Booz Allen Hamilton to GCC investment holding companies: Transform to thrive in new marketplace

With increased intraregional competition, maturing capital markets, and the arrival of a new breed of competitors, holding companies that can answer that key question can thrive. These are the companies that recognize and adjust to the new market realities.

"Many holding companies in this region are finding it difficult to manage their growth," says Rend Stephan, Principal at Booz Allen Hamilton, a global management consulting firm with offices throughout the MENA region. "They are expanding and diversifying their operations, but continue to function like they are much smaller businesses."

Holding companies, along with governments, have long served as the backbone of economic growth in the GCC region. Historically, many GCC holding companies were single, family-owned businesses that became large conglomerates, mainly through vertical integration and diversification.

"Family-owned holding companies in the region derived their competitive advantages primarily from their close-knit, extended family networks, which gave them privileged access to information and capital," according to Stephan. "They contributed significantly to the economic development of their home countries by filling the void of underdeveloped capital markets. Through their internal capital markets, they played the role that banks, venture capital firms, and financial markets ordinarily assume in developed economies."

The Case for Change

While GCC holding companies created tremendous value for their shareholders, they were insulated from competition, largely due to corporate ownership and commercial agency laws. As a result, many holding companies had few incentives to alter their legacy entrepreneurial approach to conducting business. Today, the lack of institutionalized corporate structures and practices, coupled with an opportunistic approach to corporate growth, has made it difficult for many of these companies to cope with their greater scale and diversification.

Moreover, holding companies are now facing increased competition on two major fronts. Flush with cash and operating in economic boom times, traditional family-owned conglomerates are naturally looking for growth opportunities outside their home markets. As they expand their core operations to neighboring countries, the resulting intraregional competition is making it more difficult to locate and capitalize on new investment opportunities, and, at the same time, to compete for business in their own backyards.

Holding companies also face new business competition from private equity firms and state-backed holding companies. The private equity industry raised more than $10 billion in 2006 alone and now counts more than 70 firms—with several more in the process of raising funds. These firms have ready access to business opportunities through their influential boards and limited partners. Furthermore, by compensating management with equity, they create greater incentives for company performance. The growth in the private equity market is also starting to attract interest from international private equity firms, some of which recently announced region-focused funds.

Holding companies also confront competition from state-backed holding companies and investment vehicles, which are recruiting professional managers and pursuing opportunities across a wide range of industries, such as real estate, financial services, transportation, education, and healthcare.

The arrival of these competitors erodes the competitive advantages of traditional holding companies. They effectively shift the competitive dimension from access to capital to efficient use of capital; from access to opportunities to ability to add value to portfolio companies; and from access to information to superior and timely use of information.

The Road Forward

Growth and competitive pressures have led many holding companies to rethink their value creation strategies and operating models. "It is critical," says Ahmed Youssef, Senior Associate at Booz Allen Hamilton, "for holding companies to define their value creation strategy. In doing so, they need to ask themselves: What else besides capital are they bringing to the table? Is it their ability to source attractive investment opportunities? Is it driving the value creation strategies of their portfolio companies through active ownership? Is it leveraging operating synergies among portfolio companies?"

A value creation strategy should be rooted in—and strengthen and expand—a holding company's competitive advantages. The value creation strategy will also have a direct impact on portfolio selection. Many GCC holding companies that lack clear value creation strategies have seen their non-core, listed financial investments overtake their core operating assets, leaving them uncomfortably exposed to stock market fluctuations. A historical case in point came during the 2006 stock market downturn when some holding companies with large equity trading portfolios experienced significant reductions in their net asset values.

As holding companies rationalize their portfolios, they need to clearly define their target portfolio composition, and set guidelines dictating what investments to pursue and what investments to gradually exit from.

Holding companies need to define a complex set of parameters, including the target geography, sector, stage of company, desired level of involvement and ownership, investment size, and time horizon. This involves making tradeoffs, but enables the holding company to better focus and actively source opportunities.

Holding companies must also reexamine their capital structures and dividend policies on the road to becoming more competitive in the changing marketplace.

"For many holding companies, there is a mismatch between shareholder expectations and the very fundamentals of their business," says Youssef. "As an example, some holding companies have a high proportion of income that is unrealized given the nature of their investment. However, their shareholders expect high dividend payouts, as if the companies were stable cash-flow businesses in mature industries with few attractive investment projects. Realigning their dividend policies, however, is difficult because shareholders are likely to punish their stock prices. Rather, these companies need to slowly adjust the expectations of shareholders"

This task will become easier as regional capital markets develop and attract more institutional investors whose professional managers will look at total shareholder return as the metric for company performance.

In addition to reexamining their value creation strategy and rationalizing their portfolios, holding companies need to enhance and align their operating models. "As many holding companies grew and diversified, they neglected to restructure, resulting in overlap between businesses and conflicts among managers," says Albert Muaddi, an Associate at Booz Allen Hamilton.

"A proper organizational structure should have clear separation between businesses and non-overlapping market boundaries to see where the returns on capital are being generated."

The restructuring should lead to a reexamination of key management processes, including formal strategic planning, business planning, budgeting, and performance management processes for portfolio companies. This can seem like a daunting task, especially for companies that have never institutionalized such processes, but the benefits far outweigh the risks.

"Many holding companies simply do not measure the data they need to manage their performance, and instead base their planning on historical growth rather than on potential growth," says Muaddi. "They're often surprised at the value that could be unlocked in their businesses when they see the potential top-line growth and operating efficiencies that could be realized."

Holding companies' investment processes should be particularly scrutinized. While some GCC holding companies pursue investments in an ad hoc and opportunistic manner, the leading companies have an explicit investment process to ensure that capital is used optimally and is aligned with shareholders' strategic and financial objectives. Such a process entails well-defined guidelines on what kinds of investments to pursue, as well as clear deliverables and authority levels along each stage of the process. The leading holding companies also bring significant rigor in negotiating and structuring deals in order to best mitigate risks and accentuate returns.

Holding companies should also reexamine their governance frameworks, which tend to suffer from a lack of separation between board members and management. In particular, for some family-owned holding companies, the boundaries between business and family interests often become blurred. This has raised succession-planning issues as the founders of these companies, who led for decades, now approach retirement. These companies need a robust governance framework to enable a younger generation of executives to take the helm under the direction of a larger base of family members. Holding companies looking to fund their growth through public offerings must revamp their governance frameworks to attract investors and comply with regulatory requirements.

GCC investment holding companies are at a crossroads. They have excess cash and access to fast-growing markets across the region. At the same time, they face continued risk due to regional conflicts and market sensitivity to volatile oil prices. "The structural and market-related advantages that holding companies historically benefited from are eroding while competition is increasing," concludes Ibrahim El-Husseini, Vice President at Booz Allen Hamilton.

In this new climate, GCC holding companies must reexamine their value creation strategy, rationalize their portfolio of investments, and, finally, realign their organizations, management processes, and governance frameworks to maximize future growth and profits.