revenues, made up of management and performance fees, were outweighed by bloated costs. To plug the gap, the group borrowed. In the nine months to March 2018 its financing costs came to $ 41m, according to a confidential report by its liquidators. Throughout 2016 it hoped that by selling assets, including a $ 1.8bn stake in a Pakistani utility firm, it could avoid a cash crunch. But deals were repeatedly delayed.
In a complaint filed last month against Abraaj and Mr Naqvi, the Securities and Exchange Commission (SEC), America’s main financial regulator, alleged that between late 2016 and mid-2018 the firm diverted over $ 230m it said was for acquisitions from the health fund to its bank account. When several investments failed to materialise, clients started asking questions. According to the SEC, Mr Naqvi blamed delays on “reasons beyond our control” and lied about the cash’s whereabouts.
At the end of 2017 four investors, including the Bill and Melinda Gates Foundation and the World Bank’s private-sector arm, hired investigators to track the missing millions. When the news broke in February 2018, creditors turned off the taps and sought to have the firm wound up. Abraaj filed for provisional liquidation in the Cayman Islands, where it is incorporated, to give it greater leeway over its restructuring.
For the past several weeks Mr Naqvi has been in a British jail, awaiting a decision on his extradition to America. A bail hearing is due on May 17th. Two other executives have also been arrested. Mr Naqvi maintains his innocence and says he expects to be cleared of any charges.
Liquidators are searching for new managers for Abraaj’s funds—a tedious task. Such deals must be approved by a pre-agreed share of the limited partners, as investors in buy-out funds are called—and Abraaj has over 500. “It’s like herding cats,” says an adviser to the process. But there is progress. On May 9th TPG, an American buy-out firm, said it would become the health fund’s custodian. Last month Colony Capital, based in California, bought Abraaj’s Latin American business. Actis and Franklin Templeton are in talks to acquire the African and Turkish units.
Last year Abraaj returned the money it owed, plus interest, to the health fund. Commitments secured for Fund VI have been released. The TPG and Colony deals have gathered sufficient support from investors (nearly all gave their backing). Many seem to think Abraaj, not the markets it operates in, was the problem, so business as usual can resume. “We cannot afford not to invest in private equity,” says Linda Mateza of South Africa’s Government Employees Pension Fund, an Abraaj investor, “because of the potentially higher returns.”
But the appearance of closure is misleading. Abraaj still owes over $ 1.2bn to creditors; a source familiar with its books doubts that “anything close” to that will be repaid. A letter by lawyers for investors in its $ 1.6bn Fund IV, seen by The Economist, alleges that $ 300m “at the very least” from that vehicle went towards “wrongful transactions” and is still missing. For funds raised before 2013 Abraaj had no external administrator, notes a former partner. Another vehicle from the same era is also thought to be owed tens of millions. A spokesman says that since the start of the provisional liquidations Mr Naqvi has been “working tirelessly to maximise returns for Abraaj’s creditors”.
Abraaj’s collapse is being felt across the industry. Many large institutions have stopped investing in Africa and the Middle East, its home turf. In the year after its troubles became public, buy-out funds focused on the region raised just $ 1bn, a third of their annual average in the previous five years, according to Private Equity International, a financial-information provider. That caution could contaminate other emerging markets.
The scandal has also made investors warier of private-equity firms’ less orthodox tactics. In recent years managers have increasingly used money promised by limited partners as security for short-term bank loans. Such “subscription lines” allow them to make investments without drawing investors’ capital. That flatters returns. The global stock of such debt has risen to $ 400bn, experts reckon. Yet after Abraaj defaulted on several facilities, its limited partners were urged by banks to foot the bill. “They were not best pleased,” says Kelly DePonte of Probitas Partners, which advises firms on raising capital.
And many limited partners are seeking greater comfort by demanding an absurd amount of reporting. Some “side letters”—documents from each limited partner specifying the paperwork it requires from fund managers—now reach 100 pages, ten times what they used to be. Blue-chip firms can absorb heftier compliance costs, but smaller ones will struggle. The legacy of a flawed private-equity titan could be a slaughter of innovative upstarts.
