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Interesting article from April 24th’s Investment Dealers’ Digest (IDD) regarding Houlihan Lokey (“From Century City To Baghdad”, subscription required), a middle-market investment bank whose restructuring practice has given it an international reputation, and whose decision to rebuff various bulge-bracket suitors over the past decade or so now looks increasingly prudent.

In addition to working with the Russian government on its Soviet-era debt, as well as with the Seychelles, the firm’s sovereign advisory services team is in the midst of helping Iraq ease its debt burden, and has been successful with 42 creditor nations, through meetings and negotiations with various creditors’ central banks, ministries of finance and ministries of commerce.   Bankers are now working on the closing phase with eight nations, the article states.  “There is a lot of traveling to different capitals,” notes Derrill Allatt, a managing director.  “We have had success. There was an agreement with Tunisia 10 days ago.”

Creditors, he states, fall into different categories: Paris Club and non-Paris Club nations, as well as Gulf Coast countries.  Iraq’s Paris Club debt was cured five years ago, and thus the firm now advises on money owed to non-Paris Club nations such as Turkey, China and Hungary (so far $25 billion of non-Paris Club debt has been cured).

“Every country has its own concerns and interests. Quite a lot [of the creditor nations] are understanding,” says Allatt. “Often you work day and night to get things resolved. You just have to work through it until you have an agreement.  Given the way the world economy is I’d expect our business line to keep growing.”

The “Invest Iraq, London 2009” conference will be held from April 30 to May 1 at the Landmark Hotel under the patronage of Iraq’s Prime Minister Nouri Al-Maliki and his British counterpart Gordon Brown, and will be an opportunity to present investment opportunities in several fields including oil, gas, industry, housing, infrastructure, banking services, tourism, communications, and agriculture.  The conference, in which more than 250 international companies will participate, will be attended by ministers of the two countries and a large number of Iraqi businessmen.  The head of Iraq’s National Investment Commission (NIC), Dr. Sami Raouf Al-Aaraji said that it has prepared investment plans for more than 500 projects.

Given the plummeting price of oil, Iraq faces a grave revenue crisis in 2010 that analysts speculate could derail most of its blue-sky projects.  Ahead of the London visit, Iraq’s finance minister, Baqir Jabr al-Zubeidi, admitted that the country faces a large budget shortfall, adding that oil revenues were already down by $4.5bn (£3bn) on projections made for the financial year and will likely fall further. “This time last year, in May 2008, the export market was 2m barrels per day and the oil price was around $130 a barrel.  Until now, we haven’t this year reached $50. The price is hovering around $42-$43 and exports are also right down. In my view, if we stay at less than $50 and less than 2m barrels per day, we will have to produce a supplementary budget well into debt.”

In the short-term, government employees may be asked to take a 20% cut in salaries, while several ministries have already frozen employment plans, raising questions about the viability of the integration into public sector jobs of up to 90,000 former militants

“[Iraq] is still in a stage of building up private sector awareness,” said Britain’s ambassador to Iraq, Christopher Prentice.  “[It] needs a wide education campaign to re-program 30 years of thinking.  Public-private sector partnerships are still at an early phase.  Successful joint ventures and public-private enterprises will be the agents for change.”

The latest Economist has an interesting piece on Iraq’s growing private sector, which may have all the potential in the world, but is untested, and also exists on shaky political and social ground. “Under Saddam Hussein’s dictatorship, the state controlled everything from interest rates to jobs at the bloated state-owned enterprises (SOEs) that dominated the economy.” However, since the regime’s fall, production in many of these enterprises has fallen to 10% of capacity or less. The task now is “to find companies and investors to put capital and know-how into Iraq’s SOEs and private firms” and get the economy running again.

The scheme has already notched up a few successes. Take Iskandiriyah, a manufacturing town. The Task Force arrived in late 2006 to restart the many factories once run by two SOEs there. Today they are producing machine parts, trailers and machinery for the oil industry. Case New Holland, a maker of construction equipment owned by Italy’s Fiat, began assembling farm tractors in 2007. In total around 5,000 Iraqis are back at work in Iskandiriyah’s two SOEs. The town is considered stable.

The Task Force also helps smaller investors put capital to work in Iraq. Consider the Marshall Fund’s $6m investment in the Harir tomato-paste factory, for example. Iraq imports $100m of tomato paste a year, even as its tomato farmers let their excess harvest rot on the vine, because Iraq has no way to turn tomatoes into cans of paste. The Marshall Fund’s investment in a tomato-processing plant not only gives factory workers a job, but gives tomato farmers a bigger market and shopkeepers a locally made product. “And because we expect to make a solid return—it’s a win, win, win, win,” says [Dan Rice, founder of the Marshall Fund, a private-equity fund that makes only non-oil investments in smallish firms in Iraq, along with Wayne Culbreth and Andrew Eberhart].

The piece mentions that in 2008, foreign companies invested $910m in private Iraqi joint-ventures. That number is bound to be affected by the global credit crisis, though perhaps by not as much as some might suspect. What draws investors to a situation like Iraq is high-yields and the perception that a first-move in such an illiquid market will pay handsome dividends in the future. Especially as the Republic continues to settles outstanding debt with creditor governments, its bonds may look enticing. That said, the country’s economy is still largely dependent on oil revenues, which have dropped appreciably during the global crisis, and there will likely exist an appreciable lag period until foreign donors can ignite the private sector and Iraq. Yet there is growing cause for optimism. This past week, for example, Reuters reported that “Islamic banks in the Gulf and Asia are starting to position themselves in Iraq to enable them to penetrate the relatively untouched market once the security situation improves.”

“It is simply a function of the political and military situation,” Boston Consulting partner and managing director Knut Storholm told the Reuters Islamic banking and finance summit in Dubai, citing a spike in interest among banks in the Gulf and Asia. “In the last 12 to 15 months there have been decisions made about opening representative offices in Iraq. The strategy is to be able to have established a presence in the country, so the moment the country starts to grow again you are on the ground,” Storholm said.

I stumbled upon a great quote from Godvig Capital fund manager Bjorn Englund, whose $22 million Babylon fund is the only notable foreign portfolio investor in the Iraqi bourse.

Englund, on the moral for investing in a downturn:

“The lesson is that you shouldn’t follow the herd.  You have to go somewhere where other people are not, where you have the first-mover advantage.”

As to Iraq in partiuclar, Englund mentioned that “there is very little foreign money in the market so it has not seen the sort of outflows you have had elsewhere.  The exchange has been immune to what has happened in the outside world.”

Both Iraq and Ghana, whose market I touted not too long ago and is up roughly 60 percent this year, will soon become electronically traded, which should deliver greater volatility and ease of access for foreign investors in the hope of facilitating long-term investment.  Ironically, however, the electronic switch could signal the end to the very isolation that has protected them in the first place and made them so attractive to frontiersmen.  “There are clear advantages to electronic trade,” points out Databank analyst Dorothy L. Ametefe from Accra, Ghana’s capital.  “But it will increase the vulnerability to external events.”

Danfonds noted last month that rising equity indexes in Iraq, amidst improving security, were in stark contrast to other stock markets around the world ravaged by the credit crunch.

That said, the glass is not necessarily half full. The Economist’s Iraq briefing this week suggests that whatever ‘good news’ that may be coming from the country must be tempered by the realization that, as recently departed American General David Petraeus has repeatedly said, the gains remain “fragile and reversible”.

20,000 out of Iraq’s 34,000 doctors have left (after 2,000 were murdered) and few of the 2m-plus Iraqis now living abroad (many of them middle-class professionals) are yet willing to return. In the past few weeks, suicide-bombers have killed people at the checkpoints into Baghdad’s international zone, on the road to the airport, by one of the main bridges and outside the Ministry of Trade, where eight female employees were killed. The country still offers nothing approaching a secure environment where foreigners can come and do business. A number of foreign companies, especially in the oil sector, have signed big deals. But no major foreign banks or businesses have thought it feasible to set up shop in the open in Baghdad. Though safer than it was, Baghdad is still the most dangerous capital in the world.

JGW

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