Unlocking Iraq’s true value

Despite ongoing challenges, fund managers remain upbeat about the prospects for Iraq, fuelled by the promise of substantial IPO activity over the coming months.



Economic forecasts for Iraq continue to make for pleasant reading. The most recent IMF World Economic Outlook predicted GDP growth of 10.2% in 2012 and 14.7% in 2013 and Iraq has one of the world’s largest oil reserves.

But the IMF also acknowledges that the task of rebuilding the country remains immense and that reconstruction requires not only the rebuilding of its infrastructure, but also of its economic and social institutions and the creation of a business environment that attracts capital.

The scale of the challenge is reflected in the performance of Iraq-focused funds over the last 12 months. Northern Gulf Partners’ Iraq Investment Partners fund was down 3% last year – after growing by more than 20% in 2011 – although strong final quarters enabled the Iraq Opportunity Fund and the FMG Iraq Fund to venture into positive territory. Unaudited figures for 55 North Company’s Iraq Phoenix Fund indicate growth of 5%.

Invest AD’s Iraq Opportunity Fund also bounced back in November, mainly as a result of positive investor sentiment in some of the larger-cap stocks, particularly Bank of Baghdad and North Bank, explains portfolio manager Sherif Salem. He adds that companies in the telecoms sector present a clear opportunity for growth in terms of both revenues and subsidies.


Telecoms Boost

“In a market dominated by the banking sector, the IPO of Asiacell could give the market a boost,” adds Salem. “It is expected that it will involve the floating of a 25% stake in a deal that could be worth as much as USD 1 billion, which would immediately add depth and liquidity to the Iraqi stock market.”


Shares of Asiacell Communications, in which Qatar Telecom owns a majority stake, traded higher in their market debut on  February 4, after the Iraqi telco raised about USD 1.3 billion in the Middle East’s largest initial public offering since 2008, according to a Zawya Dow Jones report.

The offer for 67.5 billion shares priced at IQD 22 each was fully subscribed. Qtel acquired shares worth USD 207.12 million in the IPO to increase its stake in Asiacell to 64.06%, from 60%.

Iraq’s three mobile companies – Asiacell, Korek and Zain Iraq – are required to list 25% of their shares under the terms of licenses bought in 2007, and forthcoming flotations could mean telecoms become a leading theme in many portfolios.

FMG investment analyst Henrik Kahm describes Iraq as one of the fastest growing telecoms markets in the world, while he is also bullish on the banking sector. He also refers to consumer stocks as “looking interesting, but still very few options currently listed” and expects more funds to enter the market once the custody issue is resolved (see below).

There is general agreement that Iraqi assets are still undervalued. “Many companies have book value several times their market cap and companies in general are operating at a fraction of their future capacity,” says Kahm.

Iraq is not a ‘dirt cheap’ market – banks are trading at 1.5 times trailing earnings, on average – but future growth opportunities are evident when you look at domestic credit provided to the private sector as a percentage of GDP. The World Bank puts this at 9%, compared to 56% in Kuwait, 47% in Russia and 40% in Saudi Arabia, observes Michael Daoud, vice president MENA sales at broker Auerbach Grayson.

Paul Collison, managing director of investment management firm 55 North Company, agrees that there are investment opportunities both in ISX listed stocks and in foreign-listed firms with activities in Iraq. But he adds that many investors – especially retail/individual investors – will not be able to fully understand and evaluate risks. “Furthermore, we have come across numerous situations that (upon more detailed analysis) we would short if we were able to. Many listed companies have dismal prospects so investors must be careful of company-specific situations. Some can (and will) go to zero over time and others will experience negative news and shocks to their valuations, most likely around corporate governance and other issues.”

Northern Gulf Partners portfolio manager Bartle Bull reckons telecom IPOs and the continuing extraordinary growth in assets, deposits and profits of Iraq’s top banks are the next big investment story for Iraqi funds.

To this list, Collison adds completion of a critical mass of the oil and gas export infrastructure from Kurdistan to Turkey, and enactment of federal oil and gas law. “As hydrocarbon production ramps every quarter, incoming cash flows become extraordinary relative to the size of the country’s GDP, let alone the market valuation of its stock exchange,” he said.

Suppressed Consumption

Daoud says the main investment story in Iraq for the last several years and for the foreseeable future is suppressed consumption because of previous wars and the sanctions imposed on Iraq from 1990 to 2003.

“Now this consumption is driving growth, alongside the rapid increase in oil and gas exploration and production. It is very hard to play specific sectors or themes in Iraq as the market is heavily dominated by banks, which constitute around 60-70% of the market cap and most of the activity on the exchange. The one name that I like outside of the banks is Baghdad Soft Drinks.”

For investment funds, Daoud accepts that the majority of investment is still going through companies listed on the ISX, but adds: “if you are talking about general investments going into Iraq, I would say it is off the exchange.”

Indeed, Bull concludes that the real foreign investment in Iraq to date has been direct investment, in private equity opportunities and oil. “With the Asiacell IPO and the follow-on opening up of the ISX to other capital raising, 2013 will be the year that public markets start to catch up as a way into Iraq’s economic boom.” Custody conundrum

One of the issues affecting Iraqi investment, and a challenge preventing to the creation of more dedicated Iraqi funds, is the continued absence of the major custody agents.

“Custody arrangements are generally not recognised in Iraq; the registered holder of securities being regarded for all purposes as the true legal and beneficial owner of said securities,” explains Khaled Al Saqqaf, partner & head of Iraq office of law firm Al Tamimi.

The Iraq Securities Commission recently issued ISX Custodian Instructions No. 17 of 2012, which regulates the licensing of custodians in Iraq. However, these instructions do not provide any guidance as to the permitted activities of such custodians, continues Al Saqqaf.

“In particular, it remains to be seen whether the relevant authorities find that such custodians shall be entitled to hold shares on behalf of others. In the past, custody arrangements have been limited to providing assistance to investors in opening accounts, obtaining an investment number and/or relaying orders to brokers.”

Henrik Kahm of FMG is relaxed about the situation, pointing out that his firm is comfortable settling all trades directly with the Iraqi central depository system. “Given the large pending IPOs in the telecom space, we envision these liquidity events to add to the level of attractiveness of a pending custodian to emerge sooner rather than later.”

Bartle Bull of Northern Gulf Partners is also unconcerned, and suggests that those who stay away because of custody are losing out to those who find good brokers and enter the market. “The ISX is providing a workaround, allowing investors to block broker sales of the stocks beneficially owned by investors.”

However, Paul Collison of 55 North Company describes the custody situation as a “deal-breaker” for many. With very few exceptions, even the emerging markets groups within global institutional firms will be unwilling to invest without custody, he suggested.