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Foreign firms prepare to dive into Iran’s lucrative private equity market

Foreign businesses are scouring Iran in search of investment opportunities when sanctions are finally lifted based on the deal reached on the country's nuclear program.
EDITORS' NOTE: Reuters and other foreign media are subject to Iranian restrictions on their ability to report, film or take pictures in Tehran. 

Investors look at a computer screen supplying stock market information about listed companies on the Tehran stock exchange September 15, 2010. While U.S. diplomats were busy upping Iran's economic punishment over nuclear activities Washington fears are aimed at making a bomb, Iranian shares, which might have been expected to fall, have, instead, gone through the r

TEHRAN — Hotels in the Iranian capital are all booked, hosting an array of bargain-hunting foreign investors in one of the world's biggest untapped markets. As Iran and six world powers have finally clinched a deal on Iran's nuclear program, the road is paved for positive economic momentum. With the most crucial systemic risk to investment no longer squeezing the insulated Iranian stock market, many institutional investors are gauging sectors in which to pump fresh capital.

At present, given the hitherto wobbly Iranian economy, most stocks have notched rock-bottom values. Listed companies are grappling with the country’s recession and credit crunch, and trade volume and value have recently reached a dramatic low. The Tehran Stock Exchange (TSE) benchmark in particular has had a bumpy ride since the beginning of the current Iranian year, which began March 21. In recent months, investors shored up their portfolios in search of gains on speculation about a nuclear deal, with TEDPIX, the main index, soaring around 6% during the month ending July 22.

After the deal was clinched July 14, however, irregular behavior, herd mentality and alleged manipulation weighed on the TSE, wiping out 3.5% of gains and spurring concern among retail and institutional investors. Making matters worse, at recent annual general meetings, Iranian firms have fallen short of announcing anticipated dividends. This has slashed already unsettled investor expectations about the performance of listed firms.

So, why is the Iranian equity market still so attractive for foreign investors?

Many factors are contributing to the stream of investors flocking to the country. Iran ranks fourth in oil reserves and has the largest natural gas reserves. It also has the second-largest population in the Middle East, with 80 million people, an abundance of strategic minerals, a well-educated labor force, cheap utilities and strategic positioning.

In this context, fresh capital inflows are expected to help revive the Iranian economy. Moreover, crippling sanctions are set to be phased out, which will subsequently project a positive outlook, aiding overall sentiment in the equity market. Hence, the anticipated post-sanctions bull market has piqued the interest of portfolio managers.

Initially, the best outlets for investors are high-yielding shares listed on the TSE and the Iran Fara Bourse, state firms going public via the Iran Privatization Organization as well as the currency market. The 48-year-old TSE has a current market value of around $85 billion, featuring 316 listed companies classified into 39 industries, the most diversified in the region. Crucially, the average price-earning ratio is comparatively low, at 5.3.

Among the most attractive sectors is the petrochemical industry. Today, the companies in the sector account for an almost 27% share of the equity market and have thus grabbed investors’ attention. Launching new projects and funding stalled ones are deemed among the most lucrative business ventures in Iran. Tumbling oil prices and ambiguities, however, have hung over feedstock prices, which may pose a risk to this sector. Meanwhile, consumer goods have always been profitable in frontier markets, while pharmaceuticals, tech-related goods and food are the most eye-catching.

Irrespective of the current losing streak on the TSE, all the listed companies are slated to unleash their potential and provide a boost to the benchmark in the near future. The TSE’s sizable market is likely to witness new record highs once Iran rejoins the Society for Worldwide Interbank Financial Telecommunication (SWIFT) and the most crippling sanctions are lifted. In this climate, speculation about steep returns on investment in Iran is luring asset managers, private equity funds and investment banks, all of who want to be the first into this frontier market.

In particular, having been closed for more than 12 years, various sectors of the Iranian economy present tremendous prospects for mergers and acquisitions (M&A). Western companies have been scouring Iran’s emerging market for lucrative deals since President Hassan Rouhani took office in August 2013. Lingering risks, as in other emerging markets, should be taken into consideration, but buyers tend to overcome fears as they strive to gain a foothold in frontier markets.

Although M&A is one of the biggest opportunities for investors, it is fraught with problems, Ali Akbar Ahsan, a partner at Magellan Capital in London, told Al-Monitor. “The Iranian legal framework is weak and does not legislate for many of the issues surrounding mergers and acquisitions,” he said. “Industries that are in need of upgrade or overhaul of their infrastructures, such as oil and gas, airlines, hotels, etc., or the ones that will benefit from an economic turnaround and domestic demand will top sectors drawing foreign capital.”

Meanwhile, Andreas Schweitzer, senior managing partner at Arjan Capital in Dubai, believes that the private equity market currently offers more opportunities compared with listed equities. The limited numbers of sanction-compliant listed companies available to foreign investors, which dramatically mitigate underlying economic factors, are the best candidates, he told Al-Monitor. “We currently focus on privately owned companies or investments in hotel, hospital construction, oil and financial services,” said Schweitzer.

In an interview with Al-Monitor, Xanyar Kamangar, founding partner at Griffon Capital, said his firm is launching two funds in Iran: a public market and a private equity. “It would be the first private equity fund in Iran, which will be focused on the rise of the middle-class consumer,” he said. “Part of our fund is dedicated to co-investment in tech, which is a consumer business.”

Overall, Iran’s economic outlook is no longer bleak, and Western companies’ enthusiasm to tap into the economy underscores its hidden potential. It is evident that prudent economic policies are needed to diminish underlying risks. The potentials outweigh lingering risks, however, and are enticing foreign firms to be the first in. It should be noted that mainstream investors will not rush in until the most hard-hitting sanctions are lifted, which is expected to take months.