Unlocking Iraq's true value

February 07, 2013

by Paul Golden

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.

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

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

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

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.

© MENA Fund Manager 2013