Investing after the Arab Spring: Unfinished business

December 13, 2011: 10:15 AM ET

The ongoing revolutions across the Middle East would seem to be good news for markets. But so far they've scared most foreign investors away.

By Peter Carbonara, contributor

egyptian_stock_exchangeFORTUNE -- A few investors look at the Arab Spring -- the wave of protest and revolution that began last December when a Tunisian street vendor set himself on fire to protest his harassment by police -- and don't see a particularly big deal. Franklin Templeton emerging markets guru Mark Mobius, a longtime bull on the economies of the Middle East, has called the tumult just a "bump" in the road towards more democracy and freer markets in the area.

The rest of the investing world is not so sure. Khaled Abdel Majeed runs a small London-based hedge fund that invests in the countries of North Africa, and he says his clients, mostly U.S. and European pension funds and endowments with plenty of trouble in their home economies, are nervous.

These institutional investors worry about what kind of post-Qaddafi government might emerge in Libya and about the elections and ongoing violence in Egypt. They worry about tensions between Muslims and Coptic Christians in Egypt and between Sunni and Shia Muslims in Saudi Arabia. They worry about the how long the brutal Assad government can hang on in Syria and at what cost. They worry about a nuclear Iran and what Israel may decide to do about it.

"There is no appetite for risk and we are in a part of the world that has historically been thought of as risky," Majeed says. Majeed started his MENA Admiral fund in 2004 with $22 million and then built it up to $120 million by June 2008. Now he's down to $15 million. "It's been a round trip and then some," he says.

Indeed, foreign capital has been fleeing the region since December 2010 when protests began in Tunisia. The Dow Jones MENA index ("MENA" is an acronym for Middle East-North Africa and usually means the Arab countries and sometimes Turkey) plummeted from 558 in late 2010 to a low of 460 in March. Lately it's been around 470. The S&P Pan Arab Composite Index is down about 13% on the year. The stock market of Egypt, the region's most populous country, was closed for 55 days during tumult there early this year.  The EGX 30 stock index has fallen about 40% on the year from about 7000 to 4000 currently. The index had stabilized around 4500 before crowds returned to Tahrir Square late in November to protest moves by the Egyptian army to consolidate its control in advance of the first round of parliamentary elections. Roubini Global Economics estimates foreign direct investment in Egypt, only about $6 billion in the 2009-2010 fiscal year, has dropped by 68%.

A bet on oil or on people?

For the hardy investors who have stayed in the region, their investments in MENA countries boil down to either a bet on the price of oil and natural gas produced mainly by the Persian Gulf states (Saudi Arabia, Oman, Qatar, Kuwait, Bahrain and the United Arab Emirates), or a bet on the demographics of the more densely populated countries of north Africa – Morocco, Algeria, Tunisia, Libya, Egypt, Sudan, Lebanon, Syria and Jordan, several of which (Egypt, for instance) are net oil importers.

The World Bank expects the MENA region to grow 3.6% in 2011, mostly from gains by big oil producers of the Gulf. (Before the fall of longtime governments in Tunisia and Egypt the World Bank had predicted 5% growth.) Javier Cervino, a partner in Isthmus Partners, a financial consultancy in Dubai, United Arab Emirates, says the Gulf economy has stabilized over the last year or so. Real estate investment in Saudi Arabia and the U.A.E. has stabilized and telecoms like Saudi Arabia's Mobily and Qatar's Qtel have done well lately. "From our point of view the events in Syria and Egypt seem as far away  as they would to someone in New York," Cervino adds.  Less explosive but still simmering political conflict in Bahrain, he says, was more urgent to Gulf investors.

Oil roars back to $100, but does anybody care?

The investment argument for the North African countries is based on their large, youthful and in many places well-educated populations. This huge pool of workers, consumers and entrepreneurs wants jobs and income to spend on themselves and their families. That means economic growth and thus opportunity for investors who can supply the capital -- and are willing to take the risks that come with investing in "frontier" markets, many of which lack stock exchanges or trustworthy legal systems.

The big problem is that the despots and monarchs who have long dominated Arab politics (recent moves toward economic liberalization over the last few years aside) don't want to give up either political or economic control of their countries. Neither do the countless bureaucrats and officials who rely on payoffs and kickbacks from business people. One of the initial sparks for the Arab Spring was the leak of a cable in which a U.S. diplomat commented that "seemingly half " the business elite of Tunisia were members of President Ben Ali's family. The Arab Spring began in earnest when the old politics of governments being able to buy off their populations with public sector jobs and subsidies finally collapsed.

Egypt: A rolling revolution

Egypt is the test case for the Arab Spring, politically and economically. It is the Arab world's most populous country and it has the most diversified economy and most mature financial institutions. Other North African economies that have had their own revolutions this year are either too small (Tunisia) or too badly damaged (Libya) to be candidates for much outside investment any time soon.

Egypt is the largest Middle Eastern economy where it is comparatively easy for outsiders to invest; in Saudi Arabia, by contrast, foreigners from outside the Gulf cannot directly own publically traded Saudi equities. Not that the Egyptian stock exchange is anywhere as large or liquid as London or Tokyo's. Brian Bandsma, a senior analyst with the investment management firm Vontobel, went to Cairo to scope out possible investments in 2010. He saw a few public companies that impressed him but the firm decided not to buy any of them because they were too thinly traded.

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Western investors, who cheered the revolution, have yet to embrace Egypt as an investment opportunity, largely because of political uncertainty that is, in turn, paralyzing the country's economy. Even before clashes between protestors and the army broke out in November, tourism, a crucial industry, had ground to a halt. When revolution broke out in neighboring Libya, the many Egyptians who worked in that country's oil industry either came home or stopped sending money to their families. Egyptian unemployment, already high before the Arab Spring, has risen to about 40%.

Efforts by the Egyptian Central Bank to support the Egyptian pound and head off inflation had the side effect of making it possible for skittish investors to liquidate their Egyptian investments and take their money out of the country without getting killed on the exchange rate. Meanwhile, the bank's reserves have been nearly depleted and it was widely expected that Egypt, which rejected an International Monetary Fund loan in June, would have to make some kind of deal with the IMF within the next few months.

And those are the things investors know about; what's really keeping institutions out of Egypt are countless unknown factors: What role will the military, which controls a sizable chunk of the country's real estate, ultimately play in the governing of Egypt? How will the Islamists of the Muslim Brotherhood and other parties fare in major elections? (Elections for the lower house of parliament began in late November to be followed by elections for the upper house and for a new president in spring 2012.)

Michael Daoud, head of Middle East equities at Auerbach Grayson, a New York brokerage specializing in the Middle East, says given all the uncertainty there's just no way to know when foreign capital will return to Egypt and other parts of the region that have been thrust into turmoil by the Arab Spring. He's more bullish on Egypt than many: he is tracking stable companies such as Juhayna Food Industries, which dominates the Egyptian market for milk and dairy products; energy products and services supplier Elsewedy Electric, and Cairo-based CIB Bank.

Still, he can't recommend that an interested foreign investor rush out and buy stakes in those companies. Not now, Daoud says. Things won't start to get clearer until the election returns start to come in.

"I'd rather be a little late," he says, "than too early."

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