Venturing into the risk gap

Many firms boast of their emerging markets pedigree, yet few can do so with the credibility of Scimitar Global Ventures. Scimitar's partner Zachary Venegas told Robin Wigglesworth about the opportunities in edgier markets.

Scimitar Global Ventures was founded in 2003 by a team of former private bankers with a wealth of private equity and risk analysis experience. The company was jointly seeded by clients inherited from their private banking days, and the partners themselves. They are now in the process of raising capital for their first standalone private equity fund at $50 million, with a 2.5% management fee and a standard 80/20 carry structure.

Scimitar specializes in markets characterized by some form of distress, with growth potential that insider expertise can unlock. So far, their main attention has been on Romania, northern Iraq and Morocco, but they are eyeing up other potentially lucrative markets.

In addition to his past at JP Morgan Private Bank in New York and an MBA in Finance and International Business from New York University's Stern School of Business, Zachary Venegas is a graduate of West Point and a former Captain in the US Army.

Who are the investors behind Scimitar?
All our investors are Saudi Arabians and Europeans. The core investors were clients of ours at JP Morgan Private Bank, and we did a lot of private equity for them. And the partners have a lot of their own wealth invested in the firm.

You have a reputation for going into areas that others won't?
I think it is because we look at issues differently from many other firms. Many people who look at emerging markets are only looking for yield. This is fine, but as they are only looking for yield on a cyclical basis when emerging markets are hot, the methodology, the nomenclature, and strategy are all just developed market models grafted onto an emerging market model.

There are times when emerging market behaviour will mimic or follow developed market behaviour, but after the inflection point it behaves very differently. As we have a dedicated group of investors, and don't need to go out there and raise a fund, that allows us to cater to the market, which is in many ways just waiting to become like the west. We designed the firm to fit the region, rather than waiting for the market to fit us.

That must entail a certain amount of risk?
There is perceived risk and actual risk, which we call the 'perceived risk discount'. The discount is often very large, which we take advantage of. For instance, three years ago, we started investing in Romania. We only do four industries: financial services, all forms of security services, energy and basic industries. Romania is great because it has fantastic opportunities in all these sectors.

Iraq seems to be plunging ever deeper into an economic quagmire, but the Kurdish north seems to be an attractive market? We went to north Iraq two years ago, and whilst we are not interested in the rest of Iraq, the north is very attractive to investors. It is now a booming mini-economy and we have the advantage of moving in there early, ahead of the rush. We are in the process of closing deals that took the better part of two years to close, but they are the most coveted deals, such as basic industries, extractive mining deals, and energy.

What sectors have you invested in?
We have invested in an independent service provider, cable television, energy-related projects and extracting deals, and we plan to bring a security company from Romania, using Kurdish Peshmergas to secure our operations there. Iraq is a dangerous place to do business, but really, the Kurdish north is a completely different proposition. Over the past 10 years, they have been able to create a separate embryonic economy, secured by the experienced Peshmergas. No one is impervious to terrorist acts, but the north is very secure.

If there is one area in the north that might defy the macroeconomic analysis of north Iraq, it is Kirkuk, and we avoid getting involved there. The Kirkuk area is the richest region, as it has plenty of production, and there is oil everywhere, but it might become a flash point, so we have decided to be careful there.

Emerging markets are far from homogenous, but what do you look for in potential markets?
What we look at in a country is what we call the 'capital system', the convergence of the financial system, the legal system, and the economic conditions. When they come together, at the intersection or convergence, of the three factors is where we come in. We look at inefficiencies in the capital systems, and liquidity masks a lot of inefficiencies and makes them impossible to exploit.

We identify markets on a macro view, with our own rigorous methodology. Once we have done this, one of the operators goes there for at least a year and immerses himself in that market. You have to know the language and the culture to work effectively.

Now that you are invested in north Iraq and Romania, which other markets are you looking at?
We are looking at Jordan now, and are attracted to it due to the structural aspects of the country. The government is committed to considerable effort into encouraging and supporting its investment and development community, so we will continue to look at Jordan. We have other markets under much more active development, such as Morocco, which is the next market in the pipeline.

How many deals have you done, and how large have they been?
We have done 10 deals in the past two years. The smallest one was just under $1 million, the largest one was $200 million, with an equity 'slug' of $70 million, in a cement company in northern Iraq. We do tend towards the extremes of investments, either $10 million or less, or $70 million or more. In more developed market, it helps to specialize when competing for deal flow, so you can offer a better value proposition. In the markets that we are in, it doesn't pay to specialize in certain stages of private equity.

Do you do venture capital investments in addition to more traditional private equity deals?
Yes, in many ways, we prefer venture capital, as there are no hidden liabilities. You can also set up the management structure that is more advantageous to a later transition in terms of a trade sale or recapitalization.

Considering the region that you are in and the economic trends, are you considering launching a Shariah compliant vehicle at some point? We understand Islamic finance, and two of our team have worked with it previously, so I definitely think that down the line we will have a Shari'ah compliant investment vehicle. The provisions of Islamic finance against hoarding and the requirement to invest and share risk is really the ultimate private equity model.

This article is from the April 2006 edition of Private Equity and Venture Capital Middle East Magazine