Qalaa bets on Egyptian reform and recovery

The Cairo-based investment firm is leading on a massive refinery project, as it focuses on a resurgent Egyptian economy. 

More than $36bn worth of deals were signed as Abdel Fattah El-Sisi, Egypt’s president, gathered global investors in the resort town of Sharm el-Sheikh in March. The ‘Egypt The Future’ event, which showcased infrastructure projects from power generation through to the construction of a new capital in the desert, was an attempt – seemingly successful – to reignite corporate interest in the country.

Egypt’s economy has suffered from the political turmoil that followed the overthrow of Hosni Mubarak’s government and the subsequent military coup that removed his successor, Mohammed Morsi. The economic conference marked a turning point, according to Hisham El-Khazindar, co-founder of Qalaa Holdings, – not just in the scale of the deals that were signed, but in the clear signalling from the government of its desire to face down vested interests and fix the country’s fiscal position and investment environment.

“I think we’ve had successive governments… under President Mubarak, under the regime that came after it, they were unwilling to make the tough decisions that needed to be made,” El-Khazindar says.

Egypt’s economy has been on shaky ground for some time. The unemployment rate is around 13.5%, but far higher among under-25s; the government has been running an annual budget deficit of more than 10% for several years; the current account has been depleted; and conflict has now engulfed neighbouring Libya.

GDP growth averaged around 2% per year in the years following the revolution, but is forecast to recover to 3.5% in 2015, and in April rating agency Moody’s raised the country’s rating from Caa1 – poor quality with a high risk of default – to the less dramatic B3, with a stable outlook, in part because of the economic reforms and commitment to fiscal consolidation.

Chief among the government’s reforms is the phased removal of the costly subsidies on fuel and power that have drained the Egyptian budget for years. In June 2014, the government announced that it would slash subsidies from E£144bn ($20bn) to E£100bn. The precipitous drop in the price of oil since that point has given the Sisi administration even more latitude to cut back its spending on energy as it targets zero subsidies by 2019.

The subsidy regime was a major stumbling block during Egypt’s torturous negotiations with the International Monetary Fund. The IMF typically resists backing the budgets of countries that subsidise consumption, but the Mubarak, and then the Morsi governments hesitated to cut support for cooking and transport fuel for a population that was already suffering from high unemployment and low wages.

Sisi, who took more than 95% of the vote in the May 2014 elections, has the mandate as well as the necessity to make the potentially unpopular decision to scale back the state support.

“I think it’s very telling and it’s very encouraging that the president and his cabinet had the guts to tackle this issue,” El-Khazindar says. “It was a failed subsidy system that had become unsustainable.

“We’ve been talking about this since 2007, 2008. A lot of the investments we have made as a group… were really bets on our part that the Egyptian government would have sooner or later to start reforming its subsidy system. Now, if you’d told me in 2007 that it would take almost eight years for that reform to kick in, I would have probably not believed it.”

Greater clarity over the corporate and income tax regime is also welcome, El-Khazindar says, while the imposition of a real estate tax – also a politically
contentious issue, has demonstrated a further willingness to take on entrenched, costly policies in order
to fix Egypt’s fiscal position. “The real estate tax has been on the drawing board since the Mubarak era, but it was never implemented because it ran against a lot of vested interests.”

Qalaa, formerly Citadel Capital, rebranded in 2014, replacing its English name with the Arabic equivalent; a reflection of its renewed focus on its “centre of gravity” in Egypt. A multibillion-dollar investment vehicle, the company has huge investments in transport and logistics, infrastructure and commodities across North and East Africa – including a majority stake in the Egyptian Refining Company, a $3.7bn refinery project.

ERC, which is 25% owned by the Egyptian government, is the second-largest project ongoing in the country – smaller only than the $8.5bn New Suez Canal – a second waterway designed to expand Egypt’s strategic shipping lane. The refinery will process heavy fuel into diesel for local consumption, and once at capacity could supply 50% of the country’s requirements.

“Ten years ago, it would have been inconceivable to have a private sector company leading the development of a large refinery in the country,” El-Khazindar says. “This was really a state monopoly.”

This is a sign, he believes, that the new Egyptian government is prepared to move ahead with privatisations in strategic industries – something that would have been unthinkable under previous administrations.

“While the government does continue to invest in the power generation side, it’s very clear to me that when you look 10 years out, 15 years out, a significant bulk of Egypt’s power generation capacity – both traditional and, in particular, renewable energy – will be private sector-led. This is something that only a few years ago would have been inconceivable,” he says.

The state is far from absent from Egypt’s corporate landscape. The involvement of the Egyptian military in several major projects – including the New Suez Canal – has raised hackles among many investors. Speaking privately, several analysts and investors warn that at best it undermines the perception of the country as an open market. During the Mubarak era, the sometimes preferential, anti-competitive treatment of companies linked to government figures was a major deterrent to foreign direct investment.

“I think some of the concerns are inflated,” El-Khazindar says. “I think the Egyptian state is going to remain active, as an investor, as an owner in certain sectors, but I think the scope of these sectors is narrowing down. I think there is greater and greater scope being opened up for the private sector.”

Given the scope and scale of Egypt’s needs, he says, no government could take on the majority of the work. The private sector will have to lead. At the March conference, Sisi said the country needed between $200-300bn to meet its development goals.

“To the extent that the military and the state institutions are involved, I think it’s involved in many cases to make up for execution weaknesses in the civil service,” El-Khazindar says. “But even in those cases where the military has taken the lead – for example, the expansion of the Suez Canal – the military there is acting as, de facto, a project manager for the project, but the actual drilling and dredging that is taking place is being done is being done by private sector and public sector contractors.”

Qalaa has investments across East Africa, including the Rift Valley Railway – the colonial era ‘Lunatic Line’ in Uganda and Kenya – and into large-scale food production in Sudan and South Sudan. For the time being, El-Khazindar says, the priority will be completing the projects the firm has in Egypt.

“We will focus on divesting the remainder of our non-core investments, and using the proceeds of these divestitures primarily to deleverage, rebuild our war chest, so to speak, and strengthen the firm’s financial position,” he says. “With that, we will continue to examine other projects in Egypt, as well as in other parts of the continent, particularly in East Africa… I think our strategy remains one where we aim to balance our investments in Egypt. Which is our base and our centre of gravity, but to balance this with opportunities in other parts of the continent.”